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Notes from the 2001 Berkshire Hathaway Annual Meeting
By Whitney Tilson
Note: This is not a transcript. No recording devices were allowed at the meeting, so this has been reconstructed from 24 pages of rapid scribbling. I did not take notes on certain questions and answers that I felt weren't very interesting or that repeated what Buffett and Munger have said many times in the past (or maybe my mind and/or wrist just needed to rest periodically).
See my 4/30/01 column, Best of Berkshire's Annual Meeting , for the most interesting things Buffett and Munger said. The rest of my notes are below:
Comments on Berkshire Hathaway
Investing Berkshire's cash
"We're always looking to put cash to work, but we'll never employ capital just to employ it.We'd be unhappy if Berkshire Hathaway's cash continues to build up."
Munger: "We're partial to putting out large amounts of money where we won't have to make another decision."
[My notes are a little fuzzy here.] "In allocating Berkshire's capital, we ask three questions: 1) Should we keep the capital or pay it out to shareholders? If pay it out, then you have to decide whether to repurchase shares or issue a dividend." [I'm not sure if this was question #2.]
"To decide whether to retain the capital, we have to answer the question: do we create more than $1 of value for every dollar we retain? Historically, the answer has been yes and we hope this will continue to be the case in the future, but it's not certain."
"3) If we decide to retain and invest the capital, then we ask, what is the risk?, and seek to do the most intelligent thing we can find. The cost of a deal is relative to the cost of the second best deal."
The difficulty of finding good investments
Munger: "We are not in a hog heaven period. The investment game is getting more and more competitive."
Buffett: "But people will always do stupid things. Over the next 20 years, I can guarantee it. The question is, will we be able to take advantage of it?"
Who buys which stocks for Berkshire?
"Even if our financial filings show a stock was purchased for GEICO, I could have bought it. And Lou Simpson's purchases occasionally end up at National Indemnity."
"Lou's record [of picking stocks] is just as good as mine."
"The purchase of Gap stock was 100% Lou. I've haven't even read the annual report. Lou's investment universe is different from mine, which is good."
Munger: "The most extreme mistakes in Berkshire's history have been mistakes of omission. We saw it, but didn't act on it. They're huge mistakes -- we've lost billions. And we keep doing it. We're getting better at it. We never get over it."
"There are two types of mistakes: 1) doing nothing; what Warren calls "sucking my thumb" and 2) buying with an eyedropper things we should be buying a lot of."
"We'd like to keep buying businesses like the eight we bought last year. Our first preference has always been to buy outstanding operating businesses outright. We've made money in stocks, especially in the 1970s, but the climate is not so favorable now."
"There are enough businesses that meet our criteria to do two acquisitions per year on average. What we'd really like to do is a $10-15 billion acquisition, but it's hard to find one that's not being auctioned, which we don't do."
In response to a question by a very young shareholder, Buffett said, "We'd like to add 40 businesses by the time you go to college."
"We haven't had much luck buying businesses overseas, but that's because our phone hasn't rung. We're not on the radar screen, but we're hoping this will change."
"Our best source of deals is word of mouth, generally in industries we're invested in. Sort of like NetJets, where 70% of our new customers are referred by current customers."
Selling Berkshire's privately held businesses
"The businesses we own aren't for sale at any price. It's my natural inclination. If I owned 100% of Berkshire, I wouldn't dream of trading businesses around so that I could die with an estate that was 5% bigger than it might have been. Since I don't own 100% of Berkshire, I want shareholders to be aware of this. This loyalty helps us buy businesses, but there is a cost as well."
Munger: "Loyalty is not nearly as important in [buying or holding the stock of] public companies as private ones."
"We would like our stock to move around less, so that every shareholder's experience reflects how the business does during the period in which they own the stock."
"We want to succeed. All our money and a lifetime of effort is in Berkshire Hathaway. We want to prove that it's not dependent on a couple of guys like us."
"We want to be very sure that the culture is so strong that it can't be changed."
"It won't serve any purpose to name successors now because it might change in 20 years. There will be somebody very good."
Munger: "The key is having good businesses. There's a lot of momentum here. [However,] I don't think our successors will be as good as Warren at capital allocation."
Buffett: "10 years ago, for nine months and four days, I was at Salomon. Berkshire did fine. The managers didn't need me. And we're far stronger today."
"We'll grow our float by $2.5 billion this year, or about 10%. But we're about 10% of the $300 billion in total float of the industry, so it'll be tough to grow our float at 10% given that the aggregate isn't growing that fast. We will not be able to grow our float at 10% for the next 25 years."
"We're more concerned with the cost of float. We could generate $5 billion of float next year, but we'd pay for it for years. There's an unlimited market for dumb insurance."
Cost of float and deliberately writing insurance at a loss
"There are two types of good losses: 1) Policies in which we show a loss today, but show no losses in the future, and we get the use of float. We had over $400 million of this last year, but only $12 million in the first quarter of this year. You should make a one-time adjustment in your mind [and ignore] losses like this. We willingly enter into contracts like this and expect to make money."
"Our cost of float last year was 6%, but 1/4th of this was due to policies like this, so our cost of float was really 4.5%. Absent a mega-catastrophe -- $20 billion or more -- our cost of float will fall substantially. In the first quarter of this year, it was a bit under 3%."
Munger added: "Almost all good businesses engage in 'pain today, gain tomorrow' activities."
"2) Retroactive insurance contracts. These also generate large float, but in this case, we don't have a large write-off. Accounting rules require us to instead spread the cost out over time. You should include these losses in your calculations [of Berkshire's performance]."
"We write huge policies or ones with unusual limits, but never ones with unlimited liability. The biggest risks are [assumed by] those who write lots of homeowner's policies." [See comments below on Fannie Mae and Freddie Mac.]
"We have 265 planes and can be at any one of 5,500 airports with four hours notice."
"NetJets isn't designed to be competitive with the major airlines. We can offer our pilots things that airlines can't, such as living where they want to."
"Fractional ownership is not a commodity business. People care about safety and service."
Munger: "On the day another charter company's jet crashed [in bad weather] flying into Aspen, we wouldn't fly into Aspen. People remember that."
Buffett: "It will be a long, long time before Executive Jet becomes a mature business. There's room to grow in Asia and Latin America. When it's mature, 5% after-tax margins is a reasonable guess, but we're so far away from that."
The threat posed by United Airlines to Executive Jet
United Airlines recently announced that it is considering entering the fractional ownership business for jets, which would represent an additional competitor for Executive Jet. Buffett and Munger were scornfully dismissive of what a foolish and costly venture this would be for United and didn't believe Executive Jet would be harmed at all. Buffett said, "No-one's going to catch us. We've had dumb competitors in the past and they bleed. We're got more blood than they have."
Munger added, "United's pilots' culture won't work for the fractional jet business. They have an extremely high cost structure. I don't know why they're doing it."
My take: while Buffett and Munger have an obvious incentive to try to discourage United from entering this business, I believe their analysis is correct and that United's management team is making a terrible strategic mistake that will incinerate billions of dollars of shareholder value.
Derivatives and Berkshire's investments in this area
"I don't think managers of derivatives know what's going on, much less outsiders reading the annual report."
"I do some fixed income arbitrage with Gen Re Securities. Charlie and I don't know exactly what's going on -- we lack an instinctive understanding, with 17,000 outstanding tickets -- but we know and trust Mark Byrne [who runs Gen Re Securities]. There's nobody I'd feel more comfortable with."
Munger: "This is one of Warren's oddball pastimes outside the field of picking stocks. The profits will be irregular."
Buffett: "We regard the area [of derivatives] as potentially being dynamite. Some in this business get incentives to front-end profits. It's dangerous to pay people up front for things in which you won't know the outcome for 15-20 years. Good people occasionally crack under this system."
Munger: "The derivatives business suffers from the accounting profession selling out yet again. It's an irresponsible system. The whole system of accounting [for derivatives] is wrong."
Buffett: "It's like writing long-tail insurance with a bonus up front based on expected profits. Mark [Byrne] is trying to set up a better [incentive compensation] system [at Gen Re Securities], but you can't deviate too much from the industry norm."
"Finova was a highly leveraged business that ran into financing difficulties, which led to a loss of confidence. Difficulties like this can strike anywhere when a loss of confidence appears. It was clear that Finova had to sell or reorganize."
"When the bonds traded down to attractive levels -- by that, I mean that the assets were substantially more than the amounts owed on the bonds -- we bought $1.4 billion of the $11 billion outstanding. We still think they are attractive."
[My notes are a little shaky here.] "With Leucadia, we formed Berkadia. Finova is now in Chapter 11. A plan or plans will be presented to a bankruptcy judge. If our plan is approved, we'll have to see how it works out."
"We think Leucadia brings a lot to how it's handled. There could be a big wastage of assets, but we think our plan will minimize this."
Munger: "It's an interesting, intelligent model -- an efficient way to clean up a corporate mess. Hopefully, it will be used again. It's a model people might gravitate toward when future problems arise -- and they will arise."
Buffett: "The swing between doing it right vs. wrong could be measured in the billions of dollars."
Potential for GEICO to grow overseas
"We think all the time about international expansion, but we're only 4% of the U.S. market, so we're focused on this."
USG and asbestos liability
"We haven't put any significant money in any company with major asbestos liabilities. We have a very, very minor investment in USG, but we don't go near asbestos. In retroactive insurance, we take over the liabilities of companies with lots of asbestos liabilities, but we assume that we'll make full payouts [which are always capped]."
Buffett and Munger refused to talk about further about USG, other than to note that their 15% stake in the company represents 1/10th of 1% of Berkshire's assets.
Fannie Mae and Freddie Mac
In 2000, Berkshire Hathaway sold its large, long-term holding in Freddie Mac. When asked to explain why, Buffett said: "We felt uncomfortable with certain aspects of the business as they developed, though they may not hurt the company. We did not sell because we were worried about more governmental regulation -- the opposite if anything. We felt the risk profile had changed."
Munger added, "Maybe it's unique to us, but we're quite sensitive to financial risks."
Buffett continued, "There are many things you don't know by looking at a financial company's financial statements. We've seen enough to be wary. We can't be 100% sure that we like what's going on. With some types of companies, you can spot problems early, but you spot troubles in financial institutions late."
Munger: "Financial institutions make us nervous when they're trying to do well." [Think about that one for a while.]
At another point in the meeting, after a question about the underwriting risks in Berkshire Hathaway's portfolio, Buffett said, "the biggest risks are [assumed by] those who write lots of homeowner's policies. If you're Freddie Mac or Fannie Mae, guaranteeing mortgages for millions of people, what happens if an earthquake hits California? They're taking on enormous risk. I don't know if Freddie Mac and Fannie Mae are demanding that all homes with mortgages they guarantee have earthquake insurance." [That's Buffett's polite way of saying they don't.]
My take: over time, Fannie Mae and Freddie Mac have effectively taken on tremendous reinsurance risk -- a business no-one knows better than Buffett -- but aren't getting compensated appropriately for it, nor are their losses capped. That is an unacceptable risk to Buffett.
(Last August, I wrote about why I sold Freddie Mac.)
Kellogg, Campbell Soup and Coca Cola
One shareholder noted that not too long ago, a reasonable person might have concluded that Kellogg and Campbell Soup had big moats around their businesses, but that has proven not to be the case and their stocks have languished. What might we learn from this? Buffett replied, "I'm not an expert on these companies, but my understanding is that Kellogg pushed their pricing too far. They didn't have to moat they thought they had versus General Mills and other major competitors. Campbell's problems are more related to lifestyle changes of Americans. Soup fits in a little less well than it did 40 years ago."
"With soft drinks, there has been no decrease in demand for decades. 30% of liquid consumption of Americans is soda and 40% of that is Coke products, so 1/8th of U.S. liquid consumption is Coke products."
"Coffee and milk consumption has been declining every year -- it's clear where preferences go once people start drinking soda."
"These trends are almost impossible not to happen in developing countries, where the consumption of Coke products is 1/50th what it is in the U.S. -- though Coke could screw it up by pricing too high."
"Coke has also benefited from its relative price. Since 1930, its cost per ounce has only doubled. This very low price inflation has contributed to the increase in per capita consumption."
Munger: "Kellogg's and Campbell's moats have also shrunk due to the increased buying power of supermarkets and companies like Wal-Mart. The muscle power of Wal-Mart and Costco has increased dramatically."
Buffett: "There is always a battle between the retailers and manufacturers of branded products. In the 1930s, A&P had its own line of branded products that did very well. It would be interesting to know what happened."
The dilemma of being on the Board of Coca Cola and Gillette
"If we're on the Board of a company, it is nearly impossible for us to sell [our stock in that company] because people would question our motives. They would wonder whether we were privy to some inside information, etc. I might sell if I were just a portfolio manager."
"If you're thinking solely of making money, you don't want to be a director of a public company."
My take: Buffett and Munger still believe that Coke and Gillette's businesses are "inevitables," but the stocks clearly are not. I believe that they are disappointed with the capital allocation decisions of these two companies over time, especially Gillette's acquisition of Duracell. I think Buffett agreed to serve on the Boards of both companies in order to try to ensure that they sensibly allocated the enormous cash flows that the businesses generated, but he has been frustrated -- though my understanding is that he was instrumental in killing Coke's bid for Snapple.
In Buffett's recent annual letter, he explained that State Farm's irrational behavior was a major cause of GEICO's difficulties:
"The competitive picture [for GEICO] changed in at least one important respect: State Farm -- by far the largest personal auto insurer, with about 19% of the market -- has been very slow to raise prices. Its costs, however, are clearly increasing right along with those of the rest of the industry. Consequently, State Farm had an underwriting loss last year from auto insurance (including rebates to policyholders) of 18% of premiums, compared to 4% at GEICO. Our loss produced a float cost for us of 6.1%, an unsatisfactory result. (Indeed, at GEICO we expect float, over time, to be free.) But we estimate that State Farm's float cost in 2000 was about 23%. The willingness of the largest player in the industry to tolerate such a cost makes the economics difficult for other participants."
That criticism drew a heated response from the CEO of State Farm, so when asked about the company at the meeting, Buffett and Munger treaded very lightly. Buffett started by saying "State Farm is not a high-cost operator. They're relatively low cost, though higher than GEICO. I have good things to say about State Farm and how it's been run in the past. [Note that he didn't say "how it is being run today."] They have a huge surplus, so they can subsidize current policy holders with profits from past ones. [Buffett is not backing down entirely from his criticism.] If I were running State Farm, I'd do the same things they're doing. I'm not critical of them." [Hmmm.]
Munger added "State Farm is a thoroughly admirable company."
In response to a question about increasing returns on equity of American companies, Buffett used GE as an example and said, "There has been a deliberate increase in GE's financial leverage. This is made possible by GE's well-deserved fine reputation. They have increased their stock repurchases and written off everything in sight, which decreases GE's equity and increases future profits."
"If you put it all together, the rise in returns on equity of American companies is due in part to management setting out to do this. Part of this is shrewd and correct management and part is borderline gamesmanship."
"We could make Berkshire Hathaway's ROE anything we wanted. We could run it with no equity."
For my thoughts on GE, see Stocks to Avoid and Following Up on IBM and GE .
Bottom fishing among technology stocks
"I've seen a list of technology companies valued below their cash, but they're determined to spend that cash, so it'll go away."
Pharmaceutical stocks in the early 1990s vs. tech stocks today
One shareholder noted that at last year's annual meeting, Buffett expressed regret at not having bought a basket of pharmaceutical stocks when they were crushed in the early 1990s. Might a similar opportunity exist today among tech stocks? Munger noted that "the future of the pharmaceutical industry is easier to predict. In this sector, almost every company did well and some did exceptionally well."
Buffett added: "There is nothing obvious to us that technology stocks as a group are undervalued today. Also, pharmaceuticals as a group have a stellar track record of generating high returns on large amounts of capital, whereas the tech industry doesn't."
For some thoughts on some of the challenges facing the pharmaceutical industry, see last week's column on How AIDS Threatens Drug Makers .
The Internet/tech stock mania
"What the Internet offered was the ability to monetize the hopes of others. A lot of money was transferred from the gullible to the promoters. It's been a huge trap so far."
"The monetization of hope and greed is the way to make a huge amount of money. The biggest money made on Wall Street in the past few years has not been made by great performance but by great promotion."
The airline industry
"The big problem is not aggregate costs, but costs versus competitors." Buffett recalled US Air's difficulties competing against Southwest and concluded, "If your costs are out of line, you're going to get killed eventually."
Munger: "Airline pilot unions are really tough. It's interesting to see people paid as well as airline pilots to have such a tough union. No airline can afford a shutdown very long."
Buffett: "If you're in a business that cannot take a long strike, then you're playing a game of chicken with labor. Ironically, if you're weak, you're in a stronger negotiating position."
"The production of electricity is a huge business and it's not inconceivable that we'd invest heavily here."
"The Public Utilities Holding Company Act [PUCA], written in 1935, has a lot of rules about what the parent company of a utility can do. It was set up to check abuses that existed then, so it was appropriate at the time. But I don't think there's anything pro-social about limiting Berkshire Hathaway's ability to acquire utilities today. We might have done one or two acquisitions in past years but for PUCA."
The California power crisis
"With deregulation, the incentives [for power producers] were changed such that instead of wanting abundant supplies, they wanted tight supplies, which would result in higher prices."
"You can't take utilities with a cost of X, invite new producers in with a cost of 3X, and expect prices to go down."
"The old system strikes me as better for society."
Munger: "The old system had the NIMBY [not in my back yard] problem. If you let unreasonable, self-centered people make decisions, you'll get into trouble. We may be making the same mistake today with oil refineries."
American corporations' exposure to pension fund risk
"Pension funds are projecting 9% annual returns. There is no way they will achieve this. It'll be interesting to see how quickly assumptions change."
Munger: "Pension fund accounting is drifting into scandal by using unrealistic assumptions. It's human nature to extrapolate the recent past into the future, but it's terrible that managements go along with this."
Buffett: "I don't know of any case in which corporations are reducing their investment return assumptions. Earnings would go down if assumptions were revised downward. If you try to talk to management, you get nowhere."
Munger: "The current practice is a dumb and improper way to handle it. If you talk to management, their eyes glaze over even before hostility comes."
"We regard using [a stock's] volatility as a measure of risk is nuts. Risk to us is 1) the risk of permanent loss of capital, or 2) the risk of inadequate return. Some great businesses have very volatile returns -- for example, See's usually loses money in two quarters of each year -- and some terrible businesses can have steady results.
Munger: "How can professors spread this? I've been waiting for this craziness to end for decades. It's been dented, but it's still out there."
Buffett: "If someone starts talking to you about beta, zip up your pocketbook."
Cost of capital
Munger: "Obviously, consideration of costs is key, including opportunity costs. Of course capital isn't free. It's easy to figure out your cost of borrowing, but theorists went bonkers on the cost of equity capital. They say that if you're generating a 100% return on capital, then you shouldn't invest in something that generates an 80% return on capital. It's crazy."
Buffett: "A corporation's cost of capital is 1/4 of 1% below the return on capital of any deal the CEO wants to do."
"I've listened to many cost of capital discussions and they've never made much sense. It's taught in business school and consultants use it, so Board members nod their heads without any idea of what's going on."
How to identify big ideas
Munger: "If you took out our 15 best ideas, most of you wouldn't be here."
Buffett: "I keep xeroxes from reports 50 years ago -- it was just so obvious. I knew when I sat with the CEO of GEICO 50 years ago that it was a big idea."
The impact of poor teaching of investment
"It hurts companies because managers need to know how to value a business to think sensibly about acquisitions. Since they don't, they rely on Wall Street, which of course recommends doing deals because they get paid X if the deal doesn't go through and 20X is the deal does."
"Our record of persuading decent, intelligent people to stop doing dumb things is very poor. (Munger added, "Worse than poor.") When people want to do something, they do it. When someone rises to be CEO, he doesn't want to hear a shareholder telling him that his latest idea is dumb. It's better to be in a business with management you're simpatico with than in a great business in which this isn't the case."
"We've learned more about human nature than understanding businesses in our long-term experience."
"Unless there is a change in legislation, I think more and more of GNP will go to the plaintiffs' bar. To lawyers, it's a lottery ticket with little cost and a huge potential payoff."
Munger: "What's particularly pernicious is the increasing political power of the plaintiffs' bar. State supreme court judges are generally on for life. The only thing that can jeopardize this is to really anger some important group -- like the plaintiffs' bar. Thus, the judges allow junk science and the like."
Buffett: "We make decisions in insurance with a pessimistic view of this trend.We assume that we'll have to make the maximum payouts that we're obligated to."
"It's an interesting item to study. It's ruined a lot of people. You can go broke doing it."
"You'll see way more stocks that are dramatically overvalued than dramatically undervalued. It's common for promoters to cause a stock to become valued at 5-10 times its true value, but rare to find a stock trading at 10-20% of its true value. So you might think short selling is easy, but it's not. Often stocks are overvalued because there is a promoter or a crook behind it. They can often bootstrap into value by using the shares of their overvalued stock. For example, it it's worth $10 and is trading at $100, they might be able to build value to $50. Then, Wall Street says, "Hey! Look at all that value creation!" and the game goes on. [As a short seller,] you could run out of money before the promoter runs out of ideas."
"Everything we've ever thought about shorting worked out eventually, but it's very painful. It's a whole lot easier to make money on the long side. You can't make big money shorting because the risk of big losses means you can't make big bets."
Munger: "Being short and seeing a promoter take the stock up is very irritating. It's not worth it to have that much irritation in your life."
Buffett: "We would never short anyway because we're too big."
For more on shorting, see my column Time to Short Stocks? .
"Asset allocation recommendations put out by Wall Street -- 65% in stocks, a certain percentage in bonds and cash -- is total nonsense."
Stocks and Rembrandts
Munger: "To some extent, stocks are like Rembrandts. They sell based on what they've sold in the past. Bonds are much more rational. No-one thinks a bond's value will soar to the moon."
"Imagine if every pension fund in America bought Rembrandts. Their value would go up and they would create their own constituency."
The only way [the current awful system] will get changed is if 15-20 large institutions band together, but they're unlikely to do so because they're benefiting too. They cluck about the little things, but are silent on this. American management will never change voluntarily, and consultants will never recommend it either."
Impact of the Internet on retailers
"Retailers are less worried about the Internet threat today, especially in jewelry and furniture, as Internet-only competitors have failed. The Internet is an opportunity."
"It's become a huge industry. I had someone come to me pitching a hedge fund he was starting, but if you looked at his Schedule D over time, he should be mowing lawns. But I don't doubt that he'll raise the $125 million that he's seeking."
"I'd bet anyone that hedge funds as a group don't compound at 10% net to investors over the next 15 years."
"A significant trade deficit over time is a significant negative [for the U.S.]. It's not a good policy to run big trade deficits year after year."
Consumer debt levels in the U.S.
"I'm not sure if consumer debt levels are a threat. There is a greater capacity for debt as income and assets have risen."
Munger: "Once you get into debt, it's hell to get out. Don't let credit card debt carry over. You can't get ahead paying 18%."
Munger: " Genome . It's perfectly amazing and very interesting. Also, Models of My Life by Herb Simon."
Buffett: " Personal History by Katherine Graham. It's very honest. I know if I were writing my autobiography, I'd make myself look like Arnold Schwartzneger."
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