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Notes from the 2002 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 many 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 5/8/02 column, Highlights from Berkshire's Annual Meeting , for the most interesting things Buffett and Munger said.
In addition, Bankstocks.com, has already published very comprehensive notes from the meeting -- click here and here to read them -- as did the Motley Fool's Selena Maranjian -- click here .
Here are my notes:
COMMENTS ON BERKSHIRE HATHAWAY AND THE INSURANCE INDUSTRY
Impact of 9/11
"It made everyone realize that human haven't progressed in how they behav e, but have progressed in terms of their ability to hurt someone they hate. 9/11 brought that home. It used to be that if you hated someone, you could only throw a rock at them."
"There are millions of people who hate us, but most can't do anything about it. But a few can, and there's incredibly more ability for a deranged person to do harm to us today."
"Before 9/11, we weren't being paid for insuring the risk of terrorist attacks. Since then, the insurance industry has recognized that it has exposures that it had to exclude or charge for."
"For new policies, we've sold quite a bit of terrorism polities, but almost all exclude NCB -- nuclear (and fires afterward), chemical and biological. The World Trade Center attack was about as extreme as you can get without NCB."
"As an industry, we can pay claims of tens of billions of dollars, but not hundreds of billions."
"We write a few policies that cover NCB because we can take a loss of a few billion."
"Most people don't realize that the World Trade Center attack was, by a huge margin, the largest workman's comp loss in history. Had the attack been on, say, Yankee Stadium, there would have been few workman's comp claims, but people were at work in the World Trade Centers. Imagine if someone developed a deadly biological agent and released it into the ventilation systems of a number of large buildings simultaneously. It would make the workman's comp claims for the World Trade Center look like nothing."
Munger: "To the extent that 9/11 causes us to be less weak, foolish and sloppy, it's a plus. We regret what happened, of course, but it's good that people become more realistic. For example, we should have tightened our immigration policies years ago." [I didn't interpret this as opposition to immigration in general -- simply that it should be monitored more carefully so that people like the 9/11 attackers couldn't enter the country and operate freely.]
Buffett: "The key to both investing and insurance underwriting is to be realistic and disciplined. 9/11 drove home these lessons."
Constraints on Berkshire Hathaway
"We have so much capital, earnings power and liquidity outside of insurance that we won't be very constrained."
Munger: "Our constraints don't come from structure, but from a lack of enthusiasm for equities in general."
"Float is like the oil business -- every day some goes out so you have to replace it."
"Insurance is our biggest business and always will be. We like it. I think we have more float than any property and casualty insurer in North America and perhaps the world. "
"We don't want people focusing on growth. It's suicide [in the insurance business]."
"The total amount of property and casualty float is about $400 billion, so we're 8-9% of the market. We should be able to grow this."
Munger noted: "Growing float at a sizeable rate at low cost is almost impossible -- but we intend to do it anyway."
Buffett added: "Of the two variables, the key is to get it at a low cost."
COMMENTS ON BERKSHIRE HATHAWAY HOLDINGS
On December 17, 2001, Berkshire Hathaway announced that it was acquiring Albecca (known as Larson-Juhl), the nation's leading provider of custom picture frames. Buffett was asked to talk about this business (these comments are from the annual meeting, plus those made at another presentation):
"Craig Ponzio, the owner of Larson-Juhl called me, told me about his business, its sustainable competitive advantages, its financial characteristics, and the price he wanted. Shortly thereafter, he came to visit me at 9am and by 10:30 we had a deal. I haven't seen him since."
"The company has $300 million in revenues, earns $50 million in pre-tax profits, ties up no capital, is growing slowly, and distributes every dime of profit."
"There are about 18,000 picture framing shops in the United States, mostly very small businesses with a few hundred thousand dollars per year in sales. They can't afford to have much inventory, so they show a catalogue to a customer who chooses the frame. Then, if they call Larson-Juhl before 3pm, 85% of the time the frame will be there the next day. Larson-Juhl and its customers are focused on service, not price."
"Larson-Juhl calls on its 18,000 customers an average of five times/year. It has an incredible distribution system. Tell me how you'd attack that business? You wouldn't want to anyway, as the market's not big enough. Larson-Juhl has a HUGE moat. I always ask myself how much it would cost to compete effectively with a business. With businesses like these, nothing's going to go wrong. If you bought 20 of them, 19 of them would work out well."
"Craig wanted to sell to me because he didn't want to waste a year doing a deal that might fall through at the end. With us, it's 100% certain that the deal gets done, and he can enjoy life."
"The only thing that's unfortunate is that it's a small business."
Fruit of the Loom
"It has a well-known brand name, is accepted by retailers, and is a very low-cost producer of a basic product. It was made-to-order for us, but only with present management. If we'd had to buy it with previous management, we wouldn't have paid $1 for it."
"We guaranteed a $6 billion loan so they could pay creditors. They only took down $5.6 billion. We make a 2% override on 98% of the loan. The loan is now down to $3.2 billion."
"We will make significant money, but not as much as we initially thought due to 9/11."
Munger: "This is a good example of 'margin of safety.' A lot went wrong, but we'll still do OK."
Buffett: "We NEEDED that margin of safety!"
Coke and Gillette
"Coke's market share is about 50% of the worldwide soft drink business, and Gillette has about 71% by revenues of the worldwide razor blade business -- both are higher than they were when I called their businesses 'inevitables' five years ago."
"With the world's population growing 2% annually, it is crazy to think they can grow profits at 15-18% per year, or even 10%, when unit grow is sure to be slower. But people got carried away, due to Wall Street and to some extent, company pronouncements."
Coke vs. bottlers
"The bottlers have a solid, steady business, but not one with abnormal profitability. Coke's syrup business is a better one."
Munger [speaking to the separation of Coke and its bottlers]: "Ideally, you wouldn't have capitalization structures that distort reality."
"We lost a very significant amount of money on Dexter, due to a dumb decision I made. There has been a big trend to moving production offshore. Of the 1.2 billion pairs of shoes sold annually in this country, only 5% are made here. Hundreds of thousands of jobs have gone offshore. You can't compete with 90% lower wages. This trend is going on in furniture manufacturing too."
"I think our shoe business will be OK. And we have great management running it. I was wrong in paying what I did for Dexter, and I compounded the error by paying in stock.
"We think people whose expectations were set from 1982 - 1999 will be disappointed [with future investment returns]. But there's nothing wrong with earning 6% annually on your money, in a world of low inflation."
Munger: "One of the smartest things a person can do is dampen investment expectations, especially with Berkshire. That would be mature and responsible. I like our model and we should do nicely."
When to sell?
"It's not our natural inclination to sell. We've never sold a share of the Washington Post, Berkshire Hathaway (since we began acquiring it in 1962), Coke or Gillette."
"We would sell if we needed the money for something else, but that hasn't been a problem in the past 10-15 years. Earlier in my career, I had more ideas than money, but now it's the reverse."
"Now, we typically sell when we reevaluate the economic characteristics of a business; when we had one view of the long-term competitive advantage, but are modifying it. That's not to say it's become a bad business -- just that the competitive advantages are not as strong as we initially thought."
"A classic case is the newspaper business. Decades ago [when Berkshire bought The Buffalo News and The Washington Post], it was impregnable. We still think it's quite a business, but it's not the same as in the 1970s. There are so many other sources of information now. Incidentally, the same thing has been happening to network television."
Are great investors made or born?
"I tend to agree that they're made. A great IQ is not needed. There's relatively little correlation between a high IQ and investment success."
"Is the critical ability to detach yourself from the crowd something you're born with?"
"I've seen nothing to improve on Graham and Fisher. Just think about stocks as a business and then evaluate that business. This requires insulating yourself from popular opinion."
Munger: "You need to have a passionate interest in why things are happening. That cast of mind, kept over long periods, gradually improves your ability to focus on reality. If you don't have the cast of mind, you're destined for failure even if you have a high IQ."
Buffett: "Few people with 80 IQs are whacking the cover off the ball [in investing], but all sorts of high IQ people don't have investment success. It would be interesting to analyze why."
Sustainable competitive advantage
"I think Kodak made a HUGE mistake allowing Fuji to take the sponsorship of the Olympics away from them at the LA Olympics. It gave them parity."
"I don't think Coke has lost its focus or drive. Daft is in tune with the product."
"It would be hard to knock Snickers from the #1 spot."
"Usually, if something can gain competitive advantage very quickly, it can lose it very quickly, so be careful of industries in flux."
"The appropriate multiple for a business compared to the S&P 500 depends on its return on equity and return on incremental invested capital. I wouldn't look at a single valuation metric like relative P/E ratio. I don't think price-to-earnings, price-to-book or price-to-sales ratios tell you very much. People want a formula, but it's not that easy. To value something, you simply have to take its free cash flows from now until kingdom come and then discount them back to the present using an appropriate discount rate. All cash is equal. You just need to evaluate a business's economic characteristics."
Munger: "Two thirds of acquisitions don't work. Ours work because we don't try to do acquisitions -- we wait for no-brainers."
Buffett: "We don't buy from financial operators."
Munger: "In the corporate world, if you have analysts, due diligence, and no horse sense you've just described hell."
More on acquisitions
"Gillette's acquisition of Duracell was not very successful. They gave away 20% of their business for a business that hasn't done as well as expected."
"GEICO is a great business. Over the past 20 years, they've done three acquisitions to get into new businesses and they've all been disasters. Why when you have a wonderful business would you want to get into an inferior business? It happens time after time after time. Charlie and I have no such inclinations."
How to avoid fraud
"There's no short answer on how to avoid fraud. But there are whole fields where there's too much fraud, so we avoid them."
"We've been defrauded very infrequently over the years. If we do get defrauded, it'll be by someone carrying [Ben Franklin's] Poor Richard's Almanac under his arm."
"Crooks are often obvious. For example, Robert Maxwell's nickname was 'The Bouncing Czech,' yet Salomon was trying to lend him money until three weeks before he went under. Wall Street has no filter, as long as there's profit."
Critique of EBITDA
"It amazes me how widespread the use of EBITDA has become. People try to dress up financial statements with it."
"We won't buy into companies where someone's talking about EBITDA. If you look at all companies, and split them into companies that use EBITDA as a metric and those that don't, I suspect you'll find a lot more fraud in the former group. Look at companies like Wal-Mart, GE and Microsoft -- they'll never use EBITDA in their annual report."
"People who use EBITDA are either trying to con you or they're conning themselves. Telecoms, for example, spend every dime that's coming in. Interest and taxes are real costs."
Munger: "It's dangerous to short stocks."
Buffett: "Charlie and I have agreed on around 100 stocks over the years that we thought were shorts or promotions. Had we acted on them, we might have lost all of our money, every though we were right just about every time. A bubble plays on human nature. Nobody knows when it's going to pop, or how high it will go before it pops."
"A.W. Jones, which had a long-short model, developed the best-known hedge fund in the late 1950s and early 1960s. They were market neutral, but didn't stick with it. Something went wrong with A.W. Jones. A very high percentage of its spin-off funds bit the dust. There were suicides and people lost their fortunes and had to drive cabs."
"Ben Graham didn't find shorting particularly successful. Quite a high percentage of his paired investments worked, but he lost a lot on the few he lost on."
"I had a harrowing experience shorting a stock in 1954. I wouldn't have been wrong over 10 years, but I was very wrong after 10 weeks, which was the relevant period. My net worth was evaporating."
"Shorting is just tough. You must bet small. You can't short the whole company. It takes just one to kill you. As it rises, it consumes more and more money."
In response to a question about which index funds he's recommend, Buffett replied, "Just pick a broad index like the S&P 500. Don't put your money in all at once; do it over a period of time. I recommend John Bogle's books -- any investor in funds should read them. They have all you need to know."
Munger: "One could imagine a period like Japan 13 years ago, however, in which indexing over time wouldn't work."
"It is part of human nature to interpret all new information such that prior conclusions remain intact."
"Having a good partner is key. Charlie will not accept anything I say because I say it. It's great to have a partner who will tell you when you're thinking is wrong."
"The typical corporate organization is structured so that a CEOs beliefs and biases are reinforced. Staffs won't give you any contrary recommendations -- they'll just come back with whatever the CEO wants. And the Board of Directors won't act as a check, so the CEO pretty much gets what he wants."
"Having good feedback mechanisms is terribly important. We have a very good system."
Munger: "You must be willing to reverse course. For example, I think we're the only big corporation in America to run off its derivative book. To say accounting for derivatives is America is a sewer is an insult to sewage."
Buffett: "I agree. We took an $88 million loss to get out of Gen Re's derivative business. Many companies have similar problems, but don't want to face up to them. You're seeing the unwinding of a derivative book in the Enron debacle. You couldn't devise a worse system. It's like hell."
Munger: "If you look at the impact of stock options, you'll see a lot of terrible behavior. To give a lot of options to a CEO who built the business and is in his 60s to incent loyalty is demented. Would the doctors at the Mayo Clinic or the lawyers at Cravath in their 60s work harder if they had options?"
Buffett: "If can lead to extremely capricious compensation results that have no link to a person's results."
"A CEO could simply put money in the bank and grow the business, so there should be a cost of capital factor built into any compensation plan. Also, options should not be issued when the stock is below intrinsic value."
Munger: "The theory that options have no cost has contributed to a lot of excesses, which is bad for the country because corporate compensation is perceived as unfair."
Buffett: "Well-fed CEOs are descending on Washington to persuade your Congressmen not to require expensing of options because they'd get less. It's sort of shameful."
"All of the opposition to options comes from people who would get fewer of them. If there was a rule saying the CEO's salary didn't count as an expense [and there was a proposal to rescind this rule], you can bet they'd be in there fighting to keep the status quo."
Wouldn't expensing stock options be double counting, since they're already factored into the diluted share count?
"No. When you issue options at the market price, there's no dilution until the stock rises, but diluted and basic shares are the same."
"I don't have any objection to options under certain conditions -- I just think they should be recorded as an expense."
"We'll take options from certain companies in lieu of cash as payment for insurance -- even 10-year, 50% out-of-the-money options."
Munger: "A stock option is both an expense AND dilution. To argue anything else is insane. I'd rather make my money playing piano in a whorehouse than account for options as recommended by John Doerr."
"Look at Dell. They're buying and selling millions of options, but at the same time people are saying companies don't know how to value them. It's specious. A disconnect."
"I can figure out what I'd pay for an option on a private business, a public company, an apartment house, a farm, etc. EVERY option has value. People that get them understand this better than those that give them."
"We don't blindly use Black-Scholes; we apply judgment."
"We would pay something for just about any option."
Munger: "Black-Scholes works for short-term options, but if it's a long-term option and you think you know something [about the underlying asset], it's insane to use Black-Scholes."
Buffett: "Companies will do everything they can to reduce the value of options they grant. We've sat in on these meetings. They assume that options have a shorter life than they really do, etc."
Munger: "The only thing that's consistent is that the whole thing is disgusting."
COMMENTS ON VARIOUS INDUSTRIES AND OTHER ECONOMIC MATTERS
"We've been somewhat surprised at how well banks have done. Some have generated 20% or greater returns on tangible equity over many years, though this is in part due to increasing leverage."
Munger: "We misdiagnosed it and, even worse than that, we haven't changed."
The healthcare industry
"The healthcare industry has been very good over time. We made a mistake [not investing in a basket of pharmaceutical stocks] in 1993. It's hard to pick winners, but there's no problem with a basket approach.
Munger: "We failed to get it right last time, so we'll probably fail to get it right next time."
"It's hard to argue with conventional wisdom most of the time. There's an occasional opportunity. You need money shut off to create big mispricings."
Munger: "We don't have big advantages -- no special competence -- so we spend almost no time on it."
Buffett: "It doesn't make sense for C corps [like Berkshire Hathaway]. We did a little in the RTC days."
Future economic predictions
Munger: "It's crazy to assume that what's happening in Argentina and Japan is inconceivable here. It's not."
Buffett: "Post-bubble periods can produce fallout that people have difficulty predicting."
"Asbestos is a big part of our liabilities. But we are capped, which is a good thing because asbestos continues to explode. Last year, we said it would be worse than anyone expected and it has been and will continue to be. Many companies thought to be insulated are being dragged in."
"Asbestos is actually creating some opportunities for Berkshire to buy companies that went bankrupt due to asbestos claims -- free of asbestos liabilities. We probably wouldn't own Johns Manville were it not for asbestos."
"It's a cancer on the American corporate world and it's growing."
Munger: "Asbestos has morphed into a situation with enormous amounts of fraud, etc. People with serious injuries are being hurt [as more and more money flows to the plaintiff's bar and claimants with no current injuries]. The Supreme Court has practically invited Congress to step in, but Congress has refused due to the influence of the trial lawyers. I'd be surprised if there's a constructive solution in the next five years. I expect there will just be more of the current mess."
Buffett: "There was a solution, but the Supreme Court didn't allow it."
"We've very careful to avoid asbestos liabilities. I'm not worried about our insurance companies [via-a-vis their exposure to asbestos]."
"You have a plaintiff's bar -- going beyond asbestos -- that will take any human adversity and try to make a profit out of it by suing those with deep pockets."
"The workman's comp system in California has morphed into something so unfair and crazy."
The tort system
Munger: "Because of the tort system, for the already rich, there are whole areas to avoid. For example, a company developed a new, safer, better police helmet, but sold the product to a judgment-proof company [because they were afraid of liability]. It would be crazy for us to be in the business of providing security guards at airports. The system discourages the best companies from entering certain businesses."
CRITIQUES OF ACCOUNTANTS AND INVESTMENT BANKERS
Creative accounting and Enron
Munger: "Creative accounting is an absolute curse to a civilization. One could argue that double-entry bookkeeping was one of history's great advances. Using accounting for fraud and folly is a disgrace. In a democracy, it often takes a scandal to trigger reform. Enron was the most obvious example of a business culture gone wrong in a long, long time."
Buffett: "To the extent people will look more carefully at companies, Enron was a plus to the American economy."
"There is no accounting issue with Coke and its bottlers."
Arthur Andersen and Enron
"Enron will have a distinct beneficial effect on auditors, and it was much needed."
Munger: "It will have a distinct beneficial effect on one less auditor."
Buffett: "I think it would have been a shame if Salomon had gone under. Charlie and I may disagree on this one. What about the innocent bottom 40,000 people at Arthur Andersen?"
Munger: "I regard it as very unfair, but capitalism without failure is like religion without hell. When it gets this bad and there's a lack of system for control -- which Arthur Andersen didn't have -- maybe a firm should just go down."
Buffett: "What if we did something terrible? Would it be fair for all of Berkshire's employees to suffer?"
Munger: "We couldn't do anything that would bring down Berkshire.Arthur Andersen was particularly vulnerable because it was a partnership. A partnership must be extra careful in its behavior, choosing clients, etc."
Munger: "The general culture of investment banking has deteriorated over the years. We did a $6 million deal years ago for Diversified Retailing and we were rigorously and intelligently screened. They bankers cared and wanted to protect their clients."
"The culture now is that anything that can be sold for a profit will be. 'Can you sell it?' is the moral test, and that's not an adequate test."
Buffett: "There used to be two classes of bankers, with clear lines between them, but the lines have disappeared."
"In fairness, Salomon did a terrific job when we created the Berkshire B shares."
ADVICE ON LIFE AND OTHER
Preparing for the future
"Imagine that you had a car and that was the only car you'd have for your entire lifetime. Of course, you'd care for it well, changing the oil more frequently than necessary, driving carefully, etc. Now, consider that you only have one mind and one body. Prepare them for life, care for them. You can enhance your mind over time. A person's main asset is themselves, so preserve and enhance yourself."
Sharing the wealth
"I'm not negative on the U.S. economic system -- it's a tremendous economic machine. I'm just critical of the way some people behave, but they'd behave this way under any economic system."
"The market system produces extraordinarily inequitable results, which should be mitigated by the tax system. It's inappropriate that the spread of prosperity in a prosperous country should be so inequitable due to quirks in people's skills. This is why I'm in favor of a progressive tax. There should be a system in this country so that people who don't get a great ticket still do pretty well."
"Imagine if a genie approached you and someone else while you were in the womb and said, 'What percent of your future income would you bid in order to be born in the U.S. vs. Bangladesh?' I'll bet the bidding would get pretty high pretty fast."
"I don't see a much better system [than the one we've got], so I wouldn't tinker with it very much."
"The people who introduced Charlie and me thought we'd either really hit it off or quickly dislike each other, as we both had very strong personalities.Over the years, we've had disagreements, but never an argument."
"You should think about what you like in other people and admire about them. Then ask yourself which of these traits you ones you physically or mentally can't have. The answer is: NONE! The reverse is also true. Habits are critical and hard to change. Ben Franklin had a list of qualities and set out to acquire them."
"Earth's carrying capacity [population-wise] is unknown, but it's better to undershoot than overshoot."
Munger: "People always underestimate the ability of earth to increase its carrying capacity."
Munger: "I recommend Ice Age [only available in the UK; will be published in the U.S. later this year], which traces the past history of glaciation. It's the best book of scientific explanation I've ever read.
I also recommend How the Scots Invented the Modern World: The True Story of How Western Europe's Poorest Nation Created Our World and Everything in It , about how a small group of people flourished."
Buffett: " I recommend Robert Miles's book, The Warren Buffett CEO: Secrets of the Berkshire Hathaway Managers . I know you couldn't have a better group of people. You'll like your investment better after reading it."
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