In Search of Warren Wisdom

So I just came back from my first Berkshire Hathaway (BRK.A) annual meeting weekend. TSC's Chris Edmonds has done an excellent blow-by-blow account, so I will try to focus on some of the sharper insights that I gleaned from the meeting -- ones that I will probably be shamelessly and insufferably recycling in my own client meetings over the next few months.

Right off the bat someone asked Chairman Warren Buffett to talk about valuation: What does it take for a certain unnamed company with a $500 billion market cap to be worth $500 billion? His answer: The company must ultimately achieve a level of $55 billion-ish in net profit in one of the far-out years of the discounted cash flow stream.

And yet we're far from there: For the purposes of scale, note that one of the two-largest profit-generating companies -- GE (GE), with a market cap of $518 billion -- produces only $11 billion in net profit. The other -- the unnamed company whose name rhymes with disco (and the subject of a recent column) -- boasts a $481 billion market cap but a mere $2.5 billion in net profit.

Buffet's conclusion, reiterated several times, was that this valuation silliness is no different than the silliness (under other names and themes) that occurs in every market cycle. "If you're around long enough, you get to see nearly everything in financial markets," he said on one occasion; on another he added, "The ability to monetize shareholder ignorance has never been greater."

The Technology Question

Obviously, a number of questions had to do with technology stocks and the Internet, and the following are mostly quotes or paraphrases of the better answers:

1. "Most major newspapers will probably be successful at transitioning to the Internet ... the question is will it destroy the economics?" Buffett, long an admirer of newspaper companies, also gave a slight backhand jab at Tribune's (TRB) proposed acquisition of Times Mirror (TMC) when he said that "newspapers see the future with the Internet, yet their billfold reflects the past as far as the prices they are paying for newspaper properties."
2. "The Internet will greatly improve the efficiency of American business, but it will decrease its market value due to greatly enhancing the efficiency of competition." Chimes in Buffett's longtime sidekick and Berkshire Vice-Chairman Charles Munger: "Perfectly obvious, but relatively misunderstood."
3. Buffett even gave a nod of recognition to America Online (AOL), of all things. Buffett noted that you have a pretty good business if customers are screaming at you, yet you continue to sign up a record number of new customers.

Out of both friendship and principle, both Buffett and Munger came out sharply against the Justice Department's decision to break up Microsoft (MSFT). You could tell that Munger was really ready to vent his feelings, but I think Buffett must have threatened backstage to cut off Munger's supply of See's peanut brittle if he really said what was on his mind.

As noted here many times, the issue Buffett has with technology in general is the lack of predictability of the economics. If he and Munger can't rationally model 10 years of reasonable projections into a discounted cash-flow analysis, then they pass on the deal. Both Buffett and Munger swear they have had long talks with everyone from Bill Gates to Andy Grove, asking them for technologies or companies they think can fit into this mold. Inevitably, the answer comes back, "I don't know who will be around in ten years, or what they will look like."

I personally think that's a little too black and white: There can be plenty of attractive opportunities in some technology service-related companies from time to time (Berkshire does own some First Data (FDC), so they have weakened a little), but last I checked I wasn't invited to the podium. Essentially, they repeated that their investing style is what made them $20 billion, and they are going to stick to it. Quoting Samuel Johnson, Buffet told the audience, "'I can give you an argument, but I can't give you understanding.'"

Says Berkshire vice-chairman Charlie Munger: "I'd personally rather buy a company whose business is good enough where we can buy it and then sit on our ass ..."

Buffett also made a point about attractive investing opportunities, one which I also use in client presentations: "You simply want the math in your favor ... if you do enough transactions with the math in your favor, the odds are much greater that you will make money."

Munger made some interesting comments regarding Berkshire and "value investing." There was the usual discussion of how "value and growth are joined at the hip," then Munger essentially said there are two ways to go about value investing. The first way is to mechanistically screen for cheap stocks that may or may not be good businesses, which then puts you in the position of having to consistently buy low, and sell at fair value. Says Munger, "I'd personally rather buy a company whose business is good enough where we can buy it and then sit on our ass ... It's good to be good at that." I am diligently working on a way to fit that into our client brochure as soon as possible.

Buffett has lost none of his sharp tongue. When one particularly gratuitous shareholder said that Buffett has had 48 straight years providing an average annualized return of about 26% -- if you include the pre-Berkshire partnership years -- Buffett responded: "You should have seen the performance before the partnership." And on another occasion, he admitted that, "The good thing about my economic predictions is that I ignore them."

Next: Buffett shares his thoughts on executive compensation, and on Berkshire's ability to get preferential deals.

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