Chris Edmonds and Robert Hagstrom chatted on Realmoney.com, Wednesday, May 1 at 5 p.m. EDT.

CSEonTSC:

Hey everyone, great to be here. Looked like a solid day in the market!! And, the Reliant IPO really smoked.

CSEonTSC:

But, on to the Buffett matters at hand. Please welcome Robert Hagstrom, a long-time Buffett watcher and author of a great new must read on the Oracle, The Essential Buffett.

CSEonTSC:

Check it out and welcome Robert. We are ready for your questions!

Robert_Hagstrom:

Good afternoon everyone, I've always enjoyed our chats, and I'm looking forward to your questions today.

Robert_Hagstrom:

Fire away!

jucojames-guest says:

Do you guys think that BRK is still undervalued or has it approached fair value? I noticed Mr. Buffet didn't mention a stock repurchase plan this year as he did last.

Robert_Hagstrom:

At my calculation of fair value for Berkshire Hathaway is between 70 and 80,000. As such, the company is approaching fair value, and certainly is not at a cheap enough price for Warren to consider a repurchase.

CSEonTSC:

Buffett made it very clear that he doesn't think that Berkshire, or any equity, for that matter will continue to grow at double digit rates in the coming years.

CSEonTSC:

In fact, Warren said he think 6-7% growth in the value of BRK is a nice target. That said, I agree with Robert -- probably toward the lower end of the range -- regarding value.

tickety-guest says:

Did the subject of inflation come up at all?

CSEonTSC:

It really didn't -- Buffett and Munger constantly say that predicting macro economic trends is outside their sphere of competency.

CSEonTSC:

Hence, even if the question had been asked, it likely would not have been answered.

Robert_Hagstrom:

Yeah, I agree.

melegirl-guest says:

Geico - outlook?

Robert_Hagstrom:

My sense is that Geico temporarily looks to be an average performer, in that its growth in policies has slowed measurably, and that Warren has reduced marketing expenses because of the low conversion rates.

CSEonTSC:

Agree with Robert and also note the nice article by old friend of mine last week,

Chris Oster

, in another publication, about the competition in the auto insurance biz, especially State Farm's rather aggressive stance on acquiring and pricing new business.

melegirl-guest says:

Any chance that they'll do a brk.c?

Robert_Hagstrom:

LOL! No, not as long as Berk B is less than 10,000 dollars a share, because that is the limit for Uniform Gift to Minors Act, where you can gift up to 10,000 dollars a year without any tax consequence.

Robert_Hagstrom:

As such, until Berk B rises above 10,000, shareholders would have little to squawk about in regards to its high price.

CSEonTSC:

Great answer and something I really hadnt thought alot about. That said, Buffett did the "B" shares for a number of other strategic reasons that would not compel him to do a class "C".

TSC-RealMoneyLaura:

How much does it cost to get into Berk A?

Robert_Hagstrom:

Berk A is about 69,000.

seabreeze2-guest says:

Hi Chris, its

Doug Kass

, did

Ernie Banks

hit buffet's pitch out of the park at

Rosenblatt Stadium

in Omaha, before the

Omega Golden Spikes

played the

New Orleans Zephyrs?

CSEonTSC:

Hey, Doug, Ernie didn't even show. Guess he was afraid of the Buffett sinker. . .

CSEonTSC:

That said,

Bob Gibson

did show and hit Buffett hi and short. Then Gibson pitched to Buffett and Warren lined it thought he hole to left. However, there were no in-fielders. Lots of fun.

tickety-guest says:

Have they recommended any fuel plays outside of CA?

Robert_Hagstrom:

Chris is the resident energy expert, there.

CSEonTSC:

There is no question that both Buffett and Munger are very interested in the power business for Berkshire and would, if PUHCA is repealed, make major investments in the power biz.

CSEonTSC:

As for specific names, see a column I wrote a couple of weeks ago. And, also note that Buffett said they would really like to do a 10-15 billion deal in the next year.

CSEonTSC:

So, plenty of opportunities -- both in the regulated and unregulated markets.

CSEonTSC:

Robert, you have been somewhat skeptical of Buffett's interest here. What did you think of what he had to say this weekend.

Robert_Hagstrom:

I think the theme of the Berkshire weekend was diminished expectations.

Robert_Hagstrom:

I think Buffett is bending over backwards to prepare shareholders for single digit investment returns. As such, an investment in utilities would be consistent with a single digit return.

Robert_Hagstrom:

For many Berkshire shareholders, this may be eye-opening, as they have been used to much higher returns in the past.

Robert_Hagstrom:

But Berkshire is a different animal today, and as such, we should expect it to perform differently.

CSEonTSC:

He seems to be much more interested in the certainty of the "good returns" in the regulated business as opposed to uncertain returns in other, higher possible return businesses.

CSEonTSC:

And, Buffett has typically been somewhat more hesitant in the past to look at regulated industries. . .Do you find that shift surprising.

Robert_Hagstrom:

Very much so. If you look at the investments Berkshire made in the 1980's, they generally were companies that generated high cash-flow, high return on investment capital, and required little in reinvestment.

Robert_Hagstrom:

The kinds of businesses that he is circling today are just the opposite. They return very low returns on investment capital, they produce little in cash earnings, and have high capital reinvestment needs.

Robert_Hagstrom:

So, I agree with Chris, in that he is exchanging high returns and uncertainty for low returns and certainty.

Robert_Hagstrom:

He is moving away from businesses that can be threatened by the Internet. i.e., newspapers, to businesses that are not threatened by the Internet.

Robert_Hagstrom:

He has always put a premium on the certainty of a business's economics, and his preference is being demonstrated quite plainly.

Robert_Hagstrom:

However, for exchange of this certainty, we now must accept the possibility, if not the certainty, of lower relative returns.

CSEonTSC:

Clearly, Berkshire is evolving in many ways. It is striking to many that he is much more focused on buying whole companies rather than on marketable securities and the size of Berkshire is now really put restrictions on investments he can make that make a different to Berkshire's bottom line.

CSEonTSC:

It is an interesting time to watch Buffett very carefully. .

jgiven-guest says:

Chris, why doesn't Buffett go north to Canada to invest in power?

CSEonTSC:

That's a very good question -- Buffett might say that the only reason he hasn't done so is because his phone hasn't rang with an opportunity in Canada.

CSEonTSC:

One very interesting fact to come from this weekend is the fact that both Buffett and Munger are very interested in doing more international business.

CSEonTSC:

Buffett is hoping that opportunities will begin to come their way in Europe and elsewhere.

CSEonTSC:

As they become more known for their style of ownership across the pond.

TSC-RealMoneyLaura:

Does he regularly invest in countries outside of the U.S.?

CSEonTSC:

Not really -- but its really a result of the lack of opportunities that have been presented than an avoidance strategy.

jucojames-guest says:

What was there outlook and explanation for General Re underwriting performance?

Robert_Hagstrom:

My take-away was that unlike GEICO, which appears to be flattening out, GEN RE is demonstrating marked improvement.

CSEonTSC:

Clearly, General Re has improved significantly since last year. However, it is a biz subject to a lot of variables and profits are directly tied to the "smartness" of the underwriting with a little luck.

Robert_Hagstrom:

Well said!

markprincetown-guest says:

I thought we might be entering a period of more rational "value" investing, but p/e s are soaring again in the usual sectors. Can you make sense of that?

Robert_Hagstrom:

In the last several weeks, there has been a shift in relative performance between "growth stocks" versus "value stocks".

Robert_Hagstrom:

Of course, as we all know, from Buffett's perspective, and our own, this distinction is senseless, but nonetheless, the attributes of the groups show that the market is favoring growth stocks over value stocks for the time being.

Robert_Hagstrom:

My sense is that the market is preparing for an economic rebound to occur sometime in the near future, and as such, it is favoring technology, retail, entertainment, relative to classic value stocks, which are slow to perform when the economy takes off.

CSEonTSC:

Well put -- There is one thing that Buffett is very right about.. . regardless of what the market does. . .if you own good businesses with good products and provide good service you will do just fine over time as long as you adapt to societal needs.

CSEonTSC:

That may sound somewhat philosophical, but that is what has made Buffett and Berkshire a long-term success.

tickety-guest says:

Since they were never big in Tech, why would expectations be lowered?

Robert_Hagstrom:

I think there are two answers to that question, first, from a macro viewpoint, recall Buffett's Fortune Magazine article, written last November, in which he lays out the formulas necessary for high stock returns, i.e., lowering interest rates for a faster GDP rate.

Robert_Hagstrom:

Of which, with rates now down, and GDP resting in the two to four percent range, it is hard for Buffett to imagine that stock prices can much outperform single digit rates.

Robert_Hagstrom:

However, in my opinion, he overlooks one important variable, which is return on invested capital.

Robert_Hagstrom:

As such, companies stock prices can improve with improving returns on capital without necessarily relying on EPS growth. Technology certainly makes this possible.

Robert_Hagstrom:

A second reason why Buffett, I believe, thinks stock prices will retard to single digits, is that inflation is largely absent, and as such, companies have a most difficult time raising prices.

Robert_Hagstrom:

In the 1980's, you could grow units at four, five, and six, increase prices, at four, five, and six, buy back stock, generate efficiencies, i.e., technology, and reach the magical fifteen percent.

Robert_Hagstrom:

But with companies unable to raise prices without consumer backlash, they are left primarily to unit growth.

Robert_Hagstrom:

Many of the consumer product companies that were so successful for Berkshire in the 1980's are struggling in the 1990's for that very reason.

Robert_Hagstrom:

So the combination of a macro understanding of how stock prices behave coupled with single digit unit growers on the individual stock companies makes it hard to imagine that stock prices will reach double digit levels.

CSEonTSC:

To quote a very wise man -- Nothing to Add!

jucojames-guest says:

Chris, what is your opinion of Herb's comment line in the CC today regarding Independent Power Generators like Calpine being the CLEC's of the future?

CSEonTSC:

I knew I couldn't escape this one. I think there is a wide range of issues that could impact the IPPs down the road.

CSEonTSC:

They are growing so fast and that growth is being financed in a number of different ways. Some companies are more aggressive in that regard than others.

CSEonTSC:

So, I say watch the balance sheets very carefully, watch the debt offerings very carefully and do your homework.

CSEonTSC:

It is interesting to note that Buffett's MidAmerican energy filed for a shelf -- $400 million I think-- a week or two ago. Just FYI!

melegirl-guest says:

Chris: Read that gas prices expected around 3/gal this summer - any truth to that?

CSEonTSC:

Could be -- jumping all over the place because of concerns over refining capacity and the recent shut down of a couple of refiners due to explosions, fires, etc.

CSEonTSC:

I think we'll work through that and get to about $1.50-$1.75 gallon -- national average

Robert_Hagstrom:

With oil prices falling at the production level, and with reports that certain OPEC members are cheating on quota limits, when will these lower oil prices work themselves down at the gas pump?

CSEonTSC:

Good question -- prices rise much faster than they fall. I remember three years ago when we moved to Atlanta we were paying under 60 cents a gallon. There is a big bottleneck at the refinery level right now -- midstream.

CSEonTSC:

That will take some time to work itself out but it should through the summer.

CSEonTSC:

However, if OPEC is able to keep the cartel in modest compliance and we don't have new finds in current E&P in the gulf and in non OPEC projects, that could put more pressure at the top of the process.

tickety-guest says:

Who will run the show when Warren leaves? Do you think shareholders will be in good hands?

Robert_Hagstrom:

Warren seemed to imply very plainly that

Lou Simpson

would the marketable securities portfolio, and some other unnamed individual would run operations.

Robert_Hagstrom:

The short list probably includes

Tony Nicely

at GEICO,

Rich Santulli

at Executive Jet, outside dark horse

Ajit Jain

at National Indemnity, that's all I've got on my short list.

CSEonTSC:

I would agree with Robert. I have said before that I think, if he is interested, that

Marc Hamburg

might play a bigger role as well -- he is currently the controller of Berkshire. . .However, he would not step into one of the top roles. Robert, what is your guess on who leads that pack. . .

Robert_Hagstrom:

Tony Nicely, it's his game to lose.

TSC-RealMoneyLaura:

So the guys on the list are running companies now -- how do they stay "sharp" when it comes to picking acquisitions?

Robert_Hagstrom:

My sense is that although none of the favorite candidates have direct acquisition experience, they are thought highly for their rational decision making skills, which become paramount in deciding what prices to pay, and how to structure compensation.

CSEonTSC:

Agree with Robert -- by the way, the best line of the meeting probably came from Buffett who said that when the envelope with the succession plan is opened the first thing that will be read will be, "Check my pulse again."

CSEonTSC:

While humorous, it does show that even Buffett knows that his death will put some pressure on the stock and, especially, on whoever follows in his shoes. Sort of like the people who followed

John Wo

.

Robert_Hagstrom:

LOL!

jucojames-guest says:

With Mr. Buffet's preference towards efficient management, how do you explain his preference for the Federal Gov to allocate his wealth upon his demise, ie his support of the estate tax?

Robert_Hagstrom:

The answer to that question lies chiefly with Warren's philosophical view of how rewards should be allocated overall.

Robert_Hagstrom:

As such, he is a firm believer that rewards should not be allocated based on bloodline, but on accomplishments.

Robert_Hagstrom:

This is the chief reason he has decided not to allocate a large majority of his personal fortune to his children, and also because he cares deeply about the causes that will benefit in the Buffett Foundation.

CSEonTSC:

Very good answer.

timgrandhog-guest193 says:

Buffet has said that illiquid small caps are the place to look for values and can give outsized returns if you are managing a small portfolio. Where and how should individual investors research these small companies? It would seem that the more unknown they are the harder it would be to find useful information.

Robert_Hagstrom:

I agree that some of the inefficiencies are evident in the small cap market.

Robert_Hagstrom:

Looking for these companies may not be as difficult as you can imagine, as there are many services that specialize in this sector alone.

CSEonTSC:

As to where you look for companies and value, Warren started with his dad -- a stockbroker -- and looked at things like Standard and Poors, Moodys, Value Line, etc.

CSEonTSC:

He still says about the only tool he uses is Value Line and company annual reports. Hereads and reads and reads but very rarely does he read sell side research except to get a confirmation or opinion of somethign he has already looked at. The lesson here is do your own research.

TSC-RealMoneyLaura:

Any closing thoughts?

Robert_Hagstrom:

My lesson from the weekend was a recognition of two important observations.

Robert_Hagstrom:

First, as a competitive money manager, my sense is that Berkshire will become less of a source of investable ideas, and more about the analysis of an amazingly run company.

Robert_Hagstrom:

Years ago, portfolio managers salivated over Buffett's picks, and today new picks appear largely absent.

Robert_Hagstrom:

If that is the case, what we are left with is observing principles.

Robert_Hagstrom:

The principles of buying a business, the principles of valuing a business, those are obviously timeless.

Robert_Hagstrom:

And so our education will shift from copycat to how would Warren think about this stock if he were in my shoes?

Robert_Hagstrom:

He spent the last twenty years taking us by the hand, my guess is, going forward, it will be up to us to apply his principles in our own search for common stocks that will outperform a chosen benchmark.

Robert_Hagstrom:

That was my take-away, Chris.

CSEonTSC:

I would agree with Robert. My biggest takeaway from the weekend is that Berkshire and Buffett are changing.

CSEonTSC:

Buffett is much more interested in creating a stable, enduring enterprise than he is in creating a portfolio of securities of great companies.

CSEonTSC:

That is clearly a function of size but more than one shareholder suggested to me it is also a function of age and his need to plan for succession.

CSEonTSC:

I would agree with that assessment. Buffett's principles remain timeless, the application of those principles -- in the investment world -- are now left to each of his followers, people like Robert, who in their daily lives apply those principles at work.

Robert_Hagstrom:

I always enjoy our chats, and hope that regardless if Warren ever picks another stock, we will still get another opportunity to talk again.

Robert_Hagstrom:

Thanks everybody!

CSEonTSC:

Robert, thanks so much as always. See you again soon. . .And, for all of you, pick up a copy of Roberts latest book, The Essential Buffett. Thanks for being here and see you on Real Money and TheStreet.com Good night!

TSC-RealMoneyLaura:

Thanks Robert and Chris.