The Berkshire Hathaway meeting of 5/5/18

Financial journalist Andrew Sorkin asked a question submitted by a shareholder about the record share repurchase recently announced by Apple. He closed the question stating the obvious, “$100 billion dollars is a lot of money.”

“I used to think so,” Warren replied.

A whimsical quip without any hint of arrogance, it revealed a lot about the man and his company.

Warren and his long-time business partner Charlie Munger do not make earnings forecasts or engage in any form of strategic planning.  They ply their trade, finding business values based as much on their world view, faith in the future, personal philosophy, time proven business principles, and a sense of their own limitations- humility.  They do not ignore the numbers, but they are only a starting point.  Munger commented at a previous meeting that what mistakes they have made were rarely related to poor number crunching.  There is no mathematical model for what they do, as much as MBA programs may teach otherwise.

They avoid influence from news cycles and political trends.  They retain a sense of history that includes but is not limited to a long-term perspective.  At age 86 Warren still reads five hours a day.  Warren was hitting his stride at an age when most consider retirement.  His shareholders have had a bonus twenty-year period to benefit from his immense experience.

A personal comment on experience: there is a considerable difference between 20 years of experience and one year of experience repeated twenty times. Buffet and Munger have experienced more and reflected on it deeper, gaining the greatest wisdom from their successes as well as their failures.

There was a large contingency of Chinese actively participating and asking questions. These were young men and women from various Chinese regions and cities, many of them investment professionals.  A few asked questions about pending trade relations and the recognition of trade opportunities.  Buffett believes that open trade between the two is inevitable and in both countries’ interest.  Munger believes that China offers some of the best investment opportunities in the world. Clearly China is embracing capitalism. Buffet and Munger are capitalist rock stars to them.

Warren and Charlie exhibit a wisdom and humility that defines capitalism in a way that may appeal to eastern culture and should be the standard for us.  Patience is a virtue and a vice for Americans.  We can be suckers for simplistic formulas, excess leverage, and delusions of certainty. Buffet and Munger avoid these traps.  Our obsession with finance distracts from the effective and efficient production of goods and services, engagement with the customer, and the patience and faith to adhere to sound principles.

We delude ourselves into thinking we can eliminate risk by transferring it, more often just sweeping it under the couch for someone else to clean up later.

The Importance of Optimism

Buffett opened with a copy of the New York Times from March of 1942.  The world was mired in a war that we were not certain of winning. Japan had advanced in the Pacific after Pearl Harbor and defenses crumbled to her advance.  The news was as bad as it could get.

If you had invested $10,000 in the equivalent of the S&P 500 index at the time (index funds were not available) it would be worth ………. $51 million dollars today.  That assumes an investment in an unmanaged average.  An investment in Berkshire since its inception in 1965 has returned more than double the S&P 500 average; 20.9 % annualized vs 9.9% for the S&P.  The same dollar investment in Berkshire would have grown 155 times the S&P Average.

The news during that period would have been fodder for the thousands of bears and doomers:  the cold war, nuclear threats, regularly recurring recessions, the oil crisis, assassinations, Korea, Viet Nam, financial collapses, a half century of war in the Middle East, inflation, leaving the gold standard, devastating storms, technological disruptions, and volatility in employment and markets. There was always a reason to hunker down, doubt the future and avoid the risk of investing.

During that period, we have had 14 presidents; 7 Republican and 7 Democrats.  Regardless of who was in office and despite news cycles of never ending disasters that $10,000 grew to $51 million.

If you had invested the $10,000 in 1942 in gold it would have grown to about $400,000 today; less than 1% of the return you would have received on productive assets. Gold grows no food, produces no product, offers no service, and hires no workers.

The same is true of Bitcoin. Warren fielded one question on the crypto currency and his reply was related to the vast superiority of productive assets over history. Like gold, Bitcoin’s value is predicated on someone paying more.  It produces nothing. A check is a great tool for facilitating transactions, but it has no intrinsic value.

The Impact of the Accounting Change

An accounting rule change now requires Berkshire to report unrealized gains and losses on their income statement.  Buffett explained his displeasure with this requirement in his annual report and justified his position in response to a question supporting the change.

Berkshire is an unusual company with a large portfolio of business it owns totally plus a substantial portfolio of publicly held companies. Berkshire owns 17.6 % of American Express, 5% of Apple, 6.8% of Bank of America, 9.4% of Coca Cola, 7.4% of Delta Airlines, 9.9% of Wells Fargo, and significant positions in several other publicly held companies.

These publicly held positions have prices that change daily, even by the minute, but the wholly owned businesses do not. Reporting unrealized market gains or losses on part of the company obscures the profits generated by the operating companies and misrepresents the financial health of Berkshire, especially considering the market volatility in a single quarter.

Market prices are already reported on the balance sheet. Since most investors pay more attention to the income statement than the balance sheet, it could adversely affect the perception of the Berkshire’s value. Few companies have a comparable mix of assets that would be as affected by this accounting change.

Is It Time to Jump Ship at Wells Fargo?

Sorkin conveyed a shareholder question on their commitment to Wells Fargo given the ethical breaches and fines that have plagued them. Wells’ employees opened millions of unauthorized credit card and deposit accounts to meet sales incentives.

The cardinal sin was management not reacting fast enough, but in the eyes of Buffett and Munger the problem has been addressed and corrected and will lead to a stronger company.  Warren reminded the shareholders that American Express and Geico had similar episodes, corrected and regained their reputation and became valuable holdings.

Warren said the episode proved the efficacy of incentives, even though it incentivized wrong behavior.  What it proved, in my opinion, was the necessity of strong ethical leadership, regardless of incentives. The fact that this ethical breach went so high in the organization posed a far greater problem than the effectiveness of an incentive on lower level workers.

In business organizations of thousands of employees, one may expect errant behavior at some point. This does not mean it is tolerated, but it does not require the wholesale rejection of the business either.  Mistakes, errors in judgment, and even ethical lapses will occur; but they can be corrected.  Warren’s response reflected his long-term commitment to his holdings and the shareholders’ interests, not any moral equivocation.

The Meeting and the Future of Berkshire

There were many questions, including many of a technical nature, but these examples illuminate the core of Berkshire’s thinking and success.

I attended with Gary Watkins (tip for the edit)  and Drew Estes of Banyan Capital Management.  They have managed money for me for over a decade. We dined the night before at The Drover and most of us ate the whiskey fillet, a tradition for this group.  I highly recommend it.

The stage featured Warren Buffett and Charlie Munger in the center munching peanut brittle from See’s Candy (Berkshire owns the company) and drinking multiple diet Cokes. Munger was probably unaware how close the cans were to the mike when he was popping the lids.

To the left facing the stage were financial journalists Andrew Ross Sorkin, Becky Quick, and Carol Loomis.  To the right facing the stage were securities analysts Jonathan Brandt, Gary Ransom, and Gregg Warren.  Questions rotated from the two panels to several stations around the arena of about 40,000 attendees.

A few of us commented that the meeting was a bit dryer than usual. The opening movie was a smaller production than many of the past. Perhaps the questions were weaker or too long and did not provide the opportunities for the range of wit the two are known for.  Yet there was solid content and their range of experience and wisdom still shined.

Warren and Charlies fielded one question that is asked every year about heirs to their thrown and they comforted the shareholders that the management of the company would be in good hands long after they were gone.

Perhaps they should begin to share the stage with these leaders.  Warren and Charlie will be very hard acts to follow.