Berkshire Hathaway 2013: Takeaways and Impressions from the Annual Meeting (Update 12)

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Berkshire Hathaway 2013The Berkshire Hathaway Annual Meeting has come and gone, and it was once again an event to remember. Berkshire Hathaway 2013 continued in the long tradition of large-scale annual meeting weekends in Omaha, Nebraska. However, there were also some new impressions made and new insights gained. It seems Warren Buffett and Charlie Munger manage to leave fellow value investors with new quotable every year.

In this article, we bring you the Berkshire Hathaway 2013 takeaways of several value investors, fund managers, and shareholders of Berkshire Hathaway.

Berkshire Hathaway 2013 — by David Rolfe

The 2013 Berkshire Hathaway annual meeting was a strong reaffirmation of our investment thesis on Berkshire. The Company’s (as well as the Company’s key subsidiary companies) considerable competitive position and competitive advantages are intact. The stock’s current valuation (at $110 per B share) remains attractive at just a 14% to Buffett’s stock buy back level of 1.2X book value ($96.43).

This was our fifth annual meeting we have attended since 2006. While the “Woodstock for Capitalist” atmosphere in the exhibition hall, at the numerous parties, gatherings, restaurants, plus investor conferences we attended were ever present (we would expect no less), the quality of the Q and A session was among the best we have experienced. The quality of the questions asked of Warren Buffett and Charlie Munger were, on the whole, top-notch. Buffett’s answers, as usual, were patiently answered, detailed, informative and well communicated. Munger was his usual quick and cryptic to the point and hilarious self. While the Q and A session lasted for six hours, Buffett and Munger both focused many of their answers and replies on three key themes of Berkshire’s distinct and differentiated culture and enduring competitive advantage.

The first is Berkshire’s unique philosophy of decentralized management (to the point of abdication per Munger) relative to any other Fortune 500 company. Buffett and Munger’s decades-long history of buying companies large and small, and then allowing management significant autonomy to run all aspects their respective companies (with exceptions to capital reinvestment) significantly reduces the CEO burden for Buffett (and his successors). Such guarantees of management autonomy and business permanence under the Berkshire corporate “umbrella” provide Berkshire a unique advantage in purchasing businesses. Buffett expounded on this critical point in the telling of the story of a business owner who wanted Berkshire to buy his business. The owner desired to have the sale of his business to have as minimal impact to both his business and his family as possible – particularly to his employees as selling to a competitor or private equity might threaten their careers.

Buffett: “When he came to me, he said, ‘It really isn’t because you’re so attractive, but you’re the only guy left standing.’ Our competitive advantage is we had no competitors.”

The second is Berkshire’s willingness and rapid ability to deploy billions when opportunity knocks – most often when the markets are seized in panic. No other company of size can match Berkshire’s competitive advantage on this score.

Buffett: “The ability to say yes very quickly with very large sums sets you apart…Berkshire is the 800 number when there’s panic in markets and people need capital…When that happens when I’m not around, it becomes Berkshire’s reputation, not mine …The area we occupy becomes more and more our own the bigger we get.”

Munger: “That’s what I like about it…We’ve always tried to stay sane when other people like to go crazy…That’s a competitive advantage.”

The third theme is essentially the “synthesis” of Berkshire’s “culture” (a favorite word of Buffet) and “system” (a favorite word of Munger). Berkshire’s conglomeration of best-in-class businesses (and amble investment portfolio), prudently levered on an +$77 billion ocean of very low cost of float and capital, has literally become a perpetual cash generating machine. Cash is currently flowing to Berkshire’s coffers to the tune of approximately $1.4 billion per month.

These three themes are Berkshire’s enduring competitive advantage. They have painstakingly been built over the past +40 years. Furthermore, Berkshire has been built to survive and thrive long after Buffett and Munger have departed the scene.

Buffett was adamant that Berkshire’s culture would “reject” the wrong CEO “like a foreign tissue.” and that Berkshire’s corporate culture will be maintained after he’s gone. Munger chimed in on the matter as, well…as only Munger can:

“I want to say to the many Mungers in the audience, don’t be so stupid as to sell these shares.”

Buffett: “That goes for the Buffet’s too!”

Other meeting items of note and interest to us was Buffett and Munger’s disquisitions on the matters of corporate profits, the Fed’s monetary policy and D.C.’s fiscal policies. On the whole the two generally shared the same concerns we have on the same as we outlined in our last Client Letter (linked on our website). Buffett’s words were certainly more sanguine than Munger’s more dire tone, but we did note both of their admonitions – particularly on the Fed’s “grand experiment” in expanding their balance sheet to $3.4 trillion and the likely consequences of the end of this expansion, as well as the concomitant consequences of unwinding of the Fed’s balance sheet.

Buffett: “My basic answer is I don’t know…There’s all this liquidity that’s been created…It hasn’t really hit the market because the banks have let it sit there…We really are in uncharted territory….It certainly has the potential to be inflationary…It hasn’t been so far…My guess is some Fed members are probably disappointed they haven’t seen more inflation.”

Munger: “Generally speaking, what’s happened in macroeconomics has surprised the people who thought they knew the answers — namely, economists…They should therefore be humble about further predictions on the effects of the money-printing.”

David RolfeDavid Rolfe is Chief Investment Officer of Wedgewood Partners, a St. Louis based investment firm founded in 1988. Over the years, Wedgewood’s focus on undervalued large-cap companies combined with its “Invest as Business Owners” strategy have resulted in significant outperformance relative to benchmark indices. David joined the firm in 1992 in his current role and has been instrumental in achieving Wedgewood’s investment track record since then. David holds a Bachelors degree in Finance from the University of Missouri-St. Louis. He is a member of the CFA Society of St. Louis, where he has served as an officer and director.

Berkshire Hathaway 2013 — by Guy Spier

Setting the Scene

This Berkshire meeting was my 17th, my first one being in 1996 when they voted to approve the B shares, the last one held at the Orpheum Theatre. From there it moved to the Askarben Auditorium, and then to the newly built Omaha Convention Center (now called the Centurylink Center).

This was one of the coldest annual meetings on record. When I landed on Thursday morning, there was snow on the ground. Snow in May?!? The Friday morning I was up at 5 am, and at the south doors to the convention center where the meeting was held at 5.30. It was drizzling light rain and the temperature was low high 30’s / low 40’s. There was a much reduced crowd, proving that even the ardor of the faithful for Warren at the Church of Capitalism can be dampened by cold weather.

In the queue, there were many familiar faces. Thankfully, they opened the doors half an hour early at 6.30, rather than at 7 am. As usual, it was a race for our seats, just behind the directors of Berkshire. The hour before the movie started, like waiting in line outside was a celebration of relationships that have been built up over the years. Tom Gayner (Director of the Washington Post) and mutual fund manger Mario Gabelli were seated around us, as well as friends and investors that I know from London, Australia, India, Hong Kong, China, New York, California, Florida, and various other places.

At 8 am, the company movie stated, the highlight of which was a cartoon — vision of the Berkshire managers dancing to “Gangnam Style”, which all 30,000 shareholders loved.

Reflections on What They Said

Warren and Charlie were in fine form, looking healthy and with all their wits.

With the higher share price, there were fewer questions about the value of Berkshire and the possibility of buybacks.

In response to questions about Burlington Northern’s business and about Mid-American’s business, they called on two managers: Chuck Rose of Burlington Northern and Greg Abel of Mid-American. I have no idea if that signaled something about who the future managers of Berkshire will be, but I think that it may have.

An unusual factor this time was the presence of a short seller as part of the panel of questioners. It seemed, though, about half way through the second, afternoon session, that he was capitulating, and launched on a public appeal to Warren to invest in a short fund that would beat Berkshire’s returns, something that did not go down well with the shareholders.

One of Charlie Munger’s many memorable answers when asked to compare Herbalife, the multilevel marketing operation that was recently and publicly shorted by William Ackman, was that there was a lot less hocus-pocus in selling pots and pans than there was in selling potions and lotions.

On the macro economy, Charlie and Warren stated that the stimulus and QE were very necessary in the aftermath of 2008, and that while they did not know what the ultimate outcome was, it was the right thing to do at the time. And while they were concerned about inflation, it was not an inevitable outcome.

In another memorable answer, Munger said to the audience that he fully expected the many members of the Munger family to hold onto their Berkshire shares long after he and Warren were gone. And Warren agreed to this, with respect to the Buffett family.

Now that Charlie Munger no longer does the Wesco meeting, my sense is that he has more energy for the Berkshire meeting, and seemed to enjoy to proceedings more than in previous years, with a lower frequency of “I have nothing to add”.

Personal Thoughts

I used to come to Berkshire to learn. Then I came to do business. Now I just come to meet old friends and to reaffirm values — to clear the windscreen, so to speak. Or, as someone in the Berkshire company movie put it, “when I go to church, I know what the message is going to be, but I go anyway to reaffirm it in myself.” So I have cut back on the myriad of social events that are available to the shareholders: the Yellow BRKers, the German Speaking Value Investors’ Meet run by Norman Rentrop, The Whitney Tilson Cocktail, the Markel Brunch — the list is endless. My goal is to enjoy Warren and Charlie at the meeting , and to attend a couple of private events.

One of my biggest personal takeaways from the meeting comes from an article that appeared in the Omaha World Herald about Todd Combs, one of the people selected to run Berkshire’s money (the other being Ted Weschler), which stated that Todd reads at least 500 pages a day. This is an estimated four hours of reading a day. Elsewhere the article quotes Warren Buffett as telling a group of students that the key to success is to do this level of reading a day, and that all of them are capable of it, although few will actually do it.

I am determined to be a part of the group that do, and as a result, I need to up my reading time. As Warren Buffett says, his goal is to go to bed each night a little wiser than he woke up. I can’t say that I do that every single day.

Guy SpierGuy Spier is a Zurich-based investor. In June 2007 he made headlines by bidding US$650,100 with Mohnish Pabrai for a charity lunch with Warren Buffett. Since 1997 he has managed Aquamarine Fund, an investment partnership inspired by, and styled after the original 1950′s Buffett partnerships. Prior to starting Aquamarine Fund, Spier worked as an investment banker in New York, and as a management consultant in London and Paris. Mr. Spier completed his MBA at the Harvard Business School, class of 1993, and holds a First Class degree in PPE (Politics, Philosophy and Economics) from Oxford University. Upon graduating, he was co-awarded the George Webb Medley prize for the best performance in that year in Economics. While at Oxford he was a contemporary of David Cameron at Brasenose and attended economics tutorials with him. Spier is the CEO of the Spier family office. He also serves on the advisory board of Horasis, and is a co-host of TEDxZurich. Spier is a member of YPO, EO, Zurich Minds and the Latticework Club. Aquamarine has offices in New York, London and Zurich where Mr. Spier currently resides with his wife Lory and their three children, Eva, Isaac and Sarah.

Berkshire Hathaway 2013 — by Robert Robotti

Berkshire remains a necessary pilgrimage for global value investors. Nowhere else will you see two octogenarian billionaires who are willing to answer questions for five hours from shareholders and an antagonistic short seller. Not only do shareholders and investors flock to Omaha to try to gain some insight into the Buffett-Munger “secret sauce” but it is also a very popular weekend for experienced and successful value portfolio management professionals to gather together and discuss current investing trends and stock ideas.

A few specific highlights:

Warren Buffett, when challenged on the placement of his inexperienced son Howard as his successor and future non-executive chairman of Berkshire Hathaway, basically stated that he thought the infrastructure and management is so strong that Howard will simply oversee the CEO and ensure the culture that was built will be retained.

The process of evaluation is still all about the businesses. Berkshire has been approached numerous times over the years to make mature or start-up airline investments. Charlie Munger summed it up best when he said nothing has changed over time, airlines (along with other industries) fall into the “too hard” pile.

Warren Buffett admits that earnings will decline in the newspaper industry but states they he buys them at such a low price they will generate a return. He estimates that Omaha newspaper purchase can generate a 10% return.

Do the obvious with interest rates: Buy homes, don’t buy Treasuries.

Charlie Munger’s explanation of value and outperformance: “We like to stay sane while others go crazy. That’s a competitive advantage.”

Berkshire will look at global opportunities, however, [Buffett and Munger] still believe the U.S. has a vast landscape and is great place to invest.

Robert RobottiRobert Robotti is the President of Robotti & Company. Prior to forming Robotti & Company, Incorporated in 1983, Bob was a vice president and shareholder of Gabelli & Company, Inc. He worked in public accounting before coming to Wall Street and is currently an inactive CPA. Bob holds a BS from Bucknell University and an MBA in Accounting from Pace University. Some of Bob’s areas of coverage include Special Situations, Energy Industry, Property-Casualty Insurance and Banking. Bob is the principal of the managing member or general partner of several investment vehicles. Bob currently serves on the Board of Directors of Panhandle Oil & Gas Company, a NYSE-listed diversified mineral company located in Oklahoma City; on the Board of Directors of Pulse Seismic Inc., a seismic data licensing business located in Calgary, Alberta; and on the Board of Directors of Build with BMC, a privately held company specializing in building materials and construction services throughout the United States. In addition, he serves on the Boards of many non-profit organizations where he generously donates his time and expertise. Previously, Bob was a member of the Securities and Exchange Commission’s Advisory Committee on Smaller Public Companies, established to examine the impact of Sarbanes-Oxley Act and other aspects of the federal securities law.

Berkshire Hathaway 2013 — by Paul Lountzis

I thought it was another enjoyable and excellent meeting. I also felt Mr. Munger was in particularly good form this year — Mr. Buffett is always in good form. Some of the key highlights for me are given below:

1. Mr. Buffett and Munger describing the unique corporate culture they have built at Berkshire Hathaway with the inherent competitive advantages. This culture will go on and continue to prosper in the decades to come. Great companies from around the world will continue to choose to become part of the Berkshire family for the many benefits over private equity or selling to competitors. While it will certainly be different without Mr. Buffett and Munger the new CEO and the team will continue to find investment opportunities including during periods of great stress. The new team given their younger ages will have more energy, plenty of wisdom and passion which when combined with Berkshire’s cash and extraordinary reputation (Berkshire will remain the financial emergency 911 number to call-Europe may present opportunities) will continue to thrive. I feel confident that Berkshire’s uniqueness will continue though differently than with Mr. Buffett and Mr. Munger. I am now more confident than ever that Berkshire the institution will prosper beyond Mr. Buffett and Munger. I could go on but this is critical.

2. I think that going forward it would be great to shed more light on the individual businesses (the larger ones) the CEO’s should answer many of the questions about their businesses. While Mr. Buffett’s grasp is extraordinary no one else will be able to replicate his knowledge so having Matt Rose answer specific railroad questions broadens our knowledge of Berkshire, illustrates the extraordinary management talent for all to see and will make it easier for the new CEO who will need their greater participation.

3. The issues of succession and the anchor of size have been beaten to death but learning more about Berkshire as with their in depth discussion of their unique culture, extraordinary collection of businesses and managers should be a much greater focus going forward and anything that can help along those lines would be great. For example I spent some time discussing Johns Manville with CEO Mary Rhinehart and she was phenomenal-describing each of the segments, competitors by segment and on and on. We need more of that.

4. Jon Brandt’s questions were terrific along the lines of the points I made above to learn more about the numerous companies within the Berkshire Family, especially the big ones.

5. The comments on the Fed were very interesting and thoughtfully illustrated their concerns, particularly the unwinding challenges and the concerns regarding our national debt to GDP.

6. I also applaud and commend his continuing emphasis and support for utilizing the extraordinary talents of women in our world.

In concluding, the institution will go on and continue to thrive beyond current leadership and beginning to showcase the key CEO’s a bit this year was a great start to doing more of this to help all of us learn more about the great companies and leaders at Berkshire as well as help the new CEO respond to questions.

Paul LountzisPaul Lountzis founded Lountzis Asset Management, LLC in October 2000. He has more than 25 years experience in the investment industry, beginning his career with Royce & Associates, a New York City-based investment advisory firm managing the Royce Mutual Funds. Paul spent nine years, with the last five as a partner at Ruane, Cunniff & Goldfarb, Inc. an investment advisory firm managing more than $9 billion including the Sequoia Mutual Fund. While at Ruane, Cunniff & Goldfarb, Inc., Paul also evaluated several companies for Warren E. Buffett, CEO of Berkshire Hathaway.

Berkshire Hathaway 2013 — by Dave Sather

The biggest things (there were many, many takeaways) I walked away from the meeting with were the need/discipline of staying rational and focusing on the long term. In doing so, you must know what is important and what is not. You must remain rational, even if it means shrinking the business for a period of time. I have had other business owners describe this as “the capacity to suffer.” I believe Tom Russo has also discussed this. This is a very difficult concept for so many investors because we want instant results. When we reach for things that aren’t there, we get in trouble.

However, it is very apparent that the super octogenarians are calmly thinking about life, business and Berkshire many, many decades into the future.

Berkshire continues to fish where others are not — or cannot. This lowers the competition they face. In looking at moats in publicly traded investments, Berkshire applies the same logic to their own operations. They have such a deep culture that many closely held businesses want to find a permanent home in the Berkshire family. Furthermore, because of Berkshire’s incredibly deep pockets they will continue to be a welcome provider of capital — whether after a period of tremendous consideration or immense stress. Either way, it will be done on terms that are favorable to Berkshire shareholders.

HOW HAS BERKSHIRE CHANGED AND WHERE ARE THEY TODAY. Berkshire has morphed over the decades from an entity looking for cheap stocks to one that today has become the first choice for families looking to sell their businesses…and in other cases has become the only choice for assistance when liquidity, or timely, decisions are in short supply.

THE PROVIDER OF CAPITAL. In assessing this, Buffett said Berkshire has become less of a value investor and more of a “provider of capital”. Adding, this is the place where large sums of money can be deployed and, just as importantly, where there are very few competitors.

RATIONAL CULTURE. Munger also said that their culture and structure makes them a top choice for families wanting to sell their businesses. Businesses looking to sell know that “Berkshire will remain sane when others are crazy” and they know that they will be treated just as Buffett and Munger would want to be treated. Berkshire’s management continues to be decentralized. Buffett and Munger recognize that they cannot run these businesses–so they find passionate people who can and leave them alone to do their jobs.

FIND YOUR PASSION. Buffett and Munger both agreed that you must stay rational and energetic–finding “what turns you on.” Munger added “I’ve never succeeded at anything I didn’t like. Both Warren and I started out in the grocery business–we’re not now–you can tell how passionate we were about groceries.” Regarding passion and energy, it was great to see Munger, at age 89, talking about the long term future. He is not a man worried about what tomorrow brings–but rather continues to think and strategize about how best to position Berkshire, its operations and its shareholders for long term wealth enhancement.

RATIONAL BEHAVIOR, LONG-TERM FOCUS, AND ENVY. Buffett said a key to their success has been NOT having controlling shareholders since that has allowed them to focus on the long term and remain rational. They don’t worry about quarterly earnings or other short term things that Wall Street remains obsessed with. Berkshire gets offered lots of stupid ideas. However, because of rational behavior we have avoided them. The bandwagon effect of quick money is alluring–but we are not envious of them. Buffett and Munger recognize that envy is the one sin where you’ll have no fun….but joked that gluttony can be great. Munger said: “If we have an edge, its that we don’t get caught up with what other people are doing.

DEALING WITH DUMB COMPETITORS. Buffett and Munger hate dumb competition. Dumb competition will sell below cost destroying value for all competitors in an industry. The rational investor/competitor will be disciplined and wait it out. They have recently experienced this with hedge funds moving into the insurance business. They chase after money offering low premiums relative to the risk exposure. When this occurs, Berkshire will not chase after business. Instead, they will simply pull back and shrink their insurance operations until attractive premiums are offered for the risk undertaken.

THE BIGGEST CHALLENGES TO BUSINESS TODAY. Buffett said that the number one challenge to American businesses is healthcare expenses. Munger said it remains complex financial and derivative markets. Munger later added that massive derivative books should be separated from insured banking deposits. Amen to that.

FOCUS. Buffett said that in his career he has owned 400 to 500 stocks–but made the serious money off of ten of them.

OLIGOPOLIES DO NOT EQUAL GREAT INVESTMENTS. There was an interesting discussion on oligopoly type industries–specifically the airlines. Bill Miller with Legg Mason asked if now that 90% of the airline industry is controlled by four carriers, will airlines become a good investment. Buffett pointed out that Fannie Mae and Freddie Mac functioned with only each other as competitors–and yet they still did stupid things which ultimately blew themselves up. Even when only a few companies exist in an industry, one is not guaranteed great management or great efficiency.

LOW RATES ROB SAVERS. Periods of low interest rates, like we are in now, rob purchasing power from savers and people trying to live off of interest income. Buffett: I feel sorry for people who have clung on to their fixed income investments. The savers of the world have been penalized by the current environment.

INSTANTLY CLASSIC MUNGER QUOTES

Munger on short selling: “We don’t like trading agony for money.”

Munger: “The Game Of Life Is A Game of Everlasting Learning.” Previously, it had been discussed that research and knowledge are cumulative.

Munger on current politics: “If the current situation doesn’t confuse you, then you don’t understand it.”

Munger: If you think you know more than you really do, you are asking for disastrous results–this is true in investing as well as matrimony.

Munger: Blessed are the meek, for they shall inherit the earth. However, after they inherit the earth will they remain meek?

Munger: You shouldn’t make lots of decisions when you are tired and making lots of decisions will make you tired. Translation: Stay focused on your highest and best use–this is true whether running an operating business or managing an investment portfolio.

Dave SatherDave Sather is a Certified Financial Planner, an Accredited Fiduciary Investment Manager, and the President and founder of the Sather Financial Group, Inc. Dave was raised in El Paso, received his B.A. in Business Management from Texas Lutheran University and received his M.B.A. from Texas A&M University. Additionally, Dave is a graduate of The College For Financial Planning and the Cannon Financial Institute. Furthermore, he holds the Group 1, NASD Series 7, NASD Series 63 and NASD Series 65 licenses. He has spent the past twenty years in the financial analysis, investment and banking industries. As team leader he is responsible for coordinating portfolio management as well as financial and strategy planning of a client’s life. This strategy planning not only includes traditional fee-only investment management, but also estate, retirement, taxation and risk management planning. In addition to his work with Sather Financial, Dave is a Director of Business Bank Of Texas. Dave is an adjunct professor in the Business program at Texas Lutheran University and is a member of the schools Executive Advisory Council. He is also Chairman of the Finance and Investments Committee for the Brownson Children’s Home and is Treasurer of First English Lutheran Church. He and his wife, Carol, live in Victoria, Texas.

Berkshire Hathaway 2013 — by Philip Ordway

One thing that stood out at this year’s annual meeting was the questioner who asked how to explain Berkshire’s long-term competitive advantage to his 14 year-old daughter. Charlie Munger’s response: We don’t go insane when other people do. In other words, Berkshire’s managers are more rational that their competition. This concept also fits with Charlie Munger’s response years ago to a question about the secret to his success. He replied simply, “I’m rational.” None of this is new, of course — Buffett and Munger have been preaching the same gospel of rationality for years. But it’s worth remembering that a few powerful, simple ideas can make all the difference.

I’m sure the questioner’s 14 year-old daughter must think she’s missing something. Surely there has to be more to being successful than just being rational, right? Munger did go on to add that Berkshire derives a long-term competitive advantage from its structure — “decentralization to the point of abdication” and from treating its partners as they would wish to be treated. Buffett later added that Berkshire’s structure, having zero outside influences, allows the managers, himself included, to avoid many common mistakes. There is no doubt that the company’s individual businesses have benefited from those factors, and the environment has made Berkshire an increasingly attractive destination for business sellers, but the company was in a position to acquire those businesses in the first place because of Buffett and Munger’s rationality.

It’s also important to remember what wasn’t said. Munger didn’t attribute his success to being smarter than everyone else, even though he is and that certainly helps. He didn’t list his impressive academic pedigree, or his experience in a particular industry, or even his relationship with Buffett. His ability to be rational was more important than everything else.

There is the question of nature vs. nurture: Were Buffett and Munger born hyper-rational, or did they develop a more rational mindset over the years? Probably both, and that’s the good news for the mere mortal investors out there. Everyone is capable of significant improvement in rational decision making. A deliberate effort to develop a more rational investment process, grounded in the principles of value investing, can lead to significantly better results.

Philip OrdwayPhilip Ordway joined Chicago Fundamental Investment Partners in 2007 and was admitted as a partner in 2012. Phil is responsible for investments across the capital structure in various industries. Phil was an Analyst in Structured Corporate Finance with Citigroup Global Markets, Inc. from July 2002 to July 2005, where he was part of a team responsible for identifying financing solutions for companies initially in the Global Power & Utilities Group and ultimately in the Global Autos and Industrials Group. Phil earned his M.B.A. from the Kellogg School of Management at Northwestern University in 2007 and his B.S. in Education & Social Policy and Economics from Northwestern University in 2002.

Berkshire Hathaway 2013 — by Christopher Begg

I have been a shareholder of Berkshire Hathaway for long over a decade; for both clients whose capital I allocate and myself. At East Coast, Berkshire Hathaway has been our largest holding since we founded the firm in late 2008. While I have attempted to read, listen, and contemplate nearly every word communicated in any medium from Warren Buffett and Charlie Munger, I have never been to an annual shareholder meeting until this past weekend. Reading the meeting transcripts from industrious note takers has always served as a good source of the meetings insights. Crowd avoidance has always served us well, even if those crowds are like-minded value investors.

I owe a great debt to what I have learned from the sound business judgment and teachings that have been shared by Warren and Charlie over the decades. I fear the day when these beacons of rational thinking are no longer there as a barometer of common sense when the world inevitably loses theirs from time to time. While the eventuality of the end game appears many years off from the energy and sharpness that Warren and Charlie exhibited this weekend, this fact of life was one of the factors that encouraged me to make this year’s trip to Omaha.

As a close follower of Berkshire Hathaway, the question and answer period was business as usual – exceptionally insightful, lucid, and translating complex into simple. The commentary and operating updates fell largely in line with the insights Warren and Charlie shared in recent interviews and in the annual report. However, I did have a very large take away from the meeting that I would not have realized without being present.

In seeing the tens of thousand attendees enter the CenturyLink Center arena early Saturday morning, I was surprised to see how many shareholders were arriving with their families. There were attendees both young and old, those dressed in suits and those in more casual appearance, all different types of people continued to pile into the arena with their shareholder badges. During the break I went out to view the Exhibit Hall where all the underlying businesses of Berkshire Hathaway were displaying their business products, and selling their products (if possible).

When I made it the Burlington Northern Santa Fe booth, I paused. A full model train track was on complete display. There were three trains running through the mountains and model city and all of the storefronts were Berkshire companies. A six-year-old boy with eyes wide open watched the train travel around the track. His delighted grandfather looked on behind him. I asked the grandfather how many years he had been coming to Berkshire, and he said it was his thirty fifth year. He said it was his grandson’s second year at the conference, and it was important for him to show his grandson the businesses he indirectly owned.

I always knew that Berkshire had a unique competitive advantage in being the chosen home for family businesses that wanted to sell to a trusted partner that would steward the business in the same manner in which they built it, honoring the managers, employees, and culture. I knew Berkshire had incentivized managers running their businesses that truly thought as owners. I knew Berkshire had an evolved decentralized system that was a model of meritocracy. What I did not fully appreciate was how the vast majority of shareholders had been led by the example of Warren and Charlie’s to truly act as owners.

As I walked through the exhibit booths I saw families fully enjoying all the displays: eating dilly bars from DQ, buying H.H. Brown shoes, trying on commemorative running shoes from Brooks, and buying peanut brittle from Sees Candy. Then, it clicked with me just how important Berkshire was to them and the pride they had in owning this collection of businesses. The persistence and generational aspect of this insight was inescapable. Shareholders that truly thought as owners! I could not think of another publically traded business that had this attribute.

At some eventual day when Berkshire must thrive without Warren and Charlie, I am comforted by the new insight I learned of Berkshire’s succession plan – a loyal, proud, and generational shareholder base that understands the values that has made Berkshire great. On the center arena stage it might not be Warren and Charlie, and the agenda might include a handful of additional voices from both investment managers and operating managers stewarding Berkshire, but the owner culture and loyalty will persist.

Christopher BeggChristopher M. Begg is the Chief Executive Officer, Chief Investment Officer, and Co-Founder of East Coast. Chris brings over fifteen years of investment experience to the team. Prior to co-founding East Coast, Chris was a Portfolio Manager and Research Analyst at Moody Aldrich Partners, LLC. Prior to Chris’s time at Moody Aldrich Partners, he was a Principal of Boston Research and Management where he served as a Portfolio Manager. Chris is currently an Adjunct Professor at the Heilbrunn Center of Graham and Dodd Investing at Columbia Business School. Chris teaches Security Analysis, the same course taught by legendary value investor Benjamin Graham for nearly thirty years, and which has produced such notable graduates as Warren Buffett ’51, Mario Gabelli ’67, Glenn Greenberg ’73, and Charles Royce ’63. Chris received his BS degree from the University of New Hampshire and currently holds a Chartered Financial Analyst (CFA) designation. Chris is a member of the Boston Security Analyst Society, the CFA Institute, the Consumer Analyst Group of New York (CAGNY) and the Boston Estate Planning Council (BEPC). Chris has served as a grader of the CFA exams for the CFA Institute. Additionally, Chris is involved in land conservation and is an active supporter of the Trustees of Reservations as a Corporate Trustee and was a Co-Founder of one of their giving societies, The Conservation Council.

Berkshire Hathaway 2013 — by Larry Cunningham

The philosophy is so simple and clear and simply and clearly stated (as collated in The Essays of Warren Buffett: Lessons for Corporate America) that most people who have read the Essays and attended a meeting or two are able to correctly anticipate the substance of all answers. As Charlie Munger quipped to me after a meeting a few years ago, we have heard another sermon of the catechism.

So when you turn to themes of the meeting consider the question of succession. We have been discussing that since at least 1993.

Berkshire culture. Partnership. “Introduce something foreign into the culture and the company will reject it.” What’s the culture? Partnership values, mutual trust, candor, strong ethics.

Roles: owners, managers, directors, employees. Reliability: count on continuity: of ownership, of stewardship, of employment. Shareholders don’t sell much; managers manage for the long term, the company never sells a subsidiary, the employees can count on the resulting security and will, in turn, give their all to their jobs.

Larry CunninghamLawrence A. Cunningham is the Henry St. George Tucker III Research Professor at the George Washington University Law School and Director of GW’s Center for Law, Economics and Finance (C-LEAF) in New York. He is the editor and publisher of The Essays of Warren Buffett: Lessons for Corporate America.

Berkshire Hathaway 2013 — by Simon Denison-Smith

Overall, there seemed to be more theatre [at Berkshire Hathaway 2013] than in previous years. For example, the film was of a higher level of quality and almost all original content (previously a lot of repeated content from prior years); the exhibition halls better laid out but also the interaction between Warren Buffett and Charlie Munger had more theatre. There was more debate between the two of them than I recall from past meetings.

Charlie has become a much more active part of the event in the last few years and this is I think a direct reflection of the quality of the questions. The inclusion of analysts and journalists has been very value added. It’s impressive that as Charlie gets older, he says more! And what he says is always brilliant and to the point.

As always, you cannot be anything but impressed with the consistency and simplicity of their message. The only answer which baffled me was the one on IBM, where Warren did not really answer the question at all.

There is so much material to comment on that it is difficult to give you a snapshot. Given that BRK is an 8% position in our fund, I listen closely to all the detail on the various businesses. I also managed to spend some time talking in some detail to the senior managers on the exhibition stands of the less consumer facing businesses: like Marmon, Iscar, Mitek and the framing business. All of these discussions reaffirmed the thesis that Berkshire has some very high quality businesses.

Part of the reason for returning each year is to “reset”. To this end, I found the following answers / quotes useful:

Charlie Munger: “People with high IQ naturally look at stocks and want to use maths to make judgements.”

My comment: This is important to me because I see a lot of managers running much larger funds than me and from institutional backgrounds, who talk numbers because they have such large portfolios that they really have to rely on maths. We come from a world in which we have bought whole businesses to run for the long-term, so first and foremost we want to focus on understanding the quality of the business, otherwise the maths does not mean very much.

Warren Buffett on emerging markets: “This would never be our starting point. It sounds good but it’s not best way to look at investments. It is a great way to sell investment advice though, i.e. splitting into categories [and selling themes]. When we hear someone talking concepts, e.g. country by country, we suspect that they are better at selling than investing…we think it’s a load of baloney.” Charlie Munger then said, “you need to be opportunistic, look for good quality businesses and buy them at good prices.”

My comment: This is particularly poignant for us. One of the biggest hurdles (apart from our size) that we have in raising money is that everyone wants to pigeonhole us. They want to be able to call us a small-cap fund, or a European special sits, or a UK income fund. This is an endemic issue with the money management industry in London. We could have chosen a much easier route – small caps UK. This would have been a much more saleable product, easier for people to ‘believe’ we have an edge, but we want run our fund for the next 30 years so it would have a huge sacrifice for the sake of raising money. Freedom and autonomy in this industry is a huge competitive edge in terms of long-term investment returns but few asset allocators, particularly in London, understand that!

Simon Denison-SmithSimon Denison-Smith has been one of the two Investment Managers of the Metropolis Valuefund since its inception in 2008. Simon is also a Director of Metropolis International, which he helped Jonathan to set up in 1994. Prior to this, Simon was a strategy consultant with Bain & Co and Kalchas. He also founded Rave Technologies, a software business that services clients across a wide range of industries. Simon sold this business to Northgate IS PLC in 2006, delivering a 32% per annum return to Rave’s principal investor. Simon graduated from Bristol University with a 2:1 in Economics.

Berkshire Hathaway 2013 — by Arko Kadajane

1. I made some quick calculations that if Berkshire makes around $12 billion a year of free cash flow, and let’s assume that small crises come every seven years — then Berkshire has around $84 billion to invest during the next down-cycle. That means that they probably have to make around 4-5 large investments, which should still be doable. At some point in the future, it becomes very hard to allocate free cash flow through new investments.

2. For me, one of the biggest risks is the control of Berkshire after Warren Buffett has left. As Warren Buffett distributes his Berkshire shares to charity, which distributes them or sells them on the market, at some point there will be no controlling shareholder. At that point, it probably becomes very hard to practice the same investment principles as is the case currently.

Despite the seemingly negative points above, I still own a position in Berkshire as the valuation is rather cheap and rational management is in place.

Arko KadajaneArko Kadajane is a Portfolio Manager at Ambient Sound Investments. He is responsible for listed equity investments, investing ASI’s stock portfolio based on value-investing principles. Investments are made into different sectors except for non-ethical industries. As Arko has been involved in stock markets since 1996 and has previously worked in the fields of private equity as well as listed equity, he has extensive expertise in the qualitative and quantitative business factors. Before joining ASI, Arko worked as an analyst, investment manager and project manager in the investment banking field, and managed a family-owned business. In ASI, he started as a senior analyst in the private equity unit. Like many of his colleagues, Arko is passionate about sports. He enjoys cycling and the peace and quiet of cross-country skiing. Arko holds a bachelor’s degree in international business administration from the Estonian Business School.

Berkshire Hathaway 2013 — by Daniel Abrahams

We were fortunate to have dinner with a local who knew the Buffett family and early Buffett employees personally. I had previously underestimated how important the support of local friends and family had been to Buffett in his early partnerships. Some investors from very modest backgrounds that had taken an unconventional approach by backing Buffett early on had amassed considerable fortunes and were now endowing buildings in the city.

It was interesting to see how many of Buffett’s investments were local businesses, despite him living in a small city. In the same way, Ted Weschler’s significant investment in WR Grace over time is very specific to Ted Wescher’s personal career experiences. The lesson for me was sticking to what I personally know rather than trying to replicate what someone else knows.

I am not a Berkshire Hathaway shareholder and I don’t expect to become one. Small but competent active value investors should be able to generate greater returns for lower risk by allocating their equity capital to securities other than BRK.

Buffett’s story is linked to his time and place to a great extent. Omaha has a very low cost of living, an unusually high concentration of insurance businesses … and one of the highest concentrations of millionaires per capita in the United States. It seemed difficult to live an expensive lifestyle in Omaha.

Buffett’s role as an international figure seemed, and probably is, more important than his role as an investor today.

Daniel AbrahamsDan Abrahams is Managing Partner of Alfreton Capital. Previously, he was a Partner at Praxient Capital LLP, an event-value investment manager based in London. He joined Praxient at launch in 2007 and works as a generalist, focusing on European equities. Prior to joining Praxient, Dan worked in Corporate Finance at Deutsche Bank. He began his career with Arthur Andersen and graduated from the University of Oxford with a First Class degree in Economics and Management. Dan is a CFA Charterholder and is the co-chair of the Value Investing Special Interest Group of the UK CFA Society.

Berkshire Hathaway 2013 — by Koon Boon Kee

Some thoughts using the Bamboo Innovator mental model:

(1) “Decentralization” = Moat at Berkshire Vs Centralization at Teledyne (Non-resilient compounder featured in “The Outsiders”)

The conglomerate Berkshire Hathaway is not an easy business to understand without a mental model to appreciate its sustainable competitive advantage. With its private operating businesses increasing in influence and expanding over the decades to include 12 insurance (33,796 employees) and 69 non-insurance businesses (254,642 employees), most would first dive into using a SOTP (sum-of-the-part) valuation approach by breaking up the business segments and valuing them piece by piece. But from an organizational and business model perspective, the natural question is to first ask: So isn’t bigger riskier? What’s the glue to hold the different operating businesses together? Shouldn’t there be a (steep) holding company discount to its book asset value? Think Alexander the Great, undefeated in battle but whose great empire disintegrated from the cultural diffusion his conquests engendered! So why should it trade at a premium?

Thus, when asked by a shareholder that he is having trouble explaining Berkshire’s business model and its sustainable competitive advantage, both Buffett and Munger talked about the central core that most value investors fail to appreciate from the second-order analysis of numbers and SOTP valuation. This core is “decentralization”. As the wise Charlie said, “Of course it would be unwieldy to have so many businesses if we were trying to run them through an imperial headquarters. If your system is decentralisation to the point of almost abdication, what does it matter how many you have?” Warren added, “The culture will remain unchanged. The pre-eminence of the operating managers will remain.” Buffett then went on to elaborate the importance of culture: “Culture is all important. People will call GEICO the day after I die. Culture has become more important over the years. Making sure that managers joining the company buy into the special culture. People have self-selected in, and the wrong sort of person would be rejected by a foreign body. We have a strong board, that isn’t paid much (chuckle). Companies acquired have chosen to be part of the culture.” Munger then elaborated by talking about being a good partner to people who come to Berkshire: “As we’ve got better we’ve used the golden rule – to treat the subsidiaries the way we’d want to be treated if we were in those subsidiaries. We try to be a good partner to people who come to us. That’s a competitive advantage. We’re leaving the field behind and becoming more unusual in that sense. That’s a very good idea – I wish it was intentional (audience laughter).” Warren again talks about the Berkshire managers as in previous years: “We create an atmosphere where they can enjoy running their business instead of running around headquarters doing show-and-tell. We operated Berkshire without Ajit for 20 years. But, if he’d come in 1965, instead of 1985, we’d own the world right now.”

Decentralization is a key competitive advantage in Bamboo Innovators too. As shared at Emerging Value Summit 2013, “emptiness” in business model is perhaps the most misunderstood and underrated virtue in resilient growth and value creation for the resilient compounders, the Bamboo Innovators. The vitality of the bamboo growth revolves around its “emptiness”: the nutrients and moisture that would have been exhausted making and maintaining this empty center can be utilized for growth of other stems. From a builder’s viewpoint, the architecture of the bamboo culm presents a powerful configuration: fibers of greatest strength occur in increasing concentration toward the periphery of the plant. Operating managers at the “periphery” with autonomy in doing their jobs are greatly motivated by the trust and empowerment to outperform. It is noteworthy that Berkshire’s “core” headquarter strength comprises only 24 people “managing” over 280,000 employees. This “core-periphery” business model at Bamboo Innovators is the reason why bamboo bend, not break, even in the most terrifying of storm that would have snapped the might resisting oak tree. Berkshire has endured several crises in its corporate life and its business model has never snapped.

In a stark contrast to Berkshire, there’s Teledyne, the non-resilient compounder mentioned favorably in the recent book The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success recommended by both Buffett and Munger. Also a conglomerate with quality operating businesses like Berkshire, Teledyne was a powerful compounder when the founder Henry Singleton was still running the business. Yet, Teledyne was not resilient like the bamboo. It snapped into pieces when Singleton was getting older and he had to break the company up into three companies as he found it difficult to manage for one CEO as he ran it using a centralized business model. During an exciting Q&A exchange between Doug Kass and Buffett and Munger, Buffett immediately responded with his wisdom again: “Berkshire seems like the easiest company to manage. Sorry, if I gave you the idea that there’d be more centralization after I’m gone. As for breaking up the company, it would be a poor result now and in the future.” Munger, who knew Singleton, commented: “Henry Singleton was a genius who could play chess blindfolded just below grandmaster level. I knew him – he lived in my community. He started with a conglomerate, and he managed those companies on a way more centralized basis that Berkshire ever operated. In the end, he wanted to sell to us and he wanted Berkshire stock. We said, we love you and we want to buy your business, but we don’t want to use Berkshire stock. Just because he’s a genius doesn’t mean he did it better than we do. Charlie: He was an enormously talented man and his cool rationality was to be admired. I like our system better.” Buffett added the most important part about value investing that the author of “The Outsiders” fail to address, about how “promoted” stocks can be so dangerously alluring: “Henry made a fortune for shareholders that stuck with him. He made at least 50 acquisitions in the 1960s. He promoted the stock. It was a game that worked wonderfully, if you don’t care how it ended up.” Interestingly, in the latter years of Teledyne when Singleton handed over the CEO position in 1986 at the age of 69, it faced a number of legal problems and it was fined $17.5 million in 1988 after pleading guilty to officials for having made false statements. In the early 1990s, two lawsuits were also brought against Teledyne by whistleblowers for falsifying test reports for relay devices sold to the US government for weapons and spacecraft use, and with padding government contract cost estimates. Teledyne settled both cases for $112.5 million, at the time one of the largest settlements by military contractors. And the mighty oak tree Teledyne was broken up and collapsed, while Berkshire Hathaway the Bamboo Innovator remained evergreen and upright throughout the multiple crises over the decades.

(2) China, emerging market and macro

In a reply to a question from a shareholder from Shanghai on whether Buffett has any plans to invest in China, Buffett displayed moral courage and wisdom in reversing his previously optimistic views on China: “We have no new plans to invest in China. There’s no competitive advantage in China.” While Berkshire’s investment in China’s electric car maker BYD is still up around 3-fold since his 2008 investment, the auto- and battery-maker reported a drop of 94% in net profits for the year 2012, blaming it on China’s slowdown and its difficulties in making headways in the exports market. The pessimistic remarks by Buffett was a sharp contrast five years ago when he also invested in a new plant in Iscar in Dalian, a coastal city in northeast China, saying China has huge potential. Contrast BYD to SUV-maker Great Wall Motor who had a record profit year in 2012 despite the macro downturn in an article that I wrote earlier over here.

In a related question from another shareholder who asked how do Buffett and Munger view investments in emerging markets, and what kind of companies are they interested in, Buffett commented, “Emerging markets aren’t our specialty. If we were poor enough, we might even consider doing that” and Munger said dryly, “It’s a great way to sell investment advice – something in every category. Lots of commissions, lots of advice, lots of action.” Buffett added, “Whenever you hear people talk about concepts, for instance, country by country ideas, they are probably better at selling than investing.” And Munger quipped, “’Our experts really like Bolivia’. You say ‘last year you really liked Sri Lanka’” Buffett ended: “We usually think it is a lot of baloney.”

Yet, perhaps both the sagacious Buffett and Munger were seduced by China’s growth potential at the “macro” level but overlooked the “micro” aspects in whether the underlying firm has competitive strength in the first place. I had earlier discussed how value investors in Asia can make sense of the macro vs micro dilemma over here.

(3) “Contradictory” views in business model at Pampered Chef (vs Herbalife) and Benjamin Moore Paints (vs Sherwin Williams)?

There seem to be some contradictory views across the Q&As in the morning and afternoon sessions. When asked by one of the shareholders on his opinion on multi-level-marketer Herbalife, given that Berkshire owns Pampered Chef who also operates in a MLM fashion, Buffett replied, “I have never looked at Herbalife 10-k. So I don’t know their operation. The key is whether multi-level marketing is based on selling products to end-user instead of loading up distributors. Pampered Chef is a million miles away from preying on distributors. True, people get paid on recruit accounts. But, loading up people with packages that they don’t sell, that’s not Pampered Chef. It is based on selling to the end user. We have thousands of parties every week that sell to people that use it. It is wrong to sell people on a dream that is not fulfilled.” And Munger made another of his immortal quotes: “Life is likely to be more flimflam selling magic potions than pots and pans.” So the key to the durability of a “services” business model is about getting closer to the end customers. Services sustainability has to stem from equitizing customer ownership based upon performance and interaction, trust, mutual respect and interdependency.

In the afternoon, there was a question from an analyst about the paints business in comparing Berkshire’s Benjamin Moore, “I always use Benjamin Moore, but some argue that because it doesn’t control distribution as Sherwin Williams, it lacks the ability to control its destiny. Others point to price competition at outlets from Behr. You recently replaced management. What sort of changes are you going to make?” Buffett shed his insights about the difference in business model: “Benjamin Moore is a relatively small part of the paint industry, but it is the best regarded at the high-end. When we purchased Benjamin Moore, I promised that we’d support the dealership system (those people had invested their livelihood in the dealership). We were always approached by big-boxes, and we could’ve pushed up volume. That would’ve really changed distribution, It wouldn’t have worked out that well over time, and it would have been double-crossing management and the dealership. A dealership network can work with a high-end paint like Benjamin Moore. We were actually approached to buy Behr. Management wanted to gut the business and break my promise, so we had a change in management. Our strategy will be a dealership model focused on the high-end. It doesn’t mean Sherwin-Williams won’t do well – they should do extremely well. Benjamin Moore is a good business, and will continue to be so.”

Perhaps the paints business is not just a “products” business to be ‘distributed” to customers, but rather it takes a “services/solution” business model to unlock a powerful compounder. The Sherwin Williams of Asia is an Indian company called Asian Paints with a market value of over $8 billion, compounding 29-fold since October 1999 relative to the 400% for the Indian Sensex index over the same period. I have discussed this company at Emerging Value Summit 2013. Like in America, distribution was also complex for Asian Paints in India. To escape the pressures of commoditization, It tried to be a Benjamin Moore by positioning itself as a premium brand in the mid-1990s and failed to ignite any end consumer interest. Asian Paints realize that its brand needed to be about people and homes to strengthen that emotional connection with its “Every home has a story to tell” and invest in ways to reach out to end customers directly, one of which was a GEICO-inspired customer help line. From analyzing these calls, Asian Paints learnt about the unmet customer expectations when it came to service (they are buying a paint job service, not a paint can product), information which the distributors do not bother to collect and share. So it went from a strictly product-based manufacturing business toward one that incorporated a services model that provide advice and information on what colors go best with other colors in their line of paints and offers designs for customers to follow. The launch of this Asian Paints Home Solutions has Wal-Mart-like features too: its channel partners can obtain status information on each paint job (quote, time to receive paint to completed job to payment) when they entered into the technology platform built by Asian Paints that served as a virtual back office. The new solution allow all parties to view all customer interactions, customer satisfaction level and financial information in real time, bringing total costs down, boosting margins, and still allowing its channel partners to enjoy better service and lower costs.

Thus, while Buffett talks about Pampered Chef being different from its MLM peers in its ability to sell directly to the end user rather than preying on distributors, he recognized the business model limitations of Benjamin Moore which had a high-end quality product but still reliant on distributors whereby the end “product’ did not have a service/solution element wrapped around it to truly meet customer expectations.

(4) Investing process: Valuations and quant measures; checklist, accounting, financial statements and detecting frauds

When asked by a shareholder on Buffett’s top five quantitative measures to analyze a company, Munger commented sharply, “People with high IQs and who are good at math naturally look at the numbers. That’s not how to invest”, to which Buufett added, “You’d do it poorly”. Buffett elaborated: “We think of businesses, not stocks. When we look at Value Line or newspapers, different numbers matter for different businesses. We see certain things that suggest further investigation. And, over the years, we’ve come to understand certain businesses. And, we don’t analyze those we don’t know. We just keep learning, and now-and-again, we find some opportunity. I look at what a business will look like in 10-15 years, the price today, and the difference between the two.”

In response to a shareholder’s question on how Buffett said that when he’s reading through financial statements, he’d find companies he was virtually certain are frauds and so what did he find that made him so certain, Buffett replied: “It varies over the years. We can’t identify 100%, 90%, 80%… but people give themselves away. In poker, it’s called tells. We try to assess the individuals that we’re dealing with. We don’t think we can assess everything accurately. But we try to be right when we make a buy. In looking at financials, for example, in insurance, you can see things done with lose reserves. Before offering stock to the public, reserve would mysteriously go down. I’ve seen how promoters act. You can spot certain people that are playing games with the numbers. I can’t give you a 40-item checklist.” Munger added, “Sometimes it’s pretty obvious. I was once introduced to a man who wanted to sell us a fire insurance company. One of the first things he said to us – with a thick accent… Eastern European, I think – said, it’s like taking candy from a baby. He said, ‘we only write insurance for concrete structures that are underwater’”. Buffett elaborated, “We’ve had some experiences with a lawyer in the movie industry. When you get into accounting… so many ways you can cheat in accounting. It’s funny, they’ve worked harder and harder on disclosure. I’m not sure I find financial statements any more useful.

(5) Defining and categorizing moats and valuation

A shareholder has asked whether Buffett can talk a little bit more about the ideal investment, how he define and categorize moats. Buffett said, “I don’t understand the moat around IBM as well as Coca-Cola. I’d have more conviction around Coca-Cola or Wrigley or Heinz. But, I feel good enough about IBM, and I put a considerable amount of money in IBM. It’s hard for me to think of things that could wrong with BNSF. I could think of things that could go wrong for IBM. IBM has big pension liabilities — it’s an annuity business on the side. The liabilities and assets seem equal, but the liabilities are more certain. At least they have a sales force pushing them on.”

There is a related question from a shareholder on whether Buffett can be more specific about what factors he considers when making an acquisition like Heinz, and just what is his thought process for large acquisitions and the price. Buffett replied, “We usually feel we’re paying too much. We sometimes feel the business and management is so compelling, we gag on the price. In the past, when we bought wonderful businesses, that continued to be wonderful, we could’ve paid more. But, you never know for sure. It isn’t as precise as you might think. If you think there is a high degree of certainty of high returns on capital, you should probably stretch for it. There have been several times, and then Charlie or I will say, let’s do it. Charlie did that with See’s Candies.”

I find that this is an interesting reply as value investors often grapple with the usefulness of the traditional net-net Graham approach that might result in picking a value-trap or cigar-butt and the fear of deviating too much from the value investing principles of not overpaying. I have written briefly about “Japan’s Heinz” and a “quality” measure, the Gross Profit/Total Asset (GP/TA) ratio, that institutional investors are using to identify companies which outperform because their future growth potential is underappreciated. I also find the following Q&A to be particularly useful to resolve this perennial tension. In the afternoon session, an analyst asked Buffett and Munger that over time, Fruit of the Loom (FOTL) has lost the t-shirt market to wholesale, low-cost franchises. Now, they’re trying to hold the underwear market. What protects them from a similar fate here? Buffett replied, “You keep your costs down, work at brand building, try very hard that your main customers keep their customers happy with good price points. Gildan is good with the non-branded aspects of the business, which has hurt Fruit of the Loom. But, we turn our first-quality, low-price underwear with strong brand recognition. I think 10 years from now, our market share in Men’s and Boy’s underwear will hold up. You can’t coast in the business — it’s not Coca-Cola. You won’t get great margins, but the business will do alright.” Munger, who urged Buffett to invest in FOTL in Jan 2002 for $835 million in cash at a “bargain price”, is more blunt and displayed moral courage with his reply, “We’re not going to win every skirmish or every battle.

When Berkshire bought FOTL in 2002, its “moat” then was its “low-cost” business model to manufacture quality low-priced products. Buffett joked how Munger encouraged him to buy the underwear company. “Warren, we have to get into women’s underwear,” Buffett said, imitating Munger. He then added, “And he’s 78. It’s now or never!” Interestingly, the same $835 million can buy either the entire FOTL at a bargain price or 20% of either Limited Brands (owner of lingerie Victoria Secrets and other brands) or VF Corp (brand owner of North Face, Nautica, Timberland and so on) at a reasonable or even premium price, so which is more attractive, particularly given the all-important nudge by Munger himself to Buffett towards the direction of “buying a wonderful business at a moderate price” as opposed to “just paying for bargains”? Limited Brands has since climbed 260% to an all-time high market value of over $14 billion, while VF Corp has rose 360% to an all-time high market cap of over $19 billion. And Gildan Activewear is up 12-fold to $5 billion in market cap from $473 million in 2002, when its market value is nearly half the size of FOTL!

(6) Making decisions

I like this part about how Munger commented how Buffett makes decisions: “We didn’t know when we started out that you shouldn’t make a lot of decisions when you’re tired, or that making a lot of decisions is tiring. We didn’t know that consuming caffeine and sugar was helpful for decision making (laughter). It turns out that this is an ideal way to sit where Warren sits. He didn’t know that – he just stumbled into it. I cannot remember an important decision that Warren made when he was tired. He sleeps soundly. He eats what he’s always eaten. Charlie: His style is absolutely perfect for human cognition.” Buffett then joked, “When we write our book on nutrition, it will be a huge seller (laughter).”

Finally, I enjoyed the reply by Buffett to Doug Kass who questioned Buffett that perhaps he has reached a point where the game matters more than the score because it seems that Buffett’s analysis is less thorough these days and has shifted from in-depth, sleuthing of companies’ fundamentals a la his Amex investment to his Bank of America investment, which Buffett said he made in his bathtub. Buffett replied, “You have to love something to do well at it. It’s a big advantage if you love it. It adds to your productivity. I have that intensity, not manifested the same way, but it’s there. I love thinking about Berkshire, its investments, its businesses. You can’t separate the game from the scorecard. But, I’d still feel the same about Berkshire if I didn’t get paid or own a share. It’s what I love to do. Just because we do things differently doesn’t mean we’ve lost any passion or intensity. That was true 40 years ago, and hopefully it’ll be that way in 10 years.” Munger added, “I think when you bought Amex you didn’t know that much, so naturally you were digging deeply. The second time you were on the golf course. The first time is hard, the second is easy. It’s cumulative.” And Buffett elaborated, “What I learned sitting at GEICO in 1951 is still useful. The universe… there’s enough in it that you can find opportunities. I didn’t know a thing about American Express in 1963 (Salad Oil Scandal), but I learned a lot about it. I absorbed knowledge.

I just like to end by saying that I am grateful to be able to share my insights from the Berkshire meeting with the value investing community using the Bamboo Innovator mental model!

Koon Boon KeeKoon Boon Kee is the founder and managing director of the Singapore-based Bamboo Innovator Institute to establish the thought leadership of resilient value creators around the world. KB has been rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets. He was a fund manager and head of research/analyst at Aegis Portfolio Managers, a Singapore-based investment management organization dedicated to the craft of value investing in Asia. He had been with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-old flagship fund. He was previously the portfolio manager for Asia-Pacific equities at Mirae Asset Global Investments, Korea’s largest mutual fund company. He received his Masters in Finance (magna cum laude) and double degree in Accountancy and Business Management (both summa cum laude) from the Singapore Management University (SMU). He had taught accounting at his alma mater in SMU and published research in the Special Issue of Istanbul Stock Exchange 25th Year Anniversary of the Boğaziçi Journal, Review of Social and Economic Studies, as well as wrote articles about value investing and corporate governance in the media.

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