Sunday, 18th May 2014

2014 Berkshire Hathaway Annual Shareholder meeting notes and more

Written by George Traganidas Topics: Presentations, Stock Investing, Wealth Building

Berkshire Hathaway meeting

On Saturday 3rd of May I joined almost 38,000 other “students” to attend the master class for investors that is the Berkshire Hathaway annual meeting. People started queuing at 2:30 am on Saturday in order to get a front seat to listen to Warren Buffett and his partner Charlie Munger. A student was paid $100 to start queuing at 3:00 am for a shareholder who arrived at 7:00 am to take his place in the line. As per usual, Warren Buffett and his long time business partner Charlie Munger sat on stage in Omaha, Nebraska, for over five hours answering questions from reporters, financial analysts, and Berkshire shareholders. Many shareholders had travelled great distances to be part of the weekend.

The questions from the shareholders and the analysts covered a plethora of topics. Some of the questions answered were about the dividend policy that warren said that 97% of the shareholders rejected a resolution calling for dividend; that the company did not need to borrow money, even at today’s low interest rates and that breaking the Berkshire into four smaller companies would be a “terrible mistake”.

Here follow some of the questions and the answers Warren and Charlie gave in their typical humorous way:

Coca-Cola (NYSE: KO) has an excessive compensation plan, but you didn’t tell shareholders before the meeting. Had it been disclosed earlier, we might have voted differently. You abstained, and you must have your reasons. Why did you engage in this strange and un-Buffett-like behaviour?

Warren: Some people think that strange and un-Buffett-like are not different. The proposal was made by a shareholder opposed to the option program. His calculations of dilution were wildly off, and we didn’t care to get into a discussion of that. But I did talk to Muhtar Kent, and I told him that we would abstain. I told him that I admired the company, but the compensation was excessive. Immediately after, we announced that we had abstained and explained why. I think that is the most effective way of behaving for Berkshire. We made a very clear statement about the excessiveness of the plan, but without going to war with Coca-Cola. And, we didn’t endorse inaccurate calculations, or join forces with someone that I hadn’t interacted with. If you’re going to war, you want to know what that alliance might be. I think the best outcome was achieved by our abstention.

Charlie: I think you handled the whole situation very well.

Warren: Charlie was the only person that I discussed the vote with beforehand. I told him about the plan, and we agreed on the course of action. In fairness to David Winters, he took figures from the Coca-Cola proxy statement, but for those of you that would like to think it through … Coca-Cola has regularly repurchased shares issued by options, so the share count has come down a little. The plan is 500 million shares, and they expect to issue them over four years (leaving out the difference between performance shares and options) … let’s assume Coca-Cola is $40 per share, and all options are issued at $40 strike, and when they are exercised, the stock is $60 per share. At that point, there has been a $10 billion transfer of value. Now, the company gets a tax deduction of $10 billion; at present rates, that would result in $3.5 billion in tax savings. Add in $20 billion for the exercise of options, and Coca-Cola will receive $23.5 billion. So at $60 per share, KO could buy back a lot of shares — 392 million shares. So the dilution would be 108 million shares, or 2.5% dilution. I don’t like it, but it’s not as bad as has been suggested.

What do you do to gain the trust of founders/owners of companies you’ve bought out in the past?

Warren: We have kept our word. We are careful about what we promise. We can’t promise not to have a layoff. We can promise not to sell the business unless it has significant loses or labour problems. We do keep certain businesses that you wouldn’t get a passing grade in business school if you wrote down your reasons. We keep them because we made a promise, which we write in the back of our annual report. We can’t make the promise we’ll never break employment or sell a business, but we can keep the promise not to sell unless there is the prospect of unending losses or labour problems. If we didn’t keep our promises, word would get around. We have put ourselves in a class by ourselves for people that care about their business. It doesn’t matter to private equity — they don’t care. But some founders do care about the future of their businesses. They don’t want to see them torn apart by a few MBAs that want to show their stuff. We have a unique asset in Berkshire, and we’ll maintain it as long as we behave ourselves. Its valuable, and it’s how we like to operate.

Charlie: Obviously, we behave the way we do because we like doing it. We’re doing pretty well, and we’re unlikely to stop.

Your son Howard serves on the board of Coca-Cola, but voted for the compensation plan you said you didn’t like. Howard is going to be non-executive chairman of Berkshire after you and will “defend the culture.” How can we be comfortable with the different stance?

Warren: I have voted for some compensation plans and acquisitions that I didn’t like. The nature of boards is that they are part business organizations, and part social organization. And people use their business brain and their social brain. In 55 years of being on corporate boards of 19 companies, I don’t think I’ve ever seen a compensation report get a dissenting vote. The board organizes itself in a way that tasks are delegated, such as a comp committee, and the committee reports on its activities. And, you’ve delegated to that committee. The so-called independent directors are receiving $200,000 to $300,000 per year, but they are not independent. How would you feel about going to work 4-6 days per year with pleasant company, prestige, and pay of $300,000 per year? I’m assuming you’d like to get another job like that. Companies are not looking for Dobermans on the board, they are looking for Cocker Spaniels. Social dynamics are important in boards. Howard has a dedication to the culture at Berkshire. His job is not to set the compensation. He is there to facilitate a change if the board of directors decides it is needed. It is a nice safety valve. And, as I said, I voted for compensation plans that are far from what I would have designed myself. I was made chairman of one comp committee, and Charlie can tell you about that.

Charlie: Warren was chairman at Salomon. People didn’t like what he was doing. I think the general idea that people should shout about everything they disapprove of is just suspect. You have to choose your battles. I don’t think you need to worry about Warren. And, if we all screamed about everything we disapproved of, we wouldn’t be able to hear each other.

Warren: If you are in any social organization, if you keep belching at the dinner table, you’ll be eating in the kitchen. You need to pick your spots and how you do it. It’s not even a bad thought to keep in mind for marriage. It’s hard to change others’ behaviour, and it’s not helped by shouting.

Charlie: I can tell you that is true.

Berkshire has done a good job of earning outsized returns, but as you’ve said, that’s harder as you get bigger. What’s your cost of capital? How much confidence do you have that your successors can earn more than that?

Warren: There is no question that size is an anchor to performance. We intend to prove that up to the point that it really starts biting. We can’t earn the same returns on capital with over $300 billion in market cap. Archimedes said he could move the world with a long enough lever. I wish I had his lever. Our cost of capital is the production of our second-best ideas. I have listened to so many nonsensical cost-of-capital discussions. I have heard CFOs talk about it, but nobody knows what it is. The real test is whether the capital that we retain generates more in market value than is retained. If we keep billions, and the present value is more than we’re keeping, we’ll do it. We bought a company yesterday because we thought it was the best thing that we could do with $3 million on that day. I have never see a CEO want to a do a deal where the CFO said it didn’t exceed the cost of capital. We can evaluate businesses, and we have capital, and we have things we can sell (marketable securities, not businesses), and we’re constantly comparing. I have heard a lot of nonsense about cost of capital.

Charlie: A phrase like cost of capital means different things to different people. We just don’t know how to measure it. Warren’s way of describing it, opportunity cost, is probably right. The answer is simple: we’re right and you’re wrong.

Berkshire owns 79 unrelated businesses — a model which has almost universally not worked well, except at Berkshire. The probabilities do not seem favourable that it’ll work well for your successors.

Warren: The model has worked well for America. If you look at all these disparate businesses, such as if you looked at the Dow Jones index during its history as a single entity [though it rotated] going from 66 to 11,000… clearly something went right. Owning a group of good business isn’t a bad plan. Many conglomerates, such as Litton or Gulf and Western, were financial engineering. You were put together to issue stock at 20-times earnings and buy stock at 10-times. The idea was to fool people with this chain-letter approach. Our approach makes sense: great managers, great businesses, conservatively capitalized. Capitalism is about allocating capital, and we can do that without tax consequences. We can take money from See’s and move it to the place of best return, as the situation says, be it wind farms or whatever. And nobody is better to do that than Berkshire. But, it needs to be done with business-like principles, not stock promotion. You can see what happened with Tyco. If companies are issuing stock continuously, they are probably playing a chain-letter game. Charlie?

Charlie: I think there are a couple of differences between us and people who are generally thought to have failed at the conglomerate model. One is that we have an alternative. When there are no other companies to buy, we have securities to buy. Also, most of them were hell-bent to buy, and we feel no compulsion to buy for the sake of it. I don’t think we’re a standard conglomerate, and we’re likely to continue to do very well.

You have said that people should operate within their circle of competence? How should we figure out what our circle of competence is?

Warren: Good question! Some of the people in the audience identify with it (laughs). Be self-realistic. That applies outside of business as well. Charlie and I are reasonably good at knowing the perimeter of our circle of competence. I would say in my own case I’ve gone out of it more often in retail than any other arena. It’s easy to think you understand retail and then subsequently find you didn’t, as in the department store in Baltimore. You can say I was outside my circle when I bought Berkshire, though; I originally bought it to resell. But when I decided to buy control that was a dumb decision, but that worked out. Being realistic when realizing you own shortcomings is important. There are a number of CEOs who don’t know where their circle begins and ends! The best really know when they are playing the game that they’re going to win. The ultimate was Mrs. B at Nebraska Furniture Mart. She told me she wanted cash, not stock. It might seem like a bad decision, but it wasn’t. She didn’t know stocks. She knew cash, property and retail, so it was a good decision. When you’re playing the game, versus playing outside the game, knowing the difference is a huge asset. I can’t tell you how to do that yourself. Asking your friends who know you may help. Charlie’s helped me, telling me, “What the hell do you know about that?”

Charlie: I don’t think it’s as difficult to figure out competence as it may appear. If you’re 5-foot-2, you don’t have much future in the NBA, and if you weigh 350 pounds, you shouldn’t dance ballet. If you can’t hardly count cards at all, you shouldn’t try playing blackjack. But competency is a relative concept. What I need to get ahead is to be better than idiots, and lucky for me there was a lot of them.

Warren: You’re ruling out everything I want to do!

Why do you annually compare growth in Berkshire book value per share (BVPS) to the S&P 500?

Charlie: Warren wants to make it extremely difficult for himself. So if you don’t understand why people want to wear hair shirts, then you’ll never understand this. It’s insane, you’re right. It’s a way for Warren to make the comparison extremely difficult on himself.

Warren: Normally when he goes wishy-washy like that I like to clarify, but I think I won’t.

Being a young person without an ability to code or build robots, I don’t know technology. If you were 23 years old, what non-tech industry would you start a business in?

Warren: I’d probably do just what I did at 23, I would go into the investment business and I would look at lots of companies, talk to lots of people and learn what I could about different industries. One thing I did when I was 23: If I got interested in a coal business, I’d go and see the bosses of eight or 10 coal companies. I’d ask a lot of questions. One question I would always ask: If they had to put all their money in a company in the industry and go away for 10 years, which would it be. And if they had to sell short under the same conditions, which company would it be and why? And, if I talked to everyone in the industry like that, I would know more about the industry than anybody. There’s lots of ways to learn about the economic characteristics of companies, such as reading, personal contact, etc… But, you need a real curiosity about it. It really has to turn you on. And, what could turn you on more than asking questions about, for instance, coal companies? (laughs) And in my case, the insurance industry was particularly interesting, and perhaps you could become well equipped to run such a business someday. If you just keep learning things, something will come along that will be very useful. But you have to be open to it.

Charlie: Try the trick that Larry Bird used when he wanted a new contract, he asked all agents what agent he should hire if he didn’t hire that agent, and when they all came up with the same second choice he went with that second choice.

Warren: We did the same thing for Salomon. I called in eight or 10 of the managers. We had to open for business, and I had to have someone to run the place. I said “Who besides you would be ideal and why?” And one guy told me no one could compare to him. He was gone within a few months (laughter), but it’s not a bad system to use. You could really learn a lot just by asking (sounds like a Yogi Berra quote, but it’s true). People like to talk. You just have to be open to it, and you will find your spot. You may not find it the first day of the week, but you’ll find what fascinates you. I found it when I was 7 or 8. Sometimes it’ll take a while, but you’ll find it.

Charlie: It’s a very competitive business. When I was at Cal Tech and studied thermodynamics, there was a guy who was tremendously talented at thermodynamics. I realized that I’d never be as smart as him in that field. I tried other industries with the same results, so I just kept doing that until I ended up here.

Warren: I had a similar experience with athletics (laughs).

I’m a big fan of [Benjamin] Graham and [Philip] Fisher. What differences do you have for calculating intrinsic value than described in Security Analysis? For instance, how do you factor in management? Second, what company do you fear the most? Why has no one done what you have done?

Warren: Graham didn’t get too specific about intrinsic value in terms of precise calculations, but intrinsic value has become the same as private business value. Now, I’m not sure who first came up with it — well, actually, it was Aesop. The intrinsic value of any business is the present value of all cash distributed between now and judgment day. We’re not perfect in judging that, by the way. Aesop said a bird in the hand is better than two in the bush, in 600 B.C., and that hasn’t been improved much by business professors since then. The question is: How sure are you that there are two in the bush, how far away is the bush, what are interest rates? Aesop wanted to leave us something to work on, but that’s intrinsic value. Fisher would say he’d want to look at the qualitative factors in calculating the value of the birds in the bush. Graham would say he wants to see the $2 in the bush, one looking at qualitative factors and the other in quantitative factors. I started out influenced by Graham, so I emphasized quantitative factors, and Charlie came along and said I should value qualitative factors. And he was right. It’s really cash in, cash out. f I had a silver bullet, what company would I shoot? I see no competitor to Berkshire. I see private equity buying lousy businesses and leveraging up while debt is cheap. Which is the main occupation for Charlie and me. But I don’t see anyone with a model or trying to build one to go after what we are trying to achieve, which is buying a business from people that care about who they sell to.

Charlie: The Berkshire model as now constructed has legs and will go on for a long time. It has enough advantage that it will just keep going a long time and most businesses don’t. Of all the great businesses of yesterday, few have gotten big and stayed big. We’re getting to a territory where very few other people have done very well. But I think we’ll just keep going. We will keep doing what we’re already doing. We’ll keep learning from our mistakes. The momentum’s in place, the ethos is in place. It’s going to keep going. For the young people in the audience, don’t be too quick to sell the stock.

Warren: Why don’t we get more copycats? [to Charlie]

Charlie: It reminds me of Ed Davis, he took on an operation and he made this operation his own and all the other surgeons came and wanted to copy him. and they watched him do this operation and they said, well this is really hard and so maybe we won’t copy him.

Warren: Ed Davis is the guy who introduced the two of us, a famous urologist in Omaha. I think slowness turns off more people than anything else.

Charlie: It doesn’t look all that easy. It’s slow. The difficulty of being slow is that you’re dead before it’s finished.

Warren: Well, that’s kind of cheerful.

Then on Monday 5th of May, Warren Buffett, Charlie Munger and Bill Gates gave an interview to Becky Quick on CNBC’s “Squawk Box”. During this interview Becky asked more questions to clarify some of the answers Warren and Charlie gave in Saturday and asked some more questions. Some of the questions were:

Some people who didn’t understand why if you thought Coca-Cola’s equity plan was excessive, you didn’t say something before the vote and you didn’t take your 9.1 percent of the outstanding shares and vote no.

Warren: Yeah. We had no desire, never will have a desire to go to war with Coca-Cola. It’s a wonderful company, it’s treated us wonderfully, the management has always been totally candid with us. I think we’ve got the right leader. I’m sure we’ve got the right leader, Muhtar Kent, but we did think the program was excessive. With those two beliefs we felt the best thing to do was express our opinions privately to the management who listened carefully and to abstain from voting at this meeting. And we think — I know we’ll have some very constructive discussions with Coca-Cola between now and when they implement any plan.

Your son, Howard Buffet, is on the board of Coca Cola. He voted in favour of this plan and there were some people who questioned this. Howard is expected to be the chairman when you step away from the company to be the protector of the culture there. Does this raise any questions or should shareholders have questions about his ability to protect the culture when he voted for a plan that you, yourself, didn’t like?

Warren: Yeah. I voted for plans over the years — I’ve on the board for 55 years. I voted for plans I didn’t like. I actually voted for acquisitions I didn’t like. I opposed a few too, but there’s only so many bullets you can use in the gun. If you start objecting to this and this and this, pretty soon people don’t pay any attention to you. You want to save your bullets for when they really count. And I have never seen a comp committee come into a boardroom, in all my time, and hundreds of times, I’ve never seen them come in with a recommendation and heard a no vote. The board delegates to a committee. They say you go out and work on this. They may say to the Governor’s committee, you go out and work on getting directors, all kinds of things. And once a board has delegated to a committee and they’ve spent hours working on something, and then they report it and there’s 20 other items on the agenda and the Chairman calls on the comp committee to give his report and gives it in about 30 seconds, it never gets voted against. And it would be regarded as sort of usurping the power of the committee to all of a sudden say I’ve got a better idea. I haven’t talked to the compensation consultants, I haven’t looked at the figures, but I still have a better idea. It doesn’t happen.

You and Charlie have been excellent about knowing your circles of competency. There was a question from a shareholder this weekend asking how they could identify their own circles of competency. Charlie, do you have any advice to anybody who’s trying to figure that out themselves?

Charlie: Well I’m really better at determining my level of incompetency and then just avoiding that. And I prefer to think that question through in reverse.

Warren: He likes to invert. He says, all I want to know is where I’m going to die so I’ll never go there. I mean, that’s his approach generally is casting out a whole bunch of things. He’s good at pointing out where my levels of competency ends.

Charlie: All I can say is we have a good batting average, and that is probably because we’re probably a little more competent than we think we are. There’s some modesty in what we’re doing.

Warren: It probably is very useful. There’s a lot of reasons why the partnership works. But to have someone that you respect enormously say, you know, you’re really out in an area where you don’t belong, Warren. I mean, I will pay attention to him when he says that, and he’ll say it.
So there’s real utility in our functions together, for one to simply just say, are you sure you know what you’re talking about?

You two work so well together. When you look at a potential successor for the CEO position at Berkshire, how do you help them along the way to try and make sure that they find someone who they can work equally well with and who can also point out when maybe they’re making an incorrect decision?

Charlie: I hardly know anybody who’s done very well in life in terms of cognition that doesn’t have somebody trusted to talk to. Einstein would not have been able to do what he did without people to talk to. Didn’t need many, but he needed some.
You organize your own thoughts as you try and convince other people. It’s a very necessary part of operations. If you had some hermit sitting on a mountain, he wouldn’t do very good.

Warren: And Charlie, by the way…

Charlie: We have some of those, and they aren’t very good.

Warren: Charlie will always emphasize the fact that we ought to state the other guy’s case as well as he can and better than he can if possible. That’s when you get to where you can think through your own case better, and that may be his legal training to some extent. But he starts out stating the opposite case.

Watching Warren and Charlie answer any question with great honesty and humour is always educational and interesting. Every year that I attend the meeting or by watching their interviews I learn something new. I hope that they keep going strong for many years to come so the rest of us can learn more from their wisdom.

Follow the practical way,
George

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