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Every year, thousands of people pack into an in-house arena in downtown Omaha for the world’s best attended annual general meeting. More than half a century after chairman Warren Buffett started the event by entertaining a few friends at a local restaurant, more than 40 000 devotees make the annual pilgrimage to the US’s 43rd largest city to take in five and a half hours of undistilled wisdom from the Oracle of Omaha and his long-time business partner and Berkshire’s deputy chairman Charlie Munger. This year the event was webcast for the first time ever, giving us the opportunity to record and transcribe the proceedings. We had a few technical issues. and a few of the questions were of marginal interest to outsiders, but most are fascinating even for those who know nothing of Berkshire, now the world’s fifth most valuable company. Here’s the first of the transcripts of the Warren and Charlie show. This segment gives considerable focus to Berkshire’s biggest ever transaction (Precision Castparts) and freewheels through to why the duo have had such happy lives. It also contains the first of many references Buffett made during the meeting to the rising power of Amazon.com – hope you own the shares. – Alec Hogg
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This year’s question and answer session kicked off with a shareholder wanting to know why Berkshire now invests in so many companies that require lots of capital; are over-regulated and generate low returns on equity…
WARREN BUFFETT: Well, it’s one of the problems of prosperity. The ideal business is one that takes no capital but yet grows. There are a few businesses like that and we own some, but we’d love to find one that we can buy for $10bn/$20bn/$30bn that was not capital-intensive and we may, but it’s harder and that does hurt in terms of compounding earnings growth. Obviously, if you have a business that grows, gives you a lot of money every year, and it isn’t required in its growth, you get a double-barrel effect: from the earnings growth that occurs internally without the use of capital, and then you get the capital it produces to go and buy other businesses.
See’s Candy was a good example of that. Back when the newspaper business was good, our Buffalo Newspaper was a good example of that. The Buffalo Newspaper was making (at one time) $40m per year and had no capital requirements. So we could take that whole $40m and go buy something else with it.
Increasing capital acts as an anchor on returns in many ways.
One of ways is that just in terms of availability, it drives us into business that are much more capital-intensive. You just saw for example Berkshire Hathaway Energy where we just announced – just in the last couple of weeks – a $3.6bn investment coming up in wind generation. We’ve pledged over $30bn for renewables. Anything that Berkshire Hathaway Energy does… anything that BNSF does, takes lots of money. We get decent returns on capital but we don’t get the extraordinary returns on capital that we’ve been able to get and in some of the business that are not capital-intensive.
As I mentioned in the Annual Report, we have a few businesses that actually earn 100 percent per year on true invested capital and clearly, that’s a different sort of operation. Something like Berkshire Hathaway Energy may earn 11 or 12 percent on capital. That’s a very decent return, but it’s a different sort of animal than a low capital-intensive business. Charlie?
CHARLIE MUNGER: Well, when circumstances changed, we changed our minds – slowly and reluctantly. In the early days…quite a few times, we bought a business that was soon producing 100 percent per annum on what we paid for it and didn’t require much reinvestment. If we’d been able to continue doing that, we would have loved to. But when we couldn’t so we went to Plan B. Plan B’s working very well and in many ways, I’ve gotten to where I sort of prefer it. How about you, Warren?
WARREN BUFFETT: That’s true. When something’s forced on you, you might as well prefer it. We knew that was going to happen. The question is, “Does it lead you from a sensational result to a satisfactory result?” We’re quite happy with a satisfactory result. The alternative would be to go back to working with tiny sums of money and that really hasn’t gotten a lot of serious discussion between Charlie and me.
What gave you the confidence to pay such a big price and high multiple for Berkshire’s largest ever acquisition, Precision Castparts?
WARREN BUFFETT: We completed the acquisition of Precision Castparts at the end of January this year. We made the deal last August. The most important asset is Mark Donegan, who runs Precision Castparts. He is an extraordinary manager. Charlie and I have seen a lot of managers over the years and I would almost rank Mark ‘one of a kind’.
He is doing extremely important work in terms of primarily making aircraft parts. I would say that there are certainly no disadvantages for him to be working there, and for that company to be a subsidiary of Berkshire, and not be a public company. I think he would say – and I think Charlie and I would agree – that over time, there could be some significant advantages. For one thing, Mark can spend 100 percent of his time now on figuring out better things to do with aircraft engines.
It was always his first love to be thinking about that and he did spend most of his time on it. But he also had to spend some time explaining quarterly earnings to analysts and perhaps negotiating bank lines, etcetera. His time, like all of our managers, can be spend exactly on what makes the most sense to them and their businesses. Mark does not have to come – ever – to Omaha to put on some show for me in terms of justifying a $1bn acquisition or planned investment. He doesn’t have to waste his time on anything that isn’t productive. And when running a public company, you do waste your time on quite a bit of stuff that isn’t productive. I would say we’ve taken the main asset at Precision Castparts and made it (him, in this case) even more valuable to the company.
In terms of acquisitions, Precision has always made a number of them but being part of Berkshire, there’s really no limitations on what can be done. There again, Mark’s canvas has been broadened and enlarged with the acquisition by Berkshire. I see no downside whatsoever. If he needs capital, I’ve got an 800 number. It wasn’t paying much of a dividend before but doesn’t need to pay any dividend now. Precision Castparts will do better under Berkshire than it would have independently, although it would have done very, very well independently. Charlie?
CHARLIE MUNGER: Well, in the early days, we used to make wiseass remarks. Warren would say, “We buy a business that an idiot could manage” because sooner or later, an idiot will. We did buy some businesses like that in the early days and they were widely available. Of course, we preferred to do that but the world has gotten harder and we had to learn more powerful ways of operating. A business like Precision Castparts requires a very superior management that’s going to stay superior for a long time. We gradually have done more and more of that and it’s simply amazing how well it works. I think that to some extent, we’ve gotten almost as good at picking superior managers as we were in the old days, at picking the no-brainer businesses.
WARREN BUFFETT: We won’t be able to find them because they’re very rare birds, but we would love to find another three or four of a similar type to Precision Castparts where they are forever going to be producing something where quality is enormously important. Where the customers depend very heavily on them when there are contracts that extend over many years, and people don’t simply take the whole bid in order to get this gadget. It’s very important that you have somebody there who has enormous skill running the business and their reputation among aircraft manufacturers and engine manufacturers is absolutely unparalleled.
When looking backwards, what would you have done differently in life in your search for happiness?
WARREN BUFFETT: Well, I’m 85 and I can’t imagine anybody any happier. By accident or whatever, I’m sitting here eating exactly what I like to eat, doing exactly what I love doing in life with people I love. It really doesn’t get any better than that.
I did decide fairly earlier in my life that my favourite employer was myself.
I manage to avoid aggravation of any sort. If you or those around you whom you love have health problems or something, that is a real tragedy and there’s not much you can do about it, but accept it. Charlie and I have really been blessed. Here, Charlie is 92. I’m 85. Every day he’s doing something that he finds fascinating. I think he probably finds what he’s doing at 92 as interesting, as fascinating, as rewarding, and as socially productive as any period you can pick in his life. We’ve been extraordinarily lucky. We’re lucky it’s a partnership. It’s more fun doing things as a partnership. I have no complaints. I would say that if you’re talking about business life, I don’t think I would have started with a textile company. Charlie?
CHARLIE MUNGER: Well, looking back, I don’t regret that I didn’t make more money or become better known, or any of those things. I do regret that I didn’t wise up as fast as I could have but there’s a blessing in that, too. Now that I’m 92, I still have a lot of ignorance left to work on.
Why has Berkshire sold down its holdings in Munich Re – the world’s biggest reinsurance company – while sticking with the reinsurance operations within Berkshire? Would you reduce exposure to Berkshire Hathaway Reinsurance and General Re if they were listed companies?
WARREN BUFFETT: Yes. I said in the Annual Report that I thought it was very likely that the reinsurance business would not be as good in the next ten years, as it has been in the last ten years. I may be wrong on that but that’s a judgment based on seeing the competitive dynamics of the reinsurance business now versus ten or 20 years ago. We sold our entire holdings, which were substantial in both Munich Re and Swiss Re. We owned about three percent of Swiss Re and we owned more than ten percent of Munich Re and last year, we sold those two holdings. They’re fine companies. They’re well-managed companies. I like the people that run them. But I think the business of the reinsurance companies – generally – is less attractive for the next ten years than it has been for the last ten years.
In part, that’s because of what’s happened to interest rates. A significant portion of what you earn in insurance, comes from investment of the float and both of those companies (and for that matter, almost all of the reinsurance industry) are somewhat more restricted in what they can do with their float because they don’t have this huge capital cushion that Berkshire has. In addition, they don’t have this great amount of unrelated earning power that Berkshire has. Berkshire has more leeway in what it can do, simply because it does have capital that’s many times what its competitors have and it also has earning power coming from a whole variety of unrelated areas. It was not a negative judgment in any way on those two companies. It was not a negative judgment on their management, but it was at least a mildly negative judgment on the reinsurance business.
At Berkshire, we have the ability to actually rearrange, to a degree. We are certainly affected by industry factors but we have more flexibility in modifying business models and we’ve operated that way over the years in insurance generally, and particularly in reinsurance. Munich, Swiss, and all the major reinsurance companies – except for us – are pretty well tied to a given type of business model. They don’t really have as many options in terms of where capital gets to go. They have to continue down the present path. I think they’ll do fine but I don’t think they’ll do as fine in the next ten years as they have in the last ten. If we played the same game as we were playing the last ten, we would do as well but we do have considerably more flexibility in terms of how we conduct all of our insurance operations, but particularly in reinsurance.
We have an extra string to our bow that the rest of the industry doesn’t have. It is no fun running a traditional reinsurance company, having money come in – particularly if you’re in Europe – and looking around for investment choices to find out that a great many of the things that you were buying a few years ago now have negative yields. The whole idea of ‘float’ is that it’s supposed to be investor-positive rate and deliver a fairly substantial investor-positive rate. That game has been over for a while and it looks like it will be at least unattractive, if not terrible, for a considerable period in the future. Charlie?
CHARLIE MUNGER: There’s a lot of new capacity in reinsurance and there’s a lot of very heavy competition. A lot of people from finance have come over into reinsurance and all the old competitors remain, too. That’s different from Precision Castparts where most of the customers would be totally crazy to hire some other supplier because Precision Castparts is so much more reliable and so much better. Of course, we like the place with more competitive advantage. We’re learning.
WARREN BUFFETT: To put it in terms of Economics 101: in reinsurance, supply is going up and the band is not going up. Some of the supply is driven by investment managers who would like to establish something offshore where they don’t have to pay taxes and reinsurance is the easiest beard behind which to actually engage in money management in a friendly tax jurisdiction. You can set up a reinsurance operation with very few people, by taking large chunks of what brokers may offer. It’s not the greatest reinsurance in the world and a couple of the operations that have done that have proven that statement to be right.
But nevertheless, it is a very easy way to have a disguised investment operation in friendly tax jurisdiction but that becomes supply in the reinsurance field. Supply has gone up relative to demand and it looks to me like that will continue to be the case. Couple that with the poor returns on float and it’s not as good a business as it was.
GEICO really got whipped by Progressive Direct over the last year. Why is GEICO suddenly losing to Progressive Direct?
WARREN BUFFETT: I forget what year it was when we passed Progressive. GEICO’s growth rate for the first quarter was not as high as in the past couple of first quarters but it was quite satisfactory. Now the first quarter is by far the best quarter for growth but last year, both frequency (how often people had accidents) and severity, which is the cost per accident (in other words, just how much those accidents cost you) – both of those went up quite suddenly and substantially. Progressive’s figures showed that they were hit by that less than All State and GEICO, and some others. I don’t necessarily think you’ll see those same trends this year.
It’s an interesting thing. Last year, for the first time in I don’t know how many years, the number of deaths in auto accidents per 100-million miles went up. If you go back to mid-1930, there were almost 15 people killed per 100-million miles driven. It got down to just slight over one (from 15 to one). You had roughly, as many people killed in auto accidents in mid-1930 (about 30 to 33-thousand per year) as we had last year or the year before when people drove almost 15 times as many miles. Cars have gotten far safer and it’s a good thing because if we had the same rate of deaths from auto accidents as we had in the 30’s relative to miles driven, we would have had over half-a-million people die last year from auto accidents, instead of a figure closer to 40-thousand.
Last year, for the first time, I think there was more distracted driving so you really had this uptick in frequency and more importantly, in severity of auto accidents.
GEICO has adjusted its rates. As I mentioned, my own prediction would be that the underwriting margins at GEICO would be better this year than last year, although you never know when stats revision comes along. March and April have had a lot of cap activity. I made a bet a long time ago on the GEICO model versus the Progressive model and as I say, they were significantly ahead of us in volume a few years back. We passed them and we passed All State, and as I put in the Annual Report, I hope that on my 100th birthday, the GEICO people announce to me that they’ve passed State Farm but I have to do my share on that too, by getting to 100. We’ll see what happens on that particular one. Charlie?
CHARLIE MUNGER: Well, I don’t think it’s a tragedy that some companies have a slightly better ratio from one period. GEICO has quintupled its market share since we bought all of it. I don’t think we should worry about whether somebody else had a good quarter.
WARREN BUFFETT: Yes. I think it’s far more sure that GEICO will pass State Farm someday than that I’ll make it to 100. I’ll put it that way.
With the rise of Amazon.com and others, there’s been a shift from push marketing to pull marketing – from millions of catalogues having been sent out in the past, to consumers now searching online for what they are looking for. What is your take on how this shift?
WARREN BUFFETT: The development is huge – really huge – and it isn’t just Amazon. Amazon is a huge part of it and what they’ve accomplished in a fairly short period of time, and continue to accomplish, is remarkable. The number of satisfied customers they’ve developed… We don’t make any decision involving even the manufacturing of goods, the retailing, or whatever it is without thinking long and hard about what the world will look like in five, ten, or 20 years. With that hugely powerful trend that you just described, we don’t look at that as something where we’re going to try and beat them at their own game. They’re better than we are at that.
Charlie and I are not going to ‘out-Bezos’ Bezos by a long shot, but we are going to think about that. It does not worry us.
Obviously, with the Precision Castings it doesn’t worry us in terms of the overwhelming majority of our businesses, but it is a huge economic trend that 20 years ago was not on anybody’s radar screen. Lately it’s been on everybody’s radar screen and many of them (including us, in a few areas) have not figured a way either to participate in it or to counter it. GEICO is a good example of a company in an industry, which had to adjust to change and some people made the change better than others did. We were slow on the Internet. The phone and traditional advertising had worked so well for us. There’s always a resistance to think about…new possibilities. When we saw what was happening on the Internet, we jumped in with both feet. We’re mobile, but the nature of capitalism is that if you’ve got a good business, somebody’s always trying to figure out how to take it away from you and improve on it.
The effect of Amazon and others that are playing the same game…the full effect on the industry is far from having been seen. It is a big force, which has already disrupted plenty of people and it will disrupt more. I think Berkshire is quite well situated. For one thing, one big advantage we have is that we didn’t ever see ourselves as starting out in one industry. We went into department stores but we didn’t think about ourselves as department store guys. We didn’t think of ourselves as steel guys or tyre guys, or anything of that sort. We’ve thought of ourselves as having capital to allocate. If you start within a given industry, you focus and spend your whole time working on a way to make a better tyre or whatever it may be.
I think it’s hard to have the flexibility of mind that you have if you just think you have a (hopefully) large and growing pile of capital and trying to figure out what the next best move is that you can make with that capital. I think we do have a real advantage that way, but I think Amazon’s got a real advantage, too. This intense focus on having hundreds of millions of (generally) very happy customers getting very quick delivery of something that they want to get promptly… They want to shop the way they shop. If I owned a bunch of shopping malls, I would be thinking plenty hard about what they might look like ten or 20 years from now. Charlie?
CHARLIE MUNGER: Well, I would say that we failed so thoroughly in retailing when we were young, that we pretty well avoided the worst troubles when we were old. I think that Net Berkshire has been helped by the Internet. The help at GEICO has been enormous and it’s contributed greatly to the huge increase in market share. Our biggest retailers are so strong that they’ll be among the last people to have troubles from Amazon.
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