Berkshire AGM 2017 – Why Warren’s wife will get an index fund (not BRK shares)

Warren Buffett has already distributed about 40% of his Berkshire shares to philanthropic causes, and on his death, it will all go to charities. His wife Astrid will only own the Vanguard S&P 500 index tracker. Buffett was asked why he has chosen the index fund over Berkshire shares – this segment of the AGM starts with his answer…

The big thing to anyone is not to be a problem and there will be no way whether she holds the S&P virtually in a way absent, something happened with weapons of mass-destruction but virtually there’s no way that she will have the money that she possibly can use. She’ll have liquid money, so that it’s structured down tremendously at some point, if they close the Stock Exchange for a while, or anything like that. She will still feel that she’s got plenty of money and the object is not to maximise it. It doesn’t make any difference whether the amount she gets doubles or triples or anything of the sort. The important thing is that she never worries about money for the rest of her life and I had an Aunt Katie here, in Omaha, and Charlie Noell had worked for her husband, as did I, and she worked very hard all her life and had lived in a house. She paid I think $8,000 for it, 45^th Hickory, all her life and because she was in Berkshire she ended up, she lived to 97. She ended up with a few hundred million and she would write me a letter every 4 or 5 months, and she’d say, “Dear Warren, I hate to bother you but am I going to run out of money?”

I would write her back and said, “Dear Katie, it’s a good question because if you lived for 986 years you’re going to run out of money.” Then about 4 or 5 months later she’d write me the same letter again, and I’ve seen there’s no way in the world, if you’ve got plenty of money, that it should become a minus in your life and it will be, people, if you’ve got a lot of money. They’d come around with various suggestions for you, sometimes well-meaning and sometimes not so well-meaning. So, if you’ve got something that’s certain to deliver, you know, it was all in Berkshire. They say, “Well if Warren was alive today, I know he would be telling you to do this.” I just don’t want anybody to go through that, and the S&P will be a…I think actually, what I’m suggesting is that a very high percentage of people should do something like that and I don’t think they will as I think there’s a chance they won’t have as much peace of mind if they own one stock and they’ve got neighbours, friends, and relatives that are trying to do some, like I say, sometimes with well intentions but sometimes otherwise, to do something else. So I think it’s a policy that will get a result and is likely to stick. Charlie…?

Well, as Becky said, the Mungers are different. I want to hold the Berkshire.

Well, I want to hold the Berkshire too.

No, but I mean I don’t…

I recognise the logic of the fact that the S&P algorithm is very hard to beat. In a diversified portfolio of big companies, it’s all but impossible for most people but, you know, I’m just more comfortable with Berkshire.

Well, it’s the family business but I’m seeing too many people if they get older they get susceptible just having to listen to the arguments of people.

Well, if you’re going to protect your areas from the stupidity of others you may have some good system but I’m not much interested in that subject.

Okay. Okay, Jay?

Berkshire reportedly parted with 3G in Kraft Heinz’s attempt to acquire Unilever for $143bn. How much was Berkshire willing to invest in this deal and does this mean Berkshires next large acquisition is likely to be in partnership with 3G?

Yes, well Kraft, you have to distinguish between two situations. Kraft Heinz was a widely-owned company, in which we and 3G act as a control group and have a little over 50% of the stock but as originally contemplated, it most certainly didn’t. It’s exactly as what would happen. We would have invested an additional $15bn and 3G would have invested an additional $15bn if a friendly agreement could have been reached.

#BRK2017: Munger – I don't see any moral fault at all in our partners 3G their retrenching people to make their businesses more productive.

— Alec Hogg (@alechogg) May 6, 2017

So if the deal had been made, if the independent directors of Kraft Heinz had approved the transaction then the likelihood is that we would have invested $15bn. But it would have required the approval of the independent directors as well. Now, Kraft Heinz in going forward with making that offer wanted to be sure that there would be enough equity capital in addition to the debt that would be incurred to make the deal, so informally, we basically committed the $15bn. It only was approved on the basis that it would be a friendly deal with Unilever and initially we thought they would be at least possibly interested in such a deal. When we found out otherwise we withdrew the offer, so it would have been $15bn of additional money in all probability. Okay, station 5?

Dear Honourable Mr Buffet and Mr Munger, I run a Chinese holdings company with a value lasting philosophy in Asia. My business partner and I are committed to awake 100 million Chinese people to return to the rational way of investing. The hardest thing in this world is to change peoples’ values or belief systems, and we would like to awake investors to change from to speculate in the market to investing in the market. It’s like changing the speculator’s values or belief systems. May I ask you, Mr Buffett, can you kindly advise us what we should do to spread your value investing philosophy or is there any word of encouragement?

In any system – Keynes wrote about this in 1936 in The General Theory of Employment, Interest and Money – I think it was chapter 12. It was a great chapter on investing and he talked about investment speculation and the perplexity of people to speculate and the dangers of it. He worded it eloquently there’s always the possibility, I mean there’s always some speculation obviously, and there’s always some value investors and all of that sort of thing in the market. But when speculation gets rampant and when you’re getting, well I guess Charlie would call ‘social proof’ that it’s worked recently. People can get very excited about speculating in markets and we will have it form time-to-time in this market. There’s nothing more agonising than to see your neighbour, who you think has an IQ of about 30 points below you, getting richer than you by buying stocks, and whether it’s internet stocks or whatever, and people succumb to it and those succumb in this economy, just as elsewhere. There’s also a point, which gets to your question. I would say that earlier on in the development of markets there is probably some tenancy for them, I think, to be more speculative than markets that have been around for a couple of 100 years. It has an invest…Markets have a casino characteristic that has a lot of appeal to people. Particularly when they see, like I said, people get rich around them, and those who haven’t and then through cycles before are probably a little more prone to speculate than, or people who have experienced the outcome of wild speculation.

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So basically in this country, Ben Graham, in the book I read in 1949, was preaching investment and that book continues to sell very well but if the market gets hot, new issues are doing well and people on leverage are doing well. A lot of people will be attracted to not only speculation but what I would call gambling and I’m afraid that would be true in the United States and I would think that China being a newer marketer, essentially in which there’s widespread participation. It’s likely to have some pretty extreme experiences in that respect. We will have some in this country too. Charlie…?

Well, I certainly agree with that. The Chinese will have more trouble. They’re very bright people, they’re all action and sure, they’re going to be more speculative and it’s a dumb idea, to the extent you’re working on it. Well, you’re on the side of the angels but lots of luck.

It will offer the investor more opportunities, if they can keep their wits about them. If you have wild speculation and Charlie just mentioned earlier that if we get into periods that are very tough, Berkshire certainly will do reasonably well because we won’t get fearful and fear spreads like you cannot believe, until you’ve seen a few examples of it. At the start of September 2008, you had 35-million people with their money in Money Market Funds, with $3.5trn in them and none of them were afraid that that Dollar wasn’t going to be a Dollar when they went to cash in their Money Market Fund, and three weeks later they were all terrified and $175bn floated out in three days. So, the way the public can react is really extreme in markets and that actually offers opportunities for investors. People like action and they like to gamble and if they think there’s easy money to be made a lot of them, you’ll get a rush to it and for a while it will be self-fulfilling and create new converts, until the day of reckoning comes. So just keep preaching, investing and if the market swings around a lot you’ll keep adding a few people here and there to a group that recognises that markets are there to be taken advantage of, rather than to instruct you as to what is going on. Okay, Andrew, any more on that Charlie?

We’ve done a lot of preaching, Warren, without much effect.

Right, and that’s probably good from our standpoint. Okay Andrew?

ANDREW ROSS SORKIN: Thank you, Warren. This question comes from Ryan Prince. President Donald Trump and his advisors have talked about proposing a substantial investment tax credit, to provide incentives from long-term corporate fixed capital investment. In BNSF, Berkshire owns a sprawling infrastructure portfolio requiring regular routine maintenance investment of substantial scale. What impact would an investment tax credit have on BNSF as capital investment decision-making from return on investment at capital perspective, as well as in terms of timing? Just as important, given the current economy and employment picture, would such a tax credit amount to a subsidisation of otherwise mandatory maintenance capital investment or a proper incentive to stimulate investment?

Well with all of that and what it’s worth because we’ve had investment tax credits in this country and we’ve had bonus depreciation, which is another form of it, and we do get extra for sheer depreciation. That does not enter into our calculation very much. In fact, certainly at a Berkshire level, I’ve never instructed anybody to do anything different because of investment tax credits or accelerated appreciation. There may be some calculations done down at the operating level. It’s certainly true in something like the wind projects and solar projects. They are dependent on the tax fall currently. There may come time when they’re aren’t but they wouldn’t have been done without some subsidisation through the tax law. I would say that if you change the depreciation schedules and double the appreciation, triple the appreciation – that, we’re going to do what we need to do at the railroad, to make it safer and more efficient if we just had ordinary depreciation and I doubt if there’s be any dramatic differences.

#BRK2017: Munger – You've got to remember the railroads were terrible businesses for decades. But then they got good. Things do change.

— Alec Hogg (@alechogg) May 6, 2017

Obviously, if you were going to say buy a bunch of planes and the law was going to change on 31^st December, and the math made it better from 1^st January, or do this December 31st you’ll make that calculation. But I can’t recall in all the years that I’ve ever sent out anything to our managers saying ‘let’s do this because the tax law is being changed’ or ‘might be changed’ or ‘something of the sort. As I mentioned earlier, a change is just a little bit if you think there’s going to be a change in capital gains rates, at a given time. Obviously, if the rates are going to be lower, give or take losses at a time and defer games maybe a little and that’s why it’s useful. Actually, if the Tax Committees in the Senate and ‘The House’ are working on something it might be useful if the chairmen would say that if we do make any changes we’re likely to use this effective date of something of the sort, and I think they’ve done that a few times in the past. We are not…The big tax driven item is in wind and solar and that is a specific policy because the government has decided they want to move people or society has decided they want to move people towards those forms of electric generation and the market system wouldn’t do it. There may come a time when the market system will do it all by itself. We won’t make big changes and it’s speculative anyway, in terms of even what the law would be but beyond that, if it becomes less speculative as the law, which looks like something that’s going too. It doesn’t change us big time at all. Charlie?

Nothing to add. I’m not going to change anything at the railroad for some little tax jiggle.

If we need a bridge repaired, we’re going to repair the bridge. We need a lot of track maintenance all the time and that sort of thing. It just, I don’t think Matt and I have ever had a talk about it since we’ve owned the railroad. Greg?

Warren, my question also relates to Burlington Northern. Despite the current administration’s belief that they can bring the coal industry back, market forces continue to lead into the industry’s demise. While 90% of US coal consumption is driven by electricity generation, natural gas has been both cheaper and cleaner burning, and renewable electricity generation has remade parts of the market as wind and solar have gained scale and became cheaper alternatives. This has created problems for Burlington Northern. With coal shipments accounting for just 18% of volume and revenue for the railroad last year, down from an average of 24% for both measures, the previous 10-years. Whilst some of this was due to the large build-up of coal supplies the past couple of winters, which finally seem to be working their out. What are your expectations for the contribution coal can make to be in a longer term and I know that the railroad currently handles some export shipments going through Canada’s specific coast ports but will there be enough rope there to offset domestic demand or will BNSF need to rely more heavily on segments like intermodal to offset lost coal volumes?

#BRK2017: Buffett – Widespread driverless vehicles would hurt Berkshire – safer trucks will affect BNSF, lower insurance premiums GEICO.

— Alec Hogg (@alechogg) May 6, 2017

Coal is going to go down over time. I don’t think there’s much question about that. The specifics of any given year relate, very importantly to the price of natural gas. I mean, right now the demand is somewhat up, a fair amount up from last year because natural gas is at $315 or $320 and the utilities can produce electricity, in many cases, quite a bit cheaper with coal than with natural gas. It would be natural gas but over time coal, in my mind, is essentially certain to decline as a percentage of the revenue. The speed at which it does, you don’t build or create generation plants and you can’t predict the rate and if natural gas is cheap enough it’s going to be…You’ll see a big conversion back to natural gas. Coal is going to go down as a percentage of revenues significantly. Certainly over 10-years it will be quite significant and who knows exactly, in my year where we are looking for other sources of growth than coal. If you’re tied to coal you’ve got problems. Charlie?

#BRK2017: Buffett – Very surprised if in 10 years we at Berkshire are not much bigger in renewable energy – we are the supplier of choice.

— Alec Hogg (@alechogg) May 6, 2017

If you go over the extremely long-term I think that all hydrocarbons will be used, including oil and coal, so I think that in the end these hydrocarbons are a huge resource for humanity and I don’t think we’ve got any good substitute. I’ve never minded saving them for the next generation. I don’t like using them up very fast, so I’m on a road of my own on this one. People think that all these hydrocarbons are going to be stranded and the whole world is going to change. I think we’re going to use every drop of the hydrocarbon sooner or later. We’ll use them as chemical feedstocks. I regard all these things as very hard to predict and I’m not at all sure that…I would eventually expect that natural gas to be pretty short in supply.

A change of storage would make a big difference. We will produce, within a few years, as much electricity in Iowa, and Berkshire gets much electricity in Iowa from wind as our customers use, but the wind only blows about 35% of the time or something like that and sometimes it blows too hard. But the storage, I’m having it 24 hours a day/7 days a week as a real problem. Even if we’ve got the capability of producing, like I say, a self-sufficient amount essentially, in Iowa before very long. Coal, our shipments of coal are up fairly substantially this year on the BNSF, but they were very low last year and, as you said, stockpiles grew and have come down somewhat, they’re still on the high side. But in my mind, Charlie has a longer-term outlook on this. In my mind, we’re going to be shipping a whole lot of this coal 10 to 20 years from now, than we are now. I think there’s some decent prospects in other long hauls. I mean it’s a pretty cheap way to move bulk commodities long-distance, railroad, and I think it’s a good business but the coal aspect of it is going to diminish. Okay, station 6?

Good morning, it’s Marcus Burns from Sydney, Australia. My question, Mr Buffett is, you’re used to buying capital light, cash generative businesses, but now buy lower growth capital consumptive businesses. I realise Berkshire generates a lot of cash flow but would shareholders have been better off if you had continued to invest in capital light companies?

Well, we’d love to find them. I mean, there’s no question that buying a high return on assets, very light capital intensive that’s going to grow, beats the hell out of buying something that requires a lot of capital to grow. This varies from day-to-day but I believe, and I don’t think it’s sufficiently appreciated, I believe that probably the five largest American companies, by market cap, and some days we’re in that group and some days we’re aren’t. Let’s assume we’re not in that group on any given day. They have a market value of over $2.5trn – $2.5trn is a big number, I don’t know what the average market cap of the US market is but that’s probably getting up close to 10% of the whole market cap of the United States. If you take those five companies, essentially you could run them with no equity capital at all, none. That is a very different world than when Andrew Carnegie was building a steel mill and then using their earnings to build another steel mill and getting very rich in the process, or Rockefeller was building refineries and buying tank cars. Generally speaking, over a very long time is our capitalism growing and earning large amounts of money required considerable reinvestment of capital and large amounts of equity capital. The railroads being a good example. That world has really changed and I don’t think people quite appreciate the difference but you literally don’t need any money to run the five companies that are worth collectively more than $2.5trn, and who have outpaced any number of those names that were familiar, if you looked at the Fortune 500 List, 30 or 40 years ago. Whether it was Exxon, General Motors, or you name it, so we love, I mean there’s no question that a business that doesn’t take any capital and grows and has almost infinite returns on required equity gavel, is the ideal business and we own a couple of businesses, a few businesses that earn extraordinary returns on capital but they don’t grow. We still love them but if they were in fields that would grow believe me, they would be number one on our list. We are seeing those that we can buy and that we understand well but you’re absolutely right. That’s a far, far better way of playing our money than what we’re able to do, when buying capital intensive businesses. Charlie?

Yes, the chemical companies of America, at one time, were wonderful investments. Dow and Du Pont sold for 20 sometimes earnings and it kept building more and more complicated plants and hiring PhD chemists. It looked like they owned the world. Now most chemical products are sort of commoditised and it’s a tough business being a big, chemical producer. In comes all these other people like Apple and Google and they’re just on top of the world. I think the question is basically right. That the world has changed a lot and that the people who have made the right decisions and getting into these new businesses that are so different from the old ones have done very well.

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Yes, Andrew Mellon would be absolutely baffled by looking at the high cap companies now. I mean the idea that you can create 100’s of billions of values, essentially without assets, or tangible assets.

And fast.

Fast, yes.

But that is the world. When Google can sell you something where GyGo was paying $11 or something every time somebody clicked something. That is a lot different than spending years finding the right site and developing iron mines to supply the steel plants and the railroads to haul the iron to where the steel is produced and distribution points and all that sort of thing. Our world was built, when we first looked at it, our US, our capitalist system, basically was built on tangible assets and reinvestment and all that sort of thing, and a lot of innovation and invention to go with it but this is so much better if you happen to be good at it. To essentially be able to build 100’s of billions of markets value without really needing any capital, that is a different world that existed in the past, and I think it’s a world that’s likely to continue. The trend is…I don’t think the trend in that direction is over by a long shot.

A lot of the people who are chasing that sort of thing very hard now, in the venture capital field are losing a lot of money. It’s a wonderful field but not everybody is going to win big in it. A few are going to win big.

Okay, Carol?

This question is from a shareholder in California, in the Silicon Valley area, who didn’t want his name mentioned because he said he wasn’t looking for publicity, but who’s picture makes him appear to be a millennial. Every Berkshire shareholder knows about the stock market value of Berkshire but my question is about the value of Berkshire to the world. For instance, the value of Apple to the world has been iPhones. The value of Geico has been auto insurance. The value of 3G, and I will tell you that some shareholders who would be arguing that here, but the value of 3G is improved operations. But about Berkshire, I just don’t know. In managing Berkshire’s subsidiaries, as Mr Munger once famously said, ‘you practice delegation just short of abdication.’ So, hand’s on management can’t be the answer. That means the majority of Berkshire’s subsidiaries would do just as well if they were to stay independent companies. That’s my question, what is the value of Berkshire to the world?

I’m with him to the point where he says, which he accurately describes as delegation to the point of abdication but I would argue that that abdication actually, in many cases, will enable those businesses to be run better than they would if they were part of the S&P 500 and the target perhaps, of activists or somebody who wants to get some kind of a giggle in the short-term. So, I think that our abdication actually has some very positive value on the companies. But you have to look at it, my company has probably got 50 managers in attendance here and naturally, they’re not going to say anything, probably on television or anything, where they’re not concerning but if you get them off in a private corner and just ask them whether they think their business can be run better with a management by abdication from Berkshire but with all the capital strengths of Berkshire, that want any project that makes sense can be funded in the moment without worrying whether the banks are still lending like in 2008, whether Wall Street will applaud it, or something in that sphere. So, I think our hands-off style actually, I think, can add significant value in many companies but we do have managers here that you could ask about that. We certainly don’t add the value by calling them up and saying that we’ve developed a better system, for turning up, or running Geico better than Tony Nicely, or anything of the sort but we do take a… We have very objective view about capital allocation. If we can free managers up, I would say that we might very well free up, at least 20% of the time, of a CEO in the normal public, who would otherwise have a public company. Just in terms of meeting with analysts and the costs and dealing with banks and all kind of things that essentially, we relieve them off. So, they can spend all of their time figuring out the best way to run their business, so I think we bring something to the party-benefit, even if we’re just sitting there with our feet up on the desk. Charlie?

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Yes, we’re trained to be a good example for the world. I don’t think we’d be having these big shareholder meetings if there wasn’t a little bit of teaching Ethos and Berkshire, and I have watched it closely for a long time. I’d argue that’s what we’re trying to do, is set a proper example. Stay sane, be honest, yeah… So, I’m proud of Berkshire and I don’t worry too much if we sell Coca-Cola.

Good news for shareholders kicking off #BRK2017 – short-term insurance arm GEICO wrote a record 700 000 new policies in first 4 months.

— Alec Hogg (@alechogg) May 6, 2017

I would say Geico is an extraordinary well-run company and it would be extraordinary well-run if it were public but it has gone from two-and-a-fraction percent of the auto insurance market to 12%. Part of the reason, a small part, the real key is Geico and Tony Nicely, but part of the reason is that when other, at least two of our competitors, big competitors, said that they would not meet their profit objectives if they didn’t lighten up their interest in new business, 8 or 10 months ago. I think our business decision to step on the gas, is a better business decision but I think that Geico, as a public company, would have more trouble making that decision than they do when they’re part of Geico because we are thinking about nothing but where Geico is going to be in 5 or 10 years, and if that requires…We want new business costs to catalyse earnings, in the short-term, and other people have different pressures. I’m not arguing how they behave because they have a different constituency than Geico has with Berkshire and what Berkshire has with its shareholders, in turn. I think, in that case, our system is superior but it’s not because we work harder, Charlie and I don’t do hardly anything.