The following is an excerpt of notes taken by Whitney Tilson, co-editor of Value Investor Insight at Berkshire Hathaway's annual meeting in May 2007. For a more complete account of Berkshire’s recent annual meeting, click here .
Warren Buffett: We favor businesses where we really think we know the answer. If we think the business’ competitive position is shaky, we won’t try to compensate with price. We want to buy a great business, defined as having a high return on capital for a long period of time, where we think management will treat us right. We like to buy at 40 cents on the dollar, but will pay a lot closer to $1 on the dollar for a great business.
If we see someone who weighs 300 pounds or 320 pounds, it doesn’t matter--we know they’re fat. We look for fat businesses.
We don’t get paid for the past, only the future [profitability of a business]. The past is only useful to give you insights into the future, but sometimes there’s no insight. At times, we’ve been able to buy businesses at one-quarter of what they’re worth, but we haven’t seen that recently [pause] except South Korea.
Charles Munger: Margin of safety means getting more value than you’re paying. There are many ways to get value. It’s high school algebra; if you can’t do this, then don’t invest.
Circle of Competence and Margin of Safety
When you’re trying to determine intrinsic value and margin of safety, there’s no one easy method that can simply be mechanically applied by a computer that will make someone who pushes the buttons rich. You have to apply a lot of models. I don’t think you can become a great investor rapidly, no more than you can become a bone-tumor pathologist quickly.
Buffett: Let’s say you decide you want to buy a farm, and you make calculations that you can make $70 an acre as the owner. How much will you pay [per acre for that farm]? Do you assume agriculture will get better so you can increase yields? Do you assume prices will go up? You might decide you wanted a 7% return, so you’d pay $1,000 a acre. If it’s for sale at $800, you buy, but if it’s at $1,200, you don’t.
If you’re going to buy a farm, you’d say, "“I bought it to earn $X growing soybeans." It wouldn’t be based on what you saw on TV or what a friend said. It’s the same with stocks. Take out a yellow pad and say, "If I’m going to buy GM at $30, it has 600 million shares, so I’m paying $18 billion," and answer the question, why? If you can’t answer that, you’re not subjecting it to business tests.
We have to understand the competitive position and dynamics of the business and look out into the future. With some businesses, you can’t. The math of investing was set out by Aesop in 600 B.C.: A bird in the hand is worth two in the bush. We ask ourselves how certain we are about birds in the bush. Are there really two? Might there be more? We simply choose which bushes we want to buy from in the future.
The ability to generate cash and reinvest it is critical. It’s the ability to generate cash that gives Berkshire value. We choose to retain it because [we think we can reinvest each dollar to generate more than $1 of value].
If you were thinking about paying $900,000 or $1.3 million for a McDonald’s stand, you’d think about things like whether people will keep eating hamburgers and whether McDonald’s could change the franchise agreement. You have to know what you’re doing and whether you’re within your circle of competence.
Munger: We have no system for estimating the correct value of all businesses. We put almost all in the "too hard" pile and sift through a few easy ones.
Buffett: We know how to recognize and step over one-foot bars and recognize and avoid seven-foot bars.
Advice on Becoming a Successful Investor
I think you should read everything you can. In my case, by the age of 10, I’d read every book in the Omaha public library about investing, some twice. You need to fill your mind with various competing thoughts and decide which make sense. Then you have to jump in the water--take a small amount of money and do it yourself. Investing on paper is like reading a romance novel versus doing something else. [Laughter] You’ll soon find out whether you like it. The earlier you start, the better.
At age 19, I read a book [ The Intelligent Investor by Benjamin Graham], and what I’m doing today, at age 76, is running things through the same thought process I learned from the book I read at 19.
I remain big on reading everything in sight. And when you get the opportunity to meet someone like Lorimer Davidson (former CEO of GEICO), as I did, jump at it. I probably learned more in those four hours than in almost any course in college or business school.
Munger: Sandy Gottesman, a Berkshire director, runs a large, successful investment firm. Notice his employment practices. When he interviews someone, he asks, "What do you own and why do you own it?" If you’re not interested enough to own something, then he’d tell you to find something else to do.
Buffett: Charlie and I have made money in a lot of different ways, some of which we didn't anticipate 30 to 40 years ago. You can’t have a defined road map, but you can have a reservoir of thinking, looking at markets in different places, different securities, etc. The key is that we knew what we didn’t know. We just kept looking. We knew during the Long Term Capital Management crisis that there would be a lot of opportunities, so we just had to read and think eight to 10 hours a day. We needed a reservoir of experience. We won’t spot every one, though--we’ve missed all kinds of things.
But you need something in the way you’re programmed so you don’t lose a lot of money. Our best ideas haven’t done better than others’ best ideas, but we’ve lost less. We’ve never gone two steps forward and then one step back--maybe just a fraction of a step back.
Munger: And of course the place to look when you’re young is the inefficient markets. You shouldn’t be trying to guess if one drug company is going to have a better pipeline than another.
Buffett: You should do well in games with few other players. The RTC [Resolution Trust Corporation; click here for more on this] was a great example of a chance to make a lot of money. Here was a seller [government bureaucrats] with hundreds of billions of dollars of real estate and no money in the game, who wanted to wrap up quickly, while many buyers had no money and had been burned.
There won’t be any scarcity of opportunity in your life, although there will be times when you feel that way.
