Last weekend, Berkshire Hathaway held its annual general meeting, which has become a yearly event where value investors and Berkshire Hathaway shareholders from all over the world, convened to hear the wit and wisdom of Warren Buffett and his partner Charlie Munger.
The most anticipated part of the weekend is the Q&A session with the Oracle of Omaha and his partner where are value investors from all over the world can put their questions to these business gurus.
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This year, questions covered many different topics from equality in the workplace to Wells Fargo's mistake, Warren Buffett's views on gun control and the political environment in the United States. There was also some discussion on investing.
Here are the five critical investing takeaways from the meeting:
Buffett on Berkshire's changing investment philosophy
One of the most exciting questions in the session came from an eight-year-old who asked about the conglomerate's changing investment philosophy. Over the past decade, Buffett has made some investments in businesses that require a significant amount of capital spending, unlike his early acquisitions that were always focused on low capital intensity businesses. Buffett characterized the change as a simple matter of scale -- there aren't many large capital-light businesses at prices Berkshire finds attractive -- but as long as the returns are attractive, Berkshire is happy to invest in these industries:
"Warren Buffett: We like efficient businesses that earn a terrific return on capital. We can’t get more money deployed in capital-light businesses at prices that make sense to us. Wouldn’t it be wonderful to run railroads without trains and tracks and bridges and tunnels and a few things? We still love a business that takes very little capital and earns high returns, but the second-best choice is still a good choice.
Charlie Munger: I like the aspiration. What you’re describing is a business that wants a royalty on the other fellow’s sales. It’s a good model, and no one could do it in everything. But returns on utilities and the railroad are entirely satisfactory, and you’re asking us to have perfection if you want all our money in Coke at a good price.
Warren Buffett: We haven’t forgone any opportunity to buy capital-intensive businesses. You definitely have a job in our capital allocation department."
On calculating the intrinsic value
One of the audience members asked the Berkshire panel about the process of calculating a company's intrinsic value. Charlie Munger answered this question, responding that calculating intrinsic value is not a precise science, it is an art based on many different factors, factors that are difficult to explain entirely. If the business looks cheap from many different perspectives, then it could be an attractive by.
"Charlie Munger: We would look for mispriced stock opportunities with less capital. I can’t give a formulaic approach to intrinsic value and don’t use one. I mix all the factors, and if the gap between value and price isn’t attractive, I go onto something else. Costco at 13x earnings was a ridiculously low value because of the brand. I like the cheap real estate and the good competitive position, and even though it traded at 3x book, it was worth more. There was not a formula. If you want one, go back to graduate school, as formulas don’t work."
On finding the moat
There was also a question about finding a company's moat. For many decades Buffett has based his investment philosophy on finding business moats or a company's competitive advantage. Once again, this is not a precise science, it is an art, and it all depends on how much money and time a company has put into developing its reputation. Buffett starts off by using the example of American Express, a business that has built a reputation for quality. He goes on to highlight the moats constructed by Coca-Cola and See's, products that have created an emotional attachment with consumers. The attachment means they have a healthy level of pricing power over the market.
"All kinds of colas came out over the years, but Coke really is the real thing. I wouldn’t take RC at half the price of Coke. A 6.5-ounce Coke sold for a nickel in 1900 and now is not much more, whereas in 1942 a newspaper was 3 cents. So, the enjoyment has gone dramatically way down on an inflation-adjusted level. Coke is a real bargain product. Just like with See’s – if a boy gave a box to a girl, and she kissed him, you lose all price sensitivity at that point. We like products where people feel like kissing you instead of slapping you. We are betting on the ecosystem of Apple products led by the iPhone but see characteristics that make me think this is extraordinary. After the Amex scandal in 1963, we worried about survival, but no one quit using the product.”
Buffett goes on to advocate using the "scuttlebutt" method to search out the products consumers associate with most:
"Common Stocks and Uncommon Profits, reading about the scuttlebutt method you can learn a lot just by using some shoe leather. These are called channel checks now. You can really get a feel for some products. It’s a good technique, and Ted and Todd do a lot of it and have others help them. Charlie does it with Costco. The product has enormous appeal to the constituency. They surprise and delight their customers, and there’s nothing like that in business. It’s a lot of the way home if you delight your customers."
On staying within the circle of competence
One of the topics that dominated the Berkshire Hathaway meeting was Buffett new position in Apple. Even though the Oracle of Omaha has repeatedly said that he does not invest in tech businesses (excluding the IBM mistake) over the past two years, Berkshire Hathaway has accumulated a substantial position in the stock.
During the Q&A session, Buffett says that he built this holding not because he understands technology (which still falls outside of his circle of competence) but because Apple has built a healthy relationship with the consumer (as noted above). Buffett explains that it's this consumer relationship side of the equation that he understands, rather than the tech side, and company-consumer relationships fall well and truly inside his circle of competence:
"We went into Apple, because of the intelligence of the capital deployed and the value of the ecosystem. It didn’t require me taking apart the iPhone and figuring out the components to see what Apple had. It was more the nature of consumer behavior. We miss a lot of things we don’t understand well enough. But there’s no penalty for not swinging at something as long as you swing at something. Stay in your circle of competence where you might have an edge because of experience or reason."
How to think about investing
The fifth and final takeaway is the first piece of advice Buffett gave when the Q&A session opened. Buffett told the story of his first investment, three shares in City Service.
"I’d been watching City Service preferred stock for a while. It was $84 a share the previous year and $55 a share at the beginning of 1942, and then in March, it was down to $40 a share. On the 11th, I told my dad I wanted to buy three shares...On the next day, the stock market was down 2.28% and broke 100 on the downside, which is the equivalent of a 500-point drop...My dad had bought me the stock at $38.25, which was the high for the day, and it was down to $37 by the end of the day. Even though the war looked bad until the Battle of Midway, the stock did well and was called for over $200 a share by City Service. But I’d sold at $40 for a $5.25 gain after watching it go down to $27."
The point of this anecdote was to explain the power of long-term investing. Buffett goes on to say that investing $10,000 in an index fund in 1942 "would now be worth $51 million, and you wouldn’t have had to do anything." This simple strategy does not require any detailed knowledge of accounting "All you had to do was figure that America would do well over time, and American business would, in turn, do well and overcome difficulties. You didn’t have to pick out winning stocks or know when to buy or sell."
"There’s no comparison trying to jump in and out of stocks and pay investment advisors and invest in nonproductive assets" Buffett goes on to say. "You do not have to know about accounting and terminology and what the Fed is doing. It’s about a philosophy and forgetting what you don’t know how to do" he concludes.
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