During the 2002 Berkshire shareholder conference one of the questions was about the process Buffett uses when he makes his quick buying decisions on investing in a business or stock.
Buffett is known for making investment decisions and buying businesses while talking to owners or analyzing the business for less than 90 minutes. The specific company the question was referring to is Albecca, a company that sells picture frames which Berkshire acquired in 2001. I have systematized the answers, here is the video with Buffett answering himself and you have the bullet points below.
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Question: When you tell us in this year's report, that you buy a company after talking to the owners for no more than 90 minutes, I'm wondering, what kind of, is the wisdom of experience just like I described it? Or do you do more background work before talking to the owners for 90 minutes? What's the process like? Do you do background checks? Or do you talk to competitors? Do the other people in headquarters do that work for you? How does this whole thing work?
Warren Buffett: Well, it's a very good question. And it, all of the things you suggest might well make sense. I mean, talking to competitors, talking to ex-employees, talking to current employees, talking to customers, talking to suppliers, all of those things, Phil Fisher laid out in a book over 40 years ago, and we have done a fair amount of that over the years. But Charlie would have behaved exactly the same way I did on the company you're referring to, I got a call from Craig Ponzio in December on a Monday, it was about a company that made custom picture frames, I'd never heard of the company before. I'd never heard of Craig before. I didn't talk to him on the phone much more than 15 minutes. He's a very, he would be here today as well, his wife became seriously ill, or at least we hope, we hope it's not serious. But at least there was a problem last night. But Craig talked to me for maybe 20 minutes. And you can tell when I mean, it was just all the difference in the world. And he laid out what the custom frame how other custom frame picture, business works.
Understand the business
Warren Buffett: And it's not complicated. I haven't thought about it for 10 seconds in my whole life up till that, you know, I've had some pictures framed and I get around. And, but it's not hard. I mean, if you think about it for 30 seconds, the economics of the industry will sort of make themselves manifest to you. They're 18,000 or so framers in the country, it's a small business. So you're dealing with thousands of people now what's important to those thousands of people that you're dealing to that they're doing 250,000 or 300,000 or $400,000 of business here, and they have customers who come in periodic, like I might have come in once every three months, or every six months and say, here, I'd like a frame and they may ask me about what kind of frame I want, or I may leave it up to them. It's a service or operation to a very great degree. And Craig builds something starting with in 1980 or so with 3 million of sales, he built an organisation that became enormously responsive to these 18,000 or so framers. They call on those people five or six times a year, they get 85% of the frames of those people the next day when they order them. That's what counts in that kind of a business. You know, it's not, you're not supplying the big three with auto parts you're not there's all kinds of things that give it a distinctive economic characteristics.
What Craig told me about that, like I say, and not more than 20 minutes, and he told me the price, and he told me the capital, it was employed, and he gave me some a few figures. I knew and talking to him that they had a deal that made sense, you know, and I said, when can you come in that was on a Monday, he said, I'll be there Wednesday morning. And I came with Steve McKenzie, who is here today, and who I encourage you to meet and I think they got there at night, and they left at 10:30. And we had shaken in hands. I was hoping to say Craig, today or tomorrow, but I won't because of this illness. But I haven't seen Craig since. And, I mean, we made that he got his money. He knew he was making a deal.
Know the price
He had a reason why he wanted to sell it to somebody that would be sure to close that would be a good owner, where the people who work there wouldn't be worried because he was leaving. He was leaving with a lot of money and you know, people he wanted to be sure a lot of people leave a lot of money and they leave the employees behind it. They don't care what happens but this guy cared and I could tell that I met that's a big plus with me.
So, you know, I have not been to their headquarters yet I plan to be to their headquarters. Steve, I apologise. The owl but I understand what the business is about. And you cannot, most good businesses, you can understand what they are about in a very few minutes. Unless they're kind of business that you can never can understand what they're about. I mean, there are other businesses if you spent years on them, you still don't understand what the hell's going on. I don't know which one of which American auto company is going to do the best 10 years from now and if I spent all year talking to dealers for Ford and Chrysler and General Motors, and I talked to suppliers and I talked to people who are driving their cars, I still wouldn't know anything about what its gonna look like 5 or 10 years from now. But I know that your can't crack our custom picture frame business. I mean, you cannot figure out a way to call on those 18,000 people that are in that business and figure out a way to do work their business to you when you can't offer a frame as good as ours, and you can't offer service remotely like ours.
Good businesses are simple
So it's a good business. And then, and Craig was 100% up. I mean, he told me exactly what they wanted to receive for the business. He wanted cash, you know, that fits us. And there's nothing complicated about I mean, you can drag it out for a long time. But what would be the sense of it? I mean, it's gonna make a deal. You're gonna make a deal. Charlie?
Can a competitor destroy the moat?
Charlie Munger: Yeah. If you stop to think about it, the ordinary result when a big publicly held corporation buys another corporation is that maybe two thirds of the time, it's a terrible deal for the buying Corporation. And yet the people have taken enormous time doing it. And we've bought all these businesses taking practically no time and doing it. On average, they worked out wonderfully. Why is that? That's a good question. The answer is we wait for the no brainers. We're not trying to do the difficult things. And we have the patience to, to wait.
Wait for the no brainers
And then we're so peculiar that, that there actually are a good number of businesses in America where they prefer selling to us than to other people. That's very helpful.
Warren Buffett: I just saw a review of a major company made 10 acquisitions in recent five year period. Every one of those 10 acquisitions was preceded by due diligence and all the baloney they go through, and they probably had an investment bankers book and everything. Not one of the 10, in 2001 lived up, or was even close to the expectation of the presentation that was made at the time of purchase. In aggregate, the 10 earned one quarter of what they were projected to earn in 2001. In other words, the projections were for four times the actual earnings.
Don’t trust projections
And this is a company with a strategic, you know, acquisition department with loads of people that go with the due diligence within that investment bankers, quote, helping them end quote all along the way. And I'm and 10 out of 10 failed miserably. And, you know, you have to ask yourself, how can you produce that because the world didn't go to hell during that period, either. I mean, it was that was not a time when we went into a great depression or anything of the sort. It's they were getting, they were buying what was getting sold to them. And it was fulfilling some things that the management missed that the management had about itself, and management's have many myths about themselves.
And it isn't that complicated if you just right wait for the fat pitch. And the fat pitch doesn't have to be somebody else doing something dumb or anything like that, because they people don't do that the people that come to us, come for a good reason. I mean, they usually want a transaction. They want one, they're sure to close they want if a deal was made, and they want one that will leave the people happy that are at the business when it was announced at Johns Manville, I believe that the Berkshire was the buyer. I understand it was a standing ovation, you know, and then I've seen it, you know, whether it's Jordans or Star Furniture, people are concerned if you've been working to cover for 20 years, and you know that the owning family is getting older and has some problems to take care of. Believe me, they talk in the hallways about that what's going to happen when you know, the family sells the place and people worry about that. And they have an answer for them. So that they all sleep the night that they get it's announced that the business has changed hands, it mean a lot to some owners, and it doesn't mean anything then other ours. I don't think we've ever bought a business from a financial operator. Can you think of any Charlie?
Use horse sense
Charlie Munger: I can't think of one. The, you know somebody once defined hell in a legal system, as a place with endless due process and no justice. And we're getting close. And and similarly in the corporate world, you have endless due diligence and no horse sense. But you've just described a corporate hell, at least for the people who own the business.