(Notes primarily taken by Professor David Kass, Department of Finance, Robert H. Smith School of Business, University of Maryland. Additional notes taken by Beija Fu, Yanting Ma, and Shiyue Wu were also included.)
Warren Buffett (WB) (age 86) met with 20 MBA/MS or undergraduate students from each of eight universities/colleges, including the University of Maryland, on November 18, 2016. (The other seven universities/colleges represented were, in alphabetical order, Boston University, Columbia University, Concordia (Montreal), Grinnell College, Marquette University, St. Louis University, and Yale University.) Mr. Buffett responded to 20 student questions over 2 ½ hours.
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Prior to responding to the questions, WB mentioned that his hearing is not as good as it used to be. He said that recently he stood across the room from Charlie Munger (age 92) (CM) and said “Let’s buy General Motors at 33, do you agree?” Since there was no response, he moved closer and repeated the same statement. Again, no response. Then he went very close to CM and repeated his statement. CM replied “for the third time, yes!”
WB also invited all of the students to Berkshire’s next annual meeting in Omaha. “Since Berkshire has invested in airline stocks”, the students “should fly first class to the annual meeting”.
Question 1: What qualities do you look for in hiring people?
WB: Berkshire has only 25 people at headquarters, but 360,000 employees. The managers of Berkshire’s 70 businesses choose their own people. The qualities they look for are intelligence, energy, and integrity. But the most important quality in a manager is having a passion for the business. It is not IQ but passion for their businesses that make Berkshire’s 70 managers stand out. When WB was 23 years old, he was rejected by Ben Graham for a job. Years later he received a letter saying the “next time you come to NY stop by my office”. WB went the next day. He never asked about pay. You should take a job that you would take if you didn’t need a job.
Question 2: What is the percentage of S&P 500 companies that are getting better?
WB: WB has been on the board of directors of 19 public companies. 3G Capital has added discipline to Kraft Heinz and Anheuser Busch InBev. Jeff Bezos is the best business person he has ever seen. The quality of management has improved and they are paid better. The CEO’s main responsibility is capital allocation. Director fees are now about $300,000 – $400,000 per year and directors generally do little. Berkshire’s directors buy stock in Berkshire with cash (rather than stock options used by most companies).
Question 3: Are you concerned by the size of the national debt?
WB: The gross debt of the U.S. is 100% of GDP, but the net debt (subtracting trust funds) is less, at 70%+ of GDP. Our net debt was as high as 120% of GDP in World War II and as low as 35% -38% in the Reagan years. As long as our debt is in dollars, it cannot cause us any problems. (We can always print more dollars.) Taxes have accounted for 16% – 20% of GDP over time. Medical costs today represent 17% of GDP, up from 5% in 1970. The next highest country spends only 11% of GDP on health care. Corporate taxes equal 2% of GDP down from 4% in the past.
Question 4: Question about Joe Rosenfeld (Grinnell College)
WB: WB was a trustee of Grinnell College for many years and Joe Rosenfeld at Grinnell was a hero of Buffett’s.
If you know who someone’s heroes are, then you will know how they will turn out.
(WB also mentioned that the most important decision we will ever make is in choosing a spouse. “If you want a marriage to last, marry someone with low expectations.”)
Question 5: What is your opinion of active vs. passive management?
WB: Passive management is active management in aggregate. The S&P 500 represents the aggregate result of America. Nine years ago WB made a $1 million bet (for charity) on the Vanguard S&P 500 (very low fees) against a fund of funds (hedge funds). The S&P 500 has substantially outperformed the hedge funds. One-half of the gross returns of the hedge funds has gone to the managers. They have underperformed by 40%. The portfolio managers are getting rich while failing their investors. Find well-managed companies that grow over long periods of time and leave them alone. That’s mostly a passive approach. Buy and hold.
Successful investors need to have the right temperament. Those with high IQ’s frequently panic.
Question 6: What is your opinion of Dodd-Frank?
WB: We are less well equipped to handle a financial crisis today than we were in 2008. Dodd-Frank has taken away the Federal Reserve’s ability to act in a crisis. In 2008/9 Ben Bernanke said he will do whatever it takes and only he could have stopped it (financial crisis). Money market funds equaled $3 ½ trillion or 50% of the $7 trillion of deposits in U.S. banks. This could have been the “greatest run” of all time. Ben Bernanke was able to draw from the Emergency Stabilization Fund set up in 1933 with respect to gold. In 2008, President George Bush said the 10 most important words ever in economics: “If money doesn’t loosen up, this sucker is going down.” But Dodd-Frank took this option away from the Fed. Fear is contagious. It paralyzes. Confidence comes back one at a time, not by a stampede. Both General Electric and Goldman Sachs were “in the domino line”. We were lucky we had the right people.
Question 7: What impact have the fixed income markets had on stocks?
WB: Interest rates are to asset valuation as gravity is to matter. It will take a lot of movement in interest rates (similar to Paul Volcker in 1981-2) before stocks are too high. The interest rates on 30 year Treasury bonds have declined from 14 ½ % to 2 ½ % from 1982 to 2016. Recently, the 30 year Treasury moved from 2.6% – 2.8%. Stocks are cheap if long term rates are at 4%, four to five years from now. “We are buying more shares than selling everyday unless interest rates move appreciably higher”. A profitable trade would be to short the 30 year bond and go long the S&P 500 (assuming no margin calls). But this is difficult to do on a big scale. Borrowed money causes more people to go broke than anything else. Charlie Munger has said, smart people “go broke from liquor, ladies and leverage”.
Question 8: Question about Jamie Dimon and best practices for asset managers
WB: Discussed this topic in conjunction with the Economic Club of Washington.
Question 9: Why doesn’t WB invest in tech companies?
WB: Ted (Weschler) and Todd (Combs) each have about $9 billion to invest. One or more invested in Apple. With Apple, people get hooked on things that they like. WB has a competitive edge within his circle of competence (which does not include tech companies). His circle grows wider over time but outside of his circle tech people know better than he does. WB mentioned that he did not invest in Microsoft even though it had no cost of goods sold and was earning a “royalty on the world” since the world needed its operating system.
Question 10: Is there a fundamental (investment) wisdom that you disagree with?
WB: Investing hasn’t changed much over time. There were 15 students in Ben Grahams’s class (where WB was an MBA student at Columbia). He focused on cash over 2- 3 years and certain returns. A stock is a bond with coupons on it. Berkshire Hathaway is a stock with coupons attached. Several years ago WB invested in 15 South Korean companies selling at two times earnings. He didn’t know much about the companies except for their low valuations. He purchased a diversified portfolio. It worked out very well. If you invest in good companies, you do not need to diversify. Anyone with an IQ above 130 should sell off the excess above that level.
Question 11: If you started with $1 million today, how would you invest it?
WB: “If I had only $1 million today, then something has gone terribly wrong.” Today, with $1 million, he and Charlie would probably invest in four stocks. When he graduated from Columbia (MBA), he had 75% of his net worth invested in Geico (then called Government Employees Insurance Company). He started his investment partnership in 1956 with $105,000 and it was worth $105 million when he closed the partnership in 1969/70.
Question 12: What qualities do you admire in others?
WB: Choose someone (among your friends and classmates) whom you would want 10% of their future earnings. Someone who is generous with a good sense of humor and you would want to be led by them.
Question 13: What is your opinion of high frequency trading?
WB: High frequency trading does not bring anything to the world. It doesn’t hurt Berkshire. WB recommends a tiny transaction tax.
Question 14: What impact have the central banks had on stock markets?
WB: Central banks have pushed down interest rates and have affected the whole world. Europe needed negative interest rates. The Federal Reserve’s balance sheet was $1 trillion 10 years ago and is $4 trillion today. If WB could be reincarnated, he would like to come back as Chairman of the Fed. It provides the fourth largest source of receipts to the U.S. Treasury. It paid dividends last year (to the U.S. Treasury) of $117 billion. It is the largest hedge fund of all time. Its net worth of $4 – $5 trillion consists of $2 ½ trillion in Treasury securities and the Fed is responsible for over 3% of U.S. receipts. Central banks have never been more important and no one knows how this (negative interest rates) will play out. Where there is chaos there is opportunity.
Question 15: What are your views on Tim Sloan (new CEO at Wells Fargo)?
WB: One-third of the country does business with Wells Fargo (WFC). WFC broke a bond of trust, but the number of depositors will be higher one year from now. Its balance sheet is $1 trillion – $2 trillion. Former CEO John Stumpf created an incentive system with perverse consequences. He should have acted quickly, but he did not. John Gutfreund at Salomon Brothers in 1989 also was slow to respond. One should face up to a problem fast. “Get it right, get it fast, get it over”. WFC will do fine over time. Berkshire has not sold any of its shares. Charlie says: “an ounce of prevention is worth a ton of cure”.
Question 16: Question about Ajit Jain and insurance.
WB: WB was very lucky in January 1950 when he took a train from New York to Washington, DC on a Saturday morning to visit Geico. Since his hero Ben Graham was chairman of Geico, he wanted to learn as much as he could about it. He knocked on the door and a janitor came out. WB didn’t know that people in Washington did not work on Saturdays (as they do in Omaha). WB asked: Is there anyone here besides you? Fortunately, an executive (who later became CEO), Lorimar Davidson, was there and then spent the next 3 – 4 hours explaining the business of insurance. It transformed WB’s life. Berkshire bought National Indemnity in 1967. In 1986, Ajit Jain walked into his office on a Saturday. Today, 30 years later, Ajit runs Berkshire’s reinsurance business and talks to WB every day. Ajit “reinvents business hourly” (after 9/11) as compared to Geico which has had the same business model since 1936. Ajit’s business will be very different 10 years from today. Berkshire offers its employees $1 million per year for the rest of their lives if they can predict which teams will be in the “Sweet 16” in the annual March Madness (college basketball). The average policy at Geico costs $1700/year. Some Geico employees have 4 times the productivity of others (selling policies) over the phone. “When talking to someone on the phone, put a photo of the person you love most on your desk and talk in the way you would talk to that person”.
Question 17: Will technology replace human intelligence?
WB: Technology will not get rid of the human element of fear and greed. You cannot program a computer to produce a durable competitive advantage nor create passion for employees. Berkshire is not at a disadvantage now. WB prefers Ted (Weschler) and Todd (Combs) over computers.
Question 18: What was WB’s biggest mistake and what did he learn from it?
WB: His initial three businesses are now out of business – (1) Berkshire Hathaway – textiles, (2) Blue Chip Stamps, and (3) Retail division – department store in Baltimore. He has made some “people” (hiring) mistakes. The worst part of his job is having to terminate an employee. He regrets “things I haven’t done even though I thoroughly investigated, but I didn’t do”. (Errors of omission rather than errors of commission)
Question 19: Why has Berkshire invested in airlines? Doesn’t WB avoid cyclical industries?
WB: WB will not discuss his recent investments. But he almost lost a lot of money in US Air Preferred (1989). For a while he could not sell his holdings for 25 cents on the dollar, but did end up selling it for 200 cents on the dollar years later and made a big profit. Normally smaller positions (under $1 billion) are Ted’s or Todd’s.
Question 20: What is the most important skill in finance?
WB: The most important skill in finance is salesmanship. That’s how you convince someone to marry you and that’s how you get a job. The most important quality to do well is temperament which would permit the control of fear and greed which have ruined many. Anyone who has become rich twice is dumb. Why would you risk what you need and have for what you don’t need? If you are already rich, there is no upside to taking on a lot more risk, but there is disgrace on the downside.
Finally, WB concluded by telling the students to “vote for me and not Charlie at the annual meeting.”