Berkshire Hathaway Annual Meeting

Berkshire Hathaway Annual Meeting

May 2, 2015

(Notes taken by David Kass, Department of Finance, Robert H. Smith School of Business,
University of Maryland)

A one hour humorous film was shown in which the highlight was Warren Buffett (“The Berkshire Bomber”) challenging World Welterweight champion Floyd Mayweatherto a boxing match to be held at the MGM Grand Hotel in Las Vegas. Charlie Rose on CBS News breaks in with a bulletin announcing this challenge. Warren Buffett shows up at Floyd Mayweather’s training facility and is being held back by his daughter and others while he yells at Mayweather (apparently curse words that are bleeped out). While Mayweather is hitting a punching bag in his gym, Buffett is working out at home on an exercise bicycle while reading the Wall Street Journal. Steve Wynn announces that he is betting $10,000 on Buffett. On the night of the championship fight, the MGM Grand is sold out, with Jack Nicholson seated in the first row. Seated in his corner, Mayweather has his handlers give him a mouth guardand a sip of water. Buffett, in his corner, is dressed with a T-shirt and still wearing his glasses. He drinks Coca-Cola and is given See’s Candies as his mouth guard. Both fighters then stand in the middle of the ring glaring at each other and separated by a referee. (The movie ends at this point.) (Note: Several hours after the Berkshire annual meeting, Floyd Mayweather defeated Manny Pacquiaofor the World Welterweight title at the MGM Grand Hotel in Las Vegas.)

Warren Buffett (age 84) and Charlie Munger (age 91) then walk on the stage and sit down. The format for asking questions was similar to the last six annual meetings. One-third of the questions were selected by three business journalists: Andrew Ross Sorkin(CNBC and the New York Times), Becky Quick (CNBC), and Carol Loomis (Fortune). Shareholders had e-mailed over 2,000 questions to the journalists, who then selected 18 questions relating to Berkshire and its operations. The journalists who were seated on the stage, alternated with analysts Gregg Warren (Morningstar), Jonathan Brandt (Ruane, Cunniff, and Goldfarb), and Gary Ransom (Dowling & Partners), and with shareholders in the audience in the asking of questions.

Approximately 45,000 – 50,000 were in attendance (celebrating Warren Buffett’s 50 years at Berkshire Hathaway). This compared to previous records of 40,000 in 2014, 36,000 – 38,000 in 2010-2013, and 35,000 in 2009, 31,000 in 2008, 27,000 in 2007, and 24,000 in 2006.) The CenturyLink Center (18,000 capacity) and all of the overflow rooms were filled for the first time.

Buffett initially commented on Berkshire’s 2015 first quarter earnings and mentioned that Burlington Northern’s results were improving.

Questions were asked in the following order:

(1)Loomis: The Seattle Times recently published an article alleging predatory lending practices by Clayton Homes. Also, Berkshire’s partnership with 3G Capital has led to massive layoffs. Is Berkshire being ethical?

Buffett: There were many errors in the Seattle Times article. We have no interest in selling a mortgage and having a default. Clayton keeps 100% of the mortgages. Only 3% of Clayton mortgages default. The customers are mostly people with low monthly incomes. Our money is at risk. The average cost of a manufactured home plus land is $95,000. The Seattle Times article alleged that Clayton was making a 20% profit. They don’t know the difference between gross margin and net profit. Our gross margin equals 20%, but our net margin is only 2%. I have not received any complaints about Clayton’s lending practices and we are regulated.

Munger: Clayton has a 50% market share of manufactured housing.

Buffett: With respect to 3G Capital, we have never said that there should be more people running the business than needed. After 3G reduced the number of employees, they have done extremely well. There were more than 1.6 million people working for railroads in 1945. Now there are less than 200,000. Trains now carry more freight, over longer distances and with very high safety standards. Capitalism requires efficiency over time.

(2) Brandt: Will Van Tuyl (car dealerships)need to adapt to new modes of selling suchas one price and no negotiations?

Buffett: I do not know the answer. People say they do not like negotiations, but then they do it. Van Tuyl will adapt to whatever the customer wants. I wouldn’t be surprised that in 5 - 10 years the buying system will still be the same. Van Tuyl will be very profitable in relation to the capital we invest in it.

(3) Audience: What five characteristics do you use to predict earnings of companies 5 - 10 years from now?

Munger: There is no one size fits all system. We keep learning. We can’t give you a formula.

Buffett: There are a lot of things that we look at such as what the business will look like. We evaluate if we want to be in partnership with this person or management and count on them to behave well into the future. That stops a fair number of deals.

(4) Quick: Charlie, did you try to talk Warren out of IBM?

Munger: I did not. IBM is very adaptable. They were undergoing a temporary reversal and we bought at a reasonable price.

Buffett: It was a 2 – 0 vote on IBM. The company will be buying back its stock in the future and we would like the price to be lower.

Munger: If people weren’t so often wrong, we wouldn’t be rich.

(5) Ransom: Do you agree with Charlie in his annual letter that Berkshire could not repeat its success if entering the insurance business today?

Buffett: There were three historical pieces of good luck that were involved in our entry into the insurance business: (1)My meeting with Lorimar Davidson at Geico in 1950 and the education he provided about the insurance business, (2) Buying National Indemnity in 1967, and (3) The arrival of Ajit Jain in the mid-80’s. The odds of repeating this today would be very low.

(6) Audience: Can Berkshire’s culture endure after you leave?

Buffett: Berkshire’s culture runs deep and is clearly defined. I expect it to continue and become even stronger. An example is 97% of shareholders voting that they do not want a dividend.

(7) Sorkin: With the negative impact that sugar is having on consumers’ health, have we reached an inflection point? Is Coke’s moat narrowing?

Buffett: Twenty years from now more Coke will be consumed than today. I estimate that a quarter of all calories I consume come from Coke. I am not sure which quarter. If I ate broccoli and Brussels sprouts I would not have lived as long.

Munger: Sugar is enormously helpful. It prevents the premature softening of the arteries.

Buffett: I don’t see smiles on people’s faces at Whole Foods.

(8)Gregg Warren: A question about buying more auto dealerships.

Buffett: There are no large economies of scale, but running them well is important. Berkshire will not be financing the auto loans. Banks such as Wells Fargo are the lenders with a low cost of capital. We will keep the dealerships local.

(9) Audience: Question about Berkshire’s culture.

Buffett: Culture comes from the top and has to be consistent and part of written communications. It should be rewarded when followed and punished when not.

(10) Loomis: Question on the general level of the market within the context of two metrics that Buffett has used before: (1) Market cap to GDP now at 125% (same as 1999), and (2) Corporate profits at 10.5% of GDP vs. 4% long term average.

Buffett: The high corporate profits percentage of GDP means that American businesses are doing well. Market cap to GDP is high because of low interest rates. If interest rates return to normal levels, then stocks look high. But if interest rates remain low, stocks are cheap. Any company with an economist has one employee too many.

(11) Brandt: Question about railroad safety and how new rules regarding oil tankers would impact BNSF and Union Tank Car (Marmon).

Buffett: BNSF and Berkshire Energy have the best safety records in their industry. We will not be buying new railroad cars, but will be retrofitting.

(12) Audience: How can students who have not gone to the best business schools develop a network?

Munger: You should just try hard. Play the hand you are dealt. I don’t have any business school training, why should you?

Buffett: Business schools taught efficient markets. I’m glad I avoided it. What about law schools?

Munger: Law schools are like pie eating contests. If you win, you get to eat more pie.

(13) Quick: How would a BP-type railroad accident affect Berkshire?

Buffett: Our reinsurance unit offers high limits up to $5 billion. You run trains slower in urban areas, down to 35 mph. We would offer insurance, but the railroad industry did not like our rates and did not buy it.

(14) Ransom: Question about moving capital around within the insurance business.

Buffett: We have moved cash from subsidiaries to parent company. It’s easier when you have one big pocket such as National Indemnity.

(15) Audience: Question on Asian Infrastructure Investment Bank (AIIB) and if the US should join. Also, will the dollar still be the reserve currency in the future?

Buffett: I know nothing about AIIB.

Munger: I know less than you.

Buffett: The probability that the dollar will be the reserve currency 50 years from now is very high.

Munger: I am nervous about printing a lot of money and spending. I prefer it be spent on infrastructure rather than spreading it around from a helicopter.

(16) Sorkin: Question about rebranding Berkshire companies and using the Berkshire Hathaway name.

Munger: Brands like See’s are enormously valuable.

(17) Gregg Warren: Question on Renewable Energy.

Buffett: There are more opportunities in wind and solar. Facilities are being developed using tax credits. This enables Berkshire Energy to invest more money, as it is part of the consolidated tax return of Berkshire. Most utilities do not pay that much income tax so they cannot invest as much.

Greg Abel: 58% of energy provided in Iowa is from wind.

(18) Audience: What was the biggest mistake you have made?

Buffett: Dexter Shoe was by far the biggest mistake. We paid $400 million for Dexter in Berkshire stock which is now worth $6 - $7 billion. Dexter went bankrupt. We do not like issuing shares.

(19) Loomis: You warned in 2008 about the possibility of inflation. Are you still concerned about it?

Buffett: So far I’ve been wrong. I would not have predicted that you could have five years of zero interest rates and negative rates in Europe without more inflation. The U.S. can sustain 2-2.5% deficit (GDP) and not increase the debt/GDP ratio. If there is economic turbulence we are prepared ($60 billion cash). Most others are not.

(20) Brandt: Question about the discrepancy between cash taxes and reported taxes ($37 billion) and if the deferred tax liability is similar to float. Will the deferred taxes ever have to be paid?

Buffett: He does not look at deferred taxes as a hidden form of equity. Float from insurance is a terrific asset. Deferred taxes are a plus but not an asset.

(21) Audience: Question about Henry Singleton’s Teledyne.

Munger: Henry was a lot smarter than Warren or me. He had very clever incentives for all of his executives. But they went too far leading to scandals.

(22) Quick: Is Berkshire too big to fail?

Buffett: The definition of a SIFI is at least 85% of revenues come from financial related businesses. Berkshire’s revenue from finance is only around 20%.

(23) Ransom: Question relating to Workers Compensation.

Buffett: We are experimenting with Workers Compensation. We’ll see if customers want to buy it.

(24) Sorkin: If 3G ran Berkshire would there be layoffs and emphasis on short term profits?

Buffett: Geico is run as efficiently as 3G. Berkshire’s home office has only 25 people.

(25) Gregg Warren: Question on 3G efficiency and private labels vs. brand names.

Buffett: Private labels have been around for a long time. Lots of people tried other cola brands. Wilkinson came up with stainless steel blades, but Gillette has 70% of the market. If you have a good brand and you invest in it, it is a great asset.

(26) Audience: Can value investing be applied in all markets?

Buffett: Value investing principles apply everywhere. I would look at stocks the same way as you would look at a farm or an apartment.

(27) Loomis: How does the threat of chemical, nuclear, biological, and cyber terrorism affect the outlook for Berkshire?

Buffett: This country has a wonderful future but can be nullified by mad men, rogue states, and sociopaths who wish to have access to weapons of mass destruction. We need to be extremely vigilant with the security of the U.S. The luckiest person in the world today is the baby being born in the U.S.

(28) Brandt: Question about CEO vs. CIO at Berkshire

Buffett: I would not want someone whose sole experience is in investments to run Berkshire. I’ve had experience with both running businesses and investments.

Munger: Marketable securities are becoming less important at Berkshire.

(29) Audience: Question about Ted Weschler and Todd Combs.

Buffett: Ted Weschler and Todd Combs are very smart about businesses and investments. They understand the reality of business operations. They have qualities of character that are important to Charlie and me. We want people that you want to be around and hand responsibility to. Ted worked on this acquisition in Germany (motorcycle accessory firm). He’s smart, has good sense, and knows how to deal with people. We run into more dysfunctional people with IQ’s of 160 or more. We’ve seen a group of brilliant people who self-destructed to make money they did not need. Some people have difficulty functioning day to day even though they have moments of brilliance.

Munger: Trustworthiness is more important than brains. We wouldn’t hire anyone if we didn’t trust him or her.

Warren Buffett updated the results of his charitybet: S&P 500 Index Fund vs. hedge funds (fund of funds): From 2008 -2014 --- cumulative: S&P 500 up 63.5% vs. hedge fund up 19.6%

Buffett: Hedge fund managers have done well, but not their investors.

Lunch Break

(30) Quick: Which types of businesses are best to own during periods of high inflation?

Buffett: Businesses that do not require reinvestment of capital are good. Real estate and brands do well in periods of inflation. In capital intensive industries, depreciation charges are inadequate in inflationary periods.

Munger: If inflation goes out of control, there is big trouble. If not for the Weimar Republic inflation, we may not have had Hitler. Think of the price the world paid for that. We don’t want inflation because it is good for See’s Candies.

(31) Ransom: Is the Berkshire Specialty Insurance business doing well enough that you don’t have to make an acquisition?

Buffett: Berkshire Specialty could be a very big operation 5 – 10 years from now. We don’t need to buy.

(32) Audience: What advice would you give to build a business with an enduring culture?

Munger: You get your reputation over a long period of time.

Buffett: The reputation companies get over time is the one they deserve.

(33) Sorkin: Many insurance companies cite global warming as a risk that impacts their business and pricing. How does it affect Berkshire?

Buffett: We price our insurance one year at a time. I see nothing on the global warming front that causes me to change the price. That doesn’t mean that global warming is not important. But if I was writing a 50 year wind farm policy in Florida, I would think hard about the effect of global warming.

(34) Gregg Warren: Question about Berkshire’s investments in ConocoPhillips (COP), Exxon Mobil (XOM)and Berkshire Energy

Munger: XOM wasn’t a bad cash substitute. The dividend yield was high at the price we paid.

Buffett: But Berkshire Energy is different. There is nothing we like better than backing Greg Abel in buying energy companies. We look for strong management, strong growth prospects, and constructive regulatory jurisdiction as key attributes for an acquisition.

(35) Audience: Question about the U.S. tax code

Buffett: The share of corporate profits to GDP is at record levels. But corporate taxes decreased as a percentage of GDP. It used to be around 4% of GDP 40 years ago and is now around 2%. The tax code can be made more rational but I don’t shed any tears for American businesses over the tax code. American businesses are earning around 15% on tangible equity.

(36)Loomis: Adam Smith wrote the Wealth of Nations in 1776. How did it shape your philosophy?

Buffett: The Wealth of Nations did not shape my investment approach, but I learned economics from it. If you read Keynes, Adam Smith, Ricardo and “Where are the Customers’ Yachts” (by Fred Schwed), you will learn a lot. I have used an idea from Adam Smith, division of labor, to let other people do what they are best at and work in the field that they are most productive – such as having the Gates Foundation manage my philanthropic activities.