Berkshire Hathaway AGM: 1995

Charlie Munger's & Warren Buffett's wisdom on
- Moat of the business
- Berkshire Investment Ideology
- Initial Stage of research analysis
- On Economics

@Sanjay__Bakshi @drprashantmish6 @varinder_bansal @Dinesh_Sairam @NonGaap


1. On Acquisition

- Warren: The company is not getting richer just by issuing shares, the company gets richer when the company gets at least as much value in a business as the value of shares that are issued.
- They do not do the transaction keeping in mind the accounting treatment, the deal is done based on the requirement of buyer and seller and then explain to shareholders whatever accounting peculiarities may arise out of the transaction
2. On Preference shares for Acquisition

- Warren: Preferred shares will be just another form of currency when an acquisition is being down.
When an acquisition is being done if the preferred stock is valued properly then it can be a tax-free transaction for the seller.
- We will equate various forms of currency to fit the desires of the seller.
3. On Insurance

Warren: 2 reasons for buying the insurance: One is to protect oneself against a loss that a person is unable or unwilling to bear himself.

- Second is to buy the insurance when one thinks the insurance company is selling the insurance at a very cheap rate.
- Berkshire sometimes do not give insurance to people who can afford that risk because the person may be buying the insurance because either he is dumb or he expects the loss to be greater than expected.

- Catastrophe insurance: This business has relatively easy entry.
- A promoter may enter the earthquake insurance in California, most of the years he would have no losses and one year he would go broke.
4. On Technology

Warren: Berkshire is not invested in high technology business. We try not to invest in companies we do not understand. So we would not do it ourselves.
- The principles of Berkshire would apply in the technology business as well once a person understands the technology business.
5. On Investing

Warren: If we do not get opportunities within our circle, we could not enlarge the circle. We would wait.
The very rule of investing is not to make the money the way you lost it.
- It is a mistake to try to make it back the way you lost it. Gamblers fall in trap of it. Stocks do not know that you own it. You remember what you paid for it and who told you about it about the stock does not.
6. Berkshire Investment Ideology

Warren: What we are trying to do is to try to find a business with a wide and long-lasting moat around it protecting a castle. And an honest lord in-charge of the castle. Moat could be anything.
- But this moat could be attacked by capitalistic system. We have to find out why is that castle still standing & how long can it continue, how much of it depends on the lord inside & also if the lord will keep everything for itself or will do something stupid with the proceeds
Charlie: In terms of economics, honest lord is low agency cost, microeconomic business advantages are advantages of scale.

Warren: We also differentiate businesses where the management has to be smart once or one has to be smart all the time.
- Tell us the bad news first because good news can take care of itself.
- Doubling 1 Billion. is more difficult than to double 1 million. At Berkshire we do not go around selling the business for 0.5-1% extra return per year.
- This is a limitation that people associated with Berkshire have to know. Best businesses are the ones that earn high returns on capital employed.
7. On Economics

Warren: Economic value added has some merits, but it is not as complicated as management school makes it.
Listening to customers is important but management schools can't write 300 page books on it.
8. On Derivatives

Warren: There would be times when we would want to enter in a derivatives contract. That time I would be more worried about the counterparty risk, as the counterparty should be both able and willing to write the cheque.
- Derivatives often combine ignorance with borrowed money, which is a very dangerous combination.
When one looks at formulas of derivatives based on interest rate, it is hard to conceive how any business problem could be solved based on it.
- There is a huge gambling element involved. This leads to creation of risk, not moderation or reduction of risk.
Option: having an option is always an advantage.
- Giving option is a mistake, but having option is a good idea if it does not cost you anything. You do not have to take decisions on them until you have to take a decision on them.
9. Discounting
Warren: We look at what kind of cash flows can the company produce if we are buying the whole company and what kind of cash the company will generate if we buy a part of the business.
- Then they are discounted to the present value. But this is never done on paper. It is just a mental calculation.
10. On Capital arrangement for subsidiaries

Warren: Charge managers, highly on incremental capital employed and credit them at an equally high rate. Berkshire has a capital arrangement with managers of wholly owned subsidiaries.
- They are charged highly to make the managers understand how highly Berkshire values capital.
The interest rate depends on the interest rate at that time, based on company and industry.
- If the business is cyclical then during peak months, capital is given at a cheaper rate but if it is for an extended period of time then they are charged considerably more.
- When managers are using their own money they know that money costs money but sometimes when they are using other people’s money they think it is free money. That is not something Berkshire wants to promote, so capital is charged at a higher rate.
11. Psychology towards market

Charlie- If you have the attitude towards the stock market that is explained by Intelligent Investor then you are ahead of 99% people operating in the equity market.
- Margin of safety also gives enormous advantages. Viewing stocks as businesses gives a very different understanding.
- With these 3 philosophical approaches whatever method of valuation is used it would not differ much.
Projections, though required by the circumstances, do more harm than good.
12. Initial stage of Analysis

Warren: First question I ask when I look at a company is can I understand it. 2nd question is does it have a high return on capital.
- First thing is looking at the past record. If a company has a lousy past record but bright future then we are going to miss the opportunity.
13. On Ben Graham and Philip Fisher

Warren Ben graham and Philip fisher do not contradict each other but have a vastly different emphasis. Ben Graham’s approach is not workable with large sums of money.
- Very few companies are so safe that you can look 20 years ahead.

- Ben Graham was more of a teacher, he had no urge to make a lot of money. He wanted something that was teachable.
- He felt one could sit and reach his books and buy something statistically cheap and one need not have any special insights about business and consumer behaviour. It is true but also one cannot apply that on big some of money.
14. On Dividends

Warren- Berkshire does not pay dividends and has superior utilisation of cash. But not necessarily other companies should also not pay dividends.
- Companies should use the cash it can effectively in the business to expand in new markets and beyond that pays dividend and repurchases shares which benefits all.
- A shareholder benefits from retention of cash when the company uses every dollar retained to produce more than a dollar of value over time. Now it depends on how long a company can create that kind of value.
It is a skill to hold cash and not do something unintelligent with it
- Charlie: Wall street has more envy and jealousy than present anywhere. Jealousy is the only sin where you would not have any fun at.
15. On Surplus Cash
Warren- It's not easy to find things to do that make sense with lots of money. It will not be the end of the world if we do not get anything for one year.
- If we have cash then it is because we haven’t found a good opportunity. We always want to invest the cash as soon as possible. We do not think about if the market is going to crash. We like something when we something when we buy it. We do not think we can buy it cheaper later
Charlie- People don’t care what floor they are at, but whether the elevator in going up or down. People feel better when they are on 2nd floor of an elevator that just come from one than they do when they are on 99th floor coming down from a 100th
16. On Accounting

Warren- If accounting confuses you, just forget about that company. It may be intentional.
When prepaid expenses, deferred asset accounts start building up suspiciously high & inventories look out of line with sales, look twice at the companies like that.
- Berkshire never bought back shares because they thought if they could create more than a dollar market value by retaining a dollar that would work better over time. They measure it based on opportunities in the next 2 years.
- Warren's popularity does not hamper the operations of Berkshire, he may be receiving more invites for speeches but he gives the same number of them.
17. On Opportunity

Warren- Berkshire is open to buying anything. They will do anything that makes sense at Berkshire and that’s compatible with the way they operate.
18. On Valuation of Berkshire

Warren- There are things more important than P/E. Moat page in the annual report is the most important. What one expects the float to do overtime will lead to large differences in numbers relative to value.
19. On Learning
Warren- We will never buy a business We do not understand.

Charlie: Nobody is invented a way to teach so that everybody is wise

Warren: it is astounding how resistant people are when its in their self interest to learn
20. Economics
Warren: Purchasing power parity does not work well in determining the exchange rate.

Warren: You cannot make a good deal with a bad person. Just forget about it. It saves one from a lot of litigation and due diligence.
Warren: If a company is working under Berkshire then they don’t have to worry about where to invest the extra cash and if they want the extra cash.

Charlie: Do not pay attention to company ratings.
Charlie: Wells Fargo, everybody saw that they had huge real estate and as there was a problem in real estate wells fargo will go down.

- But Berkshire saw Wells fargo had good quality loans and loan collection methods were also better than the rest.
Warren: there is nothing wrong In having negative shareholders’ equity

Munger: Serpico effect where one starts rewarding what one does not need more of and then it grows and grows and grows.
21. On new investment opportunities as compared to the existing investments.

Charlie: If the new thing is not better than what you already know is available then that screens out.
22. Judging the managers
Munger: There are 2 types of agency costs. One where the manager will favour himself at the cost of others. Other is he does some foolish things.

- He is just foolish by nature. Both the situations are costly for shareholders.
Warren: We like people who are focused and candid.
Warren: Money that is being tied up in sub par return business is likely to stay there for a good period of time. Eventually some event may correct it.

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