Business Lessons from Berkshire Hathaway Annual Meeting in 1994
Compilation of business lessons
The Berkshire Hathaway annual meeting is not only a chance for shareholders to engage directly with Warren Buffett and Charlie Munger and gain insights into its strategies for investing and creating value, but it is also an exceptional source of learning for investors.
The meeting provides a wealth of valuable lessons on both business and life that cannot be overstated. Attendees have the opportunity to learn from Warren Buffett and Charlie Munger's vast experience and wisdom, and to gain a deeper understanding of the principles that underpin their investment philosophy.
For a while now, I've been listening to the annual meetings of Berkshire Hathaway whenever I have the opportunity and taking notes for my personal records.
Starting with the 1994 meeting, I'd like to share what I believe to be the most valuable insights gleaned from these meetings.
To ensure greater clarity, I have refined some of the questions and grouped them by relevant topics for better comprehension. My notes prioritize the most insightful questions and answers and exclude other interesting insights that I believe are less relevant for investors.
Management
As an average investor, how do I find out what good management is?
You judge management by two yardsticks.
One is how well they run the business. You can learn a lot about that by reading about what they’ve accomplished and what their competitors have accomplished. You have to understand the hand they were dealt when they got a chance to play it. But, if you understand something about their business, then you want to look at how well they have played the hand that’s been dealt with them.
And then the second thing you want to figure out is how well they treat their owners and see how they have allocated capital over time.
You don’t have to make a hundred correct judgments in this business or 50 correct judgments. You only have to make a few. And that’s all we try to do.
Generally speaking, the conclusions I’ve come about managers are the same way you can make yours. They come about by reading reports rather than any intimate personal knowledge or knowing them personally.
How Berkshire keeps great managers?
We have to identify and keep good managers interested after we’ve figured out who they are. And that often is a little different here because I would say most of our managers are financially independent, so they don’t go to work because they are worried about putting kids through school or food on the table. So they have to have some reason to go to work aside from that. They have to be treated fairly regarding compensation, but they also have to figure out it is better than playing golf every day.
Before I ran this, I had a partnership. I had a great group of partners. And essentially, I like to be left alone to do what I did. I like to be judged on the scorecard at the end of the year rather than on every stroke and not second-guessed in a way that was inappropriate. I like to have people who understand the environment in which I am operating. And so the important thing we do with managers, generally, is to find the .400 hitters and then not tell them how to swing.
We try to have a compensation arrangement that’s appropriate for the kind of business they’re managing. We have no company-wide compensation plan. Some businesses require a lot of capital that we’re in, and some require no capital. Some are easy businesses where good profit margins are a cinch, but we’re paying for the extra beyond that. Some are very tough businesses to make money. And it would be crazy to have some huge framework that we try to place everybody in, where one size would fit all. Generally, people are compensated in some manner that relates to how their business does. And we try to make them responsible for their own units and compensate them based on how those units do.
CHARLIE MUNGER: Well, I’ve got nothing to add, but I think that concept of treating the other fellow the way you’d like to be treated if the roles were reversed — it’s so simple.
Business Models
You talked earlier about leverage and the dangers of leverage. Salomon is a business levered 30-to-1, has very narrow margins, and earns a relatively modest return on equity in light of the amount of leverage they use. What is the appeal of the business to you?
I would say Charlie and I feel extraordinarily good about the two fellows that are running that operation. They did an exceptional job under extraordinarily difficult circumstances.
It’s the sort of business that, as you point out, uses a lot of leverage. In one way, it doesn’t use as much as it looks, and in another, it uses even more than it looks.
But the test will be: A, whether they control that business in a way that that leverage does not prove dangerous, and B, what kind of returns on equity they earn while using it. You certainly should expect to earn somewhat higher returns on equity when you are necessarily exposed to a small amount of systemic risk and significant amounts of borrowed money than you would in a business that’s an extremely plain vanilla business.
But, I don’t know whether you’ve met Bob and Deryck, but I think you’d feel better about having leverage in their hands than about any other hand you can imagine.
Can you speak to some of the economic characteristics of the shoe industry that allow the business to be profitable and attractive?
I think our feelings for the shoe industry are very clear from what’s been happening over the last few years.
We think it’s a great business to be in as long as you’re in with Frank Rooney and Jim Issler and Peter Lunder, and Harold Alfond. Otherwise, it hasn’t been too good.
Given the scrutiny the tobacco business is under right now, number one, what do you see as the business prospects for those huge cash cows? And, at any point, would that be attractive to you, given their liability?
I probably know no more about that than you do because it’s fraught with questions that relate to societal attitudes, and you can form an opinion on that just as well as I could. But, I would not like to have a significant percentage of my net worth in the tobacco business. So, you have to conclude how society and the present administration will treat that business. And the economics of the business may be fine, but that doesn’t mean it has a great future.
What are the future prospects of Nike and Reebok?
I don’t know that much about those businesses.
I am not expressing a negative view in any way on that. I just don’t understand their competitive position and the likelihood of permanence of their competitive position over a 10 or 20-year period, as well as I think I understand the position of Brown and Dexter.
That doesn’t mean I think that it’s inferior. It doesn’t mean I think that we’ve got better businesses or anything.
I think we’ve got very good businesses. But I haven’t done the work, and I’m not sure if I did the work, I would understand them.
I think they are harder to understand, frankly, and to develop a fix on, than our kinds. But, they may be easier for other people who just have a better insight into that kind of business.
Some businesses are a lot easier to understand than others. And Charlie and I don’t like difficult problems. If something is hard to figure, we’d rather multiply by three than by pi. I mean, it’s just easier for us.
CHARLIE MUNGER: Well, that is such an obvious point. And yet so many people think if they just hire somebody with the appropriate labels, they can do something very difficult. That is one of the most dangerous ideas a human being can have. You don’t have to hire out your thinking if you keep it simple.
WARREN BUFFETT: We’ve said this before, you don’t have to do exceptional things to get exceptional results.
And some people think that if you jump over a seven-foot bar, the ribbon they pin on you will be worth more money than if you step over a one-foot bar. And it just isn’t true in the investment world at all.
I noticed you mention Wrigley as being a company that has worldwide dominance, like Coca-Cola and Gillette. And I am curious to know if you have looked at the company in any detail. And, if so, whether or not you decided not to invest, what were the reasons why?
It’s a good illustration of a company with a high market share worldwide, but you can understand the Wrigley Company just as well as I can. I have no insights into the Wrigley Company that you wouldn’t have, and I don’t want to go beyond that in giving you our evaluation of the company.
I hate to disappoint you on those, but we are not too forthcoming on specific securities sometimes.
Reinsurance business?
Reinsurance business, by its nature, will be a business in which some very stupid things are done en masse periodically. I mean, you can be doing dumb things and not know it in reinsurance and then suddenly wake up and find out the money is gone.
It’s what people have found out that were speculating on bonds recently. But, you know, you don’t find out who’s been swimming naked until the tide goes out. Essentially that’s what happens in reinsurance.
Reinsurance pricing?
We price to what we think is exposure. We don’t price to experience. So, I mean, the fact that there was no big hurricane last year has nothing to do with the rates next year.
And everyone says that, but the market tends to price and respond to experience and generally to recent experience. So that’s why all the retrocession operations in London went busted, because they priced, in our view, to experience rather than to exposure.
It’s very hard not to do that, to be there year after year with business coming by and investors expecting this of you and not do that.
But we will never knowingly do that. We may get influenced subconsciously in some way to do that, but we will not do that any more than we will accept stock market norms as the proper way to invest money and equities.
When you lay out money or accept insurance risks, you have to think for yourself. You cannot let the market think for you.
Capital Allocation
When you consider an acquisition, how do you look at the product's usefulness?
We look at what the market says is the utility. And the market has voted very heavily for Dexter Shoe, just to be an example. I don't know how many pairs of shoes they were turning out back in 1958 or thereabouts, but year after year, people have essentially voted for the utility of that product.
There are 750 million or so 8-ounce servings of one product or another from the Coca-Cola Company consumed daily worldwide. And there are those of us who think the utility is very high. I can't make it through the day without a few. But other people might rate it differently.
But essentially, people will get thirsty, and if this is how they take care of their thirst and prefer it to other forms, then I would rate the utility high of the product. So it's hard to argue with the market on that.
People may think that you know, listening to a rock concert is not something of high utility. But, on the other hand, other people might think it's terrific.
I don't think we would come to an independent decision there was some great utility residing in some product that had been available to the public for a long time but that the public was not endorsed in any way.
Purchase of private vs. public companies?
We prefer to buy entire businesses, or 80 percent or greater interest in businesses, partly for tax reasons, and frankly, we like it better. It’s the kind of business we would like to build if we had our absolute druthers on it.
Counter to that is we can usually get more for our money in wonderful businesses, in terms of buying little pieces of them in the market, because the market is far more inefficient in pricing businesses than is the negotiated market.
You’re not going to buy any bargains, and I mean, you shouldn’t even approach the idea of buying a bargain in a negotiated purchase.
You want to buy it from people who are going to run it for you. You want to buy it from people who are intelligent enough to price their business properly, and they are. I mean, that’s the way things are.
You said that you decentralized the operational decisions but centralized the capital allocation decisions. What kind of staff do you have in Omaha to help you with the capital allocation and stock selection decisions you make? Or do you and Charlie do that, pretty much, by yourselves?
We don’t have any staff to help us with it. That is our job. And we don’t feel we should delegate.
It’s an important job for most managements. There are some companies where it’s not, but it usually is a very important job for most managements.
And if you take a CEO that’s been in a job for 10 years, and he has a business that earns 12 percent on equity, and he pays out a third, that means he’s got 8 percent per year of equity. So when you think of his tenure in office and how much capital he’s allocated, it’s an enormous factor over time.
And yet, only a few chief executives are trained for or selected based on their ability to allocate capital. Instead, they get there through other routes.
It’s like somebody playing the piano all their life, and then getting to Carnegie Hall and they hand him a violin. I mean, it is a different function.
And so many CEOs, when they get there, think they can solve it by having a staff that does it, hiring consultants, or whatever it may be.
And in our view, that’s a terrible mistake because it is, if not the key function of the CEO, it’s one of two or three key functions at 80 or 90 percent of all companies.
When estimating a growth rate on a very predictable company, I imagine you apply a big margin of safety to it. What kind of rate do you generally apply? I mean, high single digits?
Would you rather have something that paid you 10 percent a year and never changed, or would you rather have something that paid you 2 percent a year and increased at 10 percent a year? Well, you can work out the math to answer those questions.
But you can certainly have a situation where there’s absolutely no growth in the business, and it’s a much better investment than some company that will grow at very substantial rates, particularly if they’re going to need capital in order to grow.
There’s a huge difference between a business that grows and requires a lot of capital and a business that grows and doesn’t require capital.
And generally, financial analysts do not give adequate weight to those differences. It’s amazing how little attention is paid to that. But, believe me, if you’re investing, you should pay a lot of attention to it.
Some of the best businesses that we own outright don’t grow. But they throw off lots of money, which we can use to buy something else. And therefore, our capital is growing without physical growth in the business.
And we are much better off being in that kind of situation than being in some business that is growing, but that takes up all the money in order to grow and doesn’t produce high returns as we go along. A lot of management doesn’t understand that very well.
Valuation
If you were to buy a business and you bought it at its intrinsic value, what’s the minimum after-tax free cash flow yield you’d need to get?
In a world of 7 percent long-term bond rates, we would certainly want to think we were discounting future after-tax streams of cash at least a 10 percent rate. But that will depend on the certainty we feel about the business.
The more certain we feel about a business, the closer we are willing to play it. We have to feel pretty certain about any business before we’re even interested.
So if we thought we were getting a stream of cash over the next 30 years that we felt extremely certain about, we would use a discount rate that would be somewhat less than if it was one where we thought we might get some surprises in 5 or 10 years.
Could you perhaps give an indication as to how you and Charlie come up with the economic value, or the intrinsic value, of the businesses that you finally decide to invest in? And a little bit about the process that you go through with that?
Essentially, the economic value of any asset is the present value, using the appropriate interest rate, of all the future streams of cash going in or out of business.
We are looking for things where we feel a fairly high degree of probability that we can come within a range of looking at those numbers out over a period of time, and then we discount them back.
And we are more concerned with the certainty of those numbers than getting the one that looks absolutely the cheapest but is based upon numbers we don’t have great confidence in.
And that’s basically what economic value is all about.
The numbers in any accounting report mean nothing, per se, as to economic value. Instead, they are guidelines to tell you how to get at economic value. And to figure out that answer, you have to understand something about business.
But that’s the same thing you would do if you were going to buy an apartment, house or farm, or any other small business you might be interested in.
You should figure out what you are laying out currently, what you will likely get back over time, how certain you feel about getting it, and how it compares to other alternatives.
Market & Macro Related Topics (FX, Interest Rates, Stock Movements, Derivatives, etc…)
What is Buffett's opinion on what other people say/write about stocks?
We don't pay any attention to what people say about Coca-Cola stock or Gillette stock, or any of those things. On any given day, two million shares of Coca-Cola may trade. That's a lot of people selling, a lot of people buying. You really should not make decisions in securities based on what other people think.
Charlie and I don't read anything about what business is going to be, what the economy is going to do, or what the market's going to do. So anytime I see some article that says, you know, these analysts say this or that about some business, it doesn't mean anything to us.
I have a question regarding global diversification. In general, what do you look for in a company and, if so, in Europe or Latin America, if you’d like to be specific?
All we want to be in is businesses we understand, run by people we like, and priced attractively compared to future prospects.
So, there is no specific desire to either be in the rest of Europe, the rest of the world, or the Far East or avoid it.
We don’t think in terms of the regions, so I want to be there or something of a sort. It’s something that’s specific to the companies we’re looking at, and then we’ll try to evaluate that.
Mr. Buffett, you said that you don’t read what other people say about the market or the economy, but do you or Charlie have an opinion about how you think things will go? Are you bullish or bearish?
You may have trouble believing this, but Charlie and I never have an opinion about the market because it wouldn’t be any good, and it might interfere with the opinions we have that are good.
If we’re right about a business, if we think it is attractive, it would be very foolish not to take action because we thought something about what the market would do or anything of that sort.
Because we just don’t know. And to give up something that you do know and that is profitable for something that you don’t know and won’t know, it just doesn’t make any sense to us and doesn’t really make any difference.
I bought my first stock in, probably, April of 1942 when I was 11. And since then, World War II didn’t look so good at that time. You know, we were not doing well in the Pacific. Just think of all the things that have happened since then, you know? Atomic weapons, major wars, presidents resigning, and all kinds of things, and massive inflation at certain times.
To give up what you’re doing well because of guesses about what’s going to happen in some macro way doesn’t make any sense to us. So the best thing that can happen from Berkshire’s standpoint, we don’t wish this on anybody, is that markets go down a tremendous amount over time.
We are going to be buyers of things over time. And if you buy groceries over time, you like grocery prices to go down. If you’re going to be buying cars over time, you like car prices to go down.
We buy businesses. We buy pieces of businesses: stocks. And we’ll be much better off if we can buy those things at an attractive price than if we can’t.
So we don’t have any fear at all. I mean, what we fear is an irrational bull market that’s sustained for a long time.
Many of the holdings of Berkshire are in industries that are perceived as interest rate-sensitive industries, including Wells Fargo, Salomon, Freddie Mac, and even GEICO. And yet you have an admitted sort of ambivalence towards interest rates or changes in interest rates. And it, therefore, seems that you don’t feel that those changes affect the fundamental attractiveness of those businesses. So I thought maybe you could share your thoughts on what you see in these businesses that the investment community as a whole is ignoring.
The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset is 100 percent sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be over a period of time. And the higher the interest rates are, the less that present value will be.
So every business, by its nature, whether it’s Coca-Cola or Gillette, or Wells Fargo, is a hundred percent sensitive to interest rates.
Now, the question as to whether a Wells Fargo or a Freddie Mac or whatever it may be, whether their business gets better or worse internally, as opposed to the valuation process, because of higher interest rates, that is not easy to figure.
Do you get into asset allocation by maintaining given levels of cash, depending on some kind of outlook or something of the sort?
We don’t think that way at all. If we have cash, it’s because we haven’t found anything intelligent to do with it that day to buy into the kind of businesses we like.
And when we can’t find anything for a while, the cash piles up. But that’s not through choice. That’s because we’re failing at what we essentially are trying to do, which is to find things to buy.
We do not attempt to guess whether cash will be worth more three months from now, six months from now, or a year from now.
We’re looking for things to buy that meet our tests, and if we showed no cash or short-term securities at year-end, we would love it because it would mean that we’d found ways to employ the money in ways that we like.
I must admit that if we have a lot of money, we are a little dumber than usual. It tends to make you careless.
And the best purchases are usually made when you have to sell something to raise the money to get them because it just raises the bar a little bit that you jump over in the mental decisions.
How do you think about the large position you’re willing to take in a given security?
We are willing to put a lot of money into a single security. When I ran the partnership, the limit I got to was about 40 percent in a single stock. I think when Charlie ran his partnership, he had more than 40 percent.
We would do the same thing if we were running smaller partnerships or our own capital was smaller, and we were running that ourselves.
We won’t do that unless we think we understand the business very well, and we think the nature of the business, what we’re paying for it, the people running it, and all of that lead up to virtually no risk.
But you find those things occasionally. And assuming it was that much more attractive than the second, third, and fourth choices, we would put a big percentage of our net worth into it.
But people do that all the time, incidentally, in private businesses with terrible prospects. So they buy dry cleaning establishments, filling stations, or whatever, and they put a very high percentage of their net worth into something risky. People put all their money in a farm. It’s subject to all kinds of business risk.
So it’s not crazy if you understand the business well and if the price is sufficiently attractive to put a very significant percentage of your net worth. But, on the other hand, if you don’t understand businesses, you’re better off fairly widely diversifying.
Do you hedge your FX exposure?
The answer to that is we don’t. And Coca-Cola gets 80 percent of its earnings from various currencies.
They do certain currency transactions, but it’s a practical matter. For example, if you own Coca-Cola, you own a bunch of foreign bonds with coupons on them, denominated in local currencies, that go on forever.
Now, should you try and engage in currency swaps on all those coupons?
We don’t think it’s worth it. We don’t think our opinion on currencies is any good. We don’t think we know more than the market does about currencies.
So there are hedging costs. And even though interest rate structures may cause the curve to look flat going out forward so that, in effect, there’s no contango on it, there’s still the cost in it. Now, it’s a relatively efficient market, so they’re not huge.
But we see no reason to incur those costs with what we regard as a 50-50 proposition. And it doesn’t go out that far anyway. I mean, we could do it for a couple of years.
But if you take the way we look at businesses, being the discounted flow of future cash out between now and Judgment Day, we can’t hedge that kind of a risk anyway. We could keep rolling hedges, but there’s a cost to it that we don’t want to incur.
Would you comment on the use of derivatives?
Any time you combine ignorance and borrowed money, you can get some pretty interesting consequences. The ability to borrow enormous amounts of money, combined with a chance to get either very rich or very poor very quickly, has historically been a recipe for trouble at some point.
Derivatives are not going to go away. They serve useful purposes, but I’m just saying that it has that potential.
General Questions
What were the three best books you read last year outside the investment field?
WARREN BUFFETT: Ben Graham’s biography by Janet Lowe. I think those of you who are interested in investments, for sure, will enjoy it. She’s done a good job of capturing Ben.
Geoff Cowan’s book, which is on “The People v. Clarence Darrow.” It’s the story of the Clarence Darrow trial for jury bribery in Los Angeles around 1912 when the McNamara brothers had bombed the LA Times.
CHARLIE MUNGER: Connie Bruck’s biography Master of the Game, a biography of Steve Ross, who headed Warner and later was co-chairman of Time Warner.
Van Doren’s biography of Benjamin Franklin, which came out in 1952. We’ve never had anybody quite like Franklin in this country. Never again.
Do you feel that the speed with which information is available and disseminated today has affected your decision process? And do you believe that speed has caused you to miss opportunities?
No, we perform about like we were doing 30 or 40 years ago. I mean, we read annual reports and then maybe asking questions around to ascertain trade positions or product strengths.
It isn’t the speed of information that really doesn’t make any difference to us. It’s the processing and finally coming to some judgment that actually has some utility, that it’s a judgment about the price of a business or a part of a business, a security, versus what it’s essentially worth.
None of that involves anything to do, really, with quick information. Instead, it involves getting good information.
I think you could be in someplace where the mails were delayed three weeks, and the quotations were delayed three weeks, and I think you could do just fine in investing.
From time to time, you have quoted John Maynard Keynes, the British economist. So, I assume you have read the investment writings extensively. What are two or three investment lessons one can learn from that economist?
There is a chapter in “The General Theory” that relates to markets, the psychology of markets, and the behavior of market participants that probably is, aside from Ben Graham’s two chapters, 8 and 20, in “The Intelligent Investor” I think you’ll find you’ll get as much wisdom from reading that as anything written in investments.
From vastly different starting points, Keynes and Graham came to the same conclusion at about the same time in the ’30s as to the soundest way to invest over time. However, they differed in some of their ideas on diversification. Keynes believed in diversifying far less than Graham.
But Keynes started with the wrong theory, I would say, in the ’20s and essentially tried to predict business cycles in markets, then shifted to fundamental analysis of businesses in the ’30s and did extremely well.
And about the same time, Graham was writing his first material.
To sum up
While I have read a great deal about Warren Buffett and Charlie Munger through various books, articles, and letters, I found the process of preparing this text to be especially enjoyable. Of the many valuable lessons that emerged from the 1994 meeting, I find the importance of CEO capital allocation skills to be the most significant. This is undoubtedly the most crucial skill that any CEO should possess. As we can observe from current practice, what Buffett said in 1994 remains valid to this day.