University of North Carolina

Opening

The program opens with Buffett repeating a line he credits to Peter Lynch: buy a business so good that any idiot can run it, because sooner or later one will. He adds that if he buys the right kind of business, at the right price, with the right people, he expects to do well over time. A narrator introduces him: a partnership that earned nearly 30 percent a year for thirteen years, Berkshire Hathaway bought at twelve dollars a share in 1965 and trading above $25,000 by 1995, and holdings such as Coca-Cola, Gillette, See's Candies and the Nebraska Furniture Mart. The format is a dialogue with students, who may ask anything.

The Salomon Brothers crisis

Buffett begins with a lesson on employment. On August 14, 1991, at a quarter of seven in the morning, Salomon's top management called to say they would resign, because the head of the Fed of New York had found them unacceptable. Salomon had a balance sheet of 150 billion dollars, about 4 billion of it equity, and a very high percentage of the rest could come due within a few weeks. Eight thousand people worked there and nobody was left to run it. That evening he interviewed about a dozen candidates for what he calls the most important hire he has ever made.

He never asked about grades or looked at a résumé. All twelve were smart enough, so he listened to how their machinery worked: who was full of themselves, who might lack courage. He wanted what Ben Franklin described, people who give others more credit than themselves, do not cut corners, and deliver all they promise and a little extra. He found that person in Deryck Maughan, told him "You're it," and Maughan faced about 200 reporters for three hours with two minutes' notice. A month later he had still never asked what he was paid.

Buffett turns this into an exercise. Suppose you could choose a classmate and own ten percent of that person's lifetime earnings. You would probably not choose by grades, IQ or looks, but by qualities of character, and he says every one of them is obtainable, largely a matter of habit. Habits are easiest to form young, since the chains of habit are too light to be felt until they are too heavy to be broken. The same works in reverse. The person you would short is the one who cuts corners, claims credit for things not done, or is never on time. Such traits decide whether a 300-horsepower motor delivers 300 horsepower. His advice is to decide to be the person you would buy ten percent of.

Analyzing a business: Nebraska Furniture Mart and Coca-Cola

Asked about the analysis behind Rose Blumkin's furniture mart or Coca-Cola, Buffett describes Blumkin, who turns 101 in December. She arrived with no English, started the store with $500, and now it does 230 million dollars of business at one location. She still works seven days a week, and although she cannot read, the business will make $22 or $23 million pre-tax this year. For a business run that way, he says, that is all the analysis you need. Legal and accounting fees totaled $1,400, the contract was one page, and there was no audit, because he knew anything she said was so.

He believes any good investment idea can probably be put in one paragraph, and that you should operate within your circle of competence. What matters most, he says, is not how large the circle is but how well you have defined its perimeter. Coca-Cola is simple: it is 110 years old, sells 750 million servings a day, and holds 47 percent of soft drink consumption outside the United States and 41 percent inside. The test is whether the product is durable, the appeal universal, and management honest and competent. He looks for businesses he understands, with people he likes, at a sensible price, and then likes to buy a lot and keep it.

Knowing when to sell

Asked when to sell a business, Buffett says that for a really great business the answer is never. Selling a wonderful business because the price looks a little high is almost always a mistake, and he says it took him a long time to learn that and he has not fully learned it yet. Technology companies, where a few people in a garage may change an industry, are beyond him. Gillette is his example of keeping it simple: 20 or 21 billion blades a year worldwide, about 30 percent of them Gillette's but 60 percent by value, and 90 percent market share in some countries, for a product costing about $20 a year.

He likes businesses whose shape in 5, 10, 15 or 20 years he thinks he knows. He does not have to be right about Oracle, Microsoft or DuPont, only about one decision a year. In the department store business he had to answer every competitor's move, like swinging at every pitch, but in investing there are no called strikes, so you can wait for the pitch you want. Wall Street makes buying so easy that people do things that make little sense. Most fortunes, he says, have been made in relatively few securities, held for a very long time by a buyer who understood them.

The managers he admires

Buffett says he admires no one in business more than Tom Murphy, CEO of Capital Cities, who worked with Dan Burke. He also names Roberto Goizueta and Don Keough, one of the great two-manager combinations, who took Coke's market value from 5 billion dollars to 60 billion in eleven or twelve years. He admires Bill Gates enormously too, though he knows nothing about that business. He only works with people he likes, in a very small office, and thinks it is crazy to work with people who make your stomach churn. Doing so, he says, is like marrying for money: probably a bad idea in any case, but crazy if you are already rich. His advice to a Harvard student who asked whom to work for was to work for whomever you admire most.

Splitting the stock

Asked whether Berkshire will split its stock, Buffett says that in a public company anyone can become your partner, and the only qualification is money. He wants shareholders with the same expectations, time horizons and methods of measurement as his, because it is crazy to go into business with someone who expects something entirely different. He can influence that only through his communications and policies. A hall advertising a rock concert and staging a ballet would disappoint its crowd, and he does not want to advertise the wrong event. Splitting is a relatively minor item, but he would rather have owners who expect to hold for life.

By not splitting, he has eliminated some people he would not want to eliminate, and also everyone mainly interested in actively trading stocks, a group he is glad to lose. The New York Stock Exchange is not wild about it, since Berkshire has by far the lowest turnover relative to capitalization of any stock listed. To him that is terrific. If he ran a club or preached at a church, he would not measure success by how often the congregation turned over. He would like it if nobody wanted to leave their seats.

Investment mistakes: Fannie Mae and Walt Disney

Asked about a failure, Buffett says he makes more mistakes when he has a lot of cash around, because there is more compulsion to do something when you are sitting on cash. Having studied all the larger investments from his partnership days, he says they have generally not had large losses relative to capital: the largest loss ever, partnership and Berkshire together, was probably 2 percent of net worth. Doing few things, and carefully, probably prevents big errors of commission. Errors of omission are the big sins. He started to buy Fannie Mae around 1988 and did not follow through: they made about five million dollars, where he thinks they would have made about a billion and a half.

In 1966 Berkshire owned five percent of Walt Disney, bought for four million dollars when the whole company sold for 80 million, debt-free. Disney had spent 17 million on the Pirates of the Caribbean ride, owned 200-some films, and had Disneyland drawing nine million people a year. Buffett went to see Mary Poppins to judge whether such a film could be run over and over. About a year later they sold the five percent for six million. It would now be worth about a billion. Conventional accounting never shows that kind of mistake, and the ones you do not see, he says, are far bigger than the ones you do.

USAir and temporary insanity

Asked why he invested in USAir, Buffett answers that the best explanation is probably temporary insanity. He had written in the early 1970s that airlines were about the toughest business there was. Since Kitty Hawk, he says, the American airline business has made no money, and the net return to its owners, despite billions put in, is less than zero. In 1989 he had a lot of cash and the decision was 100 percent his. Seth Schofield, he says, is as good a human being and manager as you can find, but the airline has revenues set by the market and costs that are not, a recipe for trouble. He keeps an 800 number to call if he feels the urge to buy an airline stock.

Not predicting the stock market

The narrator says Buffett pays no attention to where the market is going. Buffett explains that if a private Walt Disney had offered him five percent for four million dollars in 1966, or a private Coca-Cola six-and-a-fraction percent for a billion in 1988, he would have thought about the company, not the market. If something looks intelligent to do, he will not skip it because of an opinion about the market, even Alan Greenspan's. He does not know how to predict the stock market, interest rates or business. In stocks, he says, it is very hard to know when something will happen and very easy to know what will happen.

He bought See's Candy in 1971 or '72, thinking about whether Russell Stover could knock it out, whether it could raise prices, and how firm its hold on chocolate consumers was. The same attitude applies to six percent of Coca-Cola. He recalls that Coca-Cola went public in 1919 or 1920 at forty dollars a share, and that the Trust Company of Georgia took its fee in stock, so a cost of $110,000 now appears on SunTrust's balance sheet as worth a little over a billion. The stock later fell more than 50 percent. He does not know whether the market will be higher or lower in two years, but there will be intelligent things to do, and if you see one, do it.

Owning all of a business versus a piece

Asked about the difference between owning all of See's and a piece of Coca-Cola, Buffett says it is far smaller than most people think. Owning all of a business lets him change management and choose where the earnings go, and he would rather allocate the capital himself. But he does not want to buy a business where he expects to need to change management, since he knows nothing about making chocolate. Being in a good business with good managers matters much more, and he would rather own part of a good business than all of a mediocre one. Berkshire's advantage is mental flexibility: it is not committed to any one industry, and he is somewhat detached and, he hopes, objective.

Banking consolidation

Buffett expects banking consolidation to continue in a big way. Most managers like to grow, and the American Banker ranks banks by size, not profitability. Size is measured by assets, but assets are balanced by liabilities, so it is the only business where people brag about how much they owe. Among the banks he looks at, he sees no economies of scale beyond a certain point. He used to own a bank in Rockford, Illinois, with 30 percent of its market, earning two percent on assets after tax, and he is convinced it would earn less inside a larger institution. He has seen good acquisitions, such as Wells Fargo's purchase of Crocker, but thinks shareholders of banks being acquired will be a little luckier than those of the acquirers.

Investing outside the United States

Asked about investing abroad and hedging currency risk, Buffett points to his holdings. Gillette makes about two-thirds of its money outside the United States and Coke over 80 percent. He loves companies that do well in international markets, particularly largely untapped ones. He would buy Coca-Cola if it were based in London or Amsterdam, though he would like it a tiny notch less, because of governance, taxes or attitudes toward capitalists that he might understand less well. He prefers a U.S. domicile and businesses with high returns on capital. He will look anywhere, but understands the accounting here a little better, and says that if he cannot make money in a five-trillion-dollar market, believing distance will help may be wishful thinking.

Franchise value and the economic moat

Asked which areas have franchise value, Buffett offers a test: if a store lacks your product but has something similar, does the buyer walk across the street to get yours, or pay a nickel more? If so, that tells you something about franchise. He applied this to See's, then selling candy at $1.95 a pound, asking whether people would pay more as inflation went on. The franchise is in their minds, he says, in the experience they had, and nobody buys Valentine's Day chocolates by taking the low bid. It may rest on taste, a mental association or service. The questions are how big it is and how durable.

He calls a franchise a moat around an economic castle. Two things matter: how big the castle is and how durable the moat. Coca-Cola is a big castle, and See's is not a very big one, but both have a moat that is either eroding slightly or being widened, through service, training or research. A moat protects you from someone who comes along and offers it a penny cheaper. You will not find one in carbon steel or an integrated oil company, but you do not need many. With ten good ideas in the rest of your life, you could give away five and still get very rich.

On clear writing

The narrator notes that Buffett writes the Berkshire annual report himself. He says that if you understand an idea, you can express it so others understand it too. When he hits a block writing the report, it is not for lack of words but because he has not got the idea straight in his own mind, and nothing forces you to think like writing. Footnotes work the same way. When he has trouble understanding one, he suspects the writer did not want him to understand it. A footnote on deferred acquisition costs in life insurance can be written clearly, and he probably will not invest in a company where he cannot understand a footnote.

Size as a drag on returns

Buffett says the more capital Berkshire works with, the worse its percentage returns on equity will be, other things being equal, as he has told shareholders for years. When he started with $10,000, any cheap security could have a significant impact. Now, putting $100 million into an idea that makes 50 percent yields about $32.5 million after tax, only three-tenths of one percent of net worth. It takes very big ideas to matter, and the businesses Berkshire can buy outright have shrunk in number as its capital has grown. He remembers turning the pages of the Moody's and Standard & Poor's manuals and finding companies at two times earnings, but he could only put in five, ten or fifty thousand dollars. That would be useless to Berkshire now.

On inherited wealth

Asked about children and money, Buffett says you should leave your children enough so they can do anything, but not enough so they can do nothing, a phrase he got from somebody else. People complain that food stamps create dependency, he says, but inherited wealth is really a lifetime supply of food stamps handed out by a trust officer. He also thinks society is responsible for a very significant percentage of what he has earned: put him in Bangladesh or Peru and you would see how little his talent produces in the wrong soil. The market rewards what he does disproportionately well, as it does Mike Tyson or a .360 hitter, but not a marvelous teacher or a terrific nurse.

He does not think a comparable-worth system could redistribute that. But when the market treats someone enormously well because of a peculiar talent, he believes society should have a big claim on it. For the child of such a person, cutting them off with zero is probably a mistake, yet a lifetime supply of claims on other people's production makes little sense to him. He closes by joking that his own child will be glad to come and rebut this next week.