We Study Billionaires - The Investor’s Podcast Network - TIP195: Buffett & Munger Q & A at the 2018 Berkshire Hathaway Shareholders Meeting (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. Hey, how's everyone doing out there? So today's show is an episode that Sting and I really look forward to recording every year. And if you're new to the show, we travel to Omaha, Nebraska each year for Warren Buffett and Charlie Munger's Berkshire Hathaway Shareholders Meeting. During the meeting, we take the top 10 questions and do a recap of what we learned and thought about their responses. This coverage is going to stretch across two episodes.

Starting point is 00:00:26 So on today's show, we'll be covering our first five Q&A. that we thought were noteworthy. So without further delay, I hope you enjoy our coverage of the 2018 Berkshire Hathaway shareholders meeting. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, so as you guys heard in the intro, we're going to be covering the top 10 questions

Starting point is 00:01:05 that Stig and I both heard during this past Berkshire Hathaway. The Way Shareholders meeting. It was a great meeting, as it always is. I really had fun. You know, the highlight for me is really kind of interacting with all the folks that come out for the meeting. I think this year, how many do you think we had that came this year for the bar crawl and everything else?

Starting point is 00:01:24 How many do you think we had? We should probably have a calendar or something like that. I want to say that we're probably 200 people like when we're the most people. All those two days just coming and going, I don't know, 400? Redd? Yeah, it was busy. And we had a blast meeting everyone. So anyone who came out, just thank you so much

Starting point is 00:01:44 for making the long trip out to Omaha. I'm sure you, you know, 99% of it was coming to see Warren and Charlie, but the fact that you guys hung out with us a little bit was pretty awesome as well. So without further delay, here's the questions that we're going to play. This question comes from Paul Speaker of Chicago, Illinois.

Starting point is 00:02:00 I believe he may be here today. He writes, one of your more famous and perhaps most insightful quotes goes as follows. Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks. In light of the unauthorized accounting scandal at Wells Fargo, of its admission that it charged customers for duplicate auto insurance, of its admissions that it wrongly fined mortgage holders in relations to missing deadlines caused by delays that were its own fault, of its admission that it charged some

Starting point is 00:02:32 customers and proper fees to lock in mortgage interest rates of the sanction placed upon it by the Federal Reserve, prohibiting it from growing its balance sheet, and of the more than recent $1 billion penalty leveled by federal regulators for the aforementioned misbehavior. If Wells Fargo Company is a chronically leaking boat, at what magnitude of leakage would Berkshire consider changing vessels? Well, Wells Fargo, Wells Fargo is a company that proved the efficacy of incentives. And it's just that they had the wrong incentives.

Starting point is 00:03:16 And that was bad. But then they committed the much greater error. And I don't know exactly how or who did it or when. But ignoring the fact that they had a faulty incentive system, which was incenting people to do things that were kind of crazy, like opening non-existent accounts, et cetera. And, you know, that is the Cardinal Senate, Berkshire. We know people are doing something wrong right as we sit here at Berkshire. You can't have 377,000 employees and expect that everyone is behaving like Ben Franklin or something out there. They, they,

Starting point is 00:04:04 we, I don't know whether there are 10 things being done wrong as we speak or 20 or 50. The important thing is we don't want an incentive any of that if we can avoid it. And if we find, when we find it's going on, we have to do something about it. And that is absolutely the key to it. And Wells Fargo didn't do it, but Solomon didn't do it. And the truth is we've made a couple of our greatest investments where people have made similar errors. We bought our American Express stock. That was the best investment I ever made in my partnership years. We bought our American Express stock in 1964 because somebody was incented to do the

Starting point is 00:04:47 wrong thing in something called the American Express Field Warehousing Company. We bought a very substantial amount of GEICO we bought, but became half of GEICO for $40 million because somebody was incented to meet Wall Street estimates of earnings and growth, and they didn't focus on having the proper reserves. And that caused a lot of pain at American Express in 1964. It caused a lot of pain at Geico in 1976. It caused a layoff of a significant portion of the workforce, all kinds of things. But they cleaned it up. They cleaned it up, and look where American Express has moved since that time. Look at where Geico has moved since that time. So

Starting point is 00:05:32 the fact that you are going to have problems at some very large institution is not unique. In fact, almost every bank has all the big banks have had troubles of one sort or another, and I see no reason

Starting point is 00:05:49 why Wells Fargo as a company from both an investment standpoint and a moral standpoint going forward. is in any way inferior to the other big banks with which it competes. They made a big mistake. We have a large, unrealized gain in it, but that doesn't have anything to do with our decision-making.

Starting point is 00:06:13 I like it as an investment. I like Tim Sloan as a manager. He is correcting mistakes made by other people. I tried to correct mistakes. At Solomon and I had terrific help from Derek Maughan, as well as a number of the people of Munkertolls. And I mean that that is going to happen. You try to minimize it.

Starting point is 00:06:37 Charlie says that an ounce of prevention isn't worth a pound of cure. It's worth about a ton of cure. And we out and jump on everything. He's pushed me all my life to make sure that I attack unpleasant problems at surface. and that's sometimes not easy to do when everything else is going fine. And at Wells, they clearly, and I don't know exactly what, but they did what people at every organization have sometimes done, but it got accentuated to an extreme point.

Starting point is 00:07:13 But I see no reason to think that Wells Fargo going forward is other than a very, very, very, large, well-run bank that had an episode in his history, it wished it didn't have. But Geico came out stronger, American Express came out stronger. The question is what you do when you find the problems. Charlie? Well, I agree with that.

Starting point is 00:07:41 I think Wells Fargo is going to be better going forward than it would have been if these leaks had never been discovered. Or it happened. Yeah. So I think it, but I think Harvey Weinstein has done a lot for improving behavior too. It's, it was clearly an error, and they're acutely aware of it and acutely embarrassed and they don't want to have it happen again. no, if I had to say which bank is more likely to behave the best in the future, it might be Wells Fargo. All right, so I think that's a pretty interesting discussion all centered around Wells Fargo because it's been in the news so much lately.

Starting point is 00:08:39 Before I throw it over to you, Stig, I found it really interesting how the whole crowd really applauded Andrew Sorkin's question whenever he did this. I just really thought the crowd wanted to hear this discussion quite a bit. But what were your thoughts? Basically, what he said was that Wells Fargo has been. I don't know if they're still doing it. I think that's an interesting discussion we can have later. But he said that at least the way it was before the scandal, they incentivized bad behavior. And they did that with all the cross-selling and they were setting up accounts.

Starting point is 00:09:10 They weren't even there. And they incentivized the entire organization wrong. And you kind of get what you incentivize. And then Buffett brought up this example with American. express quite a few times, which is one of the most famous examples, because as he also proudly said, that was how he made the most money in his early days with his partnerships. And what happened just really, really briefly related to this, is that you incentivize people to do the wrong thing. That was the story that he referred to. Now, this case is different

Starting point is 00:09:41 because this was already a huge position in Buffett's portfolio. And Wells Fargo is the second largest position in Buffett's portfolio right now. So it's a different situation to be, and it's not like, oh, there has been a scandal. I'm looking at this, and I don't see that we have the same problem. So I'll go in and buy at a good price and then potentially sell out or whatever's going to happen whenever the price goes to intrinsic value. So I kind of feel that was interesting. So what are you going to do that now this is your situation? He originally bought around 12 billion. He billed at a cost around $12 billion. And it's priced around 23, 24 right now. So he's more or less doubled his money. And that's even despite all the turbulence that you've seen. So it's

Starting point is 00:10:27 still been a very profitable investment, even though the stock took a hit. But I think what was most interesting is that he talks about how Tim Sloan, the CEO, might use this as a reason to clean up and correct other people's mistakes. And Monker even said, Yeah, if I had to bet on who would behave best in the future, it might even be Wells Fargo. But I think, at least what I have a hard time understanding, perhaps all the investors is, is this truly over? Is this an inherent problem in the culture of the business that you can't just change because you get a new management and you tell people, oh, by the way, you know, don't break the law all the time? Yeah, and I think that your comment about the culture is really kind of the big issue here. And from their vantage point, and I might be wrong, but the way I kind of interpret.

Starting point is 00:11:14 is I think that they view the finance industry in general as maybe having just maybe not the best culture in general. And so then I think they're looking at it, okay, as Wells Fargo, any different than any of these other banks, is their culture worse than any of these other banks? And I think, you know, my opinion is, is if those two guys were sitting in the room, they'd tell you, well, how is this any worse than any other bank on Wall Street? And I think the answer to that is maybe they aren't. So I kind of agree with their point of view.

Starting point is 00:11:45 I think that this might be a buying opportunity if you're wanting to have banks in your portfolio because of all the bad news. And hopefully, hopefully for the people that work at Wells Fargo, it is just a few bad actors. But, you know, maybe it's not. But you heard their comments there. And let's go ahead and go on to the next question. I just found that one really fascinating. Okay, here we got.

Starting point is 00:12:07 Next question. This question comes from a Berkshire shareholder named Jack Sezowski. He's a well-known accounting expert who for many years has written the accounting observer. Mr. Buffett, in this year's shareholder letter, you have harsh words for the new accounting rule that requires companies to use market value accounting for their investment holdings. For analytical purposes, you said, Berkshire's bottom line will be useless. I'd like to argue with you about that. Shouldn't a company's earnings report say everything that happened to and within a company during an accounting period? Shouldn't the income statement be like an objectively written newspaper informing shareholders of what happened under the management for that period,

Starting point is 00:12:54 showing what management did to increase shareholder value and how outside forces may have affected the firm? If securities increased in value, surely the company and the shareholders are better off. and surely they're worse off if securities decreased in value. Those changes are most certainly real. In my opinion, ignoring changes in the way that some companies ignore restructuring costs is censoring the shareholders' newspaper. So my question is, how would you answer what I say? Well, my answer to the question that asked what my answer would be to what he said.

Starting point is 00:13:36 I would ask Jack, if we've got $170 billion of partly owned companies which we intend to own for decades and which we expect to become worth more money over time, and where we reflect the market value in our balance sheet, does it make sense to every quarter mark those up and down for the income account, when at the same time we own businesses that have become worth far more much money in most cases and become, you know, since we bought you name the company, take Geico, an extreme case,

Starting point is 00:14:14 we bought half the company for $50 million dollars roughly. Do we want to be marking that up every quarter to the value and having it run through the income account? That becomes an appraisal process. There's nothing wrong with doing that in terms of evaluation.

Starting point is 00:14:31 But in terms of value, and you can call it gain in net asset value or loss in net asset value. That's what I called an investment fund or an open investment fund would do. But to run that through an income account, if I looked at our 60 or 70 businesses or whatever number there might be, and every quarter we mark those to market, we would have obviously a great many, in certain cases where over time we'd have them at 10 times what we paid, but how quarter by quarter we should mark those up and run it through the income account where 99% of net of investors probably look at net income as being meaningful in

Starting point is 00:15:14 terms of what has been produced from operations during the year, I think would be, well, I can say it would be enormously deceptive. I mean, in the first quarter of this year, you saw the figures earlier where we had the best out, what I would call operating earnings in our history, and our securities were down $6 billion or whatever it was. To keep running that through the income account every day, you would say that we might have made on Friday. We probably made $2.5 billion. Well, if you have investors and commentators and analysts and everybody else,

Starting point is 00:15:53 working off those net income numbers and trying to project earnings for quarters and earnings for future years to the penny, I think you're doing a great disservice by running those through the income account. I think it's fine to have marketable securities on the balance sheet, the information available is to their market value. But we have businesses there. If we were, we never would do it. But if we were to sell half, we'll say, of the BNSF railroad,

Starting point is 00:16:25 we would receive more than we carry it. carry it for them, we would turn it into a marketable security and it would look like we made a ton of money overnight or if we were to appraise it, you know, appraise it every three months and write it up and down. A, it could lead to all kinds of manipulation, but B, it would just lead to the average to any investor, being totally confused. I don't want to receive data in that manner, and therefore I don't want to send it out in that manner. trying well to me it's obvious that the change in valuation should be noted and it is and always has been goes right into the net worth figures so the questioner doesn't understand his own profession i'm not supposed to talk that way but it slips out once in a while sometimes even gives it a push let's take a quick break

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Starting point is 00:21:27 Sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. I'm sorry, but I absolutely love this exchange because it just highlights how a loss some teachers are. I'm sorry to say it like this. But man, if you don't know anything about accounting, these two just absolutely schooled whoever

Starting point is 00:22:02 this teacher is that asked this question because these new accounting rules don't make any sense whatsoever for you to be run in unrealized gains into the income statement. I mean, it is just ludicrous. And like Buffett said, it's already accounted for on the balance sheet. Like, I mean, that's why Charlie just concluded so shortly, like, clearly the person who's asking this question has no idea what they're talking about and has obviously never run their own business, because if you've run your own business, this is just really obvious why this shouldn't be done this way. The thing that I think about Stig is what if they own private equity?

Starting point is 00:22:37 Let's say they had a non-controlling share of private equity. What are they supposed to do? Go out and get an appraisal every quarter? Yeah, I think that is what Buffett is getting at there. It opens up to so much manipulation in terms of accounting. It's unbelievable. So other than that, what else do you have? Well, I would really like to take the opportunity to discuss a bit more about the rule because

Starting point is 00:23:00 what Buffett was getting at before and what he's been getting at at some of the previous letters, if not almost all of them, is that it's very easy to fabricate a profit in your income statement for the type of company that works at Hathaway is. So say that he were to sell his position of Wells Fargo that we just talked about before. Now, it used to be so that he sold that, he would be making $12 billion in profit. Now, it wouldn't be a more profitable company, but he can just record that because now he sold his marketable securities. Now, so with this rule really does as now his earnings would fluctuate all the time.

Starting point is 00:23:43 And example before, that's a problem in itself. But now with this new change, and that's why he talked about, you can easily swing $10 billion in earnings over a quarter for no reason whatsoever. So right now his portfolio is $188 billion. So it shouldn't take a lot for it to swing by $10 billion. I mean, we're not talking huge percentages. And if you look at his quarter results, it works out of Hathaway since 2015. You know, they've been pretty stable. But then in 2018, because of this new rule, the first quarter, he reported a loss of 629 million, which is roughly like a $6 billion impact, not because he sold a bunch of stocks that were unprofitable,

Starting point is 00:24:28 but simply because that was what the market did at the point in time. And since then, the market has gone up again, so now he might be able to report a really, really decent profit for the next quarter. So basically what the person asked for is, shouldn't the income statement be a representative item in terms of saying how much money did the company make this quarter. And the answer is yes, but that's just not the way to do it. That's the way to confuse people, because people usually don't look in the balance sheet. You could find all this information in the balance sheet, as you also mentioned before, Preston. But that's not what people read, and that's not what reporters

Starting point is 00:25:07 talk about. So they would go on CNBC and say, you know, Berkshire Hella gave out with a loss, and people might sell because, oh, Buffett lost this magic. Now it's suddenly unprofitable. But it's all because of accounting. It was just as profitable that quarter as the last one, just as the next quarter where he'd probably record a very, very nice gain or a very nice net income, at least in accounting terms. There wasn't a dramatically better quarter. It was just the way that the marketable securities moved that quarter. So I think it's very dangerous if you go in and change the rule like that. But nonetheless, it has happened. I mean, at the end of the day, the whole purpose of the income statement is to display to the shareholder. How much operational income is this business making? And whenever you're fluctuating that amount by what the stock price is doing, with the underlying value of these businesses that you own are now influencing what the operations are doing, it just doesn't make any sense. And you're confusing people. And that's why he kept referencing, you know, if a lot of people use this to determine what they think the value,

Starting point is 00:26:11 of a business is and now they're going to be misguided, you know. So anyway, let's go on to the next question here. You recently noted that you prefer sherry purchases over dividends as a means for returning capital to shareholders should Berkshire's cash balances continue to rise. A one-time special dividend could be a useful option for returning a larger chunk of Berkshire's excess capital to shareholders without the implied promise to keep paying a regular dividend forever. The drawback with the special dividend, though, is that it would lead to an immediate decline

Starting point is 00:26:41 fine in book value and book value per share, whereas a larger share repurchase effort while depressing book value would reduce Berkshire's share count limiting the impact on book value per share. If we do happen to get a few years out and Berkshire does hit that $150 billion threshold, because valuations continue to be too high, both for acquisitions and for the repurchase of company stock, would you consider a one-time special dividend as a means for returning capital and shareholders? Well, if we thought we couldn't use capital effectively, we would try to figure out the most effective way of returning capital, the shareholds. And you could, I would have probably, I think it'd be unlikely we'd do it by a special dividend.

Starting point is 00:27:28 I think it'd be more likely we'd do it by a repurchase if the repurchase didn't result in us paying a price above intrinsic value per share. We're never going to do anything that we think is harmful to continuing shareholders. So we think the stock is intrinsically worth X, and we would have to pay some modest multiple, even above that, to repurchase shares. We wouldn't do it because we would be hurting continuing shareovers to the benefit of the people who are getting out. But we will try and do whatever makes the most sense,

Starting point is 00:28:03 but not with the idea that we have to, We have to do something every day because we simply can't find something that day. We had a vote, as you know, I don't know, a few years back on whether people wanted the dividend. The B shares, so I'm not talking my shares or Charlie's or anything, but the B shares voted 47 to 1 against it. So I think through self-selection of who become shareholders, I don't think shareholders, world, or countrywide on all stocks, would vote 47 to one at all. But we could self-selection in terms of it joins us.

Starting point is 00:28:45 And I think they expect us to do whatever we think makes the sense for all shareholders. And obviously, if we really thought we never could use the money effectively in the business, we should get it out one way or another. You've got a bunch of directors who own significant, very significant amounts of stock themselves. And you can expect them to think like owners. That's the reason they're on the board. And you expect the management to think like owners. And owners will return money to all of the owners.

Starting point is 00:29:31 if they think it makes more sense than continuing to look for things to do. But we invested in the first quarter, maybe we have to look at it up on the, well, certainly through April, probably close to $15 billion or something like that and that. We won't always be in a world of very low interest rates, nor high private market prices. So we will do what makes the most sense. But I can't see us ever making a special, almost, it's very unlikely we would just pay out a big special. I think that if we put that to the vote of the shareholders and Charlie and I did not vote, I think we would get a big negative vote. and I'd be willing to make a bet on that one.

Starting point is 00:30:27 Charlie? Well, as long as the existing system continues to work as well as it has, why would we change it? We've got a whole lot of people that are accustomed to it who've done well onto it, and if conditions change, why we're capable of changing our minds if the facts change? Yeah, and we've done that.

Starting point is 00:30:51 several times. Yes. Yeah. Although I must say it's a little hard. All right. So on this question here, I think the thing that people need to understand about Buffett's approach and why he doesn't like to pay dividends. And like he said there, he brought it to a vote.

Starting point is 00:31:08 I think we were at the meeting when that happened to maybe what two years ago or something like that. And the reason he doesn't do it is because of tax reasons. So if I get paid a dividend from a company, I'm taxed on that income on my personal level. right. But if he returns that money by doing share buybacks, then he doesn't go through the same tax implications for the people that are receiving that, the shareholders that are receiving that benefit. I think maybe the best way to think about this is think about it from Buffett's standpoint.

Starting point is 00:31:35 He owns, what, 40% of the company. So could you imagine the special dividend payout that he would receive privately as the shareholder of that many shares and what his tax bill would be that year for receiving such a huge payout. It'd be astronomical. But if he takes all that cash flow and he buys back Berkshire stock, then he reduces the number of shares that are outstanding, which then boosts the value of the shares. And that's how he can pay himself without basically getting double tax. So that's what his preference is. Now, he didn't say absolutely that's what he's going to do. And he brought up the intrinsic value of Berkshire whenever he said that, because maybe it would make more sense to make a special dividend payment, but in order for that to happen, the intrinsic

Starting point is 00:32:21 value of the Berkshire stock would have to be so overvalued that it would offset the tax bill that he would have to pay as a private owner of the shares, which he thinks is very improbable. And so that's why he kind of phrased it that way. But, you know, interesting question for people to hear because they might not understand why he has that opinion. But for anybody that follows him really closely, you kind of know exactly the direction he was going to probably take the answer on that one. I don't think I've ever gone to a meeting where someone didn't ask for that. And I kind of like Buffett's response to that because he said that there was a self-selection.

Starting point is 00:32:58 What frustrates some of the shareholders is that they just see that cash position on the balance sheet. It's just growing, growing, grown. Then they're like, we understand why you can pay out a recurring dividend, but why can't you do a special dividend, say, $50 billion. I think that's what people are considering. And so whenever we talk about a special dividend, it's typically a one-time thing. So it might be a company that has a huge one-time gain in something. Say that the sold-off division, they got it all in cash, they can find the cash in a good way,

Starting point is 00:33:30 and they might do it as a special dividend. And as you can hear from the name, it's not as a recurring dividend, say that you would get a dollar every quarter. It was actually also nice to hear why he said that even if we ask shareholders, what do you prefer? Well, by the way, we actually did that. And they said 47 to 1. And this was not like a shareholder. So it wasn't Buffett.

Starting point is 00:33:55 It wasn't Munger. There was like you and me, us being able to afford B stock. And they said, you know, people voted no in terms of dividend 47 to 1. And basically then what was Munger was getting at in terms of why it was a lot. a good idea is the track record shows that they are better at investing that most retail investors are, which is also while you invest in Berkshire in the first place in a lot of cases, because you know that they can come up that better for you over time. Now, this is definitely not my way of saying that it's never good to own stock that pays a dividend. I think that for many different

Starting point is 00:34:34 stocks, it makes a lot of sense to pay a dividend. Press now talked about gas promise. And For a stock like that, you know, it's Russian stock. The might be certainties there. It seemed to us at the time undervalued and it has performed well since. And you would collect your, what is it, 5% or 6% yield ever since. And it kind of makes sense because they have so much cash. They're having great a stream of cash flows. And you want to take off some of that risk.

Starting point is 00:35:01 So yes, for a company like that, it would make a lot of sense. It's difficult to double your production if you're in gas, especially the way the company is structured. So this is not the same as saying a special dividend is bad. For a company like Brooks of Helloway, it might not be the best example of doing it. But I wouldn't be surprised, Preston, if we heard the exact same question next year. Yeah, that's for sure. I'm sure that question will come up again next year. All right.

Starting point is 00:35:27 So let's go on the move to the next one here. Hi, good morning. Mr. Buffett and Mr. Munger. My name is Duffy Yu from Horizon Insights, a China-focused research firm based in Shanghai. So my question is, if you only have $1 billion in your portfolio today, how would you change your investments? Would you consider more investment opportunities in emerging markets such as China?

Starting point is 00:35:57 Thank you. Yeah, I would say if I were working with a billion, I would probably find within a 30 trillion dollar market in the United States, where I understood things better generally than I do around the raw. I'd probably find opportunities there that would be better, incidentally, by some margin than what we can find for hundreds of billions. But I wouldn't. There's no way I blew a lot of emergency markets. There was a time 15 years ago or so. Just because it was kind of interesting. It took me back my youth, on a weekend I went through a directory of Korean stocks and I bought, and these were small stocks.

Starting point is 00:36:51 Well, they were small by standards of either Korean or American business. They were big, big companies. But I found 15 or 20 and it were statistically cheap and I want some of each one myself. And there are opportunities with smaller amounts of money to do things that we just can't do through things in the United States. And I come through in other countries, I probably wouldn't get into very, very small markets. I guess there can be a lot of difficulties even in market execution and taxation, a lot of things. You can't find it in America and China and written in a few other places. You're probably going to find it someplace else.

Starting point is 00:37:45 You may think you found it, but that may be a different game. Our problem is size, not geography. Charlie? Well, I already have more stocks in China than you do as a percentage. So I'm with the young lady. Okay, well, you want to name names? Do these stocks have names? No, I don't.

Starting point is 00:38:14 Carol. This question. I should just add one thing. You will find plenty of opportunities. Charlie would say you've got a better hunting ground than even a person with similar capital in the United States. Yes, I do. Yeah.

Starting point is 00:38:32 And in the sense, it's logical. to be the case because it's a younger market, but still a large market. So that markets probably work toward efficiency as they age. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why Vantza is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program, VANTA keeps you secure

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Starting point is 00:42:12 All right. Back to the show. So quite an interesting discussion there with respect to investing in China. And I think it's interesting that you see the difference here between Charlie and Warren, where Charlie seems much more prone to invest in China than Warren. And he delicately said that at the start of his response that he would still invest in the U.S., even if he was working with a billion dollars. He felt like he could maybe get some better buys than what he's getting at his current threshold, but he would still be investing in the U.S. So just kind of an interesting comment that I don't really know why he's so prone.

Starting point is 00:42:48 Maybe it's the gap accounting differences that maybe he doesn't trust over there. That's all I can really think of as being maybe the prime reason. I'm curious what Stig thinks on that. Well, I also think it depends on which type of company that you're looking at. If it's something like retail, you know, consumer preferences are just very, very different in China. And I think a lot of the knowledge he would have about behavior in the States and the Western world is just very different. So I think that's where he's more hesitant. I don't think that Buffett couldn't have done that if he really wanted to.

Starting point is 00:43:25 But say it wasn't like a billion dollars he had, say it was more like $10 billion, $20 billion. So he could still make more moves. Then he might do a play like he did in Korea back in the days where he've almost like made his own index. I think he bought around 15 or 20 stocks. They were statistically cheap. And he might wanting to do that if he trusted the accounting in China. But it would more be like a statistical play than it would be, oh, I really understand the mode of these China. Chinese company and that's why that they were performed well. And despite that there are a ton of

Starting point is 00:44:00 Chinese companies also export a lot, for a lot of Chinese companies, that is the main market, just like it is in the States that the domestic market would typically also be the most important. So if you don't understand that, again, only invest in things you understand, it should be possible in a 30 trillion market cap stock market like the US to find something if you had a billion dollars. So I guess that's what he's getting at. And the other thing is also there's a lot of regular you need to take into account. As an example, just in the States, he has to sell a little Wells Fargo almost all the time because he can't push above his 10% limit because then he would be too dominating.

Starting point is 00:44:38 And that's just one regulation. He knows how to handle that and he accountable for that whenever he bought the position. But it would be different. A lot of countries, you would need to make it public at a different point in time if you have at least 5%. So there are a lot of things that you will need to take into consideration that is just not his game. And the Chinese stock market, despite the Chinese economy being so huge as it is, it's not a big stock market. You have a lot of huge private companies and you also have some

Starting point is 00:45:05 that are public, but it's just constructed in a very different way. So the overall market cap and your universe is not as big as you might expect for China. All right. So let's go ahead and play the last question we're going to play for this segment. And then next week we'll have another five questions. But here's the last question we're going to play today. Okay, station seven. Good morning. I have a question related to the bond market, the U.S. Treasury bond market. My name is Oler-Larsen.

Starting point is 00:45:35 I live in the San Francisco Bay Area. And I never worked in the financial industry. I started out buying penny mining stocks on the Vancouver Stock Exchange. And then decade later, I got married. and my wife convinced me to buy Berkshire shares. That were probably a good decision. So my question is, I read the newspapers about the Federal Reserve

Starting point is 00:46:08 and the inflation numbers, and there must be an increased supply of treasury bonds that must go to arguably. And my question is, how would, what do you expect that to impact yield or interest rate? Yeah, the answer is, I don't know. And the good news is nobody else knows, including members of the Federal Reserve and everywhere. There are a lot of variables in the picture. And the one thing we know is we think that long-term bonds are terrible and

Starting point is 00:46:51 investment at current rates or anything close to current rates. So basically all of our money that is waiting to be placed is in treasury bills that they have an average maturity of four months or something like that at most. The rates on those have gone up lately so that in 2018, my guess is, will have at least $500 million more of pre-tax income than we would have had in the bills last year. But they still, it's not because we want a hold of, we're waiting to do something else, but long-term bonds are basically at these rates, it's almost ridiculous when you think about it, because here the Federal Reserve Board is telling you we want 2% a year inflation,

Starting point is 00:47:51 And the very long bond is not much more than 3%. And, of course, if you're an individual and you pay tax on it, you're going to have some income taxes to pay. And let's say it brings your after-tax return down to 2.5%. So the Federal Reserve is telling you that they're going to do whatever's in their power to make sure that you don't get more than a half a percent a year of inflation-adjusted income. And that seems to me a very, I wouldn't go back to penny stocks, but I think I would stick with productive businesses or productive, certain other productive assets by far. But what the bond market does in the next year, you know, you've got trillions of dollars in the hands of people that are trying to guess which maturity would be the best to own and all that sort of thing.

Starting point is 00:48:46 And we do not bring anything to that game that would allow us to think that we've got an edge. Charlie? Well, really wasn't fair for our monetary authorities to reduce the savings rates paid mostly to our old people with savings accounts as much as they did. But they probably had to do it to fight the Great Recession appropriately. But it clearly wasn't fair. conditions were weird. In my whole lifetime, it's only happened once that interest rates went down so low and stayed low for a long time. It was quite unfair to a lot of people, and it benefited the people in this room enormously because it drove asset prices up, including the price of Berkshire Hathaway stock. So we're all a bunch of undeserving people, and I hope that we continue to be so. at the time this newspaper came out in 1942

Starting point is 00:49:48 it was the government was appealing to the patriots of everybody as kids we went to school and we bought savings stamps to put in well they first called them U.S. war bonds and they called them U.S. defense bonds and then they called them U.S. savings bonds but they were called war bonds then and you put up 18

Starting point is 00:50:11 $17.75 and you got back $25 in 10 years and that's when I learned that that $4 for three in 10 years was 2.9% compounded beef. They had to put in small print that and even an 11-year-old could understand that 2.9% compounded for 10 years was not a good investment but we all we all bought them it was part of the war effort basically and the government knew that significant inflation

Starting point is 00:50:48 was coming from what was taking place in finance in World War II we actually were on a massive Keynesian type behavior not because we elected to follow Keynes but because war forced us that this huge

Starting point is 00:51:04 deficit in our finances which took our debt up to 120% of GDP and it was the great Keynesian experiment of all time, and we backed into it, and it sent us on a wave of prosperity like we've never seen. So you get some accidental benefits sometimes. But the United States government then was earning every citizen to put their money into a fixed dollar investment at 2.9 percent compounded for 10 years. And I think perjury bonds have been

Starting point is 00:51:34 unattractive ever since, with the exception of the early 80s. That was something at that time. I mean, you really had a chance to buy, you had a chance to invest your money by buying zero coupon, charging bonds, and in effect, guarantee yourself that for 30 years, you would get a compounded return, you know, something like 14%, or 30 years of your lifetime. So every now and then something really strange happens in markets, and the trick is to not only be prepared, but to take action when it happens. So this was an interesting discussion here about bonds. And what I find interesting about this is you can't find a person that has a high net worth that thinks long-term bonds are a good place to be in the long term.

Starting point is 00:52:27 Not a single one of them. And Buffett and Munger obviously agree. It was kind of interesting there at the end where he was talking about back in the early 1980s when the 10-year treasury was over 15%. And where I think it was hard for people to pull the trigger and own something like that is because at that time, inflation was, you know, 14%. I mean, it was just as high. And so your real return at that point was maybe a percent or two. And so that's why people back then didn't want to own it. But hearing Buffett look back at that scenario and basically say, any person should know that this high of inflation shouldn't last for 30 years into the future. and he was exactly right. It didn't last that long. And look at what kind of return you would have got if you would have locked something like that in because those sky high rates at 15%. You know, it didn't last very long.

Starting point is 00:53:23 That was a very short-lived experience. It only happened for a few years. And then they drastically started falling from there. And like everyone knows, they're down at like 3% now. So just in general, very interesting conversation. And I would have really like to have heard his opinion on where he thinks. thinks they're going to go, but like he opened up, he said, I have no idea where they're going to go, and neither does anybody else. So he didn't pontificate. And I think that's what makes Buffett.

Starting point is 00:53:49 Buffett is because he's so open to the possibility of rates going lower or rates going higher. He's not trying to predict that. He's trying to react to that in an appropriate way. And that's what really makes him so lethal. It's difficult for investors to figure out, like, what should we do now with all our cash. And basically what Buffett said that he did was he has a, around a four-month average maturity, his bonds, and then he can get just a little less than 2% a year, something like that. But the extra return that you can get something that's on the yield or call it 30 years, it's not that much more. Like, what you gain extra is probably not worth the opportunity cost. That's really what he's getting at. So you would get 3% if you would

Starting point is 00:54:36 tie money up in 30-year bonds. And even so, you know, with taxation and inflation, you're not looking at an attractive yield. Again, then you might say if you then hold just in cash, then you're sure to lose your investment in terms of inflation. But it's also because there's an upside risk and there's a downside risk to bonds. So say that you bought a 30-year bond of 3%, and then the rates would go up by 1%. You would see a 17% loss in Facebook. of the bond if you did invest in their bond like that. To say that you would be a $1,000 bond 30 year, 3%, rates would go up to 4%. Then you could sell it for 827. So it's a risk that you incur if you do that. And I think that's also one of the reasons why people are not super excited

Starting point is 00:55:26 about it. But then again, the lower yield they're talking about. But that typically just means is that they push the prices of stocks up. That was what Munger was getting at, that we're, what is said, like, ungrateful people or undeserving people or something like that. And he hoped that we continue, because as bonds become relatively less attractive,

Starting point is 00:55:44 you would push up the price of the stock, making the yield of the stock relatively lower, but it would push up the price. And you've seen definitely a lot of that, this business cycle. So a very interesting discussion and very interesting to hear about his thoughts, even though he's basically,

Starting point is 00:56:01 I don't know. Yeah, he doesn't know and he's not buying. So, all right. Well, hey, that's all we have for this week. We really appreciate you guys tuning in and we'll see you guys next week. Thanks for listening to TIP. To access the show notes, courses, or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to ask the investors.com and win a free

Starting point is 00:56:26 subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP Network. Written permission must be granted before syndication or rebroadcasting. TIP! TIP!

We Study Billionaires - The Investor’s Podcast Network - TIP195: Buffett & Munger Q & A at the 2018 Berkshire Hathaway Shareholders Meeting (Business Podcast)

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