We Study Billionaires - The Investor’s Podcast Network - TIP443: Buffett's Biggest Blunders w/ David Kass

Starting point is 00:00:00 You're listening to TIP. On today's show, we have Dr. David Cass, who is a PhD economist and professor at the University of Maryland. Prior to joining the faculty of the Smith School in 2004, he held senior positions with the federal government, the Federal Trade Commission, General Accounting Office, Department of Defense, and the Bureau of Economic Analysis. His blog on Warren Buffett has gained notoriety from features on Bloomberg, CNBC, and Fox, and David is often quoted in the New York Times, Wall Street Journal, and Washington. So he's the perfect guest for today's exploration of Buffett's biggest blunders. In this episode, we discussed the story of how Buffett bought Berkshire after letting his emotions

Starting point is 00:00:41 get the best of him and why it was originally a huge mistake, how he could have made hundreds of billions of dollars more had he simply just invested in insurance. His early position in Conoco-Philips that resulted in a loss, why buying Dexter's shoes was, in Buffett's words, the worst purchase he ever made, how he missed out on Google, Amazon, and others, his overpayment for precision cast parts, and how even through all of that one single dollar invested with Buffett in 1965 would now be worth $3.65 million. David is such a wonderful and gracious guest. He shares his stories of visiting Buffett in Omaha with his students and so many other great insights. I really hope you enjoy it as much as I did. So without further ado, here's my

Starting point is 00:01:21 conversation with Dr. David Cass. You are listening to The Investors Podcast, where we see study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to the Investors podcast. I'm your host, Trey Lockerbie, and today I'm very pleased to have with me Dr. David Cass to come on our show and talk about Buffett's biggest blunders. Welcome to the show, David. Well, thank you very much for having me. You got your PhD in economics and business from Harvard.

Starting point is 00:02:07 You went on to do a number of things, including working at the DOD for a couple of years. So maybe catch us up on your background and then what eventually led you to studying Buffett and writing about him and teaching this class. Yes, I'd be happy to. After receiving my PhD in business and economics, I came to Washington to work for the Farrell government as a senior economist. And I worked for four different government agencies over many years. Federal Trade Commission, General Accounting Office, which is now called Government Accountability Office, Department of Defense, looking at their health care delivery system, and Bureau of Economic Analysis as part of the Commerce Department. I have the FTC, in addition to doing financial analysis on mergers.

Starting point is 00:02:54 One of my special fields in graduate school was industrial organization, which basically looks at something called structured conduct performance, competitive nature of industries, and financial analysis finance was the second special field. So at the FTC, I did, again, several studies there in those related areas. Similarly, at the general accounting office, DOD, health care for a couple of years, and Bureau of Economic Analysis. cutting across several areas. I then retired an early retirement from the federal government, and what I always wanted to do, and the reason I went for a PhD, went to school for a PhD, was so I could teach at the university level. I always had an interest in economics and finance, and I got my opportunity in 2004 with Robert A. Smith School of Business at the University of Maryland, and where I've been ever since. So it's my 18th year.

Starting point is 00:03:54 Now, as a hobby, I just have always read books. I picked up a book called The Money Masters by John Train. And I immediately turned to the back of the book. There were seven successful portfolio managers being written up in the book. And at the back of the book, I looked at the current portfolios, the latest portfolios, of each of the seven managers. Six of them did not particularly impress me. They just looked like the momentum stocks, the hot stocks from the year before.

Starting point is 00:04:23 But the seventh one just jumped right out at me as being very different. And some of the stocks included in that portfolio were American Express, the Washington Post Company, Capital Cities Broadcasting. And I knew enough about the stock market and stocks to have some knowledge, a considerable knowledge of each of those companies. And I had a good idea. These are wonderful companies below the radar. And I asked myself, gee, who's portfolio is this? And it was Warren Buffett. And that was my initial introduction to him. So I started paying careful attention to him.

Starting point is 00:05:02 A few years later, actually I noticed another book had come out and written a chapter about him. The book itself, I believe, was published a few years earlier in 1977. I think it was called Super Money. The author was Adam Smith. That was a pen name for someone named George Goodman. But Adam Smith was the official author of the book. And he had a chapter on Warren Buffett as well. And so I started following Warren Buffett through the newspaper, Wall Street Journal,

Starting point is 00:05:29 acquisitions, and it was just fascinating and finding that I felt that he and I were sort of on parallel wavelengths in terms of long-term quality, value investing. And I could learn so much from him. And after a few years of having this sitting in my mind, I finally came around saying, gee, why don't I buy a share of Berkshire Hathaway? It did around 1985. So it took me about five years to reach that conclusion. And at that time, as I recall, it was October 1985.

Starting point is 00:06:06 That share sold for $2,120 a share. And of course, back then they had only A shares. So there were no B shares. And that year today is cost value in over $500,000. So anyway, I became a big fan of Warren Buffett, became, he really was a role model for me in terms of investing. And in terms of being a wonderful person as well. And then when I arrived at the University of Maryland, fall of 2004, and spring in 2005, there was a notice posted in the main lobby of the business school at the University of Maryland. and a student was advertising for other students to join him on a trip, private trip to Omaha, Nebraska,

Starting point is 00:06:51 to meet privately with Warren Buffett. Anyone who signed up could go. I then contacted the student, and maybe I did this sort of backwards from the way it's normally done, and I asked him, could you use a faculty advisor? And I then convinced him that I was a longtime Buffett fan, my personal library at home. Probably had every Warren Buffett book written at that time. And he was quite receptive to my idea. And off we went to Omaha. We had 50 students. We didn't turn down anyone. It was undergraduates and MBA students. And that was the first year in 2005, the Warren Buffett started meeting with students at various universities. We were one of, I think, 15 universities that he met with that year. And it was very interesting experience. I remember sitting in a room by his

Starting point is 00:07:44 office. And when we signed up everyone, and this may be the third time I'm saying it, we did not turn anyone down. But the result was demographically, by gender, we had 49 men and only one woman. And Warren Buffett came into the room, looked around the room before he said hello, before he introduced himself. The first thing he said was where. are the women. And of course, I got all red in the face. I felt like trying to hide under my chair in embarrassment. And from then on, actually, in subsequent student visits from other universities, including Maryland, Warren Buffett required in future visits that at least one third of the students visiting with him would be women. And indeed, I was invited back three more times to

Starting point is 00:08:32 bring University of Maryland students with me in 2011, 2013, and 2016. And at that time, the format had changed. He'd meet with 20 students from eight schools at a time, five times during the year. So one-third of 20 would be seven, at least seven women would come on each of our trips. And I think I was very careful in that regard. I think it was brought along at least eight, trying to make up for an inadvertent error in the past, let's say. And he loves to meet with students. And so anyway, I have following him along those lines. And then on the occasion of his 80th birthday in August 30th, 2010, I launched a Warren

Starting point is 00:09:17 Buffett blog at the University of Maryland, basically blogging about Berkshire Hathaway, Warren Buffett, occasionally some more general topics on finance economics in the stock market. So anyway, Buffett has been with me, certainly a role model, and he still is today. So I admire his approach to investing, carefully follow it. And to some extent, obviously, a much smaller scale, I might duplicate a few of his steps. Well, hopefully not the steps that we're going to cover today. We're going to go over a few of these. And before we do, I just wanted to mention that I love that you brought up the super money book by Adam Smith, actually,

Starting point is 00:09:57 because when I had a chance to meet Buffett and I asked him for some resources to learn more, that was actually one of the books he recommended to me. We certainly praise Buffett a lot on this show, but I just thought it would be fun to cover some of his biggest blunders. One of his earliest reported mistakes was actually buying Berkshire Hathaway. And in fact, during a 2010 appearance on CNBC, Buffett called Berkshire Hathaway, quote, the dumbest stock I ever bought. Walk us through what Buffett was buying at that time when he approached Berkshire Hathaway,

Starting point is 00:10:29 why he decided to liquidate his partnerships to roll it into Berkshire, and then what happened next? Okay, at that time, he started invest. Berkshire Hathaway was a textile company with textile mills in New England in the early 1960s. And Buffett initiated investments in the company around 1962. to, and he was attracted to it because of low price, earnings valuations, good cash flow being generated. He thought it was sort of an undervalued asset that he could take advantage of and profit from. And the turning point, which led to what we're discussing, his purchase of the company, came in 1964 when the CEO or principal owner of the company, someone named Seaburie Stanton,

Starting point is 00:11:19 made Warren Buffett an oral offer to buy his shares, to buy him out at $11.5 a share. And Buffett agreed to do that. He would sell him his shares at 11.5. And he would move on to other investments. But sometime later, a little time later, he receives the official written offer. And instead of being at 11.5, it was at 11 and 3 eighths. And let me just take a step aside, I have to explain this to my students now that back then, whereas today stock prices trade in decimals, smallest unit generally a penny. Back then, they traded in fractions, the smallest unit being one-eighth of a point. So this is not unusual to have a price of 11 and 3-8s or 3-8s part of a price. Anyway, Warren was very upset. He was clearly being cheated out of 1-8th of a point.

Starting point is 00:12:13 They already had an agreement. And I guess he was fairly young at the time. He would have been 33, 34 years old. And I guess it's one example. He led his emotion, perhaps, take control over his better judgment. And he decided he was going to just buy out the company with a stated purpose so he could fire Mr. Stanton. And so that's what he did.

Starting point is 00:12:37 And that's the reason he bought Berkshire Halfway, sort of a vindictive action to get even and which he later regretted. Over the next several years, the textile industry declined rapidly. First, it moved to the south in the United States, lower costs, lower labor, eventually overseas, a lower labor overseas. And essentially, Berkshire essentially went bankrupt. The businesses did. So he moved on from there to investing in insurance, insurance companies and so on.

Starting point is 00:13:09 And the rest's history today, of course, you have this $500 billion. million dollars, six watches company in the United States by market cap. But that's the early history that I'm sure he's not very proud of in that investment. Yeah, I believe the quote from Buffett is that he quote unquote chiseled me for an eighth. That was just such an interesting quote. And what's even more interesting about this is, as you said, Buffett appears to be this sort of almost, even if you read the snowball book, he comes across as sort of impervious to emotional based decisions. But this stock was bought out of spite, as you put it, and it's essentially a lapse in behavioral and or emotional discipline that Buffett is known for later. So is this one of the

Starting point is 00:13:53 only times we've seen this side of Buffett come out? Well, certainly this type of context. And again, he was relatively young. He's in his early 30s at the time. And people do make mistakes as he did. At one point, there were other times where he made other investment mistakes and there are two types. I'll refer to errors of commission, buying the stock and losing money, for example, or errors of omission, planning to buy a stock, hesitating, not buying it, and then the opportunity costs, so to speak, watching the stock then skyrocket and sort of losing out on the opportunity to earn many billions for Berkshire. But those were just pretty much judgmental, being extra careful or maybe a little less careful

Starting point is 00:14:45 than he should have been, less circumspect than he should have been. But not of this emotional sort of, gee, I'm going to get even with this guy. He tried to cheat me, so I'm going to get even with him. This is the only such instance that I'm aware of of that time. So Buffett's also said that if instead of putting that money into the textile business, originally. We had just started out with an insurance company, Berkshire would be worth twice as much as it is now, he said. So basically, all in all, Buffett calculated that this mistake was worth $200 billion. So, ouch. So interesting. And, you know, despite regretting the purchase of a failing

Starting point is 00:15:25 textile company, Berkshire Hathaway, Buffett did the same thing 13 years later when he purchased Womback Mills, another New England textile company. Why was Buffett so drawn to these textile companies. Again, I think he was drawn to them. He thought that their valuation, priced earnings very low, price to cash flow very low, that they were good values. He referred to as these cigar butts that you could pick up off the street and get one or two extra puffs of at a very low price, they're almost free. And he thought he could squeeze out some additional cash flow from these companies without fully appreciating how rapidly that, industry was in decline, that those pups may not last as long as he thought or provide as

Starting point is 00:16:13 much return as he expected. So I guess it took him, he was attracted to them in another industry where he doesn't seem to learn his lessons from, although he's aware he makes mistakes, it's something called the airline industry where he can and has repeated a couple of mistakes. he's very much attracted to airlines and both attracted to them and critical of their management as well over time, but keeps perhaps repeating a couple of earlier mistakes. So he does have certain tendencies to go back into an area and he may have invested in before. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer.

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Starting point is 00:20:52 That's Shopify. slash WSB. All right. Back to the show. Well, he is human after all. And, you know, we can poke fun at Buffett, mainly because of this unbelievable performance as an investor, especially with Berkshire Hathaway. For instance, between 1965 and 2021, Berkshire Hathaway produced an annual gain of 20.1% compared

Starting point is 00:21:17 to the S&P 500 with dividends gain of 10.5%. So put another way, $1 invested in the S&P 500. in 1964 would have turned into $30,209 by the end of 2021. But $1 invested in Berkshire Hathaway in 1964 would be worth $3.64 million. Just unbelievable. Unbelievable. Okay. So in moving on to one of his other mistakes, in 2008, Buffett bought a large stake in

Starting point is 00:21:46 the stock Conoco Phillips as a play on the future energy prices. However, this turned out to be a bad investment because Buffett bought in at too high have a price resulting in a multi-billion dollar loss for Berkshire Hathaway. Was this a mistake of not paying attention to the macro conditions of the time as he's known to kind of shy away from? Well, he's been attracted to oil stocks and energy stocks over the years. Early on and Susquele, he's been in and out of Exxon Mobil, for example, and more recently in the last year or so, both Chevron and accidental petroleum. So he's invested in this industry. So he's invested in this industry. a lot in the past. I think he's attracted to it, but he is acknowledged over time that the

Starting point is 00:22:32 primary determinant of the value of oil company stocks was the price of oil. And with the case of Conoco-Philips, I guess he was making a bet that the price of oil would either stay at the current level at the time and go higher, but certainly not drop off significantly. And also, Conoco-Phillips, like the other oil stocks, also paid a good dividend. So there was an income aspect to it as well. So one certainly needs to consider both capital gains and income in the investments. But the Conoco-Philips, I guess, did not work out as well as he hoped for. So interesting.

Starting point is 00:23:11 All right. Moving on, in 1993, Buffett bought a shoe company called Dexter Shoes. And in his 2008 annual letter, Buffett claims that this investment was the worst he ever made, resulting in a loss to shareholders to the amount of $3.5 billion. Where was the folly here and what lessons did Buffett learn from this? The main folly here, the Dexter shoe lesson is actually similar to the Berkshire Halfway textile mill era of a declining industry, sort of almost doomed to go bankrupt. But that's only a minor, minor part of his mistake.

Starting point is 00:23:50 He invested $433 million in Dexterity. issue in 1993 and went to zero. His mistake, though, was not paying $4333 million in cash. His mistake was paying in Berkshire stock, 25,203 shares of Berkshire stock, which in 2008, you mentioned, was valued a $3.8 billion. Well, in 2022, today, it's valued at $13 billion. It's a $13 billion loss. It's open-ended. It keeps getting bigger and bigger of the better Berkshire Hathaway stock performs. It's open-ended. A phenomenal mistake. So he has gone out of his way in subsequent acquisitions to try to avoid using Berkshire stock in acquisitions. One exception he's made since then his acquisition of Burlington Northern Railroad about 10 years ago, because Berkshire stock was so highly priced at the time, he agreed to have a certain percentage of the acquisition in stock as well as cash. It was a combination cash and stock. It provided the opportunity

Starting point is 00:24:58 to Burlington Northern shareholders to receive the shares in Berkshire so they could continue to be equity holders. That's a rare exception he's made since then, and that was negotiated, I'm sure, with Burlington Northern, but the open-ended nature of this loss of Dexter Shoe, that will probably always be his biggest mistake. Yeah, that is so interesting to me because, you know, with the stock over half a million dollars per share, you would think that that would provide him a lot of leverage to make deals without tapping into his cash. But as you mentioned, the cash is finite, but using the stock, if it goes south, is sort of infinite, right? As it continues to compound higher. You know, obviously Buffett was familiar with the idea of a competitive advantage, right? I think he would learn that from his Graham days. But do you think this example, burn that into his kind of psyche a little bit more about making sure there was a margin of safety certainly around the competitive advantage especially. When he studied at Columbia University under Ben Graham, basically he learned early on the concept

Starting point is 00:26:06 of durable, competitive advantage, and margin of safety. And he has used that all along. And of course, as he learns from his earlier mistakes, hopefully not repeat them in the future, has applied them maybe with greater precision. But he has always approached his investments in that way. And indeed, early on, because he was a disciple of Ben Graham and since Ben Graham, as you know, it's on the board of directors of chairman of Geico at the time. Therefore, Warren Buffett became interested in Geico and learned about insurance, actually, that way, and learning about the durable competitive advantage that GEICO had its cost advantage in its business model. So he has certainly applied this going forward, but occasionally, I guess the mistakes that of commission that he's made some of them

Starting point is 00:26:58 since then are more of judgmental errors. You are, when you make an investment in equities, you are basically forecasting future earnings, future cash flows, what the future economy will look like and how that economy will interact with your investment, a company you're investing in. And that of necessity needs to incorporate, and it's very difficult to do so, the impact of future technology. And the problems that that could cause, and right now I'm thinking of a company called IBM, for example, And there you have, of course, disruptive technologies coming in. IBM was the premier technology company of the 1950s and 60s, maybe early 1970s as well. And here's Warren Buffett in the year 2011, placing a huge bet on IBM.

Starting point is 00:27:55 And between 2011-2016, I believe he invested something like $14 billion and not fully appreciating the risk that he was taking on is he always stresses that he tries to stay within his circle of competence. What industries, what businesses does he understand? And those that he does not, he leaves to others. And within his circle of competence, certainly he's demonstrated great expertise in the insurance area, the insurance industry. He's succeeded quite nicely over the years and Geico is a wonderful example of that. But in the technology area is something that with 2020 hindsight, certainly we can look back and say, gee, I don't think that's where Warren's expertise really lay. And perhaps his mistake there was looking at past performance, perhaps a

Starting point is 00:28:50 little bit more than he should have, not a fully appreciating how rapidly technology was changing in the process of changing and how competitive the future market would be for the businesses that IBM was in. And it took him a long time to acknowledge that he was going down the wrong path. And it took him about five years and he started bailing out, and five years later, around 2016 or so. And I think he may have absorbed a net loss or at best broke even, but he may have lost a little. But here, his real loss in the roughly 14 billion he invested was the opportunity cost, the S&P 500, more than double over this time period. So just investing in average for him, average for the economy would have doubled that money. And of course, investing, as he later did,

Starting point is 00:29:42 right around that time, actually. Starting in 2016, he may have learned a little bit of that lesson and started putting $30 billion or so into Apple. And that has worked out marvelous. well. Apple today is quintuple. Since then, his $30 billion investment is worth roughly $160 billion. And there Warren views Apple as producing, focusing on the iPhone, as a consumer product, although it's obviously a blend of consumer product and technology, of course, but he viewed it as a consumer product, a product that consumers could not live without. And so far, he's been absolutely correct in that regard. And I think his circle of competence around consumer products is very strong in that area. And that has worked out very well for him. But with expect to IBM, it was like

Starting point is 00:30:34 this five-year period of longer of money just sitting there, not producing a rate of return, perhaps losing a little, underestimating his ability, perhaps to forecast the future for that company and not fully appreciating how rapidly technology. was changing. Yeah, you know, I've sat in the audience for those annual shareholder meetings where people are asking about IBM, like, look, what are we doing in this position? And it's been painful, right, to kind of hear him come to terms with his mistake in that regard.

Starting point is 00:31:05 He was very, I think, stubborn to come to it. But he's totally, as you put it, redeemed himself, right, with this Apple position. There were other mistakes of omission, as you kind of highlighted earlier, for example, not buying Google. He's since put some position in an Amazon. But that, you know, even Amazon, he had Jeff Bezos in his office, you know, pitching him on Amazon very early on. And of course, hindsight's 2020. But, you know, knowing how good of a judge of character he is and he's since gone on to say how much Bezos is maybe the best business mind and, you know, ever. But what

Starting point is 00:31:36 thought he would have recognized at it, but he just was probably a little bit burned or something or not, you know, mainly from that IBM or that lack of understanding in the tech world. And one other example that is just interesting on that is, you know, Geico at one point was spending, I think, upwards of 10% of their premiums every year on Google ads. So even though Buffett was saying he doesn't understand Google, and mind you, there were actually other search engines at the time, right? You know, Mozilla or whatever, other ones, Yahoo. But seeing how much of that money from Geico is flowing into Google, you think that would have gotten him a little bit motivated to understand that business a little earlier than he did. Yes. As a matter of fact,

Starting point is 00:32:15 And the first time I brought students to meet with Warren Buffett, that's the time, again, with 49 out of 50 being male. What he does at those meetings, by the way, for those who are not aware of it, he answers student questions maybe an hour and a half. Then he takes the students to lunch and then poses for pictures with the students. And in 2005, when we were at lunch at Gorat's restaurant, one of his favorite steakhouses in Omaha, I had the good fortune of sitting at an agency, decent table from the one he was sitting at with students. I was close enough so I could hear the conversation, but not be intrusive, not taking the place of any student at the table, certainly. And one student asked him specifically in this year, 2005, Google had just gone public with its

Starting point is 00:33:02 IPO the year before, 2004. So it's one year in the public market. Why doesn't Berkshire invest in Google. And Buffett even said to the student, yes, Geico was paying a lot of money to Google to advertise him, fully aware of it. But he was hesitant. He was aware of these other search engines and he saw them come and go or being bypassed by Google and would something else come along next year and five years that would leave Google in the dust, so to speak. So he was very reluctant at the time to, again, it's in a technology area that he felt it was not his expertise. expertise, but students were pushing him on that. And it was very interesting. And he and Charlie at the annual meeting, both with the shareholder questions would come up. Why isn't Berkshire investing in

Starting point is 00:33:52 Amazon and Google? And there seemed to be this hesitation, reluctance, sort of risk aversion, so I'd rather miss out on something big than to invest and lose. It was sort of that type of mindset and maybe, again, it was not their area of expertise that maybe it took the two relatively new portfolio managers, Todd Colmes and Ted Weshler, who joined Berkshire roughly 10 years ago. And it would not surprise me that Amazon was perhaps an investment of one of those two portfolio managers. And I believe Apple initially was also an initial investment of one of those two portfolio managers, then Buffett was sort of sold on it, and certainly the bulk of Berkshire's investment

Starting point is 00:34:37 in Apple today came from Buffett, for sure, as each of the two portfolio managers have a limited amount of capital at their disposal to invest. But I believe it was those two, one or both of those two new portfolio managers, Ted Weshler and Todd Combs, who really started pushing Berkshire in the direction of technology. I totally agree with you. I think that's a great call out. And what's coming to my mind right now is the fact that Buffett has said that he uses a scuttlebutt approach to some investments. And with Apple in particular, I remember him talking about him, I think going to do a dairy queen with his granddaughters and seeing them on their iPhones and how they couldn't get off of them. And then just kind of asking people about it and studying that. It's reminding me of that old American Express bet he put on after the salad oil scandal.

Starting point is 00:35:25 Stock went way down and he came in after, you know, checking around and just qualitatively understanding that the brand, was still intact. And do you buy into this exactly? You know, he's not known to be opening up Excel files running discounted cash flows. He's taking a lot of these qualitative approaches over time. Is this maybe partly to do with some of the mistakes that we've talked about today? Well, he, in terms of discounted cash flows and analysis, he apparently, his mind, his brain, is quite capable of running a very complex discounted cash flow analysis in his head without the use of a computer, something that very few others are capable of doing. And so he is certainly, he estimates what he calls intrinsic value of a company. And for example, he'll buy back shares

Starting point is 00:36:14 and Berkshares. He's been doing for the last year or two, only to the extent that he values Berkshire's intrinsic value is above where he is buying the shares. The shares are selling below his estimate of intrinsic value. He'll buy the shares. But his estimate, he's never revealed the the calculations that he does or what his estimate is of intrinsic value. He'll just tell you that he's doing it. And he has his own way of doing it, his own discount rates that he uses. I know in business school, we teach our students quite typically to use weighted average cost of capital as a discount rate, for example. And he might use something like a treasury rate on long-term treasuries. But there are different ways. Different people can use different approaches

Starting point is 00:36:59 to discounting future cash flows. But he certainly, in making, I believe any of his investments, is certainly using a discount rate, making an estimate of future cash flows being just generated and using, in his mind, an appropriate discount rate, whereas if he views the company as being riskier than other companies who would use a higher discount rate, and it's a company he really understands real well,

Starting point is 00:37:25 been following it for many years, and he feels the business plan, and the model is very stable, he might use a lower discount rate for it. So he's very analytical, does much of it in his head rather than on a computer. 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 VANTA 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 stock two or running an enterprise

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Starting point is 00:40:51 This and other information can be found in the income fund's perspective. at Fundrise.com slash income. This is a paid advertisement. All right, back to the show. All right. So one of the last mistakes we're going to cover today is precision cast parts. So Berkshire Hathaway acquires precision cast parts for $32.1 billion in 2016. And they are obviously an aircraft industrial parts maker. It was the largest acquisition for Berkshire at the time. And Berkshire actually wrote off nearly $10 billion just last August from the start. investment as the coronavirus pandemic, you know, zapped all the demand for air travel. What was the mistake here? 32 billion, obviously a very large amount. Was this another case of

Starting point is 00:41:34 him overpaying? Well, here, the case, you know, the way he actually made the investment is very interesting that Mark Donaghan, one of his portfolio managers, let me take a step back. I had already initiated a passive stake in precision cast parts in 2015, maybe a little earlier. That was Todd Cohn's. And Mark Donagan, the CEO, a precision cast parts who does a lot of traveling, visits a lot of his large investors, including Berkshire. So one day, I guess in 2015, I think it was maybe in July or so, 2015, when Mark Donaghan was visiting Berkshire and speaking to Todd Combs, Warren Buffett came along and the story goes. And there's a very small office at Berkshire headquarters. Very few people are there. Warren Buffett walked along, started hearing part of the conversation.

Starting point is 00:42:25 asked if he could join the conversation, sit down. And of course, that's what occurred. And he was so impressed with Mark Donegan, and soon thereafter, made an offer for the whole company. Now, when wrong here in Berkshire's 2020 annual report in his letter to shareholders, he refers to this, in his words, this ugly $11 billion write down. And he said he paid too much for the company. There's certain developments in the aerospace industry, of course with the pandemic, you have less flying precision cast parts, makes large components and parts for aircraft commercial as well as defense aircraft. And Buffett says in his letter to shareholders, I was wrong in judging the average amount of future earnings and consequently paid too much. And he says he concludes PCC,

Starting point is 00:43:15 it's far from my first error of that sort, but it's a big one. So he just projected in his own mind that the company would have performed better than it actually had. And indeed, in 2016, at the Berkshire annual meeting in 2016, in which for many years, throughout 10 years in a row, I would bring students from the University of Maryland out to the Berkshire annual meeting. And in the exhibit area, there would be exhibits of all the Berkshire companies, I had the good fortune to have the opportunity to meet Mark Donegan, the CEO, and chat with him, and mentioned to him actually that I and two of my colleagues at the University of Maryland wrote a case on precision cast parts that I now use as a teaching tool in my class. And I mentioned the case to him.

Starting point is 00:44:03 And I found most interesting while I was waiting to speak with him, there were a couple of shareholders ahead of me in line chatting with him. And his conversation was such. I could see why Warren Buffett would want to buy the company with a CEO like this. He said that he spends 250 days out of of the year traveling. He doesn't create shareholder value by sending in his office. When he's on the road, he can get contract signed. He could solve problems at his various company installations. And he's like, gunhole, in trying to maximize your shareholder value. And I think it's that energy level, that focus that may have attracted, in addition, attracted Warren Buffett to the company. You know, what's interesting about that last point is I've spoken to a number of investors,

Starting point is 00:44:49 some of which do not focus at all on the management of a company, mainly because in their minds, they would say, you know, a CEO got to where he was or where she was by being a great salesperson. So I don't know if that was what was happening with Mark Donigan, which is a great salesperson, but it sounds like he certainly charmed Buffett and even charmed you and he probably has that effect on a lot of people. And that's a very interesting skill to have and obviously got him where he is. And also from Warren's letter in 2020, he said, he refers to him. Mark Donagin is a passionate manager who consistently pours the same managing to the business

Starting point is 00:45:25 they did before we purchase it. We are lucky to have him running things. So he is certainly very pleased with him. But yeah, you know, as your point is well taken, that's certainly one way for CEOs to make it to the top. They have to be able to sell the board of directors, for example, or the previous CEO on their ability. So that is certainly valid. sell the dream. Yeah, exactly. You've mentioned that you've taken your students to Omaha number of times. What were some of the best questions from your students to Buffett? And what do you think were some of his most surprising or even enlightening responses? Yeah. The first time, what surprised me that there was a 2005 visit where the questions that were asked during the formal Q&A session might be, what's your outlook for the economy? A good questions on international. National economics. What are your views on back then, 2005, investing in a country like China or Europe or Asia, or the United States, and fairly broad of that sort. But when the students were gathered around him at a table informally over lunch,

Starting point is 00:46:33 the questions were very different. And one student actually asked the question, do you have any advice on how to choose a spouse? Now, these are students in their 20s, by and large single, in their early 20s. And Buffett's answer, again, I was close enough to hear it was choose someone who will love you unconditionally and he expanded on that as well. So there were some more personal related questions of that sort. And he would give advice choosing a career, make sure you're passionate and what you do. Only do something if you really love it. And if you're really passionate about it, you'll be noticed in your office, in your company. And that should lead to advancement within your firm or where you are. The answers he has given that I found most interesting and most meaningful, I think not only for students, but actually for myself as well,

Starting point is 00:47:23 questions that almost every year of the students ask a similar question. What are the qualities that you look for when you hire people or what are the qualities that are most likely for someone to succeed as an investor in the stock market? What qualities do you need for success? And Buffett's answer, as follows, they says, well, if you have an IQ and it's always has some humor in his answers. If you have an IQ of at least 125, that's all you need. If you have any IQ is any higher than that, then jokingly, he says, then you should sell the extra points. You don't need them. And he talks about hard work, analysis, good training and accounting and finance. But then the keyword, the keyword that separates those who are really successful from

Starting point is 00:48:10 those who are not, is the word temperament. Having the right temperament. He's no many people, very high IQs who work very hard, but they cannot control their emotions when we have very sharp market swings up or down. He has given examples where he's known portfolio managers who for 19 years are outperforming the market or doing very well. Then in year 20, they blow up. And he gives examples, why risk what you have and need to try to achieve something that you don't have and don't need. And a lot of investors have just blown themselves up our portfolio managers in that regard. So the word temperament, you know, the control your motions throughout the entire market cycle, I think is critical. And the second type of answer that he gives is probably his longest answer,

Starting point is 00:49:00 questions soon after the financial crisis of 2007 through 2009, when I brought students there in 2011, 13 and 16. There were questions that came up. Can you explain what happened during the financial crisis, that type of question? And he would give a very thorough, at least a five to 10 minute response. And he then he would quote, this may not be the precise words, but he said that George W. Bush, President Bush, he gave a quote, something to the effect, that he said, the most important 10 words ever quoted by an economist anywhere. And he says something to the effect, if money doesn't loosen up, this sucker is going down. Something pretty close to those words. And indeed, of course, both monetary policy loosened up at that time. Congress provided the fiscal

Starting point is 00:49:50 stimulus that was needed. We got the monetary stimulus and we came out of it. But we were on the brink of something that could have been really a lot worse. So he always seems to have an discussion in that area. And then there are sometimes questions on interest rates. And I remember in 2016, at the student meeting. The student did ask a question of the interest rates and market valuation at the time. And I remember Warren Buffett saying back then that if interest rates or don't go above three or four percent long-term rates over the next three years, then stocks are certainly not overvalued.

Starting point is 00:50:28 Something to that effect, relating interest rates to valuation. And one of his favorite quotes, which I think is extremely meaningful, which I use in the classroom as well. And he says interest rates are to asset prices as gravity is to matter. So just think about it. If interest rates are zero, asset prices levitate. They go up to new highs. If gravity is zero, think of the astronauts around the moon just floating with no gravity,

Starting point is 00:50:59 they levitate. But as interest rates go up, of course, it provides competition for equities, equity prices come down as gravity, of course, increases people. The apple falls off of the tree. So great. With that earlier advice of finding a spouse, I thought you were going to go somewhere else. I've heard him say that to find a spouse, you need to find someone who has low expectations. My voice loved that as well. So luckily for Berkshire shareholders, there will be something to actually talk about this year, which is the recent acquisition of Allegheny after a long drought period of not making any purchases. He acquired it for over $11 billion. This seems like such a classic Buffett

Starting point is 00:51:42 purchase, right? And what I found interesting about what you just said there as well is, you know, you talked about how interest rates work. And you would think that interest rates as low as they are with the prospects they have to get any higher would have this really drastic effect on insurance and insurance businesses and affecting the profitability of those business. But he doesn't seem to be swayed by this very much, right? He's continued to invest and re-endezing. He's continued to invest in reinvest in insurance. He's obviously very bullish on the space. Right. And he has said his preferred holding period is forever. The best investments of those that he, you know, it's a one-time decision. When do you buy? You don't have to think about selling and something that compounds and grows and

Starting point is 00:52:23 just put it away. Business like Geico might be a very good example in that area. So he certainly with respect to Allegheny, insurance, it's an area he knows very well. It can, I can, He was the one area he knows best. He's got decades of experience in it. I'm sure he's been following the company for decades for many years, for many years, they're really familiar with it. The CEO, current CEO of Allegheny, is a former executive with Berkshire, General Ray, Mr. Brandon, I believe his name.

Starting point is 00:52:56 So he certainly is familiar with person running the company. And apparently right now there's an offer on the table to acquire the company is like $11.6 billion, this official 25-day shopping period, whatever, there's this opportunity of, and with maybe 14 or 10 days left to it, for another company to come in and if they so choose, make a higher bid. So, which I think is unlikely, but it's possible. It's certainly possible. So the offers on the table, and presumably at this time, Allegheny is very receptive to the acquisition by Berkshire. Just as Buffett is comfortable with Allegheny,

Starting point is 00:53:39 I'm sure the folks at Allegheny are very comfortable with Buffett and being owned by Berkshire. And when Berkshire requires a company, what's fairly unique is they leave management in place. They don't change management. So whatever you're doing now, you continue to run your business. It's an opportunity if you wish to cash out some of your equity

Starting point is 00:53:57 and the company being acquired, diversify your investments that way, but you still have your company, you're still running it, a very unique model that it's not really I'm aware of anywhere else. Yeah, and another interesting point about this acquisition that I just had to touch on is the fact that he really hasn't lost his somewhat spiteful flavor of investing, meaning I believe he negotiated the $11.6 billion minus the $27 million that they were going to pay to the investment bankers in the deal. Obviously, Charlie Munger and Warren Buffett do not think highly of investment

Starting point is 00:54:36 bankers being a part of any kind of deal. And so taking that out just to make sure they deducted that, I just, you know, you're already spending 11-something billion and just to deduct that 27 million seemed dumb. I mean, it's real money. It makes a difference. But just to make a point to do that is fascinating. And we've talked about Buffett quite a bit on this episode here, but, you know, want to just touch on Munger as well. He's been in the news as of late. He's obviously, 98, and he's finally stepping down from being the chairman of the Daily Journal. What is the impact of this for the Daily Journal? What track record is Charlie leaving behind?

Starting point is 00:55:12 What will be his legacy there? Okay, well, Charlie is the Daily Journal. They have two main businesses, and I guess they're primarily known for legal publication, I can call the Daily Journal legal times. And, of course, newspapers with the Internet are in decline. So it's really a declining business, but they have this parallel business that's growing. It's software. A software-related business that's growing, I think it's recently become profitable, which has,

Starting point is 00:55:42 I think, a fairly bright future. And like Berkshire, they have this large portfolio of stocks. And much of the value, part of the value of the Daily Journal is the value of that portfolio. And that portfolio consists of stocks, such as there are only, I think, three or four, stocks and portfolio, their largest holdings, Bank of America in Wells Fargo, and recently, and maybe in a controversial investment, Alibaba. And of course, here there's been some criticism of Charlie for investing in Alibaba, the stock sank, plus of issues. Will Alibaba BD listed, their ADRs of the shares that are trade in this country because the U.S. regulators cannot

Starting point is 00:56:25 gain access to the financial statement. So the latest, reports coming out as recently as yesterday that there may be plenty of room for compromise that access to these reports may be permitted. But one reason I believe that Charlie feels confident in investing in Alibaba is Lee Liu. Lee Lu runs Himalaya Capital. And I understand an highly regarded portfolio manager out in California. What I read elsewhere, I believe Lee Lou has dinner with Charlie every Tuesday evening. I think I read that somewhere. And Lee Lou is, It's the only person, Charlie Hissendez, who manages Charlie's money. So Charlie has a money manager, Lee Liu, and Lee Liu, who grew up in China, born in

Starting point is 00:57:09 China, and I believe he was a student there during the Tiananmen Square uprising in 1989, subsequently left there, believe, then earned an MBA from Columbia University and started his career in portfolio management. Lee Lu is apparently very good in evaluating Chinese companies and his portfolios, his hedge fund, Himalaya capital, has done extremely well over the years. And I'm pretty sure that Charlie would not have invested in Alibaba without Lee Lu's blessing. Let's put it that way. But that's been a controversial area.

Starting point is 00:57:47 But to answer your question, so a significant part of the valuation, a Daily Journal corporation, is actually the value of that portfolio. Wow, I didn't know that. That's super fascinating. Well, as I mentioned, Charlie's 98, Warren's almost 92, and this year will be a meaningful one to be in Omaha. I will be there with some of our team from TIP. You know, the days are numbered with these folks getting to their older age.

Starting point is 00:58:12 And after having the pandemic and not being able to go, I just think it makes it more meaningful to be there. And we're going to have a lot of fun. So hopefully the folks listening will be out there and can join us. David, this has been a spectacular discussion. I've really enjoyed learning from you. And I would love to have had the ability to take your class. But this will be a close proxy at least to get a taste of it. And I really appreciate you taking the time out of your day to talk to us and educate us. So with that being said, before I let you go, you do have the Warren Buffett blog. I'd love for you to hand off to our audience where they can find that, where they can learn more about you and any other books or resources you want to share. Oh, sure. No, I recommend just going to dr. Davidcast.com. We'll get you to my webpage at the University of Maryland. From there, there there'll be a link to my blog.

Starting point is 00:59:02 And please follow me on Twitter at DR David Cass. So I certainly tweet a lot about Warren Buffett and Berkshire, as well as other issues of similar interest to me. and on my webpage you could see various articles that I've written or where I've been quoted. Fantastic. Well, again, David, I really appreciate it and hope to do this again sometime. Thank you very much. You're very welcome. All right, everybody, that's all we had for you this week. If you're loving the show, don't forget to follow us on your favorite podcast app and maybe even leave us a review.

Starting point is 00:59:37 It really helps. If you want to learn how to invest like Buffett, there's really no better place to start than the investorspodcast.com or simply Google TIP Finance. And David and I originally connected on Twitter, you can find me there at Trey Lockerbie and give some feedback. And with that, we will see you again next time. Thank you for listening to TIP. Make sure to subscribe to millennial investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional.

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