We travelled to Omaha, Nebraska on Friday last for Berkshire Hathaway’s 2016 AGM, which took place on Saturday 30th April. I had previously attended a Berkshire AGM in 2007, but neither Darren nor Brian Delaney had been before.
A unique feature of Berkshire’s AGM is a marathon Q & A session (8.30am to 3.00pm), which often provides great insights into Berkshire Hathaway as a company and on investing in general. Warren Buffett and Charlie Munger did not disappoint us this year.
It was estimated that nearly 40,000 people attended. Surprisingly, the ratio of male to female attendees appeared to be about 60%/40%. We certainly don’t get that ratio at our 1-day investment training seminars in Ireland, which we run about every three months – more like 90%/10%.
We even managed to get a photo with the great man himself, although the passer-by who we asked to take the photo mistimed it slightly with Warren looking at the floor rather than into the camera. We were never going to get a second-take chance (or perhaps there was a little assistance from photoshop!).
Our day got off to a typical Irish start, with cold winds and belting rain as we queued outside the Century Link Arena in Omaha at 6.00am on Saturday morning. Thankfully, the doors to the arena were opened early due to the bad weather to visible relief all-round, and a coffee was the first order of the day. My black leather jacket had taken an unmerciful beating in the rain.
The programme of events was scheduled to kick off at 8.30am so we had time to survey the huge conference arena that held exhibitions by many Berkshire companies, including See’s Candies, a company Berkshire bought in the early 1970s (in the background of the photo below).
We also came away with two new quotes from Buffett and Munger!
‘Having a full wallet is like having a full bladder. You get the urge to pee it away.’ Warren Buffett
‘If you see the world accurately, it’s bound to be humourous, as it’s ridiculous’. Charlie Munger
Main Points we Took from the Q & A Session:
- Question: With acquisitions like Burlington Northern Santa Fe and utility businesses in general, Berkshire appears to have moved away from its old strategy of buying businesses with competitive advantages, that have high returns on equity and absorb little cash? Buffett’s Answer: Yes, Berkshire has changed by necessity of size. We can’t deploy the amount of cash the company is throwing off by waiting for the perfect business (He did make the point that the new model is more management dependent and, in this regard, he raved about Mark Donegan, CEO of Precision Castparts). We will still get decent returns on capital, but no longer extraordinary returns on capital. Our Comment: The read-through on this is that Berkshire is no longer capable of growing at its historical rate, but is still capable of growing at an above average rate and due to the leverage provided by the insurance free-float, the company should still be able to outpace the returns delivered by the S&P 500 Index.
- Question: Berkshire appears to have paid an historically high multiple (of earnings) for its biggest acquisition to date, the $33 billion acquisition of Precision Castparts? Buffett’s Answer: Mark Donegan, CEO of Precision Castparts, is an extraordinary manager and we were prepared to pay a higher than average price for this great business managed by a great CEO. Decision was based more on the quality of management than on the price. Our Comment: Precision Castparts was formed in the 1950s and today is the leader in supplying castings and designs to aircraft engine manufacturers globally. In other words, it has an entrenched position with its customers in a long-term growth industry (air travel).
- Question: Berkshire sold its positions in Swiss Re and Munich Re in 2015 – can you explain why? Buffett’s Answer: We think the reinsurance market is likely to be difficult for several years for two reasons. Firstly, a lot of companies have added capacity in the past few years particularly those using offshore tax schemes and this extra capacity is likely to reduce pricing (margins). Secondly, with interest rates so low, it’s hard to earn anything off the insurance float. This is particularly so for European operators where regulators restrict insurance companies to investing policy holders monies (the float) in government bonds and bank deposits. Berkshire has more flexibility and can invest the insurance float in companies earning decent returns. Our Comment: It’s an interesting comment and forces on to conclude that for European insurers in general they continue to face headwinds. Buffett’s comment on excess capacity in the reinsurance business also has some read-through for Markel. We met Markel management the following morning in a breakfast briefing (1,000 people attended this) and Markel management acknowledge the tougher backdrop in reinsurance, but point out that most of the business they underwrite is in niche areas with less sensitivity to pricing pressures.
- Question: Several surveys point clearly to Coca Cola’s products having high sugar content and highlighting the clear link to obesity. Why does Berkshire continue to own Coca Cola shares. Buffett’s Answer: It’s a choice in life where one decides to consume your calories. He likes Coca Cola’s products and is unconcerned about the above average sugar content. Charlie Munger’s Comment: Surveys that highlight solely the negative side of the argument without balancing them with the positive side should be banned. Our Comment: Both Buffett and Munger are pointing out that individuals make choices in life. Fair enough.
- Question: If derivatives on bank balance sheets are hard to analyse and the risks hard to quantify, how does Berkshire quantify such risks in its Bank of America and Wells Fargo holdings? Buffett’s Answer: In these instances, we trust the managers. The main risk with derivatives is an event that causes ‘discontinuity’ where the derivative you hold does not end up being able to cover the risk. Examples of situations where derivatives might not cover the intended risks are market crashes, war and other catastrophes such as a nuclear explosion. The world of finance would be safer without the invention of derivatives. Our Comment: We agree.
- Question: How would you advise children to approach stock investing when it is portrayed in the media as needing a short-term focus? Buffett’s Answer: Look at your stocks as businesses and American business will continue to do just fine over the long-term.
- Buffett on Hedge Funds: At this stage, Warren Buffett also reiterated his view that hedge funds were a poor investment and he updated the audience on his 2008 bet with Protege Partners, a hedge fund advisory company. In early 2008, Buffett agreed a 10-year bet with Protege that a simple investment in a standard S&P 500 ETF would beat any selection of hedge funds they might put forward. Protege put forward a portfolio of five hedge funds. The bet ends on 31st December 2017. As we write, the S&P 500 has gained 65% since the start of 2008 while the portfolio of hedge funds selected by Protege is up 21%. Buffett’s point is that hedge funds carry huge costs, which naturally acts as a drag over time.
- Question: What’s the ongoing impact of low interest rates on Berkshire and what if Donald Trump is elected president? Buffett’s Answer: Politics and many other issues are always unpredictable. Low interest rates are hurting savers and pensioners, but corporate America generates good returns and should continue to do just fine. We did not expect the low interest rate environment to last so long, but we invest in companies and the returns should continue to be fine. Our Comment: It’s easy to overlook the fact that return on capital in industry has been relatively unaffected by the low interest rate backdrop, and stocks may well continue to appear more attractive for as long as the backdrop of low rates persists.
- Question: How concerned should investors in Berkshire be about management succession? Buffett’s Answer: Not concerned at all. In appointing a successor to Buffett, the Board will appoint someone that is interested in Berkshire, has a great understanding of business and who is not motivated solely by money.
- Question: Berkshire is generating strong cash flows: are you confident you can invest it wisely? Buffett’s Answer: ‘Having a full wallet is like having a full bladder. You get the urge to pee it away’. Berkshire, especially in areas like its Railroad business, will probably use more cash (in capital expenditure) than the depreciation charge.
- Question: How has Berkshire been able to look ahead of the crowd over time? Buffett’s Answer: You don’t need a huge IQ in the investment business, not as you do in other areas. But you do need emotional control, to avoid self-destructive behaviour. Stick to what you can do, don’t swing at every pitch.
- Question: Given Berkshire’s success and financial strength, why is the company not AAA rated by the rating agencies? Buffett’s Answer: We think they are wrong. Berkshire does not fit easily into their models.
- Question: Does the low interest rate environment affect what you pay for companies relative to the past? Buffett’s Answer: Yes, we will pay more for the right companies when rates are so low. We are in unusual times and yes we paid a little more for Precision Castparts than we might have had interest rates been higher. Of course, if interest rates were to stay as low as this for a long time it would have a huge impact on asset prices.
- Question: The IBM investment hasn’t worked out to date, are you still confident in IBM? Buffett’s Answer: We don’t generally discuss the merits or otherwise of the portfolio investments, but IBM has immense strengths. Munger’s Comment: We see whether these strengths get IBM through this period of change. Our Comment: A slightly more defensive comment than we might have expected, but we could have picked up the wrong signals.
To conclude, we came away with our view enhanced that Berkshire Hathaway remains a superb company and that it is not expensive relative to the market and positively cheap when you consider where interest rates are today. We would expect Berkshire to outperform the S&P 500 by 2-3% per annum over the medium-term.