The Berkshire Hathaway annual meeting is an opportunity for shareholders and analysts to pose questions to Warren Buffett and Charlie Munger. They answered about 50 questions during the five-hour gathering. A touchpoint for developing good investment thinking is going to Omaha each May for the Berkshire Hathaway shareholders’ meeting to hear the insights of Warren Buffett, chairman, and his longtime business partner, Charles Munger, vice chairman. These notes are filtered observations organized to group important themes from responses to the more interesting questions, rather than a transcript, and the author’s observations are bracketed. The notes do not cover every question and answer, though that is available at a fabulous archive of Berkshire’s annual meetings at buffett.cnbc.com. The format of the meeting is question and answer. Shareholders and panels of three business journalists and three investment analysts alternate in posing over 50 questions to Buffett and Munger in two 2.5-hour sessions. Listening to Buffett and Munger, you get a course in business, investing and decision-making drawn from their combined 183 years of life experience—88 for Buffett, and 95 for Munger. The course is more how to think than what to think. The Brown Advisory Flexible Equity Strategy holds shares in Berkshire Hathaway. Members of our investment team have attended these meetings for over 30 years. Background on Berkshire Hathaway Since Buffett took control of Berkshire Hathaway in 1965, Berkshire has grown from a small, competitively challenged New England textile company to one of the largest U.S. companies, with nearly 400,000 employees and an equity market capitalization of over $500 billion as of June 30, 2019. Berkshire is the sixth most valuable company in the U.S., after Microsoft, Amazon, Apple, Alphabet and Facebook. Its share price has compounded at more than twice the rate of the stock market over Buffett’s 54-year tenure (20.5% versus 9.7% for the S&P 500® Index), though its rate of gain versus the market slowed as Berkshire grew larger and size became an anchor. Berkshire Hathaway is no longer a stock that will make investors rich with outsized returns, but it should at least keep them so by earning returns competitive with the broader market over time. Buffett said Berkshire won’t be the highest compounder by a long shot, but it should be one of the safest ways to make decent money over time. Berkshire is unusual among public companies. It doesn’t manage for quarter-to-quarter earnings, provide earnings guidance, court investors with quarterly earnings calls and management meetings, or even have budgets and strategic plans at the parent company. Major capital allocation decisions are centralized with Buffett and a few others, while operating decisions are made at the subsidiary level by the appropriately incentivized managers of those businesses. Berkshire is extremely decentralized in its operating management with just 26 employees at its corporate offices and the rest at about 90 separate operating companies, about a dozen of which would be Fortune 500 companies on their own. Buffett is still going strong, though he has prepared for his succession by naming Ajit Jain to oversee Berkshire’s insurance operations and Greg Abel to oversee the noninsurance businesses. Berkshire has a unique approach to compensation. Buffett and Munger are each paid $100,000 per year in salary, but subsidiary managers can make many millions in compensation depending on their business unit results and particular incentive plan to fit their business. Abel and Jain, the designated successors to Buffett, were each paid $18 million in 2018. The highest paid members of Berkshire’s board of directors—those serving on the audit committee and get an extra $4,000 stipend—earned just $7,300 in 2018, compared to $300,000 or more per year at most large public companies. Buffett, Munger and members of the board own meaningful amounts of stock acquired with their own money rather than through stock grants or options. The culture of Berkshire—in particular, its attitude toward capital allocation, delegation of managerial authority to business units, fiscal conservatism and treating shareholders as business partners—should outlast the current leadership. The Annual Meeting helps ingrain this culture with shareholders and employees. Berkshire had revenues of $248 billion and operating profit of $24.8 billion in 2018. The largest of Berkshire’s businesses is property and casualty insurance, with GEICO as the most recognizable brand among several insurance businesses. Insurance produced $123 billion in investable float in 2018, which partially funds Berkshire’s $339 billion investment portfolio as of March 31, 2019. Other large or recognized noninsurance businesses within Berkshire are Burlington Northern Railroad and Precision Castparts (industrials), Berkshire Hathaway Energy (utility), and consumer companies Fruit of the Loom, Dairy Queen, See’s Candies, Duracell and Clayton Homes. Berkshire’s investment portfolio holds about $210 billion in equities, $19 billion in bonds and $110 billion in cash equivalents. Among the larger equity holdings in Berkshire’s portfolio are Apple (Berkshire owns 5.4% of the Apple shares outstanding), Bank of America (9.5%), Wells Fargo (9.8%), Coca-Cola (9.4%), American Express (17.9%) and Kraft Heinz (26.7%). Readers seeking to know more about Buffett, Munger or Berkshire’s approach are encouraged to study Berkshire’s Owner’s Manual and Buffett’s many annual letters to shareholders, available at www.berkshirehathaway.com; the book Poor Charlie’s Almanack, a collection of speeches and presentations by Munger; and the CNBC Buffett Archive. Share Repurchase The first question of the day, one of several on the topic, was about Berkshire repurchasing its own shares. Buffett explained his key evaluation in buying back Berkshire’s stock is if the purchase price is clearly below the intrinsic value of the shares, so the remaining shareholders are better off after Berkshire buys the stock than before. Berkshire bought $1 billion of its shares in the first quarter and has ambitions to buy much greater amounts depending on the price relative to value of the shares. A later questioner quoted Buffett as having said Berkshire could buy back $100 billion of its stock, equivalent to 20% of its shares. Buffett confirmed the quote but noted for Berkshire to spend $100 billion, the market value of the company likely would be less than the current $500 billion at the time! Buffett has invested in companies that had retired 70% of their shares over time, so he likes the idea of companies buying shares at a discount to intrinsic value. Munger added, “When buying back stock gets really obvious, they will be very good at it.” Buffett asked Munger to repeat that for emphasis. BNSF Railway There were several questions about the profitability and efficiency of Berkshire’s BNSF Railway, the second largest railroad network in the U.S. Observing that several other rail companies had improved margins by adopting precision scheduled railroading practices, would BNSF do the same? Buffett gave some background on precision railroading, crediting Hunter Harrison, who became the CEO of several railroad companies, for originating the practice. Buffett agreed that precision railroading had been beneficial for its adopters over time, but it created disruption—sometimes substantial—to client service as it was implemented. BNSF is watching what others do and is not above copying good ideas to become more efficient while serving customers well. BNSF’s margins should be comparable to its competition over time, so there is an opportunity to improve. Munger doubted that anyone would be interested in imprecise railroading. [Longtime investors in the Flexible Equity Strategy benefited from the precision approach to railroading on two occasions—first, at Canadian National, where Harrison implemented it, and then at Canadian Pacific, when Harrison moved there]. Wells Fargo Buffett was asked why he had not been more outspoken about the fake account issues at Wells Fargo. Buffett said Wells Fargo made a mistake in how it incentivized its employees and that this resulted in the fake accounts, but it made a bigger mistake in not fixing the problem when it first surfaced, well before the government settlement brought it to the public’s attention. Problems are sometimes going to happen in companies, and misbehavior of some sort in companies with thousands of employees is almost certain. Managements need to make it easy to hear about the problems and misbehavior. Buffett’s advice for people running businesses is to take action quickly when they find something that is leading to bad results or bad behaviors. Wells Fargo is now exhibit one on the list of banks where people behaved badly, but go back a few years, and it’s a long list covering practically all major banking companies. Managers lost their jobs, and all those companies have paid a price in fines—actually, their shareholders paid the price. Berkshire, as a 9% owner of Wells Fargo, has born the cost of whatever Wells Fargo has paid in fines. Munger added that he doesn’t think people ought to go to jail for honest errors of judgement. It is bad enough to lose your job. Leaders at Wells Fargo made mistakes but were not deliberately malevolent. Munger does not think that Tim Sloan, who resigned as CEO of Wells Fargo earlier this year, even committed honest errors of judgment, and Buffett agreed. Sloan stepped up to become CEO at Wells Fargo after the problems surfaced in 2016 but failed to satisfy politicians and regulators with Wells Fargo’s pace of progress on regulatory issues. Buffett has been outspoken about financial institutions that have to be bailed out by the government. He thinks their leaders should lose their net worth, and directors should lose their prior directors’ fees. He explained that the Federal Deposit Insurance Corporation, which provides the deposit guarantees for banks and saving institutions, is actually paid for by bank fees, so it has never cost the government any money and has a $100 billion surplus. Politics and Regulation, Socialism Versus Capitalism Buffett said that when he speaks about politics, he is speaking as a private citizen, not as the CEO of Berkshire, though he has to be clear, as others assume he is speaking for the company. Berkshire does not make contributions to political candidates and does not allow people within the company to use their position to raise funds for candidates. So far as lobbying, some of Berkshire’s subsidiaries that operate in regulated industries will make contributions to industry groups to maintain the same political access to rule-makers as their competitors. Regulation can be irritating but is needed. In insurance and banking, companies make promises in return for their customers’ money. Those kind of businesses can attract charlatans, so you need regulation and regulatory policing to make sure the promises can be honored. Buffett is a card-carrying capitalist. Berkshire shareholders owe a lot to the market system and the rule of law, but capitalism also involves some regulation and taking care of people who are left behind. The private sector does a better job than the public sector in most things, but the private sector cannot solve all problems, so the public sector has a role. Buffett does not think that the U.S. will turn socialist in 2020, 2040 or 2060. Berkshire’s Succession Planning, Cultural Differences to Others, ESG Reporting Relative to succession planning, Buffett was asked if the format of the meeting might change to have Jain, Abel, Todd Combs and Ted Weschler on the stage to answer questions, as well as Buffett and Munger. Jain and Abel are Buffett’s designated successors and are vice chairs of Berkshire. Combs and Weschler manage large investment portfolios for Berkshire. Buffett said the format was flexible, and Jain and Abel were available for questions. Combs and Weschler were not going to answer investment questions because investment decisions are valuable proprietary information to Berkshire. Buffett praised Abel and Jain for their accomplishments and their knowledge of the businesses and work ethic, and invited questions for them as well. Munger added that Berkshire’s organization is peculiar in corporate America—a different and nonbureaucratic way of making decisions, few people at headquarters and a lack of committees deliberating forever and making bad decisions. Berkshire is radically different, but he does not want it to be like everyone else since Berkshire’s way has worked better. Buffett added that Berkshire’s way of operating is a huge advantage in being able to act quickly and at scale on the right opportunities when the markets get out of whack. He gave the example of the recent deal to invest $10 billion in an 8% convertible preferred stock of Occidental Petroleum as an example of acting quickly on a good opportunity. The Occidental Petroleum deal came together over a weekend with a phone call, a meeting, an agreement and a check over three days—no one else can act in size that quickly. Weschler and Combs are also able to develop and act quickly on unusual situations. Munger noted that Berkshire has a lot of cash and knows how to act when the markets panic, so if the world goes to hell in a hand basket, Berkshire is the right company to be in. If the world doesn’t fall apart, Berkshire should be OK too. As an aside related to why markets occasionally go into a panic, Munger volunteered that he has been invited to a bitcoin happy hour over the weekend. As a critic of cryptocurrencies, Munger has been trying to figure out what bitcoin people do at a happy hour and finally figured it out—they celebrate the life and work of Judas Iscariot! [Trading paradise for 30 pieces of silver]. In a related story of people making bad choices and poor calculations, Buffett told about passing through Las Vegas on his honeymoon and observing lots of well-dressed but mathematically challenged people playing betting games that are stacked against them. He told his wife, “We are going to make a lot of money!” Berkshire’s different way of operating was highlighted by a question about its environmental, social and governance (ESG) reporting from a shareholder worried that Berkshire might not score well on these measures. Buffett thinks Berkshire would score quite well on ESG measures, but it does not participate in the surveys that lead to ratings or rankings. Berkshire does not want to spend resources collecting data for reports that do not serve a good business purpose, though it wants its managers to do the right things and gives them enormous latitude to do so. As an example of good environmental practice, Buffett cited Berkshire’s electricity generation in Iowa, where Berkshire Energy produces 100% of the electricity it sells from wind power. As an example of not doing unnecessary reports, Buffett said Berkshire does not even produce a monthly profit-and-loss statement that consolidates all its operating units. They do not believe they need it and are not going to do it just because it is standard practice elsewhere. Quarterly consolidation is enough. On standard practices, Munger added that advisors on best practices do not really know what the best practices are. The advisors know what they think are the best practices, but they determine that based on what sells rather than what works. He prefers the way Berkshire does things and hopes Berkshire continues to determine its own best practices. Berkshire’s Insurance Operations A Wall Street analyst asked for guidance on how to value Berkshire’s insurance business. Buffett explained the value of the insurance business was in the float and cost of float that Berkshire generates through its operations. Float is the money (insurance premium) insurance companies receive that is invested until it is paid out to cover claims. Berkshire has $124 billion in float that is long-lived and more likely to grow than shrink. In most years, the float costs nothing to obtain because Berkshire underwrites insurance profitably. Buffett likened the float to having a bank in which people deposit $124 billion [at 0% interest] and promise never to withdraw it. The float is more or less permanent because Berkshire takes in new premiums each year that at least offset the amounts paid in claims. Profitable underwriting over time is why the float costs so little. Berkshire invests the float in businesses and securities. Buffett places a very high value on this float but won’t give a number. Berkshire’s float has taken a long time to develop and has only happened because of extraordinary people running its various insurance businesses and its financial strength. [Insurance is a mediocre business for most companies because of unprofitable underwriting, but not for Berkshire because Berkshire is better at it than others]. Insurance claimants, particularly other insurance companies who reinsure with Berkshire, need to know their claims will be honored even under the toughest conditions. [Berkshire’s financial strength helps it generate low-cost float, which in turn contributes to Berkshire’s financial strength]. Kraft Heinz Several questions focused on Berkshire’s investment in Kraft Heinz (KHC) and its relationship with 3G Capital, which Berkshire partnered with in buying Heinz in 2013 and Kraft in 2015. KHC’s share price has fallen from a high of over $90 per share in 2017 to about $30 recently. Buffett said the consumer packaged food business had gotten tougher because of changing relationships with retailers. Companies like Costco have developed their own brands, and the competition for gross margin has increased. However, the bigger problem was the mistake of paying too much for the Kraft portion of KHC. KHC makes a good business return, earning approximately $6 billion before taxes on $7 billion of tangible capital. The $6 billion is higher than it was a few years back, but Buffett implied the price paid incorporated expectations that earnings would have been much higher. You can turn any investment into a bad deal by paying too much. [KHC recently reduced its dividend, changed management and restated prior earnings because of an accounting issue. Of note, at $30 per share, Berkshire has not lost money in KHC, just not made the money it expected to, but it did lose the prior appreciation from when the stock was higher]. Buffett said it was possible to do another deal with 3G and his friend Jorge Paulo. 3G is better than Berkshire in going into situations that need improvement and fixing them, but 3G also likes more leverage than Berkshire and is more willing to pay more for a deal. Munger added that 3G had a long series of successful transactions and then one that did not work so well. That is a normal pattern. Good ideas can be pushed too far. Employment Outlook and Automation Asked how the rise of automation would affect employment, Buffett rolled the question back 200 years to the outlook for farming employment with the rise of farming machinery. Other industries developed to absorb farm jobs that were replaced by machinery. The U.S.’s economic system and the inventiveness of its people creates new jobs for people in spite of the dislocations in some areas. Our system has been remarkable in growing the number and quality of goods per person over time through improvements in productivity. Buffett does not know what the next big thing is, but he knows there is a next big thing for employment and rising standards of living. [See Berkshire’s 2015 annual report for a more detailed discussion of this topic]. Financial Disclosure in the Annual Report Asked if Berkshire is disclosing fewer financial details in its annual report, Buffett responded that he doesn’t think that is the case. The format sometimes changes from year to year as the company grows, and details on smaller operations become less important, but he writes his annual letter the same as always. He thinks about his two sisters as he writes. He communicates to them what he would tell anyone who has a large investment in the company. He writes in language an intelligent person will understand without having to be immersed in the business to follow the discussion. Buffett is communicating for shareholders instead of analysts or competitors, who might relish the fine detail, but the important facts are there about the major businesses and what management is trying to do over time. In responding to another question, Buffett said that in a world where so much is institutionalized, he likes that Berkshire is largely owned by individuals who trust management and do not worry what the next quarter’s earnings are going to be. [Of note, many large public companies no longer publish letters to shareholders at all; instead, they rely on the SEC filings as their message, or lack thereof, to shareholders. Some of these same companies spend substantial time courting Wall Street analysts and institutional investors with quarterly conference calls and access to management. Instead, Berkshire puts its communications focus on the annual letter, report and shareholders’ meeting]. General Investment Questions Buffett and Munger’s investment success leads to a number of questions each year from those seeking to understand how Berkshire invests and learn how to make their own fortunes. The first questioner on the subject sought advice on becoming a money manager and asked how to know when you are ready to manage other people’s money. Buffett explained that his partnership started in 1956, when he came back to Omaha from New York after working for Benjamin Graham. He had sold securities in Omaha before working for Graham and didn’t want to do that again. Then, some family members asked him to manage their money. He was concerned that they may not have the right expectations, so he laid out the ground rules of what he thought he could do and how he should be judged. He was very concerned about aligning expectations so he could invest without worrying about his clients panicking if the market went down. You need clients who are in sync with you and your expectations, which means you should not take on clients with unrealistic expectations. Munger retold one of his favorite stories about a young man who asked Mozart how to write symphonies. Mozart said the young man was too young to write symphonies. The young man objected. Mozart was writing symphonies at the age of 10. Mozart replied that yes, that’s true, but he was not asking others how to do it! Munger’s Mozart story has wisdom as well as humor. The greats in any field have confidence and skills to go beyond the basics to invent and innovate to take performance to new levels. Another individual noted that many technology companies have wide moats and strong brands, and are led by brilliant entrepreneurs. Buffett was asked if Berkshire should expand its circle of competence to spot future winners in this group. Buffett agreed he liked good businesses that are protected by wide moats and acknowledged that companies with a business moat in the technology field can be very valuable. However, he felt he was not the best to judge that in the technology field. Others know more about that game, and he does not want to play in games he does not fully understand. He’s not going into something just because someone else says it’s a good thing to do, but he works to expand the circle of competence of people at Berkshire. Berkshire may hire people like Combs and Weschler, who are better at understanding certain areas of investing. The question of expanding the knowledge base is a good one. They are focused on it and are trying to improve. An earlier questioner, noting Berkshire’s recent purchase of Amazon stock, asked if Berkshire might be moving away from value investing. Buffett commented that it is interesting that the term value investing came up because both Weschler and Combs, one of whom bought the Amazon position, are value investors just like Buffett. Value investing is making a calculation when you invest as to the probabilities of what money you’ll get back in the future, when you’ll get it and what interest rates will be in between. The calculation is the same whether you’re buying a bank at 70% of its book value or Amazon at some very high multiple of earnings. [The value investing philosophy, which is getting a lot of cash in the future for the cash invested today, differs from and is often confused with the value investing style. The value investing style, like that reflected in value indexes, such as the Russell 1000® Value Index, restricts itself to investing in statistically cheap investments measured by ratios such as price-to-book or price-to-earnings. The difference between the value philosophy and the value style is widely misunderstood in the investment industry. Buffett and Berkshire follow the value philosophy instead of the value style]. Buffett explained that the principles of value investing go back to Aesop, who said a bird in the hand is worth two in the bush. Buffett explained that in buying Amazon (or anything else), they try to figure out whether there are five birds in the bush, 20 birds in the bush or, in the worst case, only one. They then ask how long it will take to get to the bush, how sure they are of getting to the bush and whether someone is going to try to take the bush away. The value philosophy guides Buffett and will guide his successors in managing the investments at Berkshire. He thinks they will be more right than wrong. Later, when asked how Combs and Weschler had performed with their portfolios, Buffett said one had done slightly better than the market returns and the other slightly less, but it had been a tough period to beat the market. Both have had better returns than Buffett over the same period. Combs and Weschler have made Berkshire a lot of money over the years but had done that in a market where the S&P 500 Index did very well too. They are both very smart, particularly smart with money, and have helped Berkshire in other ways too. Munger added when something as extreme as the internet comes along and you don’t catch on, other people are going to surpass your investment results. He doesn’t mind not having caught Amazon, but he feels silly for not identifying Alphabet early when he could see what GEICO was spending on advertising at Google. On Berkshire investing in an equity index fund as an alternative to holding cash while waiting for better investment opportunities, Buffett said that this is a valid alternative and one that his successors may wish to employ. He noted that moving $100 billion in and out of index funds is different than moving $1 billion or $2 billion in terms of market impact. Berkshire invested $10 billion quickly in the Occidental Petroleum deal. Cash lets it act quickly. There are conditions, though unlikely, where Berkshire could invest $100 billion very quickly. If these conditions came along, the investments would likely do much better than an index fund. Berkshire has operated expecting to get chances to deploy its capital. If the chances come, it will come when others don’t want to invest their capital. Two or three times in the next 20 or 30 years, it will be raining gold, and all you will have to do is go outside, though they do not know when this will happen. If Buffet’s choices were only T-bills or an index fund over time, he’d take the index fund. But he still hopes to do better when the opportunities come along. Berkshire’s conservative attitude of keeping extra cash is consistent with serving its investors who have virtually all their net worth in Berkshire. On the subject of returns in public equities versus private equities, Buffett said he doubted that private equities on an unlevered basis would do better than public equities, but leverage may magnify returns. If private equity managers can buy assets that have the potential to return 7% or 8% with money borrowed at 4% or 5% and do not have to worry about bond covenants, they can see attractive results, even after some bankruptcies. Berkshire is not going to lever up, so it is not interested. Buffett has seen some very intelligent people ruined by leverage, citing the experience of Long-Term Capital Management in 1998. Buffett cautioned not to get too excited about the investment prospects of alternative investments. The supply/demand conditions that exist today for private equity money deals, which he estimated at about $3 trillion, including borrowings, versus the $30 trillion in public equities differ greatly from that of 10 or 20 years ago. There is also an issue with reported returns. Private equity managers often calculate their return on invested capital instead of committed capital. Committed capital is what an investor is on the hook to supply and is charged a fee on, regardless of whether it is called for investment. Returns are not as good as they look in the marketing materials. Salespeople are lying a little bit to make the sale.* Asked how to build your circle of competence if you were just starting today, given that investing is more competitive, Buffett agreed the investment world is much more competitive now than 70 years ago. Buffett said he would try to learn about many businesses and figure out which ones he could develop important knowledge of that was different from his competitors. Also, he said he would try to figure out which businesses he really did not or could not understand. He would want as big a circle as he could develop, but he had to be realistic about the limits to his circle. Munger offered that the great strategy for most of humanity is to specialize. He said, “Nobody wants to go to a doctor that’s half proctologist and half dentist.” Munger said he and Buffett did not really specialize, but he does not think he can recommend that path to other people. Buffett said you don’t have to know everything. Just one thing can give you an edge at some point. He quoted Thomas Watson Sr., who founded IBM, as saying, “I’m no genius, but I’m smart in spots, and I stick to those spots.” 2020 Annual Shareholders Meeting The next meeting will occur on Saturday, May 2, 2020, in Omaha, Nebraska. Omaha is a nice weekend getaway with a number of attractions in addition to the annual meeting events. Make your plans early if you would like to attend, as hotels and planes fill up. Alternatively, the meeting will be webcast. Brown Advisory Colleagues and Guests in Ohmaha The views expressed are those of Brown Advisory as of the date referenced and are subject to change at any time based on market or other conditions. These views are not intended to be and should not be relied upon as investment advice and are not intended to be a forecast of future events or a guarantee of future results. Past performance is not a guarantee of future performance and you may not get back the amount invested. *Alternative investments may be available for accredited investors and qualified purchasers only. The information provided in this material is not intended to be and should not be considered to be a recommendation or suggestion to engage in or refrain from a particular course of action or to make or hold a particular investment or pursue a particular investment strategy, including whether or not to buy, sell, or hold any of the securities mentioned. It should not be assumed that investments in such securities have been or will be profitable. To the extent specific securities are mentioned, they have been selected by the author on an objective basis to illustrate views expressed in the commentary and do not represent all of the securities purchased, sold or recommended for advisory clients. The information contained herein has been prepared from sources believed reliable but is not guaranteed by us as to its timeliness or accuracy, and is not a complete summary or statement of all available data. 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