Being a shareholder of Berkshire Hathaway, I had an opportunity to attend the shareholder’s meeting for the second time. I boarded the flight from San Francisco on Friday May 2nd. It was not a direct flight and I had to stop over in Dallas/Fort Worth.
In his insightful and entertaining book Why Zebras Don’t Get Ulcers, the neuroscientist Robert Sapolsky explains that our stress response systems, like that of all mammals, evolved to react to brief and acute stresses. That worked well when humans were out on the savanna running from predators. But modern humans rarely have to contend with lion attacks. Instead, most of our stress today comes from mental processes: from worrying about things. And the HPA axis isn’t designed to handle that kind of stress. We “activate a physiological system that has evolved for responding to acute physical emergencies,” Sapolsky writes, “but we turn it on for months on end, worrying about mortgages, relationships, and promotions.” And over the past fifty years, scientists have discovered that this phenomenon is not merely inefficient but also highly destructive.
After reading the passage I told myself that I shouldn’t get stressed under any circumstances. After 6 hours of flying I reached Omaha. While exiting the airport I noticed an advertisement from University of Nebraska. There cannot be a better choice than Warren to trigger an authority bias.
I slept very well that night. Next day I woke up early and went to the meeting hall at 7:00 a.m. I had to stand in a very long line to enter the hall.
The hall was jam packed. I reserved a seat in the last row and went down to the exhibit hall to buy some books.
In the exhibit hall I saw Buffett walking very close to me.
I purchased the following books and the last one in the list was for my elder son.
The meeting started at 8:30 a.m. with an animated fiction movie. In it Buffett assembles a US Olympic hockey team to take on the Russians. The team consisted of Charlie Munger, Bill Gates, Tony Nicely, Mrs. Sees of See’s Candy, Tom Murphy, and as coach, the reinsurance guru Ajit Jain. As expected Buffett and his team beat the Russians.
Then the famous video of Buffett’s 1991 testimony in the Salomon Brother’s case was played – Lose money for the firm I will be understanding. Lose a shred of reputation for the firm I will be ruthless.
At 9:00 a.m. Buffett and Munger came up to the stage. Buffett went through the financial results of Q1. Then the Q & A session started. Buffett (83 years) and Munger (90 years) answered 62 questions and the session lasted for 5 1/2 hours. It was mind blowing to see the breadth and depth of their knowledge. Without deliberate practice such a feat is not possible. Some of the answers that I liked are:
1. On measuring the management
One of the ways to measure the efficiency of management is to ensure that for every $1 of earnings retained by them should deliver at least $1 gain in market cap. Why is this important? There are two ways for shareholders to make money (1) Dividends and (2) Price appreciation. If the company pays all its earnings as dividends then we need not worry about anything. But most of the companies do not. If for every $1 retained earnings results in a $1 gain in market value, we as shareholders can get the retained earnings back by selling the stock. It gives us an option. If you want to learn how to calculate it, read it here. Also you can find my calculation for Berkshire here.
2. On finding circle of competence
In 1983, Buffett purchased Nebraska Furniture Mart (NFM) from Rose Blumkin (Mrs. B) by paying $60 million. For the purchase he initially offered her shares of Berkshire. But Mrs. B wanted to be paid by cash. On 31st December 1983 book value of Berkshire was $975.83. On 31st December 2013 the book value was $134,973. The compounded annual growth of book value comes to 17.86%. In hindsight Mrs B choice appears to be wrong.
She never understood what a stock is and all she knew was cash and retail. Hence she accepted cash and stayed with in her circle of competence. This is how one should behave. The answer from Buffett was a slap in my face. The lesson I learnt from this was to do things which I really understood and not do just because someone else is doing.
Munger applied inversion to answer this question. He said that if you are 5 feet 2 inches tall then you should not play basketball. If you are 90+ years old then you cannot be a star in hollywood. In Caltech Munger studied thermodynamics. The professor who taught this course was a genius. Munger figured out that he cannot come anywhere near his professor’s talent and he avoided this field. He avoided several fields like this and finally settled in the investment business. He said that competency is a relative concept and there was very little competition in the investment business as it was full of idiots.
3. On supply-and-demand
Hotel occupancy rates in Omaha averages around 59% for the year. During the shareholders meeting it went up to 96%. Because of the sudden increase in demand some of the hotel operators jacked up the price and demanded a minimum of 3 day booking. Buffett being fluent in microeconomics increased the supply by asking the shareholders to book rooms through Airbnb. This helped to reduce the price for the shareholders. Buffett’s action taught me a lesson in supply-and-demand.
4. On Brands
Buffett told that box chocolate business is not growing and he can’t do much about increasing the size of the market. Over the years See’s has generated tons of earnings which was used to purchase other businesses. Beyond earnings, See’s opened his eyes to the power of brands. This enabled him to buy companies like Coca-Cola. Munger told that they were barley smart enough when they bought See’s and it helped to remove their ignorance about businesses. The lesson I learnt was: Brand is a moat.
5. On disruptive technologies
Buffett lost close to a billion dollars on Energy Future Holdings (EFH). Because of better technology the price of natural gas went down over the years. This led to the bankruptcy of EFH. He told that all businesses should be thinking about what can go wrong and constantly adopt to technological changes. GEICO was formed in 1936 and it sold insurance at a very low cost to government employees directly through mail. Their moat is low cost. They adopted well over the years by using telephone and internet to preserve their moat. Changes are going to happen all the times. It is very hard to notice changes when they happen in slow increments (contrast effect). Hence the business owners needs to be alert and adapt to these changes.
Munger told that Berkshire the company we all see today emerged out of textile mills. Business should face hard facts and adapt to it constantly. If not it will perish. The lesson I learnt was to be a learning machine.
It was all over by 3:30 p.m. On the way out of the hall I met Shane Parrish the creator of farnamstreet blog. I thanked him for his wonderful blog.
Next day I had an opportunity to attend value investing presentation given by Whitney Tilson. He recently invested in auto rental companies like Avis and Hertz. Why would he invest in a capital intensive business which has no moat? From being a highly fragmented industry it consolidated and now controlled by three big players. This lead to oligopoly and it gave pricing power to these companies. Excerpt from Tilson’s recent interview
The railroad industry consolidated into a few big players and they all got smart and started behaving like an oligopoly and just started raising prices. More than 90 percent of the auto rental business and more than 98 percent of the airport auto rental business in this country is now controlled by three companies: Hertz, Avis and Enterprise,” he said. “They’re already taking prices up. Last quarter Hertz and Avis took pricing up about four to five percent year-over-year. When you’re talking about fairly low-margin businesses, when you can jack prices up by that amount, it has very leveraged benefits to the bottom line.”
After attending the meeting I went back to the airport.
During my last visit I had an opportunity to meet Robert Cialdini. This time I had an opportunity to sit next to Preston Pysh. He is the author of the book Warren Buffett’s 3 Favorite Books. He also has a website to teach value investing. He was kind enough to give me a free copy of his new book Warren Buffett Accounting Book.
I came back home at 8:30 p.m. and had a very good sleep.
Next day I was getting ready to go to work and my phone rang. I was told that we had production issues and I had to join the conference call immediately. My heart beat increased and I could feel the stress. Remember what I told myself during the flight journey?