Warren Buffett, Chairman, Berkshire Hathaway Investment Group | Terry Leadership Speaker Series

Testing, 1 million, 2 million. I came in from Nebraska today, and you're probably all familiar with us mainly by our football team. We have those fellas with the big white helmets with those red ends on them. I asked one of our starters the other day, "What's the N stand for?" And he said, "Knowledge." We make it tough on them, though. I mean, you don't coast in Nebraska just because you're a football player. They major in agricultural economics, and there's a two-question final for all of the players. And the first question is, "What did old MacDonald have?" And they were giving that to one of our potential Heisman trophy winners the other day, and he started to sweat. Finally, he brightened up. He said, "Farm." Professor, delighted, of course, you don't want to flunk a Heisman candidate. So he said, "Now," he said, "you're halfway home." He said, "Just one more question. How do you spell farm?" Now the guy really starts to sweat. He looks at the ceiling and he looks around. Finally, he brightens. He says, "E-I-E-I-O." So watch for that guy. They're sure he'll be dying right now.

I really want to talk about what's on your mind. So we're going to do a Q&A in a minute. There are a couple of questions I always get asked. You know, people always say, "Well, who should I go to work for when I get out?" And I've got a very simple answer. We may elaborate more on this as we go along, but you know, the real thing to do is to get going for some institution or individual that you admire. I mean, it's crazy to take a job just because they look good on your resume or because you get a little higher starting pay. I was up at Harvard a while back, and a very nice young guy picked me up at the airport, a Harvard Business School attendee, and he said, "Look," he said, "I went to undergrad here, and then I worked for X and Y and Z, and now I've come here." And he said, "I thought it would really round out my resume perfectly if I went to work now for a big management consulting firm." And I said, "Well, is that what you want to do?" And he said, "No." But he said, "That's the perfect resume." And I said, "Well, when are you going to start doing what you like?" And he said, "Well, I'll get to that someday." And I said, "Well, you know," I said, "Your plan sounds to me a lot like saving up sex for your old age. You know, it just doesn't make a lot of sense." But I told that same group, I said, you know, go to work for whomever you admire the most. And I said, you can't get a bad result. They'll jump out of bed in the morning, and you'll be having fun. And the dean called me up a couple of weeks later. Said, "What'd you tell those kids?" He said, "They're all becoming self-employed." So you've got to temper that advice a little bit.

Play one game a little bit with me for just a minute, and then we'll get to your questions. I'd like for the moment to have you pretend I've made you a great offer, and I've told you that you could pick any one of your classmates. And you now know each other probably pretty well after being here for a while. You have 24 hours to think it over, and you can pick any one of your classmates, and you get 10% of their earnings for the rest of their lives. And I ask you, what goes through your mind in determining which one of those you would pick? You can't pick the one with the richest father. That doesn't count. I mean, you've got to do this on merit, but you probably wouldn't pick the person that gets the highest grades in the class. I mean, there's nothing wrong with getting the highest grades in the class, but that isn't going to be the quality that sets apart a big winner from the rest of the pack. Think about who you would pick and why. And I think you'll find when you get through, you'll pick some individual. You've all got the ability. You wouldn't be here otherwise. And you've all got the energy. I mean, you've got, you know, the initiative is here. The intelligence is here throughout the class, but some of you are going to be bigger winners than others. And it gets down to a bunch of qualities that, interestingly enough, are self-made. I mean, it's not how tall you are. It's not whether you can kick a football 60 yards. It's not whether you can run the 100-yard dash in 10 seconds. It's not whether you're the best-looking person in the room. It's a whole bunch of qualities that really come out of Ben Franklin or the Boy Scout code or whatever it may be. I mean, it's integrity, it's honesty, it's generosity, it's being willing to do more than your share, it's just all those qualities that are self-selected.

And then if you look on the other side of the ledger, because there's always a catch to these, you know, free gifts and genie jokes. Well, you also have to, and this is the fun part, you also have to sell short one of your classmates and pay 10% of what they do. So who do you think is going to do the worst in the class? This is way more fun. And think about it again, and again, it isn't the person with the lowest grades or anything of the sort. It's the person who just doesn't shape up in the character department. I mean, we look for three things when we hire people. We look for intelligence. We look for initiative or energy, and we look for integrity. And if they don't have the latter, the first two will kill you, because if you're going to get somebody without integrity, you want them lazy and dumb. I mean, you don't want them smart and energetic. So it's that third quality, and everything about that quality is your choice. You know, you can't change the way you are wired much, but you can change a lot of what you do with that wiring. And it's the habits that you generate now on those qualities or those negative qualities. I mean, the person who always, you know, claims credit for things they didn't do, that always cuts corners, that you can't count on. I mean, in the end, those are habit patterns. And the time to form the right habits is when you're your age. I mean, it doesn't do me much good to get golf lessons now. If I'd gotten golf lessons when I was your age, I might be a decent golfer. But someone once said, "The chains of habit are too light to be felt until they're too heavy to be broken." And I see that all the time. I see people with habit patterns that are self-destructive when they're 50 or 60. And they really can't change them. They're imprisoned by that. But you're not imprisoned by anything. So when you write down the qualities of that person that you'd like to buy 10% of, look at that list and ask yourself, is there anything on that list I couldn't do? The answer is there won't be. And when you look at the person you sell short and you look at those qualities that you don't like, if you see any of those in yourself, egotism, whatever it may be, selfishness, you can get rid of that. I mean, that is not ordained. And if you follow that, and Ben Franklin did this, and my old boss Ben Graham did this at early ages in their young teens. They just, Ben Graham looked around and he said, "Who do I admire?" You know, and he wanted to be admired himself. And he said, "You know, why do I admire these other people?" And he said, "If I admire them for these reasons, maybe other people will admire me if I behave in a similar manner." And he decided what kind of a person he wanted to be. And if you follow that, at the end, you'll be the person you want to buy 10% of. I mean, that's the goal in the end. And it's something that's achievable by everybody in this room. So that's the end of the sermon. Now let's talk about what's on your mind. And you can ask anything. The only thing I won't tell you is what we're buying or selling. Let's say I don't even tell myself that. I mean, I write it down, and then it's like the Coca-Cola formula. You know, there's only two people who can get into the trust department and find out what they are, and I don't know who the two are. So we don't talk about what we're buying or selling, but anything else is fair game. Personal, business, anything I'd like to talk about. And actually, the tougher the questions are, the more interesting it is for me. So don't spare my feelings. I mean, just throw it in my head. And with that, I guess we've got a microphone. Is this the only microphone, or is there one on this?

I have an old-fashioned belief that I can only expect to make money in things that I understand. And when I say understand, I don't mean understand, you know, what the product does or anything like that. I mean understand what the economics of the business are likely to look like 10 years from now or 20 years from now. I know in general what the economics of, say, regularly chewing gum will look like 10 years from now. The internet isn't going to change the way people chew gum. It isn't going to change which gum they chew. You know, if you own the chewing gum market in a big way and you've got Doublemint and Spearmint and Juicy Fruit, those brands will be there 10 years from now. So I can't pinpoint exactly what the numbers are going to look like on Wrigley, but I'm not going to be way off if I try to look forward on something like that. Evaluating that company is within what I call my circle of competence. I understand what they do. I understand the economics of it. I understand the competitive aspects of the business. There can be all kinds of companies that have wonderful futures, but I don't know which ones they are. I've given talks in the past where I carry with me a 70-page tightly printed list, and it shows 2,000 auto companies. Now, if at the start of the 20th century you had seen what the auto was going to do to this country, the impact it would have on the lives of your children and grandchildren and so on, and what it just transformed the American landscape. But of those 2,000 companies, you know, three basically survive, and they haven't done that well at many times. So how do you pick three winners out of 2,000? I mean, it's not so easy to do. It's easy when you look back, but it's not so easy looking forward. Well, you could have been dead right on the fact that the auto industry, in fact, you probably couldn't have predicted how big an impact it would have, but if you'd bought companies across the board, you wouldn't have made any money because the economic characteristics of that business were not easy to define. I've always said the easier thing to do is figure out who loses. And what you really should have done in 1905 or so, when you saw what was going to happen with the auto, is you should have gone short horses. There were 20 million horses in 1900, and there's about 4 million horses now. So it's easy to figure out the losers. You know, the loser is the horse. But the winner was the auto overall, but 2,000 companies just about failed. A few merged out and so on. There were three auto companies in the Dow industrials in the 1920s and 30s: Studebaker, Nash, Kaiser-Frazer, and Hudson Motor. Now those names are all familiar to me, and maybe some of them are familiar to you, but they're not making any cars. You know, they didn't make money. And yet at one time they were in the Dow 30. They were the aristocrats of American business, and they got creamed. So figuring out the economic characteristics of the winners in a wonderful business is not easy. In North Carolina, you know, Orville and Wilbur took off, or I guess Orville took off and Wilbur watched. I'd have been Wilbur. But if you could have seen the future of the airline business from that point forward and how that would transform things, you know, it would have blown you away. And it's excited people, incidentally, ever since. But if there had been a capitalist at Kitty Hawk, he should have shot Orville down. I mean, because it's done nothing but cost investors money. There were over 400 airplane companies in the 1920s and 30s alone. There was one in Omaha. There was one in Nebraska. We were the Silicon Valley of aircraft, apparently. And they all disappeared. Been a terrible business. At the end of 1991, if you'd added up the aggregate earnings from all airline companies, with billions poured in since Wilbur and Orville were down there, they came to less than zero. Number of passengers went up every year. You know, the importance of the industry was dramatically increased decade by decade, and nobody made any money. So figuring out the economic consequences. TV. I think there's, I don't know, 20, 25 million sets a year sold in the United States. I don't think there's one of them made in the United States anymore. I mean, you'd say TV set manufacturer. What a wonderful business. I mean, nobody had a TV in 1950 or thereabouts, 45 to 50. Everybody has multiple sets now, but nobody in the United States has made any real money making the sets. They're all out of business. You know, the Magnavoxes, the RCAs, all of those companies. Radio was the equivalent in the 20s. Over 500 companies making radios in the 1920s. Again, I don't think there's a US radio manufacturer at the present time. But Coca-Cola, you know, was it 1884 at Jacob's Pharmacy or whatever, the fellow comes up with something. A lot of copycats over the years, but now you've got a company that is selling roughly 1.1 billion 8-oz servings of its product, not all Cokes, Sprite and some others, daily throughout the world 117 years later. So understanding the economic characteristics of a business is different than predicting the fact that an industry is going to do wonderfully. And so when I look at the internet businesses or I look at tech businesses, I say this is a marvelous thing, and I love to play around with the computer, and I order my books from Amazon and all kinds of things, but I don't know who's going to win. Unless I know who's going to win, I'm not interested in investing. I'll just play around on the computer. And defining your circle of competence is the most important aspect of investing. It's not how important, how large your circle is. You don't have to be an expert on everything, but knowing where the perimeter of that circle of what you know and what you don't know is, and staying inside of it, is all important. Tom Watson Sr., who started IBM, said in his book, he said, "I'm no genius," he said, "but I'm smart in spots, and I stay around those spots." And you know, that is the key. So if I understand a few things and I stick in that arena, I'll do okay. And if I don't understand something, but I get all excited about it because my neighbors are talking about stocks going up and everything, I start fooling around someplace else, eventually I'll get creamed, and I should.

Well, intrinsic value is what is the number that, if you were all-knowing about the future and could predict all the cash that a business would give you between now and judgment day, discounted at the proper discount rate. That number is what the intrinsic value of a business is. In other words, the only reason for making an investment and laying out money now is to get more money later on. Right? That's what investing is all about. Now, when you look at a stock, when you look at a bond, say United States government, it's very easy to tell what you're going to get back. It says it right on the bond. It says when you get the interest payments, it says when you get the principal. So it's very easy to figure out the value of a bond. It can change tomorrow if interest rates change, but the cash flows are printed on the bond. The cash flows aren't printed on a stock certificate. That's the job of the analyst, is to print out, change that stock certificate, which represents an interest in the business, and change that into a bond and say, this is what I think it's going to pay out in the future. When we buy, you know, some new machine for Shaw to make carpet, that's what we're thinking about, obviously. And you all learn that in business school, but it's the same thing for a big business. If you buy Coca-Cola today, the company is selling for about 110 to 115 billion dollars in the market. The question is, if you had 110 or 115 billion, you wouldn't be listening to me, but I'd be listening to you, incidentally. But the question is, would you lay it out today to get what the Coca-Cola company is going to deliver to you over the next 200 or 300 years? Discount rate doesn't make much difference as you get further out, but that is a question of how much cash they're going to give you. It isn't a question of, you know, it isn't a question about how many analysts are going to recommend it or what the volume in the stock is or what the chart looks like or anything. It's a question of how much cash it's going to give you. That's the only reason. It's true if you're buying a farm, it's true if you're buying an apartment house, any financial asset, oil in the ground, you're laying out cash now to get more cash back later on. And the question is, how much are you going to get? When are you going to get it? And how sure are you? And when I calculate intrinsic value of a business, when we buy businesses, and whether we're buying all of a business or a little piece of a business, I always think we're buying the whole business because that's my approach to it. I look at it and say, what will come out of this business and when? And what you really like, of course, is them to be able to use the money they earn and earn higher returns on it as you go along. I mean, Berkshire has never distributed anything to its shareholders, but its ability to distribute goes up as the value of the businesses we own increases. We can compound it internally. But the real question is, Berkshire selling for, we'll say, 105 or so billion now, what can we distribute from that? If you're going to buy the whole company for 105 billion now, can we distribute enough cash to you soon enough to make it sensible at present interest rates to lay out that cash now? And that's what it gets down to. And if you can't answer that question, you can't buy the stock. You know, you can gamble in the stock if you want to, or your neighbors can buy it, but if you don't answer that question, and I can't answer that for internet companies, for example. There are a lot of companies, all kinds of companies I can't answer it for, but I just stay away from those. Number two.

Well, I think I actually have written about that if you read the annual reports over the recent years. In fact, the most recent annual report, I use what I've just been talking about. I use the illustration of Aesop because here Aesop was in 600 BC. Smart man. Wasn't smart enough to know it was 600 BC, though. I mean, it would take a little foresight. But Aesop, you know, in between tortoises and hares and all these other things, he found time to write about, you know, birds. And he said, a bird in the hand is worth two in the bush. Now, that isn't quite complete because the question is, how sure are you that there are two in the bush, and how long do you have to wait to get them out? Now, he probably knew that, but he just didn't have time because he had all these other proverbs to write and had to get on with it. So, but he was halfway there in 600 BC. That's all there is to investing is how many birds are in the bush, when are you going to get them out, and how sure are you? Now, if interest rates are 15%, roughly, you've got to get two birds out of the bush in five years to equal the bird in the hand. But if interest rates are 3% and you can get two birds out in 20 years, it still makes sense to give up the bird in the hand because it all gets back to discounting against an interest rate. The problem is often you don't know, you know, not only how many birds are in the bush, but in the case of internet companies, there weren't any birds in the bush. But they still take the bird that you give them in the hand. But I actually have written about this sort of thing, and stealing heavily from Aesop, who wrote it some 2,600 years ago, but I've been behind on my reading.

Yeah, well, I've made a lot of mistakes. The biggest mistake, well, not the biggest necessarily, but buying Berkshire Hathaway itself was a mistake because Berkshire was a lousy textile business, and I bought it very cheap. I'd been taught by Ben Graham to buy things on a quantitative basis. Look around for things that are cheap. And I was taught that, say, in 1949, and it made a big impression on me. So I went around looking for what I call used cigar butts of stocks. And the cigar butt approach to buying stocks is that you walk down the street and you're looking around for cigar butts, and you find this, honestly, this terrible-looking, soggy, ugly-looking cigar, one puff left in it. But you pick it up and you get your one puff, disgusting. You throw it away, but it's free. I mean, it's cheap. And then you look around for another soggy, you know, one-puff cigarette. Well, that's what I did for years. It's a mistake. Although you can make money doing it, but you can't make it with big money. It's so much easier just to buy wonderful businesses. So now I would rather buy a wonderful business at a fair price than a fair business at a wonderful price. But in those days, I was buying cheap stocks, and Berkshire was selling below its working capital per share. You got the plants for nothing. You got the machinery for nothing. You got the inventory and receivables at a discount. It was cheap. So I bought it. And 20 years later, I was still running a lousy business. And that money did not compound. You really want to be in a wonderful business because the time is the friend of the wonderful business. You keep compounding and keep doing more business, and you keep making more money. Time is the enemy of the lousy business. I could have sold Berkshire, perhaps liquidated it, and made a quick little profit, you know, one puff. But staying with those kind of businesses is a big mistake. So you might say I learned something out of that mistake, and I would have been way better off taking what I did with Berkshire. I kept buying better businesses. I started an insurance business, See's Candy, the Buffalo News, all kinds of things. I would have been way better doing that with a brand new little entity that I'd set up rather than using Berkshire as the platform. Now, I've had a lot of fun out of it. I mean, everything in life seems to turn out for the better. So I don't have any complaints about that, but it was a dumb thing to do. I went into US Air. I bought a preferred stock in 1989. As soon as my check cleared, the company went into the red and never got out. I mean, it was really dumb. I mean, I've got an 800 number I call now whenever I think about buying an airline stock. I call them up any hour. Fortunately, I can call them at 3 in the morning, and I just dial and I say, "My name's Warren. I'm an aeroholic, you know, and I'm thinking about buying this thing." And then they talk me down. I mean, it takes hours sometimes, but it's worth it. Believe me. If you ever think about buying an airline, just stop. Call me, and I'll give you the 800 number because you don't want to do it. But we got lucky in terms of how we eventually came out on it. But it was a dumb, dumb decision. All mine. And I've done, the biggest, in terms of opportunity cost, I bought half interest in a Sinclair filling station when I was about 20 with a guy I was in the National Guard with, and I had about $10,000 then, and I put $2,000 in, and I lost it all. So that was 20%, and that means that the opportunity cost is now $6 billion of that filling station, which is a big price to pay for, you know, getting to wipe a few windows and a few windshields and things like that. So actually, I like it when Berkshire goes down because it reduces the cost of that mistake on an opportunity. But the biggest mistakes I've made by far are mistakes of omission and not commission. I mean, it's the things I knew enough to do. They were within my circle of competence, and I was sucking my thumb, and that is really, those are the ones that hurt. They don't show up any place. I probably cost Berkshire at least $5 billion, for example, by sucking my thumb 20 years ago or close to it when Fannie Mae was having some troubles, and we could have bought the whole company for practically nothing. And I don't worry about that if it's Microsoft because I don't know, Microsoft isn't in my circle of competence. And so I don't have any reason to think I'm entitled to make money out of Microsoft or out of cocoa beans or whatever. But I did know enough to understand Fannie Mae, and I blew it. And that never shows up under conventional accounting. But I know the cost of it. I know, you know, I passed it up. And those are the big, big mistakes. And I've had plenty of them. And unless I tell you about them in the annual report, and I resist the temptation sometimes, unless I tell you about them in the annual report, you're not going to know it because it doesn't show up under conventional accounting. But omission is way bigger than commission. There's big opportunities in life have to be seized. We don't do very many things, but when we get the chance to do something that's right and big, we've got to do it. And even to do it in a small scale is just as big a mistake almost as not doing it at all. I mean, you really got to grab it when they come. And because you're not going to get 500 great opportunities. You would be better off if, when you got out of school here, you got a punch card with 20 punches on it. And every financial decision you made, you used up a punch. You'd get very rich because you'd think through very hard each one of them. You went to a cocktail party and somebody talked about a company you didn't even understand what they did or couldn't pronounce the name, but they'd made some money last week and another one like it. You wouldn't buy it if you only had 20 punches on that card. There's a temptation to dabble, particularly during bull markets, in stocks is so easy. You know, it's easier now than ever because you can do it online. You know, just you click it in and maybe it goes up a point and get excited about that and you buy another one the next day and so on. You can't make any money over time doing that. But if you had a punch card with only 20 punches, you weren't going to get another one the rest of your life. You would think a long time before every investment decision and you would make good ones and you'd make big ones. And you probably wouldn't even use all 20 punches in your lifetime, but you wouldn't need to. Yep.

Yeah. When I started out, the sell situation has changed over the years because when I started out, I had way more ideas than money. I mean, I would go through Moody's manual. I went through it page by page. And then I went through it again, page by page, and I found stocks in there that I could understand that were selling at like two times earnings, even one times earnings. Well, when you only have 10,000 bucks, that can get a little frustrating. And if you don't like to borrow money, which I never liked to borrow money. So I was always coming up with more ideas than I had money. So I had to sell whatever I liked least to buy something new that just was compelling to me. And for a long time I was in that mode. And now our problem is we have more money than ideas. So if you look at our annual report, which is on the internet under at our homepage berkshirehathaway.com, you'll see something in the back called the economic principles of Berkshire. And you will see, which I believe in setting out for my partners. They are my partners. I don't look at them as shareholders. I look at them as partners. They're going to be my partners for life. So I want to tell them how I think. And if they don't disagree with the way I think, that's fine. But I don't want them to, I don't want to be disappointed in me, you know. So I lay out there and I say in terms of our wholly owned businesses, we're not going to sell no matter how much anybody offers us for it. I mean, if somebody offers us three times what something is worth at See's Candy, the Buffalo News, Borsheims, whatever it may be, we're not going to sell it. I may be wrong in having that approach. I know I'm not wrong if I owned 100% of Berkshire because that's the way I want to live my life. I've got all the money I could possibly need. You know, it just amounts to a change in the newspaper story on my obituary and the amount of money that the foundation has. And to break off relationships with people I like and people that have joined me because they think it's a permanent home, to do that simply because somebody waves a big check at me would be like selling one of my children because somebody waved a big check. So I won't do that. And I want to tell my partners I won't do it so that they're not disappointed in me. More and more with certain stocks, we've got that approach. Now, if we were chronically short of funds and had all kinds of opportunities coming, we might have a somewhat different approach. But our inclination is not to sell things unless we get really discouraged perhaps with the management or we think the economic characteristics of the business change in a big way. I mean, and that happens. So, but we're not going to sell simply because it looks too high in all likelihood. I mean, that you can't make that 100%. But that's the principle under which we're operating. We're generating right now 5 billion of cash a year at least. So it's 100 million bucks every week. And you know, just that we've been talking here half an hour and I haven't done a damn thing. So it's, you know, the real question is how do you put it out intelligently? And if we were selling things, it'd be just that much more. So there may come a time when that would change, but we want to, and I have partners, shareholders, partners who would say, if you can get three times what candy's worth, why don't you sell it? And that's why I want to be sure before they come in, they know how I think on that. I mean, they're entitled to know that. You really want to think for a minute, you know, if you're going to get married and you want a marriage that's going to last, not necessarily the happiest marriage, you know, or one that Martha Stewart will talk about or anything, but you want a marriage that's going to last. What quality do you look for in a spouse? One quality. Do you look for brains? Do you look for humor? Do you look for character? Do you look for beauty? No. You look for low expectations. I mean, that is the marriage that's going to last. Both have low expectations. I mean, and I want my partners to be on the low side on expectations coming in because I want the marriage to last. It's a financial marriage when they join me at Berkshire. And I don't want them to think I'm going to do things that I'm not going to do. So that's our guiding principle. The advice is all free and your terrible advice, everything else. Next.

I'm not sure I got that 100%. George, could you... Okay. I will repeat. Yeah. Earl, did you... shortly? If you think that involvement of corporations that you invest or anybody for that matter invest in tax shelters, which is by some definition... tax shelters.