I recently came across an interview with Warren Buffett, which, having kept this blog for a just few months now, is a subject I've not yet discussed in print.
Now, treating an "interview with Warren Buffett" as an event that is unique or unusual is silly for anyone who follows investing news or weblogs. Although I'm sure Mr. Buffett is speaking with people in about the same frequency as he has his entire life, people are likely writing and sharing information about it more frequently for two reasons: one, because the internet makes it easier, and two, because more people care.
I think we understand why the internet makes this easier - if you read blogs, you know what I mean about us "citizen-journalists". However, I think Buffett's popularity these days is also due to the fact that we are in a temporary-yet-enduring "New Economy" which we have been in for a decade now, and which has a few more years before it goes away and we revert to "the economy".
In the late 1990s, the new economy was conventionally explained as technology making growth restrictions on business irrelevant due to endless productivity increases. However, the true late 1990s economy was about hoping tech stocks made you a millionaire, regardless of anything related to business activity. In this sense, the "New Economy" which everyone heralded then is the same economic environment we live in now: this "New Economy" is about asset appreciation.
That is: instead of a bunch of people who seek to become rich by working hard and saving and allowing that surplus capital to accumulate and grow over time through compounding in reasonable investments, we have become a bunch of people who seek to become rich by working hard, spending more than we earn, and hoping to make up the difference plus enough on top of that to make us "rich" through gains in the value of our stocks house - or, if the madness continues (which I think it won't, a subject for future posting), through whatever asset class is popular.
I don't believe that an asset-appreciation economy is sustainable, so you can lump me amongst the "hairshirt" economists on this one, those who argue that systems need to flush out excesses before they can grow again, and I think the Fed prevented natural economic processes from occurring post September 11th with the misguided goal of making sure "the terrorists do not win" although if we enter a 10 year depression as a result, well, you can bet Osama will be thinking "I won, I won" even if the markets rallied in 2003. Bill Gross had a clever quote on this when he complained about:
...government officials who choose to look the other way or who convince themselves that they are fostering some logical adjustment in a New Age Economy dependent on the markets and not the marketplace for its survival. Link to Bill Gross
Now, good old Bill Gross was talking about adjustments to CPI when he said this, but the quote works well in this context and means basically the same.
So, if you agree with me that we are indeed in a temporary new economy based on asset appreciation, then it should not be difficult to understand why Buffett is the god of this economy, and not, say, Bill Gates as he was in the late 90s. In fact, although Buffett and Gates are often spoken of in the same sentence, there is a high degree of anti-Gates, anti-Microsoft sentiment out there, whereas Buffett tends to get a lot of hagiography and the like.
Now, before I go whole-hog and make it sound like the only reason that Buffett is lauded is because he is an investor and we are a nation of people hoping to make money through investing - let me be perfectly unambiguous: Buffett offers an object lesson in every interview I've seen on how to build wealth, plain and simple. For this reason alone, his views on investing are almost always interesting, whether novice, or seasoned professional; sort of like how you don't really ever get tired of, depending on your taste, your favorite Beatles songs, Bach, Beethoven, or for one smart investor I know, Don McLean's "American Pie".
And, the fact that Gates would lose some of his luster in the US is not surprising. Gates is, after all, the kind of man who recently said that if he could hire talent from one university in the world, it would be the Indian Institute of Technology. (That data point comes courtesy of the interview I review here.) Now, congrats Bill for verifying to the public that your strategy to enrich yourself was to get smart people to work virtually for free: if you can't get them to do that in the US through stock options, then get them to do that in India through low wages. Of course, if you agree with Gates, then this also probably means that you don't care a whit about national competitiveness (or even believe that this concept exists or matters), or that you are probably one of those McKinsey-ites in love with the idea that America can sustain its national advantage through services alone, which is another piece of nonsense I will comment on in a future post.
So, basically what I'd like to do here is look at this recent Buffett interview, find the enduring truths in it, find the useful current events in it, and identify and respond to what I think is PC pablum that Buffett repeats so that he does not incite class warfare and open revolution against his personal empire. Here goes:
Enduring Wisdom #1: There is Really Only One Secret in investing, And That Is Buying Valuable Stuff Cheaply.
Now, let's be clear: the specifics of this idea aren't expressed clearly in this interview, so I will try to
re-post useful information from Graham's work as part of my survey of
the investing landscape. But buying businesses cheaply is what Ben
Graham's writing is about: the $1 of business that you bought for $0.20 to $0.80.
This strategy is everywhere: it is the core of Buffett's business, it
is the core of my successful investing friends, and it is even the core
of quant shop AQR Capital, which I wrote up on this blog. Basically,
successful investors are all doing the same thing, although everyone
may bring to that wisdom their own "edge" - Buffett buys enduring
franchises, others add to this enduring companies that no one is
watching, and some may complicate things dramatically (AQR). The core
rule remains the same.
Q: Since Ben Graham isn't around anymore, what money managers do you respect today? Is there a Ben Graham today?
Buffett: You don't need another Ben Graham. You don't need
another Moses. There were only Ten Commandments; we're still waiting
for the eleventh. His investing philosophy is still alive and
well. There are disciples of him around, but all we are doing is
parroting. I did read Phil Fisher later on, which showed the more
qualitative aspects of businesses. Common stocks are part of a
business. Markets are there to serve you, not to instruct you. You can
often find a couple of companies that are out of line. Find one; get
rich. Most people think that what the stock does from day to day
contains information, but it doesn't. It isn't just something that
wiggles around. The stock market is the best game in the world. You can
take advantage of people who have no morals. High prices inside of a
year will typically be 100% of the low price. Businesses don't change
in value that much. That is simply crazy. There are extreme degrees of
fluctuation, and Mr. Market will call out the prices. Wait until he is
nutty in one direction or the other. Put in a margin of safety. Don't
find a bridge that says no more than 10,000 pounds when you have a 9800
pound vehicle. It isn't a function of IQ, but receptivity of the mind.
Best book
prior to Graham was written by Edgar Lawrence Smith in 1924 called
Common Stocks as Long Term Investments. It was a study that evaluated
how bonds compared to stocks in various decades of the past. There
weren't a whole lot of publicly traded companies back then. He thought
he knew what he was going to find. He thought that he'd find that bonds
outperformed stocks during periods of deflation, and stocks
outperformed during inflationary times. But what he found was that
stocks outperformed the bonds in nearly all cases. John M. Keynes then
enumerated the reasons that this was so. He said that over time you
have more capital working for you, and thus dividends would grow
higher. This was novel information back then and investors then went
crazy and started buying stocks for these higher returns. But then they
started to get crazy, and no longer really applied the sound tactics
that made the reasons given in the book true. Be careful that when you
buy something for a sound reason, make sure that the reason stays sound.
Berkshire owned the Washington Post, the ABC network and Newsweek.
It was selling for $100 million based on the stock price. No debt. You
could have held an auction, and sold off the companies individually for
$500M total, but $100M was the price. In other words they were willing
to sell us money that was worth $1 for $0.25. According to efficient
markets, the beta was higher when the stock was at $20 than at $37.
This is insanity. We bought what was then worth $9 million that is now
worth $1.7 billion.
Enduring Wisdom #2: Earning Outsized Returns Becomes Much Harder the More Money You Manage. Managing a smaller pool of capital opens up more opportunities for you to invest in. Message to all the pension fund managers out there who think that alternative investments are going to help you earn back your pension deficits and manage future liabilities too: don't count on it.
Q: According to a Business Week report published in 1999, you were quoted as saying “it's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.” First, would you say the same thing today? Second, since that statement infers that you would invest in smaller companies, other than investing in small-caps, what else would you do differently?
Buffett: Yes, I would still say the same thing today. In fact, we are still earning those types of returns on some of our smaller investments. The best decade was the 1950s; I was earning 50% plus returns with small amounts of capital. I could do the same thing today with smaller amounts. It would perhaps even be easier to make that much money in today's environment because information is easier to access.
You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map - way off the map. You may find local companies that have nothing wrong with them at all. A company that I found, Western Insurance Securities, was trading for $3/share when it was earning $20/share!! I tried to buy up as much of it as possible. No one will tell you about these businesses. You have to find them.
Other examples: Genesee Valley Gas, public utility trading at a P/E of 2, GEICO, Union Street Railway of New Bedford selling at $30 when $100/share is sitting in cash, high yield position in 2002. No one will tell you about these ideas, you have to find them.
The answer is still yes today that you can still earn extraordinary returns on smaller amounts of capital. For example, I wouldn't have had to buy issue after issue of different high yield bonds. Having a lot of money to invest forced Berkshire to buy those that were less attractive. With less capital, I could have put all my money into the most attractive issues and really creamed it.
I know more about business and investing today, but my returns have continued to decline since the 50's. Money gets to be an anchor on performance. At Berkshire's size, there would be no more than 200 common stocks in the world that we could invest in if we were running a mutual fund or some other kind of investment business.
Enduring Wisdom #3: Investing Is Not A Game Won By The Person With The Highest IQ.
That said, Buffett usually phrases this as "investing is not the game
where the guy with the 160 IQ beats the guy with the 130 IQ." But, as
someone once said, notice he did not say the 100 IQ. Some level of
smarts is required to do the reading, do the calculations, and the rest
is a product of observation and clear thinking.
Q: Are investors more or less knowledgeable today compared to ten years ago?
Buffett: There is no doubt that there are far more
“investment professionals” and way more IQ in the field, as it didn't
use to look that promising. Investment data are available more
conveniently and faster today. But the behavior of investors will not
be more intelligent than in the past, despite all this. How people
react will not change - their psychological makeup stays constant. You
need to divorce your mind from the crowd. The herd mentality causes
all these IQ's to become paralyzed. I don't think investors are now
acting more intelligently, despite the intelligence. Smart doesn't
always equal rational. To be a successful investor you must divorce
yourself from the fears and greed of the people around you, although it
is almost impossible.
Do you think Ponzi was crazy? The tech and telecom
madness that existed just 6 years ago is right up there with the
craziest mania's that have ever happened. Huge training in capital management didn't help.
Take Long Term Capital Management. They had 100's of millions of
their own money, and had all of that experience. The list included
Nobel Prize winners. They probably had the highest IQ of any 100 people
working together in the country, yet the place still blew up. It went
to zero in a matter of days. How can people who are rich and no longer
need more money do such foolish things?
Enduring Wisdom #4: Do What You Love, Everything Else Will Work Itself Out. Although I don't know if I completely agree with this philosophy, because I haven't yet had to face too many hard realities based on the decisions I've made thus far, I am starting to agree with it. Since I allowed myself to work less and focus more on reading what interested me, and even more so to write about it, I find myself more satisfied. I don't get paid to write this blog, I do it in my spare time on evenings and weekends, and since I started writing, my views and thoughts have matured and grown in depth and nuance. This latest phase has only been about a year in the making, so I'll have to let you know how it works out, but early results seem positive.
Buffett: I really knew I was rich when I had $10,000. I knew along time ago that I was going to be doing something I loved doing with people that I loved doing it with. In 1958, I had my dad take me out of the will, as I knew I would be rich anyway. I let my two sisters have all the estate.
I bet we all in this room live about the same. We eat about the same and sleep about the same. We pretty much drive a car for 10 years. All this stuff doesn't make it any different. I will watch the Super Bowl on a big screen television just like you. We are living the same life. I have two luxuries: I get to do what I want to do every day and I get to travel a lot faster than you.
You should do the job you love whether or not you are getting paid for it. Do the job you love. Know that the money will follow. I travel distances better than you do. The plane is nicer. But that is about the only thing that I do a whole lot different.
I didn't know my salary when I went to work for Graham until I got his first paycheck. Do what you love and don't even think about the money. I will take a trip on Paul Allen's Octopus ($400M yacht), but wouldn't want one for myself. A 60 man crew is needed. They could be stealing, sleeping with each other, etc. Professional sports teams are a hassle, especially when you have as much money as him. Fans would complain that you aren't spending enough when the team loses.
If there is a place that is warm in the winter and cool in the summer, and you do what you love doing, you will do fine. You're rich if you are working around people you like. You will make money if you are energetic and intelligent. This society lets smart people with drive earn a very good living. You will be no exception.
Questionable PC Pablum Item #1: Buffett Would Not Have Survived 2,000 Years Ago. Well, there were money changers and tax men in the Bible, and no doubt Mr. Buffett's talents would have been useful there. Perhaps he means 30,000 years ago, but I'm sure he'd be there happily perched in the top of a tree, thinking what fools people are to try and fight tigers and bears when trees were safer, plus they had all this great fruit. This self-effacement is probably a defense against its reciprocal - that this uncompetitive weakling might have some inherited advantages, and keeps him palatable for wide consumption. Fortunately, it doesn't affect investing returns.
Buffett: I was lucky because I knew what I loved at an early age. I was wired in a certain way when I was born, and I was lucky enough to stumble upon some books at a library at a very early age. In 1930, I won the ovarian lottery. If I had been born 2,000 years ago, I'd have been somebody's lunch. I couldn't run fast, etc.
Questionable PC Pablum Item #2: Life Outcomes are Luck; Governments are Good at Adjusting for that. Buffett espouses a way of thinking that says in order to understand a society's fairness, you have to imagine life outcomes as the result of a "cosmic lottery" where we all draw tickets that determine what advantages we receive. As a theoretical tool, it isn't bad when you try to explain why the legal system has to be fair, but applied more broadly, it has the effect of discounting the effect of intelligent observation and lots of action in pursuit of positive outcomes. For a man who is happy to call people "fools" all day long based on folksy common sense, it seems strange that he would result to the equivalent of "efficient markets theory" to explain social outcomes. And, for somone so practical to imagine that government is at all efficient or useful in guaranteeing equal and appropriate societal outcomes seems crazy; distrust in the ability of a bureaucracy to create equitable social outcomes through redistribution, especially for someone who runs a central office with 13 people in it, makes far more sense.
Q: Could you discuss your views on estate planning and how you will allocate your wealth to your children?
Buffett: It really reflects my views on how a rich society should behave. If it weren't for this society, I wouldn't be rich. It wasn't all me. Imagine if you were one of a pair of identical twins and a genie came along and allowed you to bid on where you could be born. The money that you bid is how much you had to agree to give back to society, and the one who bids the most gets to be born in the US and the other in Bangladesh. You would bid a lot. It is a huge advantage to be born here.
There should be no divine right of the womb. My kids wouldn't go off and do nothing if I give them a lot of money, but if they did, that would be a tragedy. $30 billion will be generated from estate taxes, which will go to help pay for the war in Iraq and other things. If you take away the estate tax, that money will have to come from somewhere else. If not from estate taxes then you inherently get it from poorer citizens. Less than 2% of estates will pay the estate tax. They would still have $50 million left over on average. I think those that get the lucky tickets should pay the most to the common causes of society. I believe in a big redistribution. Wealth is a bunch of claim checks that I can turn in for houses, etc. To pass those claim checks down to the next generation is the wrong approach. But for those that think I am perpetuating the welfare state, consider if you are born to a rich parent. You get a whole bunch of stocks right at the beginning of your life, and thus you are sort of on a welfare state of support from your rich parents from the beginning. What's the difference?
At $100,000 a year, I can find 10 people to paint my portraits to find the perfect one. I have that kind of money. But that is a waste, as those people could be doing something useful. I feel the same way about my kids and other heirs. They should be doing things that help to contribute to society.
Other Views Which May Contain Enduring Truths But Primarily Relate to Current Events
View: US Dollar is Still a Weak Currency: There was some trumpeting in the press about Buffett losing money on this bet in the second quarter of 2005, but that conveniently overlooks the $2.1 billion he made thus far. He's right: structurally, our economy is no better off than it was when he initiated the bet. Hence, keep the bet on.
Buffett: We have about $21 billion in about 11 foreign currencies. We have
$60-70 billion in things that are denominated in US Dollars. We still
have a huge US bias. If Martians came down with currency certificates
and could choose any currency on earth, I doubt it would be 80% in US
Dollars.
We are following policies that make me doubt that our currency will
not follow a downward spin. We lost $307 million this quarter. The net
gain since we started holding foreign currencies in 2002 is $2.1
billion. We have to mark these future contracts to market daily. If we
owned bonds instead of sterling forward contracts, it wouldn't
fluctuate around so much.
Identifying bubbles is fairly easy. You don't know how big they will
get and you don't know when they will pop. You don't know when midnight
will hit, but when it does, it turns carriages to pumpkins and mice.
What markets will do is pretty easy. When they will do it is more
difficult. Some people want to stick around for the last dance, and
they thought that a bigger fool would be just around the corner
tomorrow.
View: Eddie Lampert Aside, K-Mart and Sears Are Not Destined for Success. Interesting how he refers to the Buffett grocery stores, as though that family experience might be irrelevant to his own perspective. His family has 100 years in the grocery business, which is certainly useful to someone who wants to understand how he became who he is.
Q: What is your opinion of the prospects for the Kmart/Sears merger?
How will Eddie Lambert do at bringing Kmart and Sears together?
Buffett: Nobody knows. Eddie is a very smart guy but putting Kmart and Sears
together is a tough hand. Turning around a retailer that has been
slipping for a long time would be very difficult. Can you think of an
example of a retailer that was successfully turned around? Broadcasting
is easy; retailing is the other extreme. If you had a network
television station 50 years ago, you didn't really have to invent or
being a good salesman. The network paid you; car dealers paid you, and
you made money.
But in retail you have to be smarter than Wal-Mart. Every day
retailers are constantly thinking about ways to get ahead of what they
were doing the previous day.
Retailing is like shooting at a moving target. In the past, people
didn't like to go excessive distances from the street cars to buy
things. People would flock to those retailers that were near by. In
1996 we bought the Hochschild Kohn department store in Baltimore. We
learned quickly that it wasn't going to be a winner, long-term, in a
very short period of time. We had an antiquated distribution system. We
did everything else right. We put in escalators. We gave people more
credit. We had a great guy running it, and we still couldn't win. So we
sold it around 1970. That store isn't there anymore. It isn't good
enough that there were smart people running it.
It will be interesting to see how Kmart and Sears play out. They
already have a lot of real estate, and have let go of a bunch of Sears'
management (500 people). They've captured some savings already.
We would rather look for easier things to do. The Buffett grocery
stores started in Omaha in 1869 and lasted for 100 years. There were
two competitors. In 1950, one competitor went out of business. In 1960
the other closed. We had the whole town to ourselves and still didn't
make any money.
How many retailers have really sunk, and then come back? Not many. I
can't think of any. Don't bet against the best. Costco is working on a
10-11% gross margin that is better than the Wal-Mart's and Sams'. In
comparison, department stores have 35% gross margins. It's tough to
compete against the best deal for customers. Department stores will
keep their old customers that have a habit of shopping there, but they
won't pick up new ones. Wal-Mart is also a tough competitor because
others can't compete at their margins. It's very efficient.
If Eddie sees it as impossible, he won't watch it evaporate. Maybe
he can combine certain things and increase efficiencies, but he won't
be able to compete against Costco's margins.
Source: University of Kansas: Warren Buffett Q&A May 6, 2005 Link
