Dave Sather’s Money Matters
May 9, 2012
Buffett, Bono and Gates: Nowhere But Berkshire Hathaway
The first weekend in May was spent in Omaha with my Texas Lutheran University students. We made the trek to listen to Warren Buffett and partner Charlie Munger at the Berkshire Hathaway annual meeting.
The trip allowed us to rub elbows with well known value investors Whitney Tilson, Mohnish Pabrai and Mario Gabelli. Berkshire director Bill Gates was there and for some unknown reason, Bono, from the rock band U2 was sitting on the front row. Maybe Bono was looking for a discount on his car insurance from Berkshire subsidiary GEICO.
As is always the case, the six hour Q & A session spans a very broad range. However, the topic of risk was repeatedly discussed.
Buffett at age 81 and Munger at 88, have been around the block a time or two. Buffett is famous for saying that Rule #1 in investing is “Don’t Lose Money” and Rule #2 is “Don’t Forget Rule #1”. With this background, Buffett said that whether at Berkshire, or any other company, the CEO must be the Chief Risk Officer and the responsibilities that accompany this position cannot be outsourced.
Buffett has been, and continues to be, critical of many academic methods for assessing types of risk. Although he acknowledges that schools are slowly improving, the silliest things they continue to teach are investment related. Throughout the years, different fads run through the biggest and most well known of the B-Schools. Once they become popular it is very hard for faculty to challenge irrational practices for fear of offending tenured professors and therefore derailing their careers.
Buffett and Munger encouraged the business programs to teach one course in their curriculums—not stock trading, efficient market hypothesis or modern portfolio theory—but rather the boring, but critically important, discipline of business valuation. Business valuation is the heart of investing and risk management--and without it you are blind.
Buffett explained that in valuing any business you must be honest with yourself about which businesses you truly understand and those you don’t. As Buffett has done many times before, he stated it is impossible to value a business that you don't truly understand.
Munger added that the accounting profession has made matters worse. In an effort to quantify corporate risks, accountants have developed standardized models because they ‘’don’t require much thought.” The pair agreed that when assessing the complexities of risk, there is no such thing as “standard.”
The partners agree that when it comes to assessing risk and opportunity, what matters most is your facts and your reasoning. They elaborated that a variety of risks will always be present in the world at any given time. Despite this, it is ultimately the investor’s job to understand the value of a business and to act when opportunities present themselves—regardless of worldwide drama.
As Buffett and Munger look at risk, they always think in worst case scenario terms and then add a significant “margin of safety.” The conservative approach generally finds them with a slug of cash on hand for emergencies. This allows Berkshire to avoid “fat tail risk”—the risk of something small, but significant, from completely wiping them out over a long period of time. With 98% of his net worth held in Berkshire Hathaway stock, Buffett said the goal for them and their shareholders is to sleep well at night by managing these risks.
This approach has allowed them to double the returns of the market, on average, every year for the past 45 years.
The super octogenarians then added that complicated math models created by Wall Street do not ensure a fair understanding of risk or history of financial disasters. As they made this comment, I thought to myself about all of the smart people at Enron, Worldcom, Bear Stearns, AIG and Lehman Brothers who completely failed in this task.
Buffett and Munger also offered a few tips on “what not to do.”
First, if you don’t understand it—avoid it. Second, know how to value a business and avoid paying high prices. They also said that in the last thirty years they have never bought a new issue (sorry Facebook). Then they cautioned about industries that have a great future—but in which you cannot clearly identify the winners. Finally, they reiterated that you must avoid the disasters—the things that can completely wipe you out.
Although it was a quick trip, it was very worthwhile. After twenty years of following Berkshire Hathaway I learn something new every time. I think my students learned something too.
Dave Sather is a Victoria CERTIFIED FINANCIAL PLANNER™ and owner of Sather Financial Group. His column, Money Matters, publishes every other week.