28 April 2022

On today’s show, Trey Lockerbie chats with Dr. David Kass, who is a Ph.D. economist and professor at the University of Maryland. Prior to joining the faculty of the Smith School in 2004, he held senior positions with the Federal Government (Federal Trade Commission, General Accounting Office, Department of Defense, and the Bureau of Economic Analysis). His blog on Warren Buffett has gained notoriety from features on Bloomberg, CNBC, and Fox. David is often quoted in the NYT, WSJ, and Washington Post. So, he is the perfect guest for today’s exploration of Buffett’s biggest blunders. David is such a wonderful and gracious guest. He shares his stories of visiting Buffett in Omaha with his students and so many other great insights. I really hope you enjoy it as much as I did. Without further ado, here is my conversation with Dr. David Kass.

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  • The story of how Buffett bought Berkshire after letting his emotions get the best of him and why it was originally a huge mistake
  • How he could have made hundreds of billions more had he simply invested in insurance
  • His position in Conocophillips that resulted in a loss
  • Why buying Dexter Shoes was, in Buffetts words, the worst purchase he ever made.
  • How he missed out on Google, Amazon and others
  • His overpayment for Precision Castparts
  • And how even through all of that, 1 single dollar invested with Buffett in 1965 would now be worth $3.65 M
  • That And a whole lot more!


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

Trey Lockerbie (00:03):
On today’s show, we have Dr. David Kass, who is a Ph.D. economist and professor at the University of Maryland. Prior to joining the faculty of the Smith School in 2004, he held senior positions with the federal government, the Federal Trade Commission, General Accounting Office, Department of Defense, and the Bureau of Economic Analysis. His blog on Warren Buffet has gained notoriety from features on Bloomberg, CNBC and Fox and David is often quoted in the New York Times Wall Street Journal and Washington Post. He’s the perfect guest for today’s exploration of Buffet’s biggest blunders.

Trey Lockerbie (00:36):
In this episode we discuss the story of how Buffet bought Berkshire after letting his emotions get the best of him and why it was originally a huge mistake, how he could have made hundreds of billions of dollars more had he simply just invested in insurance. His early position in ConocoPhillips that resulted in a loss, why buying Dexter Shoes was, in Buffet’s words, the worst purchase he ever made. How he missed out on Google, Amazon, and others, his overpayment for Precision Castparts and how even through all of that one single dollar invested with Buffet in 1965 would now be worth $3.6 million.

Trey Lockerbie (01:10):
David is such a wonderful and gracious guest. He shares his stories of visiting Buffet in Omaha with his students and so many other great insights. I really hope you enjoy it as much as I did. So without further ado, here’s my conversation with Dr. David Kass.

Intro (01:30):
You are listening to the Investor’s Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

Trey Lockerbie (01:48):
Welcome to the Investor’s Podcast. I’m your host, Trey Lockerbie and today I’m very pleased to have with me, Dr. David Kass to come on our show and talk about Buffet’s biggest blunders. Welcome to the show, David.

David Kass (02:01):
Well, thank you very much for having me.

Trey Lockerbie (02:04):
You got your Ph.D. in economics and business from Harvard. You went on to do a number of things including working at the DOD for a couple of years. Maybe catch us up on your background and then what eventually led you to study Buffet and writing about him and teaching this class?

David Kass (02:19):
Yes. Be happy too. After receiving my Ph.D. in business and economics, I came to Washington to work for the federal government as a senior economist. And I worked for four different government agencies over many years, the Federal Trade Commission, the General Accounting Office, which is now called the Government Accountability Office, Department of Defense, looking at their healthcare delivery system, and the Bureau of Economic Analysis part of the commerce department. At the FTC, in addition to doing financial analysis on mergers, one of my special fields in graduate school was industrial organization, which basically looks at something called structured conduct performance, competitive nature of industries, and financial analysis. Finance was the second special field. At the FTC I did again, several studies there in those related areas, similarly at the General Accounting Office, DOD, healthcare for a couple of years, and Bureau of Economic Analysis cutting across several areas.

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David Kass (03:26):
I then retired, early retirement from the federal government and what I always wanted to do, and the reason I went for a Ph.D., went to school for a Ph.D. was so I could teach at the university level. I always had an interest in economics and finance, and I got my opportunity in 2004 with the Robert H. Smith School of Business at the University of Maryland and where I’ve been ever since. This is my 18th year. Now as a hobby, I just have always read books. I picked up a book called The Money Masters by John Train. And I immediately turned to the back of the book there were seven successful portfolio managers being written up in the book and at the back of the book, I looked at the current portfolios, the latest portfolios of each of the seven managers. Six of them did not particularly impress me.

David Kass (04:19):
They just looked like the momentum stocks, the hot stocks from the year before, but the seventh one just jumped right out at me being very different. And some of the stocks included in that portfolio were American Express, the Washington Post Company, and Capital Cities Broadcasting. And I knew enough about the stock market and stocks to have some knowledge, a considerable knowledge of each of those companies. And I had a good idea these are wonderful companies below the radar. And I asked myself, gee, whose portfolio is this? And it was Warren Buffet. And that was my initial introduction to him. I started paying careful attention to him. A few years later, actually I noticed another book had come out and written a chapter about him. The book itself, I believe was published a few years earlier in 1977. I think it was called Supermoney. The author was Adam Smith.

David Kass (05:16):
That was a pending for someone named George Goodman, but Adam Smith was the official author of the book. And he had a chapter on Warren Buffet as well. And so I started following Warren Buffet through the newspaper, Wall Street Journal, acquisitions and it was just fascinating and finding that I felt that he and I were sort of on parallel wavelengths in terms of long term quality and value investing, and I could learn so much from him. And after a few years of having this sitting in my mind, I finally came around saying, gee, why don’t I buy a share of Berkshire Hathaway bid around 1985. It took me about five years to reach that conclusion. And at that time, as I recall, it was October 1985 that share sold for $2,120 a share. And of course back then they had only A share there were no B shares and that share is cost valued at over $500,000.

David Kass (06:20):
Anyway, I became a big fan of Warren Buffet, he really was a role model for me in terms of investing and in terms of being a wonderful person as well. And then when I arrived at the University of Maryland fall of ’04 and spring 2005, there was a notice posted in the main lobby of the business school at the University of Maryland and a student was advertising for other students to join him on a trip, private trip to Omaha, Nebraska to meet privately with Warren Buffet. Anyone who signed up could go, and I then contacted the student and maybe I did this sort of backwards from the way it’s normally done. And I asked him, could you use a faculty advisor. And I then convinced him that I was a longtime Buffet fan. My personal library at home probably had every Buffet book written at that time.

David Kass (07:15):
And he was quite receptive to my idea. And off we went to Omaha, we had 50 students, we didn’t turn down anyone, was undergraduates and MBA students. And that was the first year in 2005 that Warren Buffet started meeting with students at various universities. We were one of, I think, 15 universities that he met with that year. And it was a very interesting experience. I remember sitting in a room by his office and when we signed up everyone, and this may be the third time I’m saying it, we did not turn anyone down, but the result was demographically or by gender, we had 49 men and only one woman and Warren Buffet came into the room, looked around the room before he said hello, before he introduced himself, the first thing he said was where are the women and of course I got all red in the face, I felt like trying to hide under my chair in embarrassment.

David Kass (08:15):
And from then on actually in subsequent student visits from my other universities, including Maryland Warren Buffet required in future visits that at least one third of the students visiting with him would be women. And indeed I was invited back three more times to bring University of Maryland students with me in 2011, 2013, in 2016. And at that time, the format had changed. He’d meet with 20 students from eight schools at a time, five times during the year. One third of 20 would be seven, at least seven women would come on each of our trips and I think I was very careful in that regard, I think I always bring along at least eight, trying to make up for an inadvertent error in the past, let’s say, and he loves to meet with students.

David Kass (09:06):
And so anyway, I have followed him along those lines. And then on the occasion of his 80th birthday and August 30th, 2010, I launched a Warren Buffet blog at the University of Maryland, basically blogging about Berkshire Hathaway, Warren Buffet occasionally some more general topics on finance economics in the stock market. Anyway, Buffet has been with me, certainly a role model and he still is today. I admire his approach to investing, carefully follow it and to some extent, obviously much smaller scale I might duplicate a few of his steps.

Trey Lockerbie (09:47):
Well, hopefully not the steps that we’re going to cover today. We’re going to go over a few of these. And before we do, I just wanted to mention that I love that you brought up the Supermoney book by Adam Smith, actually, because when I had a chance to meet Buffet and I asked him for some resources to learn more, that was actually one of the books he recommended to me. We certainly praise Buffet a lot on this show, but I just thought it would be fun to cover some of his biggest blunders. One of his earliest reported mistakes was actually buying Berkshire Hathaway. And in fact, during a 2010 appearance on CNBC Buffet called Berkshire Hathaway “the dumbest stock I ever bought” walk us through what Buffet was buying at that time when he approached Berkshire Hathaway, why he decided to liquidate his partnerships to roll it into Berkshire and then what happened next?

David Kass (10:36):
Okay. At that time, Berkshire Hathaway was a textile company with textile mills in New England in the early 1960s and Buffet initiated his investments in the company around 1962. And he was attracted to it because of low price, earnings valuations, good cash flow being generated. He thought it was sort of an undervalued asset that he could take advantage of and profit from. And the turning point, which led to what we’re discussing is purchase of the company came in 1964 when the CEO or principal owner of the company someone named Seabury Stanton made Warren Buffet an oral offer to buy his shares, to buy him out at 11 and half dollars a share and Buffet agreed to do that.

David Kass (11:30):
He would sell him his shares at 11 and a half and he would move on to other investments. But sometime later, a little time later, he receives the official written offer and instead of being at 11 and a half, it was at 11 and three eights. And let me just take a step aside. I have to explain this to my students now that back then, whereas today’s stock prices trade in decimals, smallest unit, generally a penny back then they traded in fractions, the smallest unit being one eighth of a point. This was not unusual to have a price of 11 and three eights or three eights part of a price. Anyway, Warren was very upset. He was clearly being cheated out of one eighth of a point they already had an agreement and I guess he was fairly young at the time. He would’ve been 33, 34 years old. And I guess it’s one example where he let his emotion perhaps take control over his better judgment and he decided he was going to just buy out the company with the stated purpose so he could fire Mr. Stanton.

David Kass (12:36):
And so that’s what he did. And that’s the reason he bought Berkshire Hathaway sort of a vindictive action to get even, and which he later regretted over the next several years, the textile industry declined rapidly versus it moved to the south and the United rates lower costs, lower labor, eventually, certainly overseas, a lower labor overseas, and essentially Berkshire essentially went bankrupt. The businesses did. So he moved on from there to investing in insurance, insurance companies and so on. And the rest is history today, of course you have this $506 billions six largest company in the United States by market cap, but that’s the early history that I’m sure he is not very proud of in that investment.

Trey Lockerbie (13:25):
Yeah, I believe the quote from Buffet is that he “chiseled me for an eighth.” That was just such an interesting quote. And what’s even more interesting about this is, as you said, Buffet appears to be this sort of almost, even if you read The Snowball book, he comes across as sort of impervious to emotional based decisions. But this stock was bought out of spite as you put it. And it’s essentially a lapse in behavioral and or emotional discipline that Buffet is known for later. Is this one of the only times we’ve seen this side of Buffet come out?

David Kass (13:58):
Well, certainly this type of context, and again, he was relatively young and he’s in his early thirties at the time and people do make mistakes as he did and one point there were other times where he made other investment mistakes and there are two types I’ll refer to, errors of commission buying the stock and losing money, for example or errors of omission planning to buy a stock, hesitating, not buying it. And then the opportunity costs, so to speak, watching the stock then skyrocket and sort of losing out on the opportunity to earn many billion for Berkshire. But those were just pretty much judgmental being extra careful or maybe a little less careful. And he should have been less circumspect than he should have been, but not of this emotional sort of gee I’m going to get even with this guy, he tried to cheat me so I’m going to get even with him. This is the only such instance that I’m aware of at that time.

Trey Lockerbie (15:04):
Buffets also said that if instead of putting that money into the textile business originally we had just started out with an insurance company Berkshire would be worth twice as much as it is now. He said, so basically all in all Buffet calculated that this mistake was worth $200 billion. Ouch, so interesting. And despite regretting the purchase of a failing textile company, Berkshire Hathaway Buffet did the same thing 13 years later when he purchased Waumbec Mills, another new England textile company. Why was Buffet so drawn to these textile companies?

David Kass (15:39):
Again, I think he was drawn to them. He thought that their valuation price earnings very low, price to cash very low, that they were good values. He referred to as these cigar butts that you could pick up off the street and get one or two extra puffs of at a very low price or almost free. And he thought he could squeeze out some additional cash flow from these companies without fully appreciating how rapidly that industry was in decline that those puffs may not last as long as he thought or provide as much return as he expected. I guess he was attracted to them in another industry where he doesn’t seem to learn his lessons from, although he is where he makes mistakes. It’s something called the airline industry where he can and has repeated couple of mistakes. He’s very much attracted to airline and both attracted to them and critical of their management as well over time, but keeps perhaps repeating a couple of earlier mistakes. He does have certain tendencies to go back into an area and he may have invested in before.

Trey Lockerbie (16:49):
Well, he is human after all. And we can poke fun at Buffet mainly because of this unbelievable performance as an investor, especially with Berkshire Hathaway, for instance, between 1965 and 2021, Berkshire Hathaway produced an annual gain of 20.1% compared to the S&P 500 with dividends gain of 10.5%. Put another way, $1 invested in the S&P 500 in 1964, would’ve turned into $30,209 by the end of 2021, but $1 invested in Berkshire Hathaway in 1964 would be worth $3.64 million, just unbelievable. Unbelievable. In moving on to one of his other mistakes in 2008, Buffet bought a large stake in the stock ConocoPhillips as a play on the future energy prices. However, this turned out to be a bad investment because Buffet bought in at too high of a price resulting in a multi-billion dollar loss for Berkshire Hathaway. Was this a mistake of not paying attention to the macro conditions of the time as he’s known to kind of shy away from?

David Kass (17:57):
Well, he’s been attracted to oil stocks and energy stocks over the years early on and subsequently he’s been in and out of Exxon Mobil, for example, and more recently in the last year or so, both Chevron and Exxon petroleum. He’s invested in this industry a lot in the past. I think he’s attracted to it, but he is acknowledged over time that the primary determinant of the value of oil company stocks is the price of oil. And with the case of ConocoPhillips, I guess he was making a bet that the price of oil would either stay at the current level at the time and go higher, but certainly not drop off significantly. And also ConocoPhillips, like the other oil stocks also paid a good dividend. There was an income aspect to it as well. One certainly needs to consider both capital gains and income in the investments, but the ConocoPhillips, I guess, do not work out as well as he hoped for.

Trey Lockerbie (19:00):
So interesting. All right, moving on in 1993, Buffet bought a shoe company called Dexter Shoes and in his 2008 annual letter Buffet claims that this investment was the worst he ever made resulting in a loss to shareholders to the amount of $3.5 billion. Where was the folly here and what lessons did Buffet learn from this?

David Kass (19:25):
The main folly here of the Dexter Shoe lesson, that’s actually similar to the Berkshire Hathaway textile mill era of a declining industry, sort of almost doomed to go bankrupt, but that’s only a minor part of his mistake. He invested $433 million in Dexter Shoes in 1993 and went to zero. His mistake though was not paying $433 million in cash, his mistake was paying in Berkshire stock, 25,203 shares of Berkshire stock, which in 2008, you mentioned was value in a $3.8 billion. Well, in 2022, today it’s valued at $13 billion. It’s a $13 billion loss, it’s open ended, it keeps getting bigger and bigger on the better Berkshire Hathaway stock performs. It’s open ended a phenomenal mistake. He has gone out of his way in subsequent acquisitions to trying to avoid using Berkshire stock in acquisitions. One exception he’s made since then, his acquisition of Burlington Northern Railroad about 10 years ago, the cost of Berkshire stock was so highly priced at the time.

David Kass (20:37):
He agreed to have a certain percentage of the acquisition in stock as well as cash. It was a combination cash and stock. It provided the opportunity to Burlington Northern shareholders to receive the shares in Berkshire so they could continue to be equity holders. But that’s a rare exception he’s made since then. And that was negotiated, I’m sure with Burlington Northern, but the open ended nature of this loss of Dexter Shoe, that will probably always be his biggest mistake.

Trey Lockerbie (21:09):
Yeah, that is so interesting to me because with the stock over half a million dollars per share, you would think that would provide him a lot of leverage to make deals without tapping into his cash. But as you mentioned, the cash is finite, but using the stock, if it goes south is sort of infinite as it continues to compound higher. Obviously Buffet was familiar with the idea of a competitive advantage. I think he would learn that from his Graham days. But do you think this example burned that into his kind of psyche a little bit more about making sure there was a margin of safety certainly around the competitive advantage especially.

David Kass (21:48):
When he studied at Columbia University under Ben Graham, basically he learned early on a concept of durable, competitive advantage and margin of safety. And he has used that all along. And of course, as he learns from his earlier mistakes, hopefully not repeat them in the future has apply them maybe with greater precision, but he has always approached his investments in that way and indeed early on because he was a disciple of Ben Graham and since Ben Graham, as you know, it’s on the board of directors or chairman of GEICO at the time, therefore Warren Buffet became interested in GEICO and learned about insurance actually that way and learning about the durable, competitive advantage that GEICO had its cost advantage in his business model. So he has certainly applied this going forward, but occasionally I guess the mistakes that of omission that he’s made, some of them since then are more of judgmental errors.

David Kass (22:51):
When you make an investment in equities, you are basically forecasting future earnings, future cash flows. What the future economy will look like and how that economy will interact with your investment, the company you’re investing in and that necessity needs to incorporate and it’s very difficult to do so the impact of future technology and the problems that that could cause and right now I’m thinking of a company called IBM, for example, and there you have, of course, disruptive technologies coming in IBM was lead premier technology company of the 1950s and sixties, maybe early 1970s as well. And here’s Warren Buffet in the year 2011 are placing a huge bet on IBM. And between 2011, 2016, I believe he invested something like 14 billion and not fully appreciating the risk that he was taking on as he always stresses that he tries to stay within his circle of competence.

David Kass (24:01):
What industries, what businesses does he understand and those that he does not, he leaves to others. And within a circle of competence, certainly he’s demonstrated great expertise in the insurance area. The insurance industry, he succeeded quite nicely over the years and GEICO is a wonderful example of that. But in the technology area is something that with 2020 hindsight, certainly we could look back and say, gee, I don’t think that’s where Warren’s expertise really lay. And perhaps his mistake there was looking at past performance perhaps a little bit more than he should have, not a fully appreciating how rapidly technology was changing in the process of changing and how competitive the future market would be for the businesses that IBM was in. And it took him a long time to acknowledge that he was going down the wrong path and it took him about five years and he started bailing out five years later around 2016 or so.

David Kass (25:08):
And I think he may have solved a net loss or best broke even, but he may have lost a little, but here his real loss in the roughly $14 billion he invested was the opportunity cost the S&P 500 more than double over this time period. So just investing in average, for him, average for the economy, would’ve doubled that money. And of course investing as he later did right around that time actually, and starting in 2016, I may have learned a little bit of that lesson and started putting $30 billion or so into apple and that has worked out marvelously well. Apple today is quintuple since his $30 billion investments worth roughly $160 billion.

David Kass (25:51):
And there Warren views apple as producing, focusing on the iPhone as a consumer product, although it’s obviously a blend of consumer product and technology, of course, but he viewed it as a consumer product, a product that consumers could not live without. And so far he is been absolutely correct in that regard. And I think his circle of competence around consumer products is very strong in that area and that has worked out very well for him, but with expect to IBM, it was this five year period of longer of the money just sitting there, not producing rate of return, perhaps losing a little underestimating his ability perhaps to forecast the future for that company and not fully appreciating how rapidly technology is changing.

Trey Lockerbie (26:42):
Yeah. I’ve sat in the audience for those annual shareholder meetings where people are asking about IBM like, look, what are we doing in this position? And it’s been painful to kind of hear him come to terms with his mistake in that regard. He was very, I think, stubborn to come to it, but he’s totally, as you put it redeemed himself with this Apple position. There were other mistakes of omission as you kind of highlighted earlier, for example, not buying Google he’s since put some position in Amazon, but that even Amazon, he had Jeff Bezos in his office pitching him on Amazon very early on. And of course hindsight’s 2020, but knowing how good of a judge of character he is and he’s since gone on to say how much Bezos has been maybe the best business mind ever, but would’ve thought he would’ve recognized that but he just was probably a little bit burned or something or not, mainly from that IBM or that lack of understanding in the tech world.

Trey Lockerbie (27:34):
And one other example that is just interesting on that is, GEICO at one point was spending, I think upwards of 10% of their premiums every year on Google ads. Even though Buffet was saying he doesn’t understand Google and mind you, there were actually other search engines at the time, Mozilla or whatever other ones, Yahoo, but seeing how much of that money from GEICO was flowing into Google you think that would’ve gotten him a little bit motivated to understand that business a little earlier than he did.

David Kass (28:03):
Yes. As matter fact, the first time I brought students to meet with Warren Buffet, that’s the time again, with 49 out of 50 being male, what he does at those meetings, by the way, for those who are not aware of it, he answers student questions for maybe an hour and a half then he takes the students to lunch and then poses for pictures with the students. And in 2005, when we were at lunch at Gorat’s Restaurant, one of his favorite steakhouses in Omaha, I had the good fortune of sitting at an adjacent table from the one he was sitting at with students that was close enough so I could hear the conversation, but not be intrusive, not taking the place of any student at the table certainly. And one student asked him specifically this year, 2005, Google had just gone public with its IPO the year before 2004.

David Kass (28:55):
It’s one year in the public market. Why doesn’t Berkshire invest in Google and Buffet even said to the student, yes, GEICO is paying a lot of money to Google to advertise him fully aware of it, but he was hesitant. He was aware of these other search engines and he saw them come and go or being bypassed by Google and would something else come along next year in five years that would leave Google in the dust, so to speak. He was a very reluctant at the time to, again, as in a tech knowledge area that he felt and was not his expertise, but students were pushing him on that. And it was very interesting. And he and Charlie at the annual meeting or both with the shareholder questions would come up, why isn’t Berkshire investing in Amazon and Google. And there seemed to be this hesitation, reluctance sort of risk aversion so that I’d rather miss out on something big than to invest and lose.

David Kass (29:53):
It was sort of that type of mindset. And maybe again, it was not their area of expertise that maybe you took the two relatively new portfolio managers, Todd Collins, and Ted Weschler who joined Berkshire roughly 10 years ago. And it would not surprise me that Amazon was perhaps an investment of one of those two portfolio managers. And I believe Apple initially was also an initial investment of one of those two portfolio managers then Buffet was sort of sold on it and certainly the bulk of Berkshire’s investment in Apple today came from Buffet for sure as each of the two portfolio managers have a limited amount of capital at their disposal to invest. But I believe it was those two, one or both of those two new portfolio managers, Ted Weschler and Todd Collins who really started pushing Berkshire in the direction of technology.

Trey Lockerbie (30:48):
I totally agree with you. I think that’s a great call out and what’s coming to my mind right now is the fact that Buffet has said that he uses a scuttlebutt approach to some investments. And with Apple in particular, I remember him talking about him, I think going to get dairy queen with his granddaughters and seeing them on their iPhones and how they couldn’t get off of them and then just kind of asking people about it and studying that it’s reminding me of that old American Express bet he put on after the salad oil scandal, stock went way down and he came in after checking around and just qualitatively understanding that the brand was still intact. And do you buy into this exactly. He’s not known to be opening up Excel files, running discounted cash flows. He’s taken a lot of these qualitative approaches over time. Is this maybe partly to do with some of the mistakes that we’ve talked about today?

David Kass (31:37):
Well, he, in terms of discounted cash flows and analysis, he apparently his mind, his brain is quite capable of running a very complex discounted cash flow analysis in his head without the use of a computer. Something that very few others are capable of doing. And so he is certainly, he estimates what he calls intrinsic value of a company and for example, he’ll buy back shares and Berkshire, he’s been doing for the last year or two only to the extent that he values Berkshire’s intrinsic value is above where he is buying the shares. The shares are selling below his estimate of intrinsic value, he’ll buy the shares, but his estimate he’s never revealed the calculations that he does or what his estimate is of intrinsic value. He’ll just tell you that he’s doing it. And he has his own way of doing it, his own discount rates that he uses.

David Kass (32:33):
I know in business school, we teach our students quite typically to use weighted average cost of capital as a discount rate, for example. And he might use something like a treasury rate on long term treasuries, but there are different ways different people can use different approaches to discounting future cash flows. But he’s certainly in making, I believe any of his investments is certainly using a discount rate, making an estimate of future cash flows being just generated and using in his mind an appropriate discount rate. Whereas if he views the company as being risky or than other companies, he would use a higher discount rate and a company really understands real well been following it for many years and he feels the business plan, the model is very stable, he might use a lower discount rate for it. He’s very analytical. Does much of it in his head rather than on a computer.

Trey Lockerbie (33:29):
All right. One of the last mistakes we’re going to cover today is Precision Castparts. So Berkshire Hathaway acquires Precision Castparts for $32.1 billion in 2016 and they are obviously an aircraft industrial parts maker. It was the largest acquisition for Berkshire at the time. And Berkshire actually wrote off nearly $10 billion just last August from this investment as a coronavirus pandemic zapped all the demand for air travel. What was the mistake here? $32 billion obviously a very large amount, was this another case of him overpaying?

David Kass (34:03):
Well here, the way he actually made the investment is very interesting that Mark Donegan, one of his portfolio managers, let me take a step back, I had already initiated a passive stake in Precision Castparts in 2015 and maybe a little earlier that was Todd Combs, and Mark Donegan the CEO of Precision Castparts who does a lot of traveling visits a lot of his large investors, including Berkshire. One day, I guess in 2015, I think it was maybe in July or so, 2015 when Mark Donegan was visiting Berkshire and speaking to Todd Combs, Warren Buffet came along and the story goes, and there’s a very small office at Berkshire headquarters. Very few people are there. Warren Buffet walked along, started hearing part of the conversation, asked if he could join the conversation, sit down and of course that’s what occurred.

David Kass (34:57):
And he was so impressed with Mark Donegan and soon thereafter made an offer for the whole company. Now what went wrong here in Berkshire’s 2020 annual report and his letter to shareholders, he refers to this in his words, this ugly $11 billion write-down and he said he paid too much for the company. And there’s certain developments in the aerospace industry plus with the pandemic, you have less flying Precision Castparts makes large components and parts for aircraft commercial as well as defense aircraft. And Buffet says in his letter to shareholders, I was wrong in judging the average amount of future earnings and consequently paid too much. And he says, he concludes PCC is far from my first era of that sort, but it’s a big one. So he just projected in his own mind that the company would’ve performed better than it actually had. Indeed in 2016 at the Berkshire annual meeting in 2016, in which for many years, throughout 10 years in a row, I would bring students from the University of Maryland out to the Berkshire annual meeting.

David Kass (36:06):
And in the exhibit area, there’d be exhibits of all the Berkshire companies. I had the good fortune from having the opportunity to meet Mark Donegan the CEO and chat with him and mention to him actually that I, and two of my colleagues at the University of Maryland wrote a case on Precision Castparts that I now use as a teaching tool in my class. And I mentioned the case to him and I found most interesting while I was waiting to speak with him there were a couple of shareholders ahead of me in line chatting with him and his conversation was such, I could see why Warren Buffet would want to buy the company with a CEO like this. He said that he spends 250 days out of the year traveling. He doesn’t create shareholder value by sending in his office when he is on the road, he can get contracts signed. He could solve problems at his various company installation. And he’s like gung-ho in trying to maximize your hold of value. And I think it’s that energy level that focus that may have in addition, attracted Warren Buffet to the company.

Trey Lockerbie (37:11):
What’s interesting about that last point is I’ve spoken to a number of investors, some of which do not focus at all on the management of a company, mainly because in their minds, they would say a CEO got to where he was or where she was by being a great salesperson. I don’t know if that was what was happening with Mark Donegan. He’s a great salesperson, but it sounds like he certainly charmed Buffet and even charmed you. And he probably has that effect on a lot of people. And that’s a very interesting skill to have, and obviously him where he is.

David Kass (37:41):
And also from Warren’s letter in 2020, he refers to Mark Donegan as a passionate manager who consistently pours the same managing to the business than he did before we purchase it. We are lucky to have him running things. He is certainly very pleased with him, but as your point is well taken, that’s certainly one way for CEOs to make it to the top. They have to be able to sell the board of directors for example, or the previous CEO on their ability. Then it’s certainly valid.

Trey Lockerbie (38:15):
Sell the dream. Yeah, exactly. You’ve mentioned that you’ve taken your students to Omaha number of times, what were some of the best questions from your students to Buffet and what do you think were some of his most surprising or even enlightening responses?

David Kass (38:30):
Yeah, the first time, what surprised me, that was a 2005 visit where the questions that were asked during the formal Q&A session might be what’s your outlook for the economy, the good questions on international economics, what are your views on back then 2005 or investing in a country like China or Europe or Asia versus the United States, they were fairly broad of that sort. But when the students were gathered around him at a table informally over lunch, the questions worked very different. And one student actually asked the question, do you have any advice on how to choose a spouse? Now, these students in their twenties by and large single in their early twenties and Buffet’s answer again, I was close enough to hear it was, choose someone who will love you unconditionally and he expanded on that as well. So there were some more personal related questions of that sort, and he would give advice, choosing a career, make sure you’re passionate in what you do.

David Kass (39:28):
Only do something if you really love it. And if you’re really passionate about it, you’ll be noticed in your office, in your company, and that should lead to advancement within your firm or where you are. The answers he has given that I found most interesting and most meaningful, I think not only for students, especially for myself as well, questions that almost every year, the students ask similar question, what are the qualities that you look for when you hire people or what are the qualities that are most likely for someone to succeed as an investor in the stock market? What qualities do you need for success? And Buffet’s answer as his follows, he says, well, if you have an IQ and he always has some humor in his answers, if you have an IQ of at least 125, that’s all you need. If you have any IQs any higher than that, then jokingly, he says, then you should sell the extra points. You don’t need them.

David Kass (40:27):
And he talks about hard work analysis, good training and accounting and finance, but then the keyword, the keyword that separates those who are really successful from those who are not, is the word temperament, having the right temperament. He’s known many people, very high IQs who work very hard, but they cannot control their emotions. When we have very sharp market swings up or down, he has given examples or he is known portfolio managing for 19 years outperforming the market, or doing very well, then in year 20, they blow up and he gives examples why risk what you have and need to try to achieve something that you don’t have and don’t need. And a lot of investors have just blown themselves up portfolio managers in that regard. So the word temperament, being able to control your emotions throughout the entire market cycle, I think is critical.

David Kass (41:23):
And the second type of answer that he gives is probably his longest answer questions soon after the financial crisis of 2007 through 2009, when I brought students there in 2011, 13, and 16, there were questions that came up can you explain what happened during the financial crisis? That type of question. And he would give a very thorough at least a five to 10 minute response. And he then he would quote, this may not be the precise words, but he said that George W. Bush, President Bush, he gave a quote something to the effect that he said the most important 10 words ever quoted by an economist anywhere and he says something to the effect if money doesn’t loosen up, this sucker is going down, something pretty close to those words. And indeed of course, both monetary policy loosened up at that time, congress provided the fiscal stimulus that was needed.

David Kass (42:18):
We got the monetary stimulus and we came out of it, but we were on the brink of something that could have been really a lot worse. He always seems to have a discussion in that area and then there were sometimes questions on interest rates. And I remember in 2016 at the student meeting, a student did ask a question of the interest rates in market valuation at the time and I remember Warren Buffet saying back then that if interest rates don’t go above three or 4% long term rates over the next three years, then stocks are certainly not overvalued, something to that effect, relating interest rates to valuation.

David Kass (42:59):
And one of his favorite quotes, which I think is extremely meaningful, which I use in the classroom as well and he says, interest rates are to asset prices as gravity is to matter. Just think about it. If interest rates are zero asset prices levitate, they go up to new highs. If gravity is zero, think of the astronauts around the moon, there’s floating with no gravity, they levitate, but as interest rates go up, plus it provides competition for equities equity prices come down as gravity, of course increases people, the apple falls off of the tree.

Trey Lockerbie (43:40):
So great with that earlier advice of finding a spouse, I thought you were going to go somewhere else. I’ve heard him say that to find a spouse you need to find someone who has low expectations. I always loved that as well. So luckily for Berkshire shareholders, there will be something to actually talk about this year, which is the recent acquisition of Allegheny after a long drought period of not making any purchases, he acquired it for over $11 billion. This seems like such a classic Buffet purchase. And what I found interesting about what you just said there as well is, you talked about how interest rates work and you would think that interest rates as low as they are with the prospects they have to get any higher would have this really drastic effect on insurance and insurance businesses and affecting the profitability of those businesses. But he doesn’t seem to be swayed by this very much. He’s continued to invest and reinvest in insurance. He’s obviously very bullish on the space.

David Kass (44:37):
And he has said his preferred holding period is forever the best investments of those that it’s a one time decision when do you buy, you don’t have to think about selling and something that compounds and grows and you just put it away. Business like GEICO might be a very good example in that area. He certainly with respect to Allegheny and insurance it’s an area he knows very well, I guess is the one area he knows best. He’s got decades of experience in it. I’m sure he’s been following the company for decades for many years, for many years thoroughly familiar with it. The CEO, current CEO of Allegheny is former executive with Berkshire or General Re is Brandon, I believe is his name. He certainly is familiar with person running the company and apparently right now there’s an offer on the table to acquire the company for like $11.6 billion, this official 25 day shopping period, whatever there’s this opportunity of and with maybe 14 or 10 days left to it for another company to come in and if they so choose, make a higher bid.

David Kass (45:49):
Which I think is unlikely, but it’s possible. It’s certainly possible. The offers on the table and presumably at this time, Allegheny is very receptive to the acquisition by Berkshire, just as Buffet is comfortable with Allegheny. I’m sure the folks that Allegheny are very comfortable with Buffet and being owned by Berkshire. And when Berkshire acquires the company what’s fairly unique is they leave management in place. They don’t change management. Whatever you’re doing now, you continue to run your business. It’s an opportunity if you wish to cash out some of your equity and the company being acquired, diversify your investments that way, but you still have your company, you’re still running it a very unique model then it’s not really I’m aware of anywhere else.

Trey Lockerbie (46:37):
Yeah. And another interesting point about this acquisition that I just had to touch on is the fact that he really hasn’t lost his somewhat spiteful flavor of investing. Meaning I believe he negotiated the $11.6 billion minus that $27 million that they were going to pay to the investment bankers in the deal. Obviously Charlie Munger and Warren Buffet do not think highly of investment bankers being a part of any kind of deal. And so taking that out just to make sure they deducted that. You’re already spending $11 something billion and just to deduct that $27 million seemed dumb. It’s real money, it makes a difference but just to make a point to do that is fascinating. And we’ve talked about Buffet quite a bit on this episode here, but want to just touch on Munger as well. He’s been in the news as of late, he’s obviously 98 and he’s finally stepping down from being the chairman of the daily journal. What is the impact of this for the daily journal? What track record is Charlie leaving behind? What will be his legacy there?

David Kass (47:41):
Okay. Well Charlie, at the Daily Journal, they have two main businesses and I guess they’re primarily known for legal publication, I think called the Daily Journal Legal Times. And of course newspapers with the internet are in decline. It’s really a declining business, but they have this parallel business that’s growing. It’s some kind software, a software related business that’s growing. I think it’s recently become profitable, which has I think a fairly bright future and like Berkshire, they have this large portfolio of stocks and much of the value part of the value of the daily journals, the value of that portfolio and that portfolio consists of stocks such as … And there are only, I think three or four stocks in portfolio, their largest holdings Bank of America and Wells Fargo and recently maybe in a controversial investment Alibaba. And of course here there’s been some criticism of Charlie for investing in Alibaba as the stock sunk, list of issues, will Alibaba be de-listed. There are ADRs.

David Kass (48:48):
The shares that are trading this country because the US regulators connecting access to the financial statements. The latest reports coming out as recently is yesterday that there may be plenty of room for compromise that access to these reports may be permitted. But one reason I believe that Charlie feels confident in investing in Alibaba is Li Lu. Li Lu runs Himalaya Capital and I understand a highly regarded portfolio manager out in California. What I read elsewhere, I believe Li Lu has dinner with Charlie every Tuesday evening. I think I read that somewhere. And Li Lu is the only person, Charlie has said this, who manages Charlie’s money. So Charlie has a money manager, Li Lu and Li Lu who grew up in China, born in China. And I believe he was a student there during the Tiananmen Square uprising in 1989, subsequently left there believe then earned an MBA from Columbia University and started his career in portfolio management. Li Lu is very good in evaluating Chinese companies and his portfolios, his hedge fund Himalaya Capital has done extremely well over the years.

David Kass (50:03):
And I’m pretty sure that Charlie would not have invested in Alibaba without Li Lu’s blessing. Let’s put it that way, but that’s been a controversial area, but to answer your question, a significant part of the valuation, a Daily Journal corporation is actually the value of that portfolio.

Trey Lockerbie (50:23):
Wow. I didn’t know that, that’s super fascinating. Well, as I mentioned, Charlie’s 98. Warren’s almost 92 and this year will be a meaningful one to be in Omaha. I will be there with some of our team from TIP. The days are numbered with these folks getting to their older age and after having the pandemic and not being able to go, I just think it makes it more meaningful to be there. And we’re going to have a lot of fun. Hopefully the folks listening will be out there and can join us.

Trey Lockerbie (50:49):
David, this has been a spectacular discussion. I’ve really enjoyed learning from you. And I would love to have had the ability to take your class, but this will be a close proxy at least to get a taste of it. And I really appreciate you taking the time out of your day to talk to us and educate us. With that being said, before I let you go, you do have the Warren Buffet blog. I’d love for you to hand off to our audience where they can find that, where they can learn more about you and any other books or resources you want to share.

David Kass (51:14):
Oh sure. I recommend just going to drdavidkass.com. Will get you to my webpage at the University of Maryland. From there, there’ll be a link to my blog and please follow me on Twitter at Dr. David Kass. So I certainly tweet a lot about Warren Buffet and Berkshire as well as other issues of similar interest to me. And on my webpage, you could see various articles that I’ve written or where I’ve been quoted.

Trey Lockerbie (51:48):
Fantastic. Well again, David, I really appreciate it and hope to do this again sometime. Thank you very much.

David Kass (51:55):
No, you’re very welcome.

Trey Lockerbie (51:58):
All right, everybody. That’s all we had for you this week. If you’re loving the show, don’t forget to follow us on your favorite podcast app and maybe even leave us a review, it really helps. If you want to learn how to invest like Buffet, there’s really no better place to start than the investorspodcast.com or simply Google TIP finance. And David and I originally connected on Twitter you can find me there @Trey Lockerbie and give some feedback. And with that, we will see you again next time.

Intro (52:19):
Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investor’s Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses go to the investorspodcast.com. This show is for entertainment purposes only, before making any decision consult a professional. This show is copyrighted by the Investor’s Podcast Network written permission must be granted before syndication or rebroadcasting.


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  • David’s Blog on Warren Buffett.
  • Supermoney Book.


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