17 June 2018

On this two-part episode, Preston and Stig talk about their amazing experience from meeting up with the TIP community in Omaha for the 2018 Berkshire Hathaway annual shareholder meeting. In this episode, you’ll also hear Warren Buffett’s answer to the best questions asked by the shareholders for the 2018 Berkshire Hathaway meeting. After hearing each response by Buffett and Munger, Preston and Stig’s provide their analysis of the discussion.

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  • If Buffett plans to sell his investment in Well’s Fargo after the recent scandal?
  • How the new accounting rules change the way investors value companies.
  • If Buffett wants to pay a special dividend as Berkshire Hathaway is approaching a $150B cash position.
  • How Buffett would invest differently if he only had $1B in his portfolio.
  • How Buffett evaluates the attractiveness of bonds.


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.

Preston Pysh  0:02  

How is everyone doing out there? Today’s show is an episode that Stig and I really look forward to recording every year. If you’re new to the show, we travel to Omaha, Nebraska each year for Warren Buffett and Charlie Munger’s Berkshire Hathaway Shareholders’ meeting. 

During the meeting, we take the top 10 questions and do a recap of what we learned in thought about their responses. This coverage is going to stretch across two episodes. 

On today’s show, we’ll be covering our first five Q&A’s that we thought were noteworthy. Without further delay, I hope you enjoy our coverage of the 2018 Berkshire Hathaway shareholders meeting. 

Intro  0:41  

You are listening to The Investor’s Podcast where we study the financial markets and read the books that influenced self-made billionaires the most. We keep you informed and prepared for the unexpected.

Preston Pysh  1:01  

As you guys heard in the intro, we’re going to be covering the top 10 questions that Stig and I both heard during this past Berkshire Hathaway Shareholders’ meeting. It was a great meeting, as it always is. I really had fun.

The highlight for me is really kind of interacting with all the folks that come out for the meeting this year. How many do you think attended this year for the bar crawl and everything else, Stig? How many do you think we had?

Stig Brodersen  1:25  

We should probably have a calendar or something like that. I want to say that probably 200 people. We were the most people. Although two days just coming and going. I don’t know, 400?

Preston Pysh  1:37  

It was busy. We had a blast meeting everyone. Anyone who came out just thank you so much for making the long trip out to Omaha. I’m sure 99% of it was coming to see Warren and Charlie but the fact that you guys hung out with us a little bit was pretty awesome as well. 

Without further delay, here’s the questions that we’re going to play. 

Emcee  1:57  

This question comes from Paul Spieger of Chicago, Illinois. He may be here today. He writes one of your more famous and perhaps most insightful quotes goes as follows: 

“Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks. In light of the unauthorized accounting scandal at Wells Fargo of its admission that it charges customers for duplicate auto insurance, of its that it wrongly fined the mortgage holders, in relationship to missing deadlines caused by delays that were its own fault, of its admission that it charged some customers in proper fees to lock in mortgage interest rates of the sanction placed upon it by the Federal Reserve, prohibiting it from growing its balance sheet, and of the more than recent $1 billion penalty levelled by federal regulators for the aforementioned misbehavior. 

“If Wells Fargo company is a chronically leaking boat, at what magnitude of leakage would Berkshire consider changing vessels?”

Warren Buffet  3:01  

Wells Fargo was a company that proved the efficacy of incentives. It’s just that they had the wrong incentives. That was bad, but then they committed a much greater error. I don’t know exactly how, who did it or when. 

However, ignoring the fact that they had a faulty incentive system, which was incenting people to do things that were kind of crazy, like opening nonexistent accounts, etc. That is a cardinal sin.

In Berkshire, we know people are doing something wrong, right? As we sit here at Berkshire, you can’t have 377,000 employees and expect that everyone is behaving like Ben Franklin or something out there. We don’t know whether there are 10 things being done wrong as we speak.

The important thing is we don’t want to incent any of that if we’re going to avoid it. If we find that it is going on, we have to do something about it. That is absolutely the key to it. 

Wells Fargo didn’t do it, but Solomon didn’t do it. 

The truth is we’ve made a couple of our greatest investments were people who made similar errors. We bought our American Express, that was the best investment I ever made in my partnership years. 

We bought our American Express back in 1964 because somebody was incented to do the wrong thing and something called the American Express a steel warehousing company. 

We bought a very substantial amount of Geico. We bought what became half of Geico for $40 million because somebody was incented to meet Wall Street estimates of earnings and growth. They didn’t focus on having the proper reserves. That caused a lot of pain at American Express in 1964. It caused a lot of pain at Geico in 1976. It caused a layoff of a significant portion of the world workforce, all kinds of things.

However, they cleaned it up and looked where American Express has moved since that time. Look at where Geico has moved since that time. 

So the fact that you’re going to have problems at some very large institutions is not unique. In fact, almost every bank has. All the big banks have had troubles of one sort or another. I see no reason why Wells Fargo as a company from both an investment standpoint and a moral standpoint, going forward is in any way inferior to the other big banks with which it competes. 

They made a big mistake. We have a large unrealized gain in it, but that doesn’t have anything to do with our decision-making. 

I like it as an investment. I like Tim Sloan as a manager. He is correcting mistakes made by other people. I tried to correct mistakes at Solomon and I had terrific help from Derek Mont as well as a number of people that *inaudible*. 

That is going to happen. He tried to minimize it. Charlie says that an ounce of prevention is worth a pound of cure. It’s worth about a ton of cure. We ought to jump on everything. 

He’s pushed me all my life to make sure that I attack unpleasant problems of service. That’s sometimes not easy to do when everything else is going fine at *inaudible.” Clearly and I don’t know exactly what… they did what people in every organization have sometimes done but it got accentuated to an extreme point. However, I see no reason to think that Wells Fargo going forward is other than a very large well-run bank that had an episode or has a history it wished it didn’t have

However, Geico came out stronger and American Express came out stronger. The question is what you do when you find the problems. 


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Charlie Munger  7:40  

Well, I agree with that. I think Wells Fargo is going to be better going forward. I wouldn’t have been if these leaks had never been discovered or happened. 

It was clearly an error. They’re acutely aware of it and acutely embarrassed. They don’t want to have that happen again. If I had to say which bank is more likely to behave the best in the future, it might be Wells Fargo.

Preston Pysh  8:32  

Alright, so I think that’s a pretty interesting discussion all centered around Wells Fargo because it’s been in the news so much lately. 

Before I throw it over to you, Stig I found it really interesting how the whole crowd really applauded Andrew Sorkin’s question when he did this. I just really thought the crowd wanted to hear this discussion quite a bit, but what were your thoughts, Stig?

Stig Brodersen  8:53  

Basically what he said was that Wells Fargo has been, I don’t know if they’re still doing it. I think that’s an interesting discussion we can have later, but he said that, at least the way it was before the scandal, they incentivized bad behavior. They did that with all the cross selling and they were setting up accounts that weren’t even there. They incentivized the entire organization and that was wrong. You kind of get what you incentivize. 

Then Buffett brought up this example with American Express product a few times as one of the most famous examples because as he also proudly said, that was how he made the most money in his early days with his partnerships.

What happened, just really, really briefly related to this is that you incentivize people to do the wrong thing. That was the story that he referred to. 

Now this case is different, because this was already a huge position in Buffett’s portfolio. Wells Fargo is the second largest position in Buffett’s portfolio right now. So it’s a different situation to be in. It’s not like, “There has been a scandal. I’m looking at this and I don’t see that we have the same problem so I’ll go in and buy a good price, and then potentially sell out or whatever is going to happen when the price goes to intrinsic value.”

That was interesting. What are you going to do that now this is your situation? He originally bought around $12 billion. He built at a cost around $12 billion. It’s priced around $23 to $24 billion right now so he’s more or less doubled his money. That’s even despite all the turbulence that you’ve seen. It’s still been a very profitable investment, even though the stock took a hit. 

I think what was most interesting is that he talks about how Tim Sloan, the CEO, might use this as a reason to clean up and correct other people’s mistakes. Munger even said, “Yeah, if I had to bet on who would behave best in the future, it might even be Wells Fargo.”

But I think, at least what I have a hard time understanding perhaps all investors is, is this truly over? Is this an inherent problem in the culture of the business that you can’t just change because you get a new management and you tell people “Oh, by the way, we don’t break the law all the time”?

Preston Pysh  11:05  

Yeah and I think that your comment about the culture is really kind of the big issue here. From their vantage point, I might be wrong. but the way I kind of interpret it is I think that they view the finance industry in general as having just maybe not the best culture in general. I think they’re looking at it, “Okay, is Wells Fargo any different than any of these other banks? Is their culture worse than any of these other banks?”

My opinion is if those two guys were sitting in the room, they tell you, “Well, how is this any worse than any other bank on Wall Street?” I think the answer to that is maybe they aren’t  so I kind of agree with their point of view. I think that this might be a buying opportunity if you want to have banks in your portfolio, because of all the bad news, and hopefully, for the people that work at Wells Fargo, it is just a few bad actors. Maybe it’s not.

You heard their comments there. Let’s go ahead and go on to the next question. I just found that one really fascinating. Okay, here we go. 

Emcee  12:08  

This question comes from a Berkshire shareholder named Jack Cieselski. He’s a well known accounting expert, who for many years has written the Accounting Observer. 

“Mr. Buffett, in this year’s shareholder letter, you have harsh words for the new accounting rule that requires companies to use market value counting for their investment holdings. 

“For analytical purposes, you said, ‘Berkshire’s bottom line will be useless.’ I’d like to argue with you about that. Shouldn’t a company’s earnings report, say everything that happened to and within a company during an accounting period, shouldn’t the income statement be like an objectively written newspaper informing shareholders of what happened under the management for that period, showing what management did to increase shareholder value and how outside forces may have affected the firm? 

“If securities increased in value, surely the company and the shareholders are better off? Surely they’re worse off if securities decreased in value. Those changes are most certainly real. In my opinion, ignoring changes in the way that some companies ignore restructuring costs is censoring the shareholders newspaper. 

“So my question is, how would you answer what I say?”

Warren Buffet  13:31  

My answer to the question, I would ask Jack, if we’ve got $170 billion of partly owned companies, which we intend to own for decades, and which we expect to become worth more money over time. When we reflect the market value in our balance sheet, does it make sense to every quarter the market goes up and down for the income account, while at the same time we own businesses that have become worth far more money, in most cases and have become more known since we bought. 

For example, in Geico, an extreme case, we bought half the company for $50 million roughly. Do we want to be marking that up every quarter to the value and having it run through the income account? That becomes an appraisal process. 

There’s nothing wrong with doing that in terms of valuation, but in terms of value, and you can call it gain and net asset value or loss in net asset value. That’s what I call them the investment fund or an open investment fund would do. 

However, to run that through an income account. If I looked at our 60 or 70 businesses or whatever number there might be, and every quarter we mark those to market, we would obviously have a great many in certain cases where overtime we’d have 10 times what we paid. But quarter by quarter, we should mark those up and run it through the income account where 99% of net of investors probably look at net income as being meaningful in terms of what has been produced from operations during the year.

Well, I can say it would be enormously deceptive. I mean, in the first quarter of this year, you saw the figures earlier, where we had the best of what I would call operating earnings in our history. 

Our securities when we’re down 6 billion or whatever it was… to keep running that through the income account every day, you would say that we might have made on Friday, we probably made $2.5 billion.

Well, if you have investors, commentators, analysts and everybody else working off those net income numbers and trying to project earnings for quarters and earnings for future years to the penny, I think you’re doing a great disservice by running those through the income.

I think it’s fine to have marketable securities  on the balance sheet. The information is available to their market value, but we have businesses there. We never would do it, but if we were to sell half, say of the BNSF railroad,we would receive more than we carried… could turn it into a marketable security. It would look like we made a ton of money overnight or if we were to praise it every three months and write it up and down, A.) it could lead to all kinds of manipulation, but B.) it would just lead to any investor totally confused. I don’t want to receive that in that manner. Therefore I don’t want to send it out in that manner. 


Charlie Munger  16:58  

Well, to me, it’s obvious that the change in valuation should be noted and is and always has been, goes right into the net worth figures. The questioner doesn’t understand his own *inaudible*. I’m not supposed to talk that way, but it slips out once in a while.

Preston Pysh  17:34  

I’m sorry, but I absolutely love this exchange, because it just highlights how lost some teachers are. Sorry to say it like this, but man, if you don’t know anything about accounting, these two just absolutely schooled whoever this teacher is who asked this question.

These new accounting rules don’t make any sense whatsoever for you to be running unrealized gains into the income statement. I mean, it is just ludicrous. Like Buffett said, it’s already accounted for in the balance sheet. 

I mean, that’s why Charlie just concluded so surely, like literally the person who’s asking this question has no idea what they’re talking about and has obviously never run their own business because if you’ve run your own business, this is just really obvious why this shouldn’t be done this way. 

The thing that I think about, Stig, is what if they own private equity? Let’s say they had a non-controlling share of private equity. What are they supposed to do? Go out and get an appraisal every quarter?

Stig Brodersen  18:33  

Yeah, I think that is what Buffett is getting at there. It opens up to so much manipulation in terms of accounting. It’s unbelievable.

Preston Pysh  18:42  

So other than that, what else so you have Stig?

Stig Brodersen  18:44  

Well, I would really like to take the opportunity to discuss a bit more about the rule, because as Buffett was getting at before and what he’s been getting at some of the previous letters, if not, almost all of them is that it’s very easy to fabricate a profit in your income statement for the type of company that Berkshire Hathaway is. 

So say that he was to sell his position of Wells Fargo that we just talked about before. Now, it used to be so that if he sold that he would be making $12 billion in profit. Now, it wouldn’t be a more profitable company, but he can just record that because now he sold his marketable securities.

What this rule really does as of now, his earnings will fluctuate all the time and the example before that’s a problem in itself. But now with this new change, and that’s why he talked about, you can easily swing $10 billion in earnings for a quarter for no reason whatsoever. 

Right now his portfolio is $188 billion so it shouldn’t take a lot for it to swing by $10 billion. We’re not talking huge percentages. If you look at his quarterly results, with Berkshire Hathaway since 2015, they’ve been pretty stable. Then in 2018, because of this new rule, the first order, he reported a loss of $629 million, which is rough, like a 6 billion impact, not because he’s sold a bunch of stocks that were unprofitable. But simply because that was what the market did at that point in time. 

Since then the market has gone up against. Now he might be able to report a really, really decent profit for the next quarter. 

Basically, what the person asked for is, shouldn’t the income statement be representative in terms of saying, “How much money did the company make this quarter?” And the answer is yes, but that’s just not the way to do it. That’s the way to confuse people because people usually don’t look at the balance sheets.

You could find all this information in the balance sheet, as you also mentioned before, but that’s not what people read. That’s not what reporters talk about. They would go on CNBC and say, “Berkshire Hathaway came out with a loss and people might sell because oh, Buffett lost his magic. Now, it’s suddenly unprofitable.” 

However, it’s all because of accounting. It was just as profitable that quarter as the last one, just as next quarter where he probably would record a very, very nice gain or a very nice net income, at least in accounting terms. 

There wasn’t a dramatically better quarter. It was just the way that the marketable securities moved in that order. I think it’s very dangerous if you go in and change the rules like that. Nonetheless, it has happened.

Preston Pysh  21:32  

At the end of the day, the whole purpose of the income statement is to display to the shareholder how much operational income is this business making. Whenever you fluctuate that amount by what the stock price is doing, the underlying value of these businesses that you own are now influencing what the operations are doing. It just doesn’t make any sense and you’re confusing people. 

That’s why he kept referencing that a lot of people use this to determine what they think the value of a business is and now they’re going to be misguided. 

So anyway, let’s go on to the next question here. 

Emcee  22:07  

You recently noted that you prefer share repurchases over dividends as a means for returning capital to shareholders, should Berkshire’s cash balances continue to rise. A one time special dividend could be a useful option for returning a large chunk of Berkshire’s excess capital to shareholders, without the implied promise to keep paying regular dividends forever. 

The drawback with a special dividend though is that it would lead to an immediate decline in book value and book value per share, whereas the larger share repurchase effort, while depressing book value would reduce purchase share count, limiting the impact on book value per share. 

If we do happen to get a few years out and Berkshire does hit that $150 billion threshold, because valuations continue to be too high, both for acquisitions and for the repurchase of company stock, would you consider a one time special dividend as a means to returning capital to shareholders?

Warren Buffet  22:57  

Well, we thought we couldn’t use capital effectively. We figured we would try to figure out the most effective way of returning capital to shareholders. 

I think it’d be unlikely we’d do it by a special dividend. I think it’d be more likely we do buy a repurchase… The repurchase didn’t result in us paying a price above intrinsic value per share. We’re never going to do anything that we think is harmful to continuing shareholders or we think the stock is intrinsically worth X. We would have to pay some multiple, some modest multiple even above that to repurchase shares. We wouldn’t do it because we will be hurting continuing shareholders, to the benefit of the people who are getting out. 

However, we will try and do whatever makes the most sense, but not with the idea that we have to do something every day because we simply can’t find something that day. 

We had a vote as you know… A few years back on whether people wondered about the dividend and the B shares so we’re not talking about my shares or Charlie’s or anything but the B shares voted 47 to one against that. 

I think through self selection who becomes shareholders, I don’t think shareholders rule or countrywide on all stocks would go for it out in the water at all, but we could sell selection in terms of who joins us. 

I think they expect us to do whatever we think makes sense for all shareholders. Obviously, if we really thought we never could use the money effectively in the business, we should get it out one way or another. 

You’ve got a bunch of directors who own very significant amounts of stock themselves. You can expect them to think like owners. That’s the reason they’re on the board and expect the management to think like owners. Owners will return money to all of the owners if they could. It makes more sense than continuing to look for things to do. 

However, we invested in the first quarter maybe… certainly through April, not close to 15 billion or something like that net. 

We won’t always be in a world of very low interest rates or high private market prices. So we will do what makes the most sense, but I can’t see us ever making a special… It’s very unlikely we would just pay out a big special dividend.

I think that if we put that to the vote of the shareholders, and Charlie and I did not vote, I think we would get a big negative vote. I’d be willing to want to make a bet on that one.

Charlie Munger  26:19  

As long as the existing system continues to work as well as it has, why would we change it? We’ve got a whole lot of people that are accustomed to have done well under and if conditions change, we’re capable of changing our minds if the facts change.

Warren Buffet  26:40  

We’ve done that several times.

Charlie Munger  26:42  

Yes. Although I must say it’s a little hard.

Preston Pysh  26:49  

Alright, so on this question here, I think the thing that people need to understand about Buffett’s approach on why he doesn’t like to pay dividends and like he said there, he brought it to a vote. I think we were at the meeting when that happened, Stig. Maybe two years ago or something like that. 

The reason he doesn’t do it is because of tax reasons. So if I get paid a dividend from a company, I’m taxed on that income, on my personal level, right? But if he returns that money by doing share buybacks, then he doesn’t go through the same tax implications for the shareholders who are receiving that benefit.  

I think maybe the best way to think about this is to think about it from Buffett’s standpoint. He owns 40% of the company so could you imagine the special dividend payout that he would receive privately, as the shareholder of that many shares and what his tax bill would be that year, for receiving such a huge payout. It’d be astronomical. 

But if he takes all that cash flow, and he buys back Berkshire stock, then he reduces the number of shares that are outstanding, which then boosts the value of the shares. That’s how he can pay himself without basically getting double tax. That’s what his preferences are. 

Now he didn’t say absolutely that’s what he’s going to do. He brought up the intrinsic value of Berkshire when he said that, because maybe it would make more sense to make a special dividend payment.

However, in order for that to happen, the intrinsic value of the Berkshire stock would have to be so overvalued, that it would offset the tax bill that he would have to pay as a private owner of the shares, which he thinks is very improbable. And so that’s why he kind of phrased it that way.

Interesting question for people to hear, because they might not understand why he has that opinion, but for anybody that follows him really closely, you kind of know exactly the direction he was going to probably take the answer to.

Stig Brodersen  28:38  

I don’t think I’ve ever gone to a meeting where someone didn’t ask for that. I kind of like Buffett’s response to that, because he said that there’s a self selection. 

What frustrates some of the shareholders is that they just see that cash position on the balance sheet. It’s just growing. Then they were like, “We understand why you can pay out a recurring dividend, but why can’t you do a special dividend, say 50 billion?” I think that’s what people are considering.

When we talk about a special dividend, it’s typically a one time thing. It might be a company that has a huge one time gain in something say that the sold out division, they got it all in cash. They can either cash in a good way and do it as a special dividend. 

As you can hear, like from the name, it’s not as common as recurrent dividends say that you would get $1 every quarter. It was actually also nice to hear why he said that even if we asked shareholders, what do you prefer? Well, by the way, we actually did that and they said 47 to one. This was not as a shareholder. So it wasn’t possible. It wasn’t Munger. It was you and me to be able to afford the stock and people voted no in terms of dividend, 47 to on.

Basically, then what was Munger was getting at in terms of why was it good idea is the track record shows that they are better at investing that most retail investors are, which is also why you invest in Berkshire in the first place, in a lot of cases, because you know that they can compound that better for you over time. 

Now, this is definitely not my way of saying that it’s never good to own stock that pays a dividend. I think that for many different stocks, it makes a lot of sense to pay a dividend. 

Preston and I talked about *inaudible*. For a stock like that, it’s a Russian stock, there might be some uncertainties there. It seemed to us at the time undervalued and has performed well since. You would collect your what is 5-6% yield ever since. It kind of makes sense, because they have so much cast. They are having a great stream of cash flows. You want to take off some of that risk. 

So yes, for a company like that, it would make a lot of sense. It’s difficult to double your production if you’re in gas, especially the way the company is structured. 

This is not the same as saying a special dividend is bad for a company. Berkshire Hathaway might not be the best example of doing it, but I wouldn’t be surprised, Preston, if we heard the exact same question next year.

Preston Pysh  31:11  

Yeah, that’s for sure. I’m sure that question will come up again next year. Let’s go on the move to the next one here.

Audience 1  31:20  

Good morning, Mr. Buffett and Mr. Munger. My name is Steph Yu from Horizon Insights, a China focused research firm based in Shanghai. My question is, if you only have $1 billion in your portfolio today, how would you change your investments? Would you consider more investment opportunities in emerging markets such as China? Thank you.

Warren Buffet  31:48  

Yeah, I would say, if I were working with a billion, I would probably find within a $30 trillion market in the United States, where I understood things better generally than I do around the world.

I’d probably find buying opportunities there that would be better, incidentally, by some margin, than what we can find for hundreds of billions. There’s no way I would Google other emerging markets. 

There was a time 15 years ago or so when just because it was kind of interesting, that took me back to my youth. On a weekend, I went through a directory of Korean socks and I bought when they were small stocks. While they were small by US standards of either Korean or American business, they were big companies. About 15 or 20 were statistically cheap, but what some *inaudible* one myself.

There are opportunities with smaller amounts of money to do things that we just can’t do through.. Things in the United States… but I’ve gone through in other countries.

I probably wouldn’t get into very small markets, because there can be a lot of difficulties even in market execution and taxation modeling. If you cannot find it in America, China, Britain and few other places, you’re probably not going to find it someplace else. You may think you’ll find it, but it may be a different game. Our problem is size, not geography. Charlie?

Charlie Munger  33:45  

Well, I already have more stocks in China than you do and as a percentage, so I’m with the young lady.

Warren Buffet  33:56  

Okay, well, you want to name names? These stocks have names?

Charlie Munger  34:01  

Oh, I don’t.

Warren Buffet  34:09  

You will find plenty of opportunities in China. Charlie would say you’ve got a better hunting ground than even a person with similar capital that I’d say. Would you agree? 

Charlie Munger  34:18  

Yes, I do.

Warren Buffet  34:22  

In the sense that it’s logical, that should be the case, because it’s a younger market, but still a large market so the markets probably work toward efficiency as they age.

Preston Pysh  34:41  

Quite an interesting discussion there with respect to investing in China. I think it’s interesting that you see the difference here between Charlie and Warren, where Charlie seems much more prone to invest in China than Warren. 

He delicately said there at the start of his response that he would still invest in the US, even if he was working with a billion dollars. He felt like he could maybe get some better buys than what he’s getting at his current threshold, but he would still be investing in the US. 

So just kind of an interesting comment that I don’t really know why he’s so prone, maybe it’s the gap accounting differences that maybe he doesn’t trust over there. That’s all I can really think of as being maybe the prime reason. I’m curious what Stig thinks about that.

Stig Brodersen  35:25  

Well, I also think it depends on which type of company that you’re looking at. If it’s something like retail, consumer preferences are just very different in China. I think a lot of the knowledge he would have about behavior in the States and in the Western world is just very different. I think that’s where he’s more hesitant. 

I don’t think that Buffett couldn’t have done that if he really wanted to, but say it wasn’t like a billion dollars, more like $10 billion or $20 billion, so you still make more moves, then he might do a play like he did in Korea back in the days where he almost made his own index. I think he bought around 15 or 20 stocks. They were statistically cheap. 

He might want to do that if he trusted the accounting in China, but it would be more like a statistical way, than it would be, “Oh, I really understand the math of this Chinese company and that’s why they performed well.”

Despite that, there are a ton of Chinese companies that also export a lot. For a lot of Chinese companies, that is the main market, just like it is in the States that the domestic market would typically also be the most important. 

So if you don’t understand that, again, only invest in things you understand. It should be possible in a 30 trillion market cap and stock market like the US to find something if you had a billion dollars. So I guess that’s what he’s getting at. 

The other thing is also is there’s a lot of regulation, you need to take into account. As an example, just in the States, he has to sell a little Wells Fargo almost all the time, because he can’t push above his 10% limit, because then he will be too dominating.  That’s just one regulation. He knows how to handle that and he accounted for that when he bought the position. 

But it would be different in a lot of countries where you will need to make it public at a different point in time if you have at least 5%. There are a lot of things that you will need to take into consideration. That is just not his game. 

The Chinese stock market, despite the Chinese economy being so huge as this, it’s not a big stock market. You have a lot of huge private companies and you also have some that are public, but it’s just struck in a very different way. The overall market cap in your universe is not as big as you might expect for China. 

Preston Pysh  37:42  

Alright, so let’s go ahead and play the last question we’re going to play for this segment. Next week, we’ll have another five questions, but here’s the last question we’re going to play today.

Audience 2  37:53  

Good morning. I have a question related to the bond market, the US Treasury bond market. My name is Sola Larsen. I live in the San Francisco Bay Area. I never worked in the financial industry. I started out buying Penny mining stocks on the Vancouver Stock Exchange. A decade later,  I got married and my wife convinced me to buy Berkshire shares, that was probably a good decision. 

My question is, I read the newspapers about the Federal Reserve and the inflation numbers. There must be an increased supply of treasury bonds that must go to auction. My question is what do you expect that to impact yield low interest rate?

Warren Buffet  38:58  

The answer is I don’t know. The good news is nobody else knows, including members of the Federal Reserve.

There are a lot of variables in the picture. The one thing we know is we think that long term bonds are a terrible investment at current rates or anything close to current rates. 

Basically, all of our money that is waiting to be placed is in treasury bills, that thing has an average maturity of four months or something like that at most. T

The rates on those have gone up lately, so that in 2018, my guess is we’ll have at least $500 million more of pre-tax income than we would have had in the bills last year. But still, it is not because we want to hold on and we’re waiting to do something else. However, long term bonds are basically, at these rates, it’s almost ridiculous when you think about it, because here the Federal Reserve Board is telling you we want 2% a year inflation. The very long bond is not much more than 3%. 

Of course, if you’re an individual and you pay tax on it, you’re going to have some income taxes to pay. Let’s say it brings your after tax return down to 2.5%. So the Federal Reserve is telling you that they’re going to do whatever’s in their power, to make sure that you don’t get more than a half a percent a year of inflation adjusted income. 

That seems to me a very, I wouldn’t go back to penny stocks, but I would stick with productive businesses or other productive assets by far.

What the bond market does in the next year, you’ve got trillions of dollars in the hands of people that are trying to guess which maturity would be the best on and all that sort of thing. AWe do not bring anything to that game that would allow us to think that we’ve got an edge.

Charlie Munger  41:18  

It really wasn’t fair for our monetary authorities to reduce the savings rates paid mostly to old people with savings accounts, as much as they did. However, they probably had to do it to fight the Great Recession appropriately. It clearly wasn’t fair.

The conditions were weird. In my whole lifetime, it’s only happened once that interest rates went down so low and stayed low for a long time. It was quite unfair to a lot of people. 

It benefited the people in this room enormously because it drove asset prices up including the price of Berkshire Hathaway stock. So we’re all a bunch of undeserving people and I hope that we continue to be so.

Warren Buffet  42:12  

At the time, this newspaper came out in 1942. The government was appealing to the patriotism of everybody as kids. We went to school and we bought saving stamps to put in. 

Well, the first column US war bonds, and they called those defense bonds then they called them us savings bonds, but they were called war bonds. You put up $18.75 and you got back $25 in 10 years. That’s when I learned that $4 for three in 10 years was 2.9% compounded. They had to put in small print that and even an 11 year old could understand that 2.9% compounded for 10 years was not a good investment. Well, we all bought them. It was part of the war effort.

The government knew nobody knew that significant inflation was coming from what was taking place in finance in World War Two. We actually were on a massive Keynesian type behavior, not because we elected the following Keynes but because war forced us into this huge deficit in our finances, which took our debt up to 120% of GDP.

It was the great Keynesian experiment of all time, and we backed into it. It centers on a wave of prosperity, like we’ve never seen. So we get some accidental benefits sometimes, but the United States government, literally every citizen, puts their money into a fixed dollar investment at 2.9% compounded for 10 years.

I think treasury bonds have been unattractive ever since, with the exception of the early 80s. That was something at that time. I mean, you really had a chance to buy and he chance to invest your money by buying euro coupon treasury bonds, and in effect, guarantee yourself that for 30 years, you would get a compounded return in something like 14% or 30 years of your lifetime. Every now and then something really strange happens in markets. The trick is to not only be prepared but to take action when it happens.

Preston Pysh  44:41  

This was an interesting discussion here about bonds. What I find interesting about this is you can’t find a person that has a high net worth that thinks long term bonds are a good place to be in the long term. Not a single one of them. Buffett and Munger obviously agree. 

It was kind of interesting at the end where he was talking about back in the early 1980s, when the 10-Year Treasury was over 15%. 

Where I think it was hard for people to pull the trigger and own something like that is because at that time inflation was 14%. I mean, it was just as high. Your real return at that point was maybe a percent or two. That’s why people back then didn’t want to own it. 

However, hearing Buffett, look back at that scenario, and basically say, any person should know that this high of inflation shouldn’t last for 30 years into the future. He was exactly right, it didn’t last that long. Look at what kind of return you would have got if you would have locked something like that in because those sky high rates of 15% didn’t last very long. That was a very short lived experience. It only happened for a few years, and then they drastically started falling from there. Like everyone knows, they’re down at like 3% now. So just in general, very interesting conversation. 

I would really like to have heard his opinion on where he thinks are going to go. But like he opened up, he said, I have no idea where they’re gonna go, and neither does anybody else. He didn’t pontificate. 

I think that’s what makes Buffett Buffett is because he’s so open to the possibility of rates going lower or rates going higher. He’s not trying to predict that he’s trying to react to that in an appropriate way. That’s what really makes him so lethal.

Stig Brodersen  46:29  

It’s difficult for investors to figure out what we should do now with all our cash. Basically, what Buffett said what he did was he has a around the four month average maturity is bonds. He can get just a little less than 2% a year, something like that. 

However, the excess return that you can get for something that’s all on a yield curve, call it 30 years, it’s not that much more like what you gain extra is probably not worth the opportunity cost. That’s really what he’s getting at. You’ll get 3% if you would tie money up in 30 year bonds. 

Even so, with taxation and inflation, you’re not looking at an attractive yield. Again, then you might say, if you then hold it in cash, then you are sure to lose your investment. There’s inflation. 

However, it’s also because there’s an upside risk and there’s a downside risk to bonds. Say that you bought a 30 year bond of 3% and then the rates would go up by 1%, you would see a 17% loss face value of the bond, iIf you did invest in the bond.

Say that you would have a $1,000 bond 30 year, 3%, raise for about 4%, then you could sell it for 827. So it’s a risk that you incur if you do that.  I think that’s also one of the reasons why people are not super excited about it. 

Then again, the lowest yield they’re talking about, but that just means is that the *inaudible* the prices of stocks up. That was what Munger was getting at that with saying ungrateful people or undeserving people. He hoped that would continue because as bonds become relatively less attractive, you would push up the price of the stock, making the heel of the stock relatively lower, but it would push up the price. 

You’ve seen definitely a lot of that this cycle. So a very interesting discussion and very interesting to hear his thoughts, even though he’s basically saying, “I don’t know.”

Preston Pysh  48:29  

Yeah, he doesn’t know and he’s not buying. All right, well, that’s all we have for this week. We really appreciate you guys tuning in and we’ll see you guys next week.

Outro  48:40  

Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP Network. Written permission must be granted before syndication or rebroadcasting.


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