Preston Pysh 6:20
All right, so moving along to the next question.

Audience 2 6:24
Larry Fink of BlackRock has predicted that in the near future all investors will be using ESG, environmental social governance, metrics to help determine the value of a company. I’m worried we don’t score well on everything from climate to diversity to inclusion. How well do you think Berkshire measures up on those metrics? Are they valuable metrics?

Warren Buffet 6:46
I think in reality we measure well. We don’t want to be preparing a lot of reports and asking 60 subsidiaries each to do something, whether they’ll set up a team and then mail things to headquarters. Then we’ll supply them to somebody who has… Our stock goes up some and probably going to sell them anyway.

We want our managers to do the right things. We give them enormous latitude to do that. I think that our batting average really is quite good. I mentioned this in the annual report. I can’t imagine another company like it, but here we are 500 billion in market capitalization. We do not have a consolidated P&L monthly. We don’t need it.

I can’t imagine any other organization doing that, but we don’t need it. We’re not going to tie up resources *inaudible* doing things we don’t need to do just because it’s the sort of standard procedure in corporate America.

Corporate America is very worried about, in general, they’re very worried about whether somebody is going to upset their apple cart, with activists and everything, so they want to be very sure that every shareholder is happy with issues like that. Fortunately, we don’t have to worry about that so we don’t have to run up a lot of expenses doing things that don’t actually let us run the business better.

Charlie Munger 8:06
Well, I think in Berkshire, the environmental stuff is done one level down from us. I think Greg Abel is just terrific at it. I think we scored very well. It gets the so-called Best Corporate Practices. I think the people who talk about them don’t really know what the best practices are. They just know what they think are the best practices. They determined that based on mobile cell, not work. And so, I like our way of doing things better than theirs. I hope to god we never follow their best practices.

Warren Buffet 8:44
I’d like to point out one thing about independent directors. I’ve been on 20 public company, corporate boards, not counting any Berkshire subsidiary. I’ve seen a lot of corporate boards operate and the independent directors in many cases are the least independent. If the income you receive as a corporate director, which typically may be around 250,000 a year now…

If that’s an important part of your income, and you hope that some other corporation calls the CEO and says, “How’s so and so as a director?” And as your CEO says,” Oh, he’s fine and never raises any problems,” and then you get on another board at 250,000. That’s an important part. How in the world is that independent?

Just by observation, I can’t recall particularly any independent director, where their income from the board was important to them. I can’t recall them ever doing anything in board meetings or committee meetings, that actually was counter to the interest. I’d probably be the same way in the same position.

Is 250,000 years important to you? Why the hell would you behave in a way that’s going to cause your CEO to say to the next CEO, say this guy acts up a little bit too much, you’d better get somebody else. You don’t get invited to the board if you belch too often at the dinner.

Charlie Munger 10:16
We had a director who said *inaudible* important just because you own shares.

Warren Buffet 10:25
Charlie and I used to have to cool off after the blue chip stamps meetings. We and Rick *inaudible* what percent probably…

They appointed all these. It came out of a government settlement or something. It was not an ideal form of decision making. They just had a different calculus in their mind. I can understand it, but I’m not going to replicate it.

Stig Brodersen 10:50
I absolutely love this discussion. We wanted to play this to show you how different Warren Buffett and Charlie Munger think about everything in business. I’m not the one to tell you what they do is right or wrong, but I do want to say that every successful company starts with integrity in abundance.

That integrity, whether you agree with the decisions or not, is the very foundation of why Berkshire Hathaway today is a 500 billion market cap company, starting from nothing in the 60s when Buffett took over.

Preston Pysh 11:23
Stig, you talked a little bit about this one after the first question about pushing authority and pushing responsibility down to the next level. You heard a little bit about that in the second part of the way they were answering this question. It really kind of came when Charlie Munger was talking when he said, “We take care of all that at the second level, not at the top level.”

I think what he’s saying is we put so much responsibility in our managers and our operational subsidiary CEOs beneath us, that we charge them with that responsibility in order to handle it. If they’re not doing their job, well, then we will replace that person. We’ll get rid of them if we don’t think that they’re taking care of things that they need to be taken care of.

For people that aren’t really familiar with Berkshire Hathaway, they’ll be blown away that a company with a 500 billion market cap would only have a handful of people at the headquarters level. You can literally fit in one picture. You’ll see this in the shareholders annual report that comes out once a year. They have a picture of their entire staff in Omaha and it’s like 30 to 40 people.

It’s kind of amazing to think that you’d have a company that’s half a trillion dollars and those are all the more people that are at the top of the business. Everything else is pushed down to the next level for them to manage and that’s their model. That’s how they operate. So just some really fascinating points there.

If for people that aren’t real familiar with the last part where they’re talking about board members, people sitting on the board that are representing the shareholders interests, what he’s talking about is if a person is sitting on a board and they’re collecting most board members, if it’s a large company are collecting around a quarter of a million dollars a year, and they attend four meetings a year and have a little bit more responsibilities throughout the year, but not a lot. And so, what he’s saying is if that’s a person’s primary salary, like they’re bringing in a quarter of a million dollars a year because they sit on one board, and that’s basically it, that person cannot act on behalf of the shareholders.

That person is going to act on behalf of the shareholders that are going to keep them on that board so that they can just… They’re basically buying their vote. They’re controlling that person’s vote because they’re reliant on that income of a quarter million dollars to continue to sit on that board. And so, that’s where Buffett and Munger both are frustrated with that model.

They obviously don’t have that model on the Berkshire board, but they see this in other companies. They don’t want that to be replicated in their own board structure. So that’s what some of that conversation was if you weren’t following at all.

All right, so let’s go ahead to the next question.

Emcee 14:15
Warren, you’re a big advocate of index investing not trying to shine the market, but by having Berkshire hold such a large amount of cash and T-bills. It seems to me you don’t practice what you preach. I’m thinking that a good alternative would be for you to invest most of Berkshire’s excess cash in a well-diversified index fund until you find an attractive acquisition or buy back stock.

Have you done that over the past 15 years all the time keeping the $20 billion cash cushion you want? I estimate that at the end of 2018, the company’s 100 and 12 billion balance in cash cash flow balance and short term investments in T-bills would have instead been worth about 155 billion. The difference between the two figures is an opportunity cost equal to more than 12% of Berkshire’s current book value.

Warren Buffet 15:15
That’s a perfectly decent question. I wouldn’t quarrel with the numbers. I would say that that is an alternative, for example that my successor may wish to employ, because I’m balanced, I would rather own an index fund than carry treasury bills.

If we didn’t do that policy, in 2007 or 2008, we might have been under a different position in terms of our ability to move late in 2008 or 2009. It has certain execution problems with hundreds of billions of dollars and it does.

If you were having a similar policy with a billion or 2 billion or something. It’s a perfectly rational observation and certainly looking back on 10 years of a bull market, it really jumps out at you. However, I would argue that if you’re working with smaller numbers it would make a lot of sense. If they’re working with large numbers, iit might well make sense in the future.

We committed 10 billion a week ago, and there are conditions. They’re not remote. They’re not likely in any given week or a month or a year, but there are conditions under which we could spend 100 billion dollars very, very quickly. If we did, those conditions existed. The capital, very well deployed and much better than in an index fund. And so, we’ve been operating on the basis that we will get chances to deploy capital. They will come in clumps in all likelihood. They will come when other people don’t want to allocate capital.

Charlie, what do you think about them?

Charlie Munger 16:52
Well, I plead guilty to being a little more conservative with the cash than other people, but I think it’s all right. We get up all the money in a lot of securities that would have done better than the S&P, the 2020 hindsight.

Remember, we had all that extra cash in that period, if something did along the way of opportunities and so on. I don’t think it’s a *inaudible* that be a little strong on cash when you’re as big a company as we are.

I watched Harvard use the last ounce of their cash, including all our prepaid tuition from the parents and plunge it into the market at exactly the wrong moment and make a lot of forward commitments to private equity. They suffered like two or three years of absolute agony. We’re not going to change.

Warren Buffet 17:42
We do like having a lot of money to be able to operate very fast and very big. We know we won’t get those opportunities frequently. In the next 20 or 30 years, it will be two or three times when it’ll be raining gold and all you have those go outside but we don’t know when they will happen.

We have a lot of money to commit. I would say that if you told me I had to either carry short term treasury bills, or have index funds and just let that money be invested in America, generally, I would take the index funds, but we still have holes.

The one thing you should very definitely understand about Berkshire is that we run the business in a way that we think is consistent with serving shareholders who have virtually all of their net worth in Berkshire. I happen to be in that position myself, but I wouldn’t do it that way under any circumstances.

We have a lot of people who trust us and who really have disproportionate amounts of Berkshire compared to their net worth, if you were to follow standard investment procedures.

We want to make money for everybody but we want to make very, very sure that we don’t permanently lose money for anybody that buys our stock somewhere around the intrinsic business value they begin with.

Stig Brodersen 19:05
This was one of my favorite questions asked during the meeting, if not, the very best question. Buffett’s idea of having plenty of cash aside from the around $20 billion cushion he would need for his insurance business.

If everything goes south, aside from that, it is really to be able to pull the trigger if a big buying opportunity comes along, and as any good capital allocator who wants to deploy the money where it’s best put to use.

Now, the $10 billion deal he briefly mentioned, that would just sell right before the meeting. That was a $10 billion for Occidental Petroleum, where Berkshire Hathaway could collect an 8% dividend of preferred shares and the right to buy 80 million shares at a pre-negotiated price of $62.5. Now, this is a great deal if you’re a shareholder.

These deals do not come along as often as we would like. Even though the last 15 years, which was what the question was all about, has generally been the bull market. I think it’s worth discussing if the opportunity cost is so high from having cash that it might even outweigh the potential benefit of forgoing a few big deals.

Keep in mind the $10 billion could easily be freed up from an index fund, if needed somewhat fast and deployed into the deal. Really, I don’t like Munger’s response about how Berkshire Hathaway could make more in hindsight.

I kind of feel like he’s dodging the question too much because this is more a question about a conceptual change in how to allocate cash. Before too long, they might not be struggling with deploying 100 billion dollars in cash. Given the sheer size of Berkshire Hathaway, it might soon be $200 billion in cash, whenever it’s a trillion dollar company.

What then? Having a significant part of that cash parked in an index fund, I think would likely be a good idea. I was happy to hear that Buffett opened up for that possibility for his successor.

Preston Pysh 21:29
Stig, I’m with you on this. I like this question. Hands down the best out of all the questions from the meeting. I think it’s the most pertinent question because it’s the most realistic for me. You keep hearing him go on CNBC and all these different talk shows. He’s saying you should be indexing, it’s probably the best thing to do for the typical investor out there. And yet, he’s sitting on 100 billion dollars of cash. It’s really hard to see what he’s doing on his balance sheet and then hear what he’s saying. It just does not match up.

Him retaining a lot of cash to do big deals is one thing. So if he wants to sit on 60 billion or 50 billion in excess of the $20 billion buffer, I think that makes sense. I’m just kind of surprised that he’s not even allocating a small portion of the hundred billion plus to some, maybe the S&P 500 or the Russell 2000. I’m just a little surprised that he’s not allocating some, call it $10 billion or 10% of the cash position or whatever.

You rarely see him interrupt the person as they’re asking the question. In fact, I don’t know that I’ve ever heard him kind of jump in mid question and start responding to it. That’s kind of what you heard him do here with this question. He didn’t even want her to go any further. He just started saying, “Hey, that’s a fair question.”

It was an interesting way in which he responded and it was not typical of him to respond like that. I think that that also demonstrates that it was a very fair question. I think that he answered it reasonably. I think he owned up and said, “Hey, maybe you’re right. Maybe we should have been doing that.”

That’s why I like Buffet. I think that’s why most people like Buffet because he’s just so open to the opportunity that maybe he is wrong. I think that’s such a great characteristic for people to see and observe.

Audience 3 23:28
My name is Carrie. And this is my daughter, Chloe. She’s 11 weeks, sir, very first Berkshire meeting. We’re from San Francisco. We have a question on employment for you. As both a major employer and a producer of consumer goods, what do you make of the uncertain outlook for good full time jobs with the rise of automation and temporary employment?

Warren Buffet 23:56
If we’d asked that question 200 years ago and somebody said, with the outlook for development of farm machinery and tractors, meaning that 90% of the people on farms were going to lose their job. It would look terrible but our economy, our people, and our system have been remarkably ingenious in achieving whatever we have now, 160 million jobs. Throughout the period ever since 1776, we’ve been figuring out ways to get rid of jobs.

That’s what capitalism does. It produces more and more goods per person. We never know exactly where they’re going to come from. I don’t know what occupation. Well, if you’re in the passenger train business, that is going to change.

We find ways in this economy to employ more and more people. Well, now we have more people employed than ever in the history of the country, even though company after company and particularly in heavy industry, that sort of thing, has been trying to figure out naturally how to get more productive all the time, which means turning out the same number of goods with fewer people, and turning out more goods with the same number. That’s capitalism.

I don’t think you need to worry about American ingenuity running out. I mean, when we started with 4 million people, with 80% of the labor being employed on farms, so the system works and will continue to work. I don’t know what the next big thing will be. I do know there will be a next big thing. Charlie?

Charlie Munger 25:37
Well, we want to shift the *inaudible* the robots to the extent we can. That’s what we’ve been doing, as Warren said, for 200 years. Nobody wants to go back to being a blacksmith. They’re scooping along the street, picking up the horsemen, or whatever.

We’re glad to have eliminated those. A lot of us worried about the future. The people at the bottom of the economic pyramid have had a long stretch, when the people top got ahead faster. That happened by accident because we were in so much trouble that we had to flood the world with money and drive interest rates down to zero. Of course that drove asset prices up and helped the rich. Nobody did that because they suddenly love the rich. It was just an accident, it will soon pass.

Stig Brodersen 26:30
I do think that no matter what we’re discussing, it’s too easy to say this is what history shows. There is something that does work and therefore it will continue to do so. But the important thing is to understand why something has happened. Not just observe that something has happened.

It is likely what Buffett and Munger do think though, but another part of it might also be that they are major employers and it would be hard to say otherwise.

However, if we do look at job creation, we can generally divide it into two groups. We have physical and cognitive jobs. So for physical jobs, that is traditionally what we have seen in agriculture. As Buffett also mentioned, they were replaced by machines because they had better physical capabilities than humans have.

Then we started to work in factories. Now, factory jobs can be automated, because machines can do it better and faster than us. But what happens when AI machine learning takes over cognitive jobs, for instance, the job of a doctor?

For many diseases today already, machines could diagnose much better than doctors. For many fields in law, we already see that machines can do repetitive tasks much better than educated lawyers.

It’s not a natural law that will create more jobs than humans. There will definitely be new jobs, but not necessarily more than job destruction that is left to be seen. Rather, I would say that just as it’s a natural law that machines replaced for fiscal jobs is just as much a natural law that we as humans will be replaced in most fields for many cognitive jobs. Even though we don’t know this yet, hopefully it will be for the better.

Preston Pysh 28:13
For the most part, this is an interesting discussion. I think it’s a discussion that you hear a lot amongst investors and people trying to understand the impacts of artificial intelligence and all the innovation that’s happening in the tech industry. I hear this argument that Munger and Buffett are talking about. You probably kind of hear this same argument at any point in time, because technology is always revolutionising the labor force and how people are going to be employed in the coming years.

I also want to say that I’m also familiar with a thing called normalcy bias, which is people having the opinion that because something’s never happened or situations never happened to them before that reason alone is why it won’t happen to them in the future.

I think that it’s just important to kind of have a balance between having an appreciation to not fall victim to normalcy bias, but also take it at face value. What they’re saying is, this is something that happens. Technology will uproot jobs in the labor force. Typically what’s happened is people find new ways to get employed. The market is continually evolving and changing.

Like them, I have no idea what implications this is going to have. But I do know that it’s going to be quite fascinating and there’s going to be, like anything, huge opportunities, especially for investors in this area.

If you stay current, try to read as much as you can, try to understand what it is and understand where the markets are going. There are opportunities there too. So you just can’t look at the doom and gloom and the negative side of it. There’s absolutely a positive side of every negative piece that’s out there. I would just challenge people to try to find how you can take advantage of something like that.

Stig Brodersen 29:59
All right. We will play a question from the audience. This question comes from Kyle.

Sender 30:06
My name is Kyle. I’m from Philadelphia. First off, I want to thank you guys, both for the incredible information you guys put out in the podcast that definitely helped me become a much better investor.

My question is, some companies forgo profits in the short term in order to expand and grow creating an accounting loss for several years. Think Amazon? Would you guys consider buying a company using this business strategy? And if so, what would you look forward to valuing it given they have no current earnings? Thank you.

Stig Brodersen 30:35
Great question, Kyle, and very timely, now that we’re doing an episode about value investing at Berkshire Hathaway. We actually have covered your question a few times before here on the show about how to value a company with no earnings, or should I say we talked about it, but not really explained how to do it. Primarily. because we don’t know.

As value investors we discount the future expected cash flows and if we don’t have any, or if we can’t make meaningful predictions, I really can use our normal valuation approach.

Now, the reason why I still wanted to play your question is because we as investors should not only ask what is the approach or the equation to how to value a profitable business, versus how to value an unprofitable business? These are questions that Buffett has been asked multiple times before.

I actually took the liberty to tweak your question just a little into something I think would be more interesting, perhaps a bit more relevant for all of us. Rather, I would like to discuss something I hardly see covered nearly what is in between. So please allow me to elaborate.

Everyone basically knows how much profit any public company is producing. It’s all in the financial statements. Successful investors are better at predicting how much money the company will make in the future. After all, it’s the future and cash flow should be *inaudible* to ask an investor.

Now as a value investor, you’re looking for a company that already has a proven track record of being very good at making money and can be expected to make more money.

Munger talked about this during the annual shareholders meeting. He was not unhappy about not spotting Amazon, because that was not within his circle of competence. And as you mentioned, it is not until recently that it made money.

Rather, Munger is kicking himself for not investing in Google. So let’s take Google as an example. You might for good reasons say that so much has been said about Google. AIt’s hard to find any future cash flows that the market has not accounted for. But I think Google serves as a great example, not just because Munger mentioned it but really as an understanding of the current cash flows and projecting future cash flows.

As you might know, the vast majority of Google’s revenue will come from digital advertising, actually as much as 85%. This is primarily through AdWords and AdSense.

The industry grew as much as 21% last year with Facebook and Google capturing the lion’s share. Also you have Amazon coming to this market. Now, speaking of which, now conventional valuation metric would allow for you to determine how much you think the industry will grow and how much of that growth Google will capture. You can fairly easily come up with intrinsic value. That is definitely a vital part of the equation.

Then you have to figure out if you think that Google currently trading at little more than 21 times enterprise value to earnings before interest and tax is high for a company with those growth prospects. It’s really up to you.

Where it really starts to become interesting is what you refer to with Amazon, the short term pain for the long term profitability. For Google, you should pay attention to the division they refer to as other bets. At first glance, it is nothing to be impressed about. In the fourth quarter in 2018, for example, these other bets lost $1.3 billion and this was in revenue and only $154 million. But still, there’s a good reason why you should pay attention because in other bets, you have Google’s long term investment. You have multiple companies including Calico, a very interesting company that is combating aging associated diseases.

Instead of thinking in terms of how to evaluate unprofitable companies, and how to value profitable companies, respectively, I would rather refer to what famous value investor *inaudible* say, called emerging moat. There was something he talked about whenever we had him here on the show.

What he would do is he would focus on companies. It could be a company like Google. So really good companies. If you think about the trade and a good valuation, to ensure that you have a decent margin of safety, then you should really scrutinize the existing business model. Check also the projects that the company has in the pipeline when making your valuation.

Preston Pysh 35:43
Kyle, I don’t have too much more to add other than what Stig said there. My only addition would be personally I look a lot at the top line, especially now because I think you’re seeing extremely large companies call it Google or Amazon, that when you go back to the early days, the Benjamin Graham time frame. He’s talking about growth companies versus value companies.

Back then you didn’t have companies that were the largest market cap businesses on the planet in a growth phase of their lifecycle at that size. They weren’t growing at the speed that we see today.

And so, my argument for let me just use a company that’s out there right now: Tencent, a huge company, massive, multi billion dollar size company. Yet you look at their top line and the rate at which that company is growing and it’s growing like crazy. That’s not something that you saw 50 to 60 years ago.

So what I would tell you, for me personally, I am very scared of investing in a growth company that’s very small, that I don’t really understand what at an intimate level so publicly traded business that’s out there, that’s small cap. I don’t know it like I know my own business or something that you might own operationally.

That’s why I say I’m a little scared of owning something like that because the top line revenues or sales could be dependent on one critical thing that then just poof, it’s gone. Then next quarter, there goes your investment, there goes the share price, because it’s so heavily reliant on that top line.

However, when you’re dealing with a large cap company, I would argue the disappearance of that revenue, or that top line is so much more difficult for it to disappear because you’re dealing with so many assets on that balance sheet that are driving that top line.

I guess what I’m trying to say is, I’m more comfortable if it’s a large cap company. I’m personally looking at the revenue growth. I’m looking at the rate of that revenue growth. I’m tracking the change in that rate. For me, I’m looking at potentially investing in a “growth like” company.

So that’s the only thing I want to add to what Stig said. I think some of his points are just right on target and super important for people to understand but this would be the only thing that I would add in addition to that.

Outro 39:12
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