Stig Brodersen  01:07

The Q&A with Warren Buffett and Charlie Munger is typically the main attraction of the event. First of all, Charlie Munger wasn’t there, so you’re going to hear, primarily, what Warren Buffett has to say, but also the CEO of Berkshire Hathaway Energy, Greg Abel, who’s sitting in instead of Charlie Munger this year. I think that in itself is actually interesting, that Charlie didn’t make it. I think the way Buffett said it was that it just didn’t make any sense in that there wasn’t really any event for Charlie to make the flight out to Omaha, but the plan is still that he will be back next year.

Before the actual Q&A, there’s always a segment where Warren Buffett talks about Berkshire Hathaway, and he does that in this annual meeting, too. He talked a lot about airlines, which was very interesting. The very first question from Becky Quick was about airlines too, why Warren Buffett sold his airline stocks. What we’ve done just for this question is that we’re playing what Warren Buffett said in the segment about Berkshire Hathaway, about the airlines, transition into the first question, and then hear what Warren Buffett has to say. It’s just going to be for the very first question, but yeah, let’s see what he has to say.

Warren Buffett  02:19

I just decided that I’d made a mistake in evaluating. That was an understandable mistake. It was a probability-weighted decision when we bought that. We were getting an attractive amount for our money investing across the airline business. We bought roughly 10% of the four largest airlines. It is not 100% of what we did in April, but we probably paid $7 or $8 billion. We were getting billion dollars, roughly, of earnings.

Now, we weren’t getting a billion dollars of dividends, but we’ve felt our share of the underlying earnings was a billion dollars, and we felt that that number was more likely to go up and down over a period of time that it would be cyclical, obviously. It was as if we bought the whole company, but we bought it through the New York Stock Exchange, and we can only effectively buy 10%, roughly, of the four. And we treat it mentally, exactly as if we were buying a business.

The companies we bought are well-managed. They did a lot of things, right. It’s a very, very, very difficult business because you’re dealing with millions of people every day, and if something goes wrong for 1% of them, they are very unhappy.  The airline business, and I may be wrong, and I hope I’m wrong, but it changed in a very major way.

It’s obviously changed in the fact that there are four companies, and that they are each going to borrow perhaps an average of at least $10 or $12 billion each. You’re going to have to pay that back out of earnings over some period of time. You’re $10 or $12 billion worse off if that happens. Of course, in some cases, they are having to sell stock or sell the right to buy a stock of these prices. That takes away from the upside-down.

I don’t know whether two or three years from now that as many people will fly as many passenger miles as they did last year. They may and they may not. But the future is much less clear to me how the business will turn out through absolutely no fault of the airlines themselves. A low probability event happened, and it happened to hurt, particularly, the travel business, the hotel business, cruise business, and the airline business.

04:27

The airline business has the problem that if the business comes back 70% or 80%, aircrafts don’t disappear. You’ve got too many planes, but it didn’t look that way when the orders were placed a few months ago, and the world changed. I wish them well, but it’s one of the businesses we have, and we have businesses that we own directly that are going to be hurt significantly.

The virus will cost Berkshire money. It doesn’t cost money because our stock and various other businesses move around. If XYZ, say, is one of our holdings, and we own it as a business, and we like the business, but the stock goes down 20% or 30% or 40%, we don’t feel that we’re poor in that situation. We felt we were poor in terms of what actually happened to those airline businesses just as if we had owned 100% of them. So, that explains those sales, which are relatively minor, but I want to make sure that nobody thinks that involves a market prediction.

We were not disappointed at all in the businesses that they were being run in, the management, but we did come to a different opinion on it. They’re the four largest US airlines, that’s American Airlines, Delta Airlines, Southwest Airlines, and United Continental. I think, collectively, at least 80% of the revenue passenger miles is just flown in the United States, and they have significant international flying too, excluding Southwest. So, we like those airlines, but the world has changed for the airlines, and I don’t know how it’s changed and I hope it corrects itself in a reasonably prompt way.

I don’t know whether the Americans will have now changed their habits or will change their habits because of an extended period if it happens that we’re semi shut down in the economy. Who knows how we’ll come out of this? But I think that there are certain industries, and unfortunately, I think that the airline industry, among others, is really hurt and could be forced, and in effect shut down by events that are far beyond our control. I really have nothing to add more.

Greg Abel  06:28

Okay, we have another Charlie here.

Warren Buffett  06:32

I didn’t intend to use that as a line, but you’ve covered it well.

We would have bought other airlines still, incidentally, but those were the four big ones. Those were the ones we could put some money into, and we put, whatever it was, was $7 or $8 billion into it, and we did not take out anything like $7 or $8 billion. That was my mistake. But it’s always a problem if there are things on the lower levels of probabilities that happen sometimes, and it happened to the airlines, and I’m the one who made the decision.

Stig Brodersen  06:59

I really liked this conversation. I think Warren Buffett has, or sometimes can have, a habit of not talking too much about his positions, and why he just bought and sold. I guess it’s also to shield himself from too much confirmation bias. But I really liked this discussion.

07:15

One of the key learning outcomes for me was when he talked about the probable mistake. What he means by that is that if you played this scenario an infinite amount of time, the decision to buy airlines probably would be a good decision. He mentioned that he paid between $7 and $8 billion for around $1 billion in profits, and he expected that to increase. So yeah, it probably would be a good idea in most scenarios. But then because of COVID-19 happening, this situation completely changed the intrinsic value of his airline stocks. I think it’s very important to then say that you cannot control the outcome, but you can always control your decision. I found that insightful.

08:02

Also, I think it’s very interesting to note that Buffett bought Delta stocks back in February for $44. Right now, it’s trading at $22. He actually said to Becky Quick at the time that he didn’t intend to sell any of those stocks due to COVID-19. Not long before that, Delta was actually trading at $60. Now, what then later happened was that Buffett first sold Delta, and also a position in Southwest Airlines back in March. The way that was conducted was just a bit weird because he basically took his position down to a little less than 10%. It looked like it was really just for legal regulation purposes that he did that. The reason why we even had information about what he did in February was that he held more than 10% stake, so it just looked like a trimming. And then we just saw that he sold out completely off his position. To me that was quite interesting.

09:00

Another thing that Buffett said in that interview with Becky Quick back in February was that only three out of those four major airline positions were his. The fourth was Tedd and Todd’s. He didn’t say which one on the four was not his, but what he’s told us here was that he made the decision for the entire portfolio that all of them should be sold off. I felt that was very interesting, because I was quite certain, up to today, really, that Ted and Todd would completely manage their own portfolio, so that was interesting. Perhaps it was just his way of saying it, and he talked to them about it, and they made a decision. Who knows? But I’m curious to hear about your thoughts, Preston.

Preston Pysh  09:40

It’s fascinating to see how he was talking about this. A big point that I had was the one where he talked about that the borrowing was going to be between $10 billion per company that he owned in order to just offset what they were going through. We’re looking at that from an enterprise to earnings level.

We mention enterprise value a lot. For people that are listening to the show, they might hear the term, but they might not understand the term. Stig and I, and some other value investors really like to look at the earnings a company makes relative to that enterprise value. When you’re looking at that proportion, let’s just say that the enterprise value of a company is $10, and it makes $1 of earnings. Therefore, we think that, just in really rough estimates, that the company should probably yield about a 10% annual return based on those kinds of metrics.

10:34

The reason we like enterprise value is that it also accounts for the debt of the company. So, let’s say a company has no debt. Going back to the example of $10, we’d say that the enterprise value of the company is $10. But if the company had, let’s say, another $10 of debt, and its market cap was $10, you’d add those two numbers together in order to get your enterprise value. There’s also a little bit of a cash calculation in there, but I’m just going to act like that doesn’t exist for this really easy example. But let’s say the company had $10 of debt and $10 of market cap for an enterprise value of $20. If that company still has $1 of earnings, you’re not getting a 10% return, you’re getting a 5% return because you’re accounting for the debt in the valuation, the enterprise value of the company. That’s the easiest way I can break it down.

So, when I hear Buffett saying each one of these companies is going to have to take on an additional $10 billion of debt to be able to sustain what’s happening, in my mind, I’m saying, “Yep, he’s doing an enterprise value calculation. He’s adding that into the market cap of the company, and he’s having a reduction in the percent that he’s expecting to get back from that company because of the debt implications, the burden that those companies now have.” I think that’s an important point for people to think about that he’ll never get into and explain in that way. He says it real casually, like oh, yeah, each one of the companies is going to have to take on $10 billion of debt, then he’s on to the next comment. But that’s a gem of a comment for people to understand how he’s thinking about valuations.

Stig Brodersen  12:07

One thing that really stood out to me was that Buffett said, at least between the lines, “I have a hard time valuing these companies.” This was not Buffett necessarily saying, “Airlines will be a bad investment in the next 5 or 10 years.” He was more saying, “I can’t own it because it’s too difficult for me to value.” To me, that was something that was really worth noting. He knew how to do that beforehand. Airline traveling is such a monetized business, and it was so easy to make so many projections, at least if you look at it historically. A lot of good things are happening, like low oil prices. That would be really good if you own an airline because it’s a major expense. But it’s difficult if you don’t know your top line anymore. It used to be that you had a reasonably good idea of the top line, and that it typically followed some sort of function of GDP. That’s just not the case in more, and Buffett just didn’t know how to make that calculation. How can you own something, but you don’t know what it’s worth?

Preston Pysh  13:01

I totally agree with that. He’s looking at it and saying, “This is too hard for me to come up with a future value.” He’s saying, “I think there’s a major change in buying habits for the consumer of this,” because come on, let’s face the facts. I think most business travel can be done virtually, and the impact is very minimal. I think this is his concern. He’s seeing that in the next six months, these businesses are going to realize how invaluable all that travel that they’ve been doing is. I think he’s seeing this as that’s going to result in a business habit change.

13:33

The final thing that I think is really important is he wasn’t deep in the money on these positions. When you’re not deep in the money, and you’re having trouble calculating what you think the future value is going to be, and you think there’s going to be a change in the consumer habits, it’s a perfect time to offload, and go somewhere else where you think that you do have an advantage, because there are no tax implications to that.

I think those are the big points on that one. Okay, we’re going to go and play the next question here.

Becky Quick  14:01

The next question comes from Robert Tomas from Toronto, Canada, and he says, “Warren, why are you recommending listeners to buy now, yet you’re not comfortable buying now as evidenced by your huge cash position?”

Warren Buffett  14:13

Well, as I explained, the position isn’t that huge. When I look at worst-case possibilities, I would say that there are things that I hope they don’t happen, but that doesn’t mean they won’t happen.

For example, in our insurance business, we could have world’s, or the country’s, number one hurricane that it’s ever had, but that doesn’t preclude the fact we could have the biggest earthquake a month later. So we don’t prepare ourselves for a single problem. We prepare ourselves for problems that sometimes create their own momentum. In 2008 and 2009, you didn’t see all the problems on the first day. What really kicked it off was when the Freddie and Fannie, the GSEs went into conservatorship in early September, and when money market funds broke the buck. There are things to trip other things, and we take the worst-case scenario in mind than probably is a considerably worse case than most people do. So I don’t look at it as something huge.

15:22

I’m not recommending that people buy socks today or tomorrow or next week or next month. I think it all depends on your circumstances. But you shouldn’t buy stocks unless, in my view, you expect to hold them for a very extended period, and you are prepared financially and psychologically to hold them the same way you would hold a farm, and never look at a quote, and never need to pay attention to them. You’re not going to pick the bottom, and nobody else can pick it for you or anything of the sort. You’ve got to be prepared. When you buy a stock, have it go down 50% or more, and be comfortable with holding.

15:58

Also, I pointed out, I think a year or two years ago on the annual report that there have been three times in Berkshire’s history when the price of Berkshire stock went down 50%. Three different times. Now, if you hold it on borrowed money, you could have been cleaned out. The wasn’t anything wrong with Berkshire when those three times occurred. Some people are more subject to fear than others. It’s like the virus. It strikes some people with much greater ferocity than others. And fear is something some people can handle psychologically. If you can’t handle a psychologically, then you really shouldn’t own stocks because you’re going to buy and sell at the wrong time.

Preston Pysh  16:34

I love this response. I think that what he’s saying here is so counter to Wall Street thinking. To make a quick buck, this guy’s running a business. When I hear somebody talk like this, I know that he’s running a business, and he’s thinking about the employees that work for him so that they will continue to have a business to walk into or to work from. He’s mitigating risks that other people don’t see. He’s mitigating risks that could be 100-year storms or 500-year storms through his actions.

17:10

Now, a lot of people might not like the amount of risk that he’s calculating and that he’s preparing for, with the fact that the stock price might not be keeping up with other companies that are levering and doing all these things in order to produce results that outperform. But, when I heard that, oh, my god. I know I think about my own business through a very similar light. I could give two craps about whether I’m outpacing this or outpacing that, and I just love this response. I really like this.

And, as a person that has thrown a lot of rocks at Warren for having such a large cash-positioning, and telling people to buy the S&P 500, and not buying it with his massive cash position, I think that this response talks to how he views insurance. I think his comment there, “I could have a hurricane, and then I could have another major 100-year event back to back,” and seeing that they’re going to be looking at Berkshire Hathaway to cough up some money in order to take care of this is how he’s viewing the world right now. I think he’s looking at the lens of seeing some interesting things happening in the market and feeling like he needs to be prepared for a very, very rainy day here in the future.

Stig Brodersen  18:19

The other thing is that he is sitting on $130+ billion in cash. But as Buffett has just said, repeatedly, people always compare it to his equity holdings, which is, I think, at the end of last quarter was like $180 billion, probably even more than $200 billion now. But that’s not the right equation because he has hundreds of billions in operating companies, so it does not feel that he has as much cash as people tell him that he has. So, I think that’s one thing.

But I really wanted to play this question because Buffett is so often misunderstood when it comes to whether or not you should be investing in the stock market. I’ve seen hundreds of interviews with Warren Buffett over the years, and he’s so often asked this question. There’s always a journalist asking, “Is now the time to invest in the stock market?”

I kind of feel that the question is unfair. And really, Buffett spent almost an hour before Q&A session talking about betting on America. Like, how, if you bought an index and just held on to it, how much money you’d have made. I think that it’s so unfair because the headlines after interviews are typically like, “Buffett says that now is the time to buy stocks,” and that’s just the complete opposite of Buffett’s view. Buffett’s view is bets, and hold on. Don’t try and time the market for the vast, vast, vast majority of people.

But I definitely understand why the question was asked. Because, especially for retail investors, and even for many institutional investors, it can mentally be very hard to sit on cash. You always look for the right time to be fully invested, and if you’re sitting on some cash, and you tend to think, “Is now the time to go into the stock market?” But that’s not at all how Buffett looks at it because he doesn’t buy that broad world market index. That’s not what he’s looking into doing for his own portfolio, so it doesn’t really make any sense. He’s looking at specific businesses.

20:19

I think one of the biases that we have, and I think the person who asked the question might be prone to that bias, is that we tend to think very short term. Right now, we look back at the peaks in February, just before COVID-19, and it really looked like Buffett has missed out on this major opportunity in March. Listening to this in May, it might be easy to look at Buffett, and say, “Oh my god, you should have acted.” But there were quite a few things that we need to factor into this, just like the airline stocks we talked about before. It took months for him to build up that position of $7 and $8 billion. It takes time to build a position in public stocks, especially whenever you have that type of money. I think that when I saw the financial statements, I thought, “Oh, I thought you would have put in tens of billions of dollars,” but after listening to his responses, I think it makes a lot more sense why he’s still cautious of what’s happening right now.

Preston Pysh  21:17

The only other thing that I would add, Stig, as to why I think was a very fair question is. when you look at how he’s been allocating his free cash flow over the last two years, a significant portion of that free cash flow has been going to cash or into really short duration bonds, which are cash equivalents. And so, I think a lot of people, including myself, have been screaming, “Hey, he’s going on TV and saying you should be an owner of equities, yet you look at how he’s allocating his free cash flow in the last two years. 70% of its going to cash.” So, I think it was a very fair question. I think it was a very fair response, and how he’s looking at it.

21:58

To be quite honest with you, I think he’s looking at GEICO as a huge vulnerability to how he’s positioned going into this, and rightfully so. I think that when you look at GEICO in the past, you used to invest the float and make decent returns on the float, but now you can’t do that. But, as the parent company, which is a fully-owned operational subsidiary, that’s what GEICO is to Berkshire Hathaway, the fact that he fully-owns that thing, he’s fully responsible for any missteps or any issues that the thing has at this point. I think the insurance industry is not a place I would want to own. I would not want to own GEICO today based on where interest rates are at. I mean, what’s the advantage to him other than the liabilities that he talked about in that response? I think it’s a big concern.

It’s amazing how things go in phases as it used to be that his biggest asset was GEICO, and how he could invest that float. But now that you got interest rates pegged at 0% in hell, they’re going negative, right? That becomes a liability at that point, especially if you’re talking about being a parent company and you fully-own the thing. So, I don’t know. I think it’s a very, very interesting conversation, and I’m sure there are layers deeper than we’re even talking about right now that, I think, if you got Warren in the room, and had no cameras on, I think he would say that GEICO is a little scary for him right now.

Stig Brodersen  23:25

I think that looking at GEICO specifically, there are a lot of different moving parts that will make that interesting. One thing is the interest rate, as you said. I think that they still make a decent margin on the underwriting, still. The other thing is the way that they’re positioned, the way that these deals are renewed. I don’t think he’s too concerned about that. You can even make the argument that, to some extent, he’s been forward-looking when something like COVID-19 happens. Whenever there’s fear, there’s a lot of money to be made in insurance. Also, looking at the very, very short term, you can even say, especially GEICO, with their business model, a lot of the claims that they would typically have, they probably won’t have at the moment.

24:04

I think a much more serious issue, for not just GEICO, but the insurance industry is that that industry is really looking to be disrupted heavily in so many ways in the way that you file claims. In the way that you make new risk evaluations of people who are on the other end of that underwriting, with all the new technology that’s coming, it’s already changed in a major way over the last decade. I think the insurance industry would be almost unrecognizable in the next decade or two. I guess that’s more my issue.

If you’re really, really interested in learning more about that, I would actually highly, highly recommend that you would listen to The Future is Faster Than You Think, where there’s a long segment about how the insurance industry will be disrupted.

24:49

The last thing I just want to say to this is I think there could be some really interesting deals coming up. A lot of this depends on the Fed, too, but there is definitely a lack of the real economy if you could put it like that, and that can lead to some fire-sale prices for some of the major companies. That’s also one of the reasons why Buffett might be looking like he’s sitting on his hands right now.

Preston Pysh  25:14

I just want to add that I agree with you. I think that there are a lot of margins still left by owning GEICO. Please don’t take my comment as being that it’s a bad company because it’s not a bad company. It makes a ton of profit I think, relatively speaking, compared to where it was 10-20 years ago. It’s a way different company in his portfolio than it used to be. Okay, we’re going to go and play the next question here.

Becky Quick  25:39

All right. This next question comes from Leanne Dar, and his question is, “In the last financial crisis, Berkshire acted as a lender of support for eight different deals. Despite the injection of expensive capital through preferred stocks and securing warrants, these companies were in fact paying for the sign of confidence from Berkshire in the midst of a crisis, and that was invaluable. Today, we have QE, Infinity, low-interest rates, and Hungry Hedge Funds. Even though the economy has deteriorated rapidly over the last few months, why have we not acted as a lender of support?”

Warren Buffett  26:10

We haven’t seen anything attractive. Frankly, it wasn’t predicated on those, but the Federal Reserve did the right thing, and they did it very promptly, which they should have, and I salute them for it. But that means that a lot of companies that needed money and probably should have done their financing a little earlier, but they’re perfectly decent companies, got the chance to finance in huge ways in the last five weeks or thereabouts.

It’s set records. Some companies have come back twice. A number of very big companies that didn’t bother to extend out their borrowings, came a couple of times. Berkshire actually raised some more money. We don’t need it, but I think it’s still a good idea over time. There are some pretty marginal companies that have also had access to money, so there is no shortage of funds at rates which we would not invest at. So, we have not done anything because we don’t see anything attractive to do.

Now, that could change very quickly, or it may not change. But in 2008 and 2009, the truth is, we weren’t buying those things to make a statement to the world. They may have made a statement to the world to some extent, and I’m glad that they did if they did, but we made them because they seemed intelligent things to do, and markets were such that we didn’t really have much competition. Now, it turned out that we would have been a lot better off if we’d waited four or five months to do similar things, so my timing was actually terrible in 2008 or 2009. But what was available was so attractive that even though my timing was terrible, we still came out a little bit better than okay.

27:36

What we did was not designed to make a statement. It was designed to take advantage of what we thought were very attractive terms, but they were terms that nobody else was willing to offer at that time because the market was in a state of panic. The market, in equities, was in a state of panic for a short period of time when the virus broke out, and it became apparent. The debt market was frozen, or in the process of freezing, and that changed dramatically when the Fed acted. But who knows what happens next week or next month or next year? The Fed doesn’t know. I don’t know. And nobody knows.

There are a lot of different scenarios that can play out. In some scenarios, we’ll spend a lot of money. In other scenarios, we won’t. Greg, you’ve been watching what’s been happening.

Greg Abel  28:21

Yeah, I think I have something on your comment on the Fed, Warren. Interestingly, when it was first occurring, there were calls coming in, not the size of transactions we’re interested in nor companies we were inclined to act upon, but there was a general interest out there as people were, in a difficult point in time, looking at their balance sheet, and deciding what they were going to do. But the reality is those companies were not of interest, and post, effectively, March 23rd, the companies have been able to act. Warren touched on it at Berkshire Hathaway Energy.

28:57

Post the Fed action, we actually issued $4 billion of securities that were associated with debts or obligations we had maturing. Some short term obligations, we wanted to, clearly, lengthen out. We also pre-funded one of our capital programs at Pacific Corp. with the thought: “This was the time to get the funds in place,” such that we could proceed with what is really an excellent opportunity both for Pacific Corporate customers, and ultimately, for the Berkshire shareholders. So we’ve taken action within Berkshire, as Warren noted.

Warren Buffett  29:33

This is a very good time to borrow money, which makes it such a great time to lend money. It’s good for the country that it’s a good time to borrow money. Not good for Berkshire, particularly, although we borrowed some money. But we’ve put our money where our mouth is.

Preston Pysh  29:45

Stig, what I found interesting about how they responded to this, so Becky asked a great question. And they’re able to basically take a question of “Why are you guys not lending money into the market, and taking advantage of this as you did in ’08-’09?” And they just smoothly say, “Not only are we not doing that, but we’re also issuing debt and raising cash because rates are 0%.” But they did it in this in a really smooth and slow way.

Stig Brodersen  30:15

I looked into one of the deals that Berkshire did back in February, and they raised a billion euros, and five-year notes for 0% because it might come in handy at some point in time to have cash laying around. I think that was very, very interesting.

But you know, I really like this question because it was comparing 2008 to today, and it really gave us a chance to talk about why it’s a different situation, but obviously, also, some of the things that we can learn from that time.

30:47

One example that the person asking that question might have been thinking of would be the famous deal that he made with Goldman Sachs for $5 billion back in 2008. Buffett, more or less, dictated those terms. He just made billions and billions of dollars on that deal in a very short period of time because Goldman Sachs was so much in a pickle at the time. I can’t help but notice that 2008, also, was an election year, and it’s election year now, too. But it’s also very different in so many ways because back then, there definitely wasn’t strong support from the voters of, “Hey, let’s bail out Goldman Sachs.” That’s not what we were talking about back then. It was just very different in terms of supporting the system. It was still heavily subsidized even though not nearly to the same extent as today. You can even argue that we’re just getting started with that.

31:40

I also think that Buffett was very, very humble whenever he talked about that he should have waited back in 2008, that he was too early in selling the deals. Yes, it is very, very difficult to time, but I think there were a few different factors that played in here. I definitely don’t think that he’s saying this because he’s thinking about 2008, but I think that he has changed his perception, or he’s changed his opinion on how severe COVID-19 is. We just talked about before of buying Delta in February, and then selling at much, much lower prices in March, and even lower prices later, so I think it was a change in thought. “Okay, this is just more severe than I thought. And now we need to act on that.”

32:22

The other thing I would like to mention is that one deal that really goes under the radar compared to the Goldman Sachs deal is what happened in 2011 when he made a fantastic deal with the Bank of America. This was a 6% preferred share deal, and he came with warrants that he could purchase at a fixed price of $7.14. To me, that was very interesting. He had the right to do that for the next 10 years, and so, at a very depressed price, Buffett made more than 3x plus dividends. I guess that’s my way of saying that, sometimes, to make good deals, even if you have a huge crisis, it just takes time. Your lizard brain might be screaming to you that you should act now, but like in the case of the Bank of America, you should wait three years to make that deal.

Preston Pysh  33:12

In talking about the Goldman deal, so yeah, he supplied $5 billion to Goldman in a time of need back then, but there were convertibility clauses to common stock on these deals, and I think that’s something that people lose sight of. A person who doesn’t know the history of it would hear: “Oh, he was providing cash to the market back then.” He was, but he was also orchestrating the conversion of that into common stock. I think the strike on that Goldman Sachs was like $115, and back then, Goldman was trading it like $70 or $80 when he did that deal. And so, when he eventually exercised it, I think the price of Goldman was well over $200 a share, so his $115 strike was an immediate 100% gain.

Those are important pieces to this, especially when you get into how he does preferred deals that are typically a lot more complex than just “Are you issuing debt, or are you buying debt?” There’s a lot more to it than that. I think it’s hard to extract some of that information out of some of the questions.

Alright, so we’re going to go ahead and play the next question, and here it goes.

Becky Quick  34:25

That gets kind of to another question that came in from Mark McNicholas in Chicago, Illinois. He says, “Berkshire itself has a Fort Knox-like balance sheet, but some of its operating companies may be tight on cash during the pandemic. Would Berkshire consider sending cash to its operating companies to one, ensure that they can get through the pandemic, and two, to allow them to increase market share while their competitors struggle?

Warren Buffett  34:47

Well, we’ve sent money to a few, and we’re in a position to do that. We’re not going to send money, indefinitely, to anything where it looks like their future has just changed dramatically from what it was years ago, or even six months ago. We made that decision in terms of the airline business. We took money out of the business, basically, even at a substantial loss, and we will not fund a company that we think is going to chew up money in the future.

We started out with a company like that in our textile business at Berkshire Hathaway in 1965, and we went for 20 years trying to think we could solve something that wasn’t that solvable. So, we’re not in the business of subsidizing any companies with shareholders’ money. If people want to do that with their own money, ok, but we’re not going to do it on their behalf.

But we have advanced money. We’re perfectly ready to advance by gaining market share and all that. That may happen, but the companies that need money, probably don’t have a market share as their number one problem. I’ll put it that way.

Greg Abel  35:49

Yeah, it’s interesting when we look at our different companies as we went into the pandemic, or we’re addressing the COVID-19 crisis. Obviously, the first focus by our management team, and appropriately, was our employees, effectively making sure they’re safe, and that the business environment was in, that they could continue to operate.

Then we quickly moved to look at where our customers were in the cycle. What was the underlying demand within the business? To great credit to our managers, they very much have adjusted their businesses consistent with the underlying needs and demands of our customers. So, effectively, they’re moving with the customer, meaning very few of our businesses have actually required funds. Some have, as Warren said. We’ve advanced the funds to them, but the businesses have really reacted in a way where they’re managing consistent with where the market’s at i.e. the demand for their products.

Warren Buffett  36:46

Berkshire is almost certain to generate cash. I mean, nothing’s 100% certain, but as Greg mentioned, at Berkshire Hathaway Energy, we had some short-term financing, but we don’t have short-term financing. At any degree, we’ll never get ourselves in a position where we have a lot of money that can come due tomorrow. People that we’re financing heavily with commercial paper, and then found their business stopped. You’ve seen what’s happened to the airlines. I mean, they need money. Cruise lines need money. For some businesses, that’s just the nature of what they’re in.

37:17

Berkshire will never get in a position where it needs money. We factor in some things that are not ridiculously unlikely, and I’m not going to spell out scenarios because, to some extent, if you start spelling out scenarios, you may increase the chance of them happening. So it’s not something that we really want to talk about a lot. But our position will be to stay at Fort Knox. We don’t need $130 billion or $135 billion, but we need a lot of money that’s always available. And that means we own nothing but treasury bills. I mean, we never buy commercial paper. We don’t count on bank lines. A few of our subsidiaries have them, but we basically want to be in a position to get through anything. And we hope that doesn’t happen, but you can’t rule out the possibility any more than in 1929 where you could rule out the possibility that you would be waiting until 1955, or the end of 1954, to get even. Anything can happen, and we want to be prepared for anything.

But we also want to do big things. As Greg said, there was a period right before the Fed acted. We were starting to get calls. They weren’t attractive calls, but we were getting calls, and the companies we were getting calls from after the Fed acted, a number of them were able to get money in the public market, frankly, in terms we wouldn’t have given to them.

Stig Brodersen  38:39

I really like this question. I like the question because the person asking really gives Buffett a chance to highlight the advances of Berkshire Hathaway to be able to move around cash tax-free in the organization, where it’s put best to use. That’s really when it pays off to be a conglomerate, where you have a great capital allocator in charge, which is surely the case here for Berkshire Hathaway.

39:03

But what I like even more about this is how Warren Buffett talks about that he doesn’t want to subsidize companies that need cash just because they’re in a difficult situation, and he mentioned airlines. Airlines are in a tricky spot, so he’s selling his position in airlines. He doesn’t want to subsidize them for the sake of doing that because they are now part of the Berkshire family.

It’s very interesting because, in a way, you could even say that Buffett is being penalized for being a capitalist. What I mean by that is that there are so many people, especially the government, that have a strong incentive, and perhaps for good reason, as to why major airlines or companies like Boeing are so important to the infrastructure, and so important for so many parts of the US. But you don’t have to think like that. When you are a businessman, you’re just thinking, “What makes sense to ‘subsidize’? What makes sense to invest in? Where do I get the best return?” Not, “Which company should I save for the sake of saving them?”

40:07

Additionally, if those companies haven’t been bailed out by the Fed, I’ll be very interested to see what would have happened. Perhaps that won’t happen. I do think for the record, though, that we will continue to see a lot of companies being saved for time to come, not just this year, but perhaps also going to next year.

I’m really curious to see what happens when that credit truly freezes. How will Buffett act? I think that’s when we’re going to see him bring back that elephant gun that he talked about for so long, making those huge acquisitions. That’s the time when we’re going to see a new Bank of America deal or Goldman Sachs deal. Buffett is basically thinking like he owns an insurance company, which, coincidentally, he also does. But he’s thinking that, at the right price, he can more or less ensure and invest in anything. But it’s just not attractive right now. Not with the way things are for the Fed and the current market conditions.

Preston Pysh  41:04

Yeah, I don’t really have too much to add on this one. I think, in effect, he’s saying if we think that the business will continue to have viability into the future, and we own it as a wholly operational subsidiary, we’ll supply them some cash to help them get through that so that they don’t have to borrow. But, for the most part, and this is how he’s always treated his businesses, “Hey, run your business, and update me on how things are progressing. If you get in a world of hurt, and we think that you’re still viable, we’ll help you out.” But for companies like airlines…

I think for a person who’s listening to this, that’s not intimately familiar with all the assets on their balance sheet, the airlines were a non-operational subsidiary at 10% holdings. It’s really simple for them to just say, “We’re done with this, and we don’t have any type of obligations to you in the future when we sell all your stock.” But when he has like 80 or 70 completely fully-owned operational subsidiaries, they’ve got to treat those businesses a little bit differently than they treat a Delta or some type of equity position that they bought off the open market. That might be lost a little bit in the response, as well, but I think those were the businesses that they were talking about in their response.

I know that they own Encyclopedia Britannica, or at least they had, they might have sold it by now. But I’ve seen that on their display at the shareholders’ meeting. I don’t know how that business is still possibly making money, so if they come to them, saying, “We need cash.” I’m sure they’re saying, “Sorry, we’re not going to provide it.” Right? I think his comment is pretty straightforward as far as where they’re providing capital and where they’re not.

42:47

All right, at this point, we’re going to continue this conversation next week. We’ve got another four questions to play. We just thoroughly enjoyed doing this. I don’t know if the audience enjoys it, but I know Stig and I really enjoy doing these.

42:57

All right, so we’re going to play a question from the audience, and this question comes from Morris.

Morris  43:02

Hey, Preston and Stig. I love the podcast. Today, my question is regarding inflation. I’m a relatively new investor, and don’t understand the phrase “Cash is trash.” When I think about it, in an inflationary period, security prices are bound to drop. And while the value of my dollar is decreasing, the ratio between the value of my dollar and the value of securities is higher than ever before. That makes me think, is this phrase only referring to gold and other commodity types?” Please explain where my reasoning may be wrong. Thanks.

Preston Pysh  43:34

This one could go on for a while.

Stig Brodersen  43:39

I just knew you would say that Preston.

Preston Pysh  43:41

And you know the phrase, “Cash is trash,” that you’re referring to, for people that aren’t familiar with where that came from, it was from Ray Dalio at Davos. He was sitting there talking to the Squawk Box crew, and he made the comment, “Cash is trash,” and it just happened to coincide with market highs, then you had the big COVID-19 meltdown, and everybody in all of finance has been just beating Ray Dalio over the head with that quote.

He has a LinkedIn profile and he posts a lot of great articles on how he’s seeing the market. I’m seeing the market from a very similar perspective. Heck, I think you could just say that I’m copying a lot of the stuff that Ray Dalio is stating, as far as how he’s seeing the currencies today. And what he’s really getting at, as far as “cash is trash” is through monetary policy, every fiat currency around the world is being devalued in a major and massive unprecedented way. Okay?

44:50

The reason you’re not seeing a 1920s scenario happen, at least not today, of the fiat currency just debasing itself in an unprecedented way is that the way that the money that’s being freshly printed is nesting itself into the economy. If you would follow a new, freshly-printed, and when I say “printed”, I mean keystroked dollar bill that’s been added into the system, where it ends up almost like you’re following water in a stream going downstream, where does it end up? I think what you would find is that those freshly-printed dollars, freshly-printed euros, and all these fiat currencies that are being debased, are nesting themselves into securities. They’re either ending up in the bond market or they’re ending up in the stock market, and then they dwell there, and they don’t move.

45:45

And so, when Ray says “cash is trash,” what he’s referring to in a very simple couple of words is actually hundreds, if not thousands of words, deep in understanding. For anybody that really, really truly wants to understand Ray Dalio, and his thoughts on all of this, I would tell you to pick up his book, Big Debt Crises. It goes into excruciating detail, talking about all of these dynamics. When you see that, and a person who’s saying, “Well, how is cash ‘trash’, when the stock market just keeps on going up? If I’ve owned bonds since 1981, and they just keep going up, how is cash ‘trash’ in those environments?”

If relatively speaking, you’re talking about the timeframe of 1981 until now, it’s not, on a relative basis. Those other securities have gone up, and they have been a way better position than cash. But what I think Ray is talking about, and the drumbeat that he’s beating is, if you’re viewing it from a lens 10-20 years from now, and you’re looking back at when he was saying this, and he was saying that we’re going to have to have a new monetary system, a new currency system, in the coming years, it’s going to look like total brilliance when it’s viewed from that spot in the future back to now.

It’s really, really difficult for somebody to wrap their head around all these nuances, especially when they’re said in a cute blurb that is really easy to say and really easy to iterate. But, without the understanding of where it’s coming from, I think it can be lost in a massive amount of confusion.

So, Stig, I’m kind of curious to hear your thoughts.

Stig Brodersen  47:29

Yeah, I think you bring up a good point with that interview with Ray Dalio. I know I come off like a bitter grumpy old man, but I think the interview was like five or seven minutes long, and I think the interviewers probably interrupted him like 10 times or something like that.

I just remember it was so frustrating listening to because I wanted to hear about this monetary system. I wanted to hear about like, what’s going to happen? Why is cash trash? Sometimes, in life, there are complicated topics, including currency systems, that just can’t be explained on CNBC for 35 seconds. Unfortunately, I would have loved to have that conversation just drag on.

48:09

But I like that question for a bunch of different reasons. I think you can look at it from many different angles. One thing is the typical Warren Buffett way of looking at this. He’s saying that if you bought the Dow in 1900 at $66, now, it would be trading at $28,538 at the end of 2019. In that sense, yes, cash is truly trash. Then there’s the component of inflation. Obviously, you can’t get the same $400 today as you could in 1900, so that’s definitely one part of it.

48:43

The other part of it is to understand that cash is fantastic in many ways because it is basically a call option on all asset classes as you have the flexibility to immediately go into different investment opportunities. So, in that way, it’s a good thing. You can also say it’s a good thing to have as a hatch. For instance, for those of us who had a cash position going into this drawdown in the market, we don’t experience the same drawdown simply because cash, more or less, maintains the same value if you just discount that for inflation.

So, you can look at it from different angles, but generally, if we look at this historically, definitely, you can say cash is trash because of the opportunity cost for having cash lying around. We were talking definitely about a minor allocation of your portfolio.

49:29

The other thing I want to say about this, going back to this inflation and going back to Ray Dalio, during this interview where he had 35 seconds or whatnot, he had been answering one of those questions, which was, “What should you invest in?” And he said, “You should buy gold.” And he had at least 12 seconds to explain why he wants to hold gold. Sorry, I’ll stop dissing that soon. But gold has historically been a good hedge, especially for unexpected inflation. It’s very important for you to understand the difference between expected and unexpected inflation. If there’s expected inflation, it’s already priced into the price of gold, which is also why you saw, when Nixon took the US, and effectively the world, off the gold standard in ’71, you saw that huge spike almost right away. I think that’s important to understand.

50:20

Another authority in this that I would like to bring up is Jim Rickards. He’s our friend whom we’ve interviewed here on the podcast multiple times. I just read his book, Aftermath, a few weeks ago, and he talks a lot about: What would you do when there is a crisis? Keep in mind that this book is from 2019, and he’s talked about how to position yourself if you see massive inflation, or perhaps even deflation.

I think a lot of people are sitting right now, and thinking, “Hmm, we have this massive money printing that should mean high inflation,” even though they might not see those numbers measured in the official numbers, and they are thinking about deflation. They might have listened to the episode with Jeff Booth here a few weeks ago, and they might be thinking about the impact of technology, and all the deflationary pressures that you see in society right now because of the massive unemployment.

What Jim Rickards said that he would recommend someone to do, adding this into the mix, is that if you are in a world with high inflation, you would want to buy real assets, like real estate, commodities, and hot currencies, such as gold. However, if you want to work with deflation, you would rather consider investing in utility stocks, say, fixed income, and currencies. Currencies might actually also be interesting because just being in cash will improve your purchasing power. Also, he said that if you really don’t know what to do, you can diversify into both categories, but always maintain a position in cash, and when you know which direction you’re going, inflation or deflation, that’s when you’ll want to size up your bets.

Preston Pysh  52:01

Stig brought up a good point about Ray’s comment and the context of his comments. When he said, “cash is trash,” he’s also out there beating the drum on owning gold. If you look at how cash has performed relative to gold since that interview, gold has drastically outperformed. It also outperforms the S&P 500 and many other stock indexes you want to bring up, except NASDAQ. I don’t know if it’s outperformed the NASDAQ, but it’s close. So, that was where Ray was coming from with the comment.

52:32

Something else that I just want to briefly talk about is how currencies fail. What does that look like when a currency fails? For people who have never experienced this, myself included, as I’ve never experienced a currency failure in any kind of market, but I do know that they’ve happened since I’ve been alive in other countries, I don’t know exactly what that’s going to feel like or look like. But I’ve read enough books to hopefully understand the nuances of that. I’ve been beating this drum on social media for people to study this thing, called The Cantillon Effect. We can have a link to that idea in the show notes, but read up on how the Cantillon Effect works.

53:15

It goes back to what I was describing earlier, where freshly-printed money nests itself into securities, into financial assets, because of how that money is being inserted into the system through quantitative easing today. All of those things are important for a person to know and understand, but when a currency ultimately fails, to the person who’s experiencing it, it feels like it happens all at once. There are all these events leading up to it that just don’t feel right, that don’t seem right.

For instance, unemployment being at 15%, yet, the stock market’s trying to make new all-time highs. Those two being together does not make any sense whatsoever. Those are kind of the cues that there are cracks in the dam, and that’s how I would probably describe a currency failure. It’s you have a dam that’s built for a certain water level, and the water level is getting higher and higher and higher, that it’s exceeding the capacity of the dam to hold it. And you’re starting to see these cracks in the dam, but then when the dam breaks, it happens all at once. It happens abruptly.

I think the people that are looking at the government bonds right now, are saying, “There’s not a lot of volatility in the yield. They’re pretty calm. They’re at 50 basis points, and they’re not jumping all over the place.” But if people could see why that’s happening, it’s because there’s massive selling, and then there’s massive government buying on the other side of that, providing more and more liquidity into the system. The way I would describe that is you’re getting bigger cracks in the dam. The dam is just covered with cracks all over it, and yet you have people still living in the town down below, dancing all around, thinking that things are perfectly fine when in fact you’re about to have a catastrophic meltdown of that system. I personally believe that’s what Ray Dalio is saying with his quote, “Cash is trash.”

55:09

He’s suggesting that we are upon a time where there is going to be a new currency, a new system that is built. You don’t know if it’s going to happen tomorrow. You don’t know if it’s going to happen a year from now, two years from now, because it’s so hard to know when the strength of that dam is going to break. Based on how the government is responding to this, they’re not taking water out of that water level. They’re raising the water level, they’re chipping away at the dam. They’re actually making it more unstable through their interactions and the manipulation that they’re doing, and so, I think it’s just making that situation all the more inevitable.

I know this was a super, super long response to a really simple statement, but there’s a lot behind that. A LOT behind that.

55:57

Okay, so Morris, loved the question. We’re going to give you a free annual subscription to TIP Finance. This is the tool that Stig and I developed. It helps people find undervalued picks in the market. It also helps people manage some of that risk of buying undervalued companies with our momentum tool that’s really super simple to use. It either has a green status or a red status to indicate long-term momentum trends, and we’re really excited to give that to you for free, so thank you for asking such a great question.

For anybody else out there, go ahead and check out our TIP Finance tool. Just go straight on to our website, and click on Finance in the navigation bar, and you can check it out there. Also, if you want to ask a question and get it played on the show go to asktheinvestors.com, and if you get your question played on the show, you’ll get a free subscription to TIP Finance.

Stig Brodersen  56:44

Alright, guys! That was all that Preston and I had for this week’s episode of The Investor’s Podcast. We’ll see each other again next week!

Outro  56:52

Thank you for listening to TIP. To access our show notes, courses, or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permissions must be granted before syndication or rebroadcasting.