14 November 2023

In this episode, Kyle Grieve chats with Lawrence Cunningham about Warren Buffett’s focus on value, Warren’s unique long-term perspective, how the most successful managers utilize self-reflection to help reduce further mistakes, why capital efficiency metrics are so important to the success of a business and its incentive program, a great biological mental model called “security from obscurity” to help identify under the radar businesses, why quality shareholders are so important for public corporations, and a whole lot more!

Lawrence Cunningham’s seminal work was the book The Essays Of Warren Buffett: Lessons for Corporate America. He was a Professor of Corporate Governance for 15 years at George Washington University. He serves on the board of directors for several public businesses such as: Constellation Software, Kelly+Partners Group, and Markel Group. He’s published several other books on quality such as Quality Shareholders, Margin Of Trust, and Quality Investing.



  • The role of trust in Berkshire Hathaway.
  • Why personal connections are so underrated in investing.
  • The benefits of incremental innovation and who is doing it well.
  • Overcoming the challenge of assessing management decision-making.
  • The three different shareholder types and why you should be a quality shareholder.


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.

[00:00:00] Lawrence Cunningham: I think it pays off. I, obviously compared to the indexer, the trap is you underperform, you make bad decisions and just can’t get it right and you underperform. The real upside is being able to discern high quality businesses run by high quality people and making investments in them at least a fair price and then holding it for a really long time.

[00:00:20] Lawrence Cunningham: And you can perform exceedingly well. And there are lots of examples of individual human beings who’ve done that. Famous examples. We list a whole bunch of in quality shareholder that we’ve got a whole index, a whole appendix of some of the famous people and then funds that they’ve gone on to create.

[00:00:38] Lawrence Cunningham: So I think there’s a lot of upside for the investor and related upside is especially as maybe not for. individual stock pickers with a relatively small nest egg. But for larger individuals who come to have significant positions in companies, they have a voice, they have an influence, and they can help companies.

[00:01:02] Kyle Grieve: In this episode, I chat with Lawrence Cunningham about Warren Buffett’s focus on value, Warren’s unique long term perspective. How the most successful managers utilize self reflection to help reduce mistakes. Why capital efficiency metrics are so important to the success of a business and its incentive program.

[00:01:19] Kyle Grieve: A great biological mental model called security from obscurity to help identify under the radar businesses. Why quality shareholders are so important for public corporations. And a whole lot more. The Essays of Warren Buffett was one of the earlier books I read on investing. I’ve taken so many lessons from it and regularly reference the book to draw wisdom from it.

[00:01:38] Kyle Grieve: Lawrence Cunningham did a wonderful job of organizing it and making it easily accessible to investors of all experience levels. But what I didn’t know was how wide Lawrence’s breadth of knowledge was on all things Buffett, quality, and governance. So when I decided to read more of his books, I was very impressed with the many different aspects of quality that he discussed in detail.

[00:01:57] Kyle Grieve: Lawrence is one of the most passionate writers on quality that I’ve come across. I was ecstatic to interview him about many of the questions I had in relation to his books. Lawrence is on the board of three very high quality businesses. Constellation Software, Kelly Partners Group, and Markel Group. He understands why these businesses and many others are exceptional, not just from a business standpoint.

[00:02:16] Kyle Grieve: But because of the culture and relationships they have built with their partners, subsidiaries, and shareholders. If you’re an admirer of quality businesses, you’ll take many great insights from this episode. Without further delay, let’s get right into this week’s episode with Lawrence Cunningham.

[00:02:32] Intro: You’re listening to Millennial Investing by The Investor’s Podcast Network, where your hosts, Robert Leonard, Patrick Donley, and Kyle Grieve, interview successful entrepreneurs, business leaders, and investors to help educate and inspire the millennial generation.

[00:02:56] Kyle Grieve: Welcome to the millennial investing podcast. I’m your host, Kyle Grieve. And today we bring on Lawrence Cunningham onto the show. Lawrence, welcome to the podcast. 

[00:03:05] Lawrence Cunningham: Thank you, Kyle. Great to be with you. 

[00:03:08] Kyle Grieve: You wrote one of my favorite investing books of all time, The Essays of Warren Buffett. To any investor or corporate manager out there listening to this or who haven’t read it, you need to get yourself a copy ASAP.

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[00:03:17] Kyle Grieve: Now, one of the most interesting insights from that book that differentiates Warren Buffett from 99. 9 percent of other managers is his emphasis on intrinsic value over stock price. Buffett’s strategy is to keep the share price of Berkshire Hathaway aligned with the intrinsic value of the business rather than seeing massive mispricings.

[00:03:34] Kyle Grieve: Why do you think it’s so rare for executives to place such a low emphasis on stock price in today’s markets? 

[00:03:40] Lawrence Cunningham: Market prices have a powerful effect on everybody and CEOs in particular because many consider that to be the scorecard of managerial performance and Many managers are compensated in stock options whose value is strongly influenced by stock price And so it’s easy for CEOs to become myopic And just focus on that result, which is a temporary fleeting thing, instead of the underlying business value.

[00:04:08] Kyle Grieve: Yeah, makes sense. So Warren has made it abundantly clear that he doesn’t put much value on short term price fluctuations at Berkshire Hathaway’s publicly held companies. Warren said, and I quote, As owner of, say, Coca Cola or American Express shares, we think of Berkshire as being a non managing partner in two extraordinary businesses.

[00:04:25] Kyle Grieve: in which we measure our success by the long term progress of the companies rather than by the month to month movement of their stock prices. So there’s no real reason that retail and professional investors can’t take the exact same stance that he does in reference to their portfolios, but obviously very few do.

[00:04:41] Kyle Grieve: Why do you think Buffett is able to think on a different level than most investors? 

[00:04:46] Lawrence Cunningham: Being long term is not easy. He has been around a long time. I think he’s been. relatively patient from the beginning, but even he had a learning curve. He had to grow into recognizing the difference between short term stock prices and long term value.

[00:05:01] Lawrence Cunningham: And he did develop that habit and it’s helped him a great deal. The rest of us, it takes time to build that kind of confidence and patience. After all, if people might buy a stock and think, boy, this is terrific. It’s got a long term runway. I’m going to hold it through thick and thin. And By golly, when that stock price crashes or it has problems, you start to think, oh gee, maybe I was wrong and people get nervous.

[00:05:26] Lawrence Cunningham: Did it with IBM, did it with Amazon, doing it today, who knows which stock, AMC for that matter. So it’s just hard to tune out the day to day market. activity, tune out the daily headlines, and he consumes that information, but he manages to discipline himself to recognize that’s just a momentary picture, and you’ve got to zoom back and remind yourself that you’re in it for the long term.

[00:05:50] Lawrence Cunningham: Another notion, Kyle, that your quote from that section of the essay is about how he sees himself or Berkshire as a non managing partner of Coca Cola or American Express. That image can help people, can help your listeners. If you think rather than that, I just bought a hundred shares of Facebook or Meta on my Charles Schwab account, and I could sell them anytime I wanted to.

[00:06:14] Lawrence Cunningham: You think I have just joined a business that. We’ll be around for 10, 20, 30 years and I can’t sell it and I don’t want to sell it and I know there’ll be trouble, but I’m not going to respond to that. So that’s another passage elsewhere in the book talks about he makes an investment assuming that he can’t sell it.

[00:06:31] Lawrence Cunningham: That helps. He’s got a line about if I’m not interested in a stock when the stock exchange is closed, I’m not interested in a stock when the stock exchange is open. Your listeners have to develop their own kind of mental tricks or mental discipline to provoke that long term focus, but that’s what he has done.

[00:06:50] Kyle Grieve: Excellent. So Buffett has made many great points about mergers and acquisitions that you cover in Essays, Warren Buffett. One of the main themes that he discussed is how mergers are often great for the acquiree, but very poor for the shareholders of the acquirer. Do you think Warren Buffett’s competitive advantage for acquisitions lies in the fact that he doesn’t use outside help with these investments via investment banks and stuff like that?

[00:07:13] Lawrence Cunningham: Almost certainly. There are two parts to that query, if I may, that first part about buyers tending to overpay. It’s, it is true. And now that part of that might be. built in competitive market economics, independent of advisor. If Cisco wants to buy this wonderful cyber firm, wow, it might have to pay 26 billion because someone else would pay 24 or 25.

[00:07:36] Lawrence Cunningham: So there’s a natural competitive environment that may lead to high prices. There’s also a little bit of natural salivating that managers imagine a wonderful result occurring from some growth in the business, some platform, some acquisition. So there, there are those natural psychological. social reasons why bidders do tend to overpay.

[00:07:55] Lawrence Cunningham: But the helpers, thanks for mentioning helpers, Warren has a whole section, there’s a whole section in the essays of Warren Buffett called the helpers. And he points out that corporate America has fostered a cottage industry in advisors, consultants, bankers, accountants, lawyers, who help companies do all kinds of things.

[00:08:15] Lawrence Cunningham: They’re expensive. They cost money. They then try to add value, and sometimes that adds up to overpaying. And that ecosystem Warren’s quite critical of it. I’m in it, so I’m a little less critical of it. There are people and there are services that do add value, but the overall effect is to, I think, increase prices and maybe get people increasing value.

[00:08:39] Lawrence Cunningham: If I may, he’s got another joke because the, on the investment bankers in particular, the advisors to buyers in merger and acquisition transactions will often charge on a contingency basis on a success basis. So they get a piece if the deal goes through and it’s usually a percentage. And so their interest is to get the price high also, and indeed higher the price.

[00:08:59] Lawrence Cunningham: The more likely it is, that bidder will win. So the bankers have a structural incentive to bid them up. And when that happens, you obviously risk overpaying. And Warren’s got a joke on that. He said he typically does not use advisors or bankers for these transactions, but he had a joke that said If I’m going to pay a banker a percentage of the deal, if it goes through, I think I should pay another banker a percentage of the, of what it would have been if it didn’t go through.

[00:09:28] Lawrence Cunningham: And then you’ll get the best advice either way. 

[00:09:32] Kyle Grieve: I like that. So another awesome part from your book was when Warren talked about intrinsic value and I quote, the percentage change in book value in any given year is likely to be reasonably close to that year’s change in intrinsic value. Many of our listeners are invested in businesses that are high in intangible assets.

[00:09:49] Kyle Grieve: Do you think Buffett would stand by this as a useful measure for changes in intrinsic value of asset light businesses? 

[00:09:56] Lawrence Cunningham: I think you probably would. I think the main reason is that you’re right, that the elements of assets have changed from say steel to silicon and even more abstract.

[00:10:07] Lawrence Cunningham: And so book value as such is measuring something different and may have different reliability measuring the value of a. Warehouse or a plant might be quite different than measuring the value of a trademark or a copyright or a patent or even some other intangible like reputation. That said, I think there’s probably fewer ways to impose yourself on book value psychologically, systematically, and it’s easier to get carried away with estimated cash flows and discount rates with earnings and multiples and comparables.

[00:10:40] Lawrence Cunningham: A book value is still a pretty disciplined accounting metric, conservative, that may underestimate, it may leave things out. But you’re right, the elements are changed, what it measures is different. But, in terms of it’s conservatism, my guess is he’d probably still offer a defense of book value per share.

[00:10:58] Lawrence Cunningham: I think his annual letters typically lead off with a statement about book value per share, plus all the securities. The overall mix, I’m sure, compared to 30 or 50 years ago, is way more intangible than tangible assets. But there’s still an enormous amount of value residing in the measurable tangibles and and sometimes there’ll be goodwill within the book value.

[00:11:19] Lawrence Cunningham: So they’re capturing across that huge enterprise. I think book value still might be overall the most either meaningful or disciplined expression. 

[00:11:29] Kyle Grieve: Excellent. So there’s a great quote from Quality Investing, quote, If smart people learn from their own mistakes, while wise people learn from the mistakes of others, the goal is to be both smart and wise.

[00:11:39] Kyle Grieve: What strategies have you seen in the corporate world by the best managers out there that help ensure that they are acting both smart and wise? 

[00:11:47] Lawrence Cunningham: I enjoyed writing that book and it did make me think a lot about how we learn and how we develop intelligence and wisdom. And I do think both self reflection, self criticism and observation of other people’s decision making processes and errors is important and doing both.

[00:12:04] Lawrence Cunningham: And Buffett is an exemplar. He may even be a little extreme. He remembers his mistakes, he writes about them, and then he he often picks at them over and over again. You’ll see throughout the essays, he constantly revisits his acquisition of Jen Ray, which is long ago in the rearview mirror, and just kicks himself over and over again.

[00:12:23] Lawrence Cunningham: I try not to do that. I don’t think it’s strictly necessary but for most ordinary people, probably. recognizing the imperfection in your process, what you learn from it, and then moving on. And so I think doing that on a regular basis about and certainly investment decisions, hiring decisions, or could be other relational decisions that you make.

[00:12:42] Lawrence Cunningham: And then also, I think picking up on patterns that you can observe from others. We’ve already hit on a couple of them. Overpaying for acquisitions, selling, Stocks because they’ve struggled in short periods. These are two big categories of mistakes. How do you avoid that? And I think if you look at what corporate America does in valuing targets or what so many retail investors and probably some larger, what institutional do selling when prices are falling and buying is.

[00:13:11] Lawrence Cunningham: Peaking out what’s happening there and you study that and there are some social psychological forces again, and in both cases that we’ve touched on internalize that and try to avoid allowing yourself to make those kinds of mistakes. The quality investing book is really all about an approach.

[00:13:28] Lawrence Cunningham: to evaluating companies that’s a little different. And we have a whole chapter in there about how this different perspective can lead to its own set of mistakes. But the basic premise is to recognize a common mistake and try to correct for it. Common mistake is a, an insistence or a habituated commitment to overcommitted, overzealousness about value investing.

[00:13:50] Lawrence Cunningham: Warren got over this a long time ago too. There’s a lot of people who say, I only want to buy a stock when it’s a 50 percent discount to price. to value, or only by business when you get some big discount. And there are all kinds of problems with that approach. One is that you might buy a really terrible business or a terrible stock and you may get what you paid for.

[00:14:09] Lawrence Cunningham: The other is even if you did satisfy yourself that it’s an intelligent purchase, it may not Deliver or may take extraordinarily a long time to deliver and really may test your patience. And the point of quality investing was to recognize that if you can identify a business with long term and durable mouthwatering economics, even if it seems to be proudly priced today, still might be a good investment.

[00:14:35] Lawrence Cunningham: Anyways, that area is probably the more fruitful place to work in. We argue in the book. And so thanks for that question, Kyle. It’s, I think that whole book in a way is, was trying to learn from the mistakes of others and try to do something a little bit different for your own McKell. 

[00:14:52] Kyle Grieve: Yeah, that book was excellent.

[00:14:54] Kyle Grieve: I have more questions for you on that. Just I wanted to touch on one thing you said that I really liked. You said that obviously that an amount of self reflection is obviously really good. Now, as a retail investor, How can we tell if a manager of a company that we want to invest in is using self reflection in order to make decision making?

[00:15:12] Kyle Grieve: Obviously we don’t know them on a personal basis. Is there anything that we can look at outside of their shareholder letters to try and get that information or how would you go about that? 

[00:15:21] Lawrence Cunningham: Yeah, I do think character counts and the personality of a company’s leadership can have a significant influence on its value, its performance, and its time rise.

[00:15:31] Lawrence Cunningham: And so I think having some appreciation of who may maybe even if you can get at it, the CFO, the super top leadership, maybe even the board. And obviously in our system, we have abundant disclosure buying about those people in the proxy statement in your ports. And you mentioned annual shareholder letters.

[00:15:48] Lawrence Cunningham: We have annual meetings. Many companies host investor days or quarterly calls that are usually people can dial into. And if you have. The time and patience, you can really get a sense, the cut of a person’s jib their style, their manner. You can assess every person is different. People have different appetites for what signals to them a high degree of candor or a high degree of competence.

[00:16:12] Lawrence Cunningham: And whether in today’s world, there’s always an association with some aspect of the intangibles a person brings in terms of what they value highly, what their priorities are. And so you can certainly take some time, but spend time listening to those audios or presentations and reading the letters and the annuals.

[00:16:30] Lawrence Cunningham: And there’s, I think, quite different range of styles. Yeah, it’s hard to do that for hundreds of companies, but if you’re able to narrow down your own. Circle of competency, what you think you understand well, and zero in. It may not be unbearable, it may be bad one. Sometimes it’s even fun to spend some time you trying to size somebody up that way.

[00:16:50] Kyle Grieve: So in quality investing, you also mentioned that you prefer businesses to prioritize return on capital. over per share earnings growth as businesses that emphasize this are more likely to be a little bit more long term oriented. Are there businesses that have converted to this line of thinking from say like a total shareholder return or other subpar incentive structures?

[00:17:10] Lawrence Cunningham: Yes. And that’s another thing you can get from the readings and audios that I just mentioned, because you’ll hear what priorities a CEO adopts or a CFO adopts or. We’re a company adopts what they’re measuring and what they emphasize in their measuring. And if they’re measuring growth and earnings per share that signals the opposite of what I appreciate.

[00:17:28] Lawrence Cunningham: Some people may appreciate that’d be an accounting based kind of growth orientation over shorter periods of time or return on invested capital is instead really ultimately what is a shareholder getting for each dollar. And that’s to me. What the shareholder ultimately must care about, and that you may generate a higher return on invested capital with a company that’s not growing its earnings.

[00:17:50] Lawrence Cunningham: It may be better to shrink a business or allow it to get smaller and the returns might get higher depending on the economic environment, product, the mix. Pricing depending on every business factor. And so I think prioritizing earnings per share gross, and that may be good. Actually, going back to your second question, managers who are compensated on the basis of earnings per share of growth are going to grow and not care so much about returning that to capital, but for a shareholder.

[00:18:18] Lawrence Cunningham: Her net worth will be a function of the return on the capital, not necessarily the growth in anything. 

[00:18:25] Kyle Grieve: Another great insight from quality investing was the importance of incremental innovation. So this had two benefits that you outlined. One, the customers are happier that they aren’t seeing large shifts in price.

[00:18:35] Kyle Grieve: And two, the business is happy because it can charge slightly more for an improved product without angering its customers. What type of businesses can you name that you think do a really good job of incremental innovation? 

[00:18:47] Lawrence Cunningham: I think that keeping that philosophy in mind is attractive because it’s a very customer first business model.

[00:18:53] Lawrence Cunningham: And I think the best companies are those who appreciate that their fundamental purpose is serving customers. Yes, the idea is to deliver a return to your investors, but the reason to be in business is because you sell so people want, or you provide accounting service that people value or. You help an industry discover new ways of doing things.

[00:19:14] Lawrence Cunningham: And so I think in all of those settings, catering to customers is crucial. And that incremental innovation is a part of that. It may vary industry to industry, but generally people who are buying goods and services, prize stability and continuity. And they’re appreciate innovation, novelty, new ways of doing things that they’re quite attracted to that, but not so much disruptive technology, disorienting technology.

[00:19:39] Lawrence Cunningham: And from the seller’s point of view, again, keeping customers and keeping them happy is very important to business. So abrupt and bold innovation can alienate customers, entice them to decide we’re facing this major shift, why don’t we put out a. request for proposals and see what other businesses can offer this service to us.

[00:19:58] Lawrence Cunningham: And so I think a great many companies do appreciate this customer focus and follow some sense of incremental innovation and Procter Gamble would strike me as one. 3M, Illinois Tool Works, these are companies that are always innovating in some way. They’ve got. budgets to do research and experimentation and product improvements, and they’ll once in a while announce some big bold breakthrough product that might be more than incremental innovation, but on throughout their product lines, they’re always trying to make it a little bit better.

[00:20:31] Lawrence Cunningham: And I think that adds a sense of stability to that and quality to that kind of company. 

[00:20:36] Kyle Grieve: Excellent. You used a great mental model about nature and business and quality investing in that both An animal and a business have an advantage if they can stay out of sight out of potential predators. You called it, quote, security from obscurity.

[00:20:49] Kyle Grieve: What are good ways of learning how obscure a business’s products are? 

[00:20:54] Lawrence Cunningham: Yeah, I think it’s a really nice analogy. Thanks for sharing it. I think it can help us. And that’s a surprising analogy too, because I think many retail, many individuals investors and some prominent stock pickers, Peter Lynch comes to mind, had this thought that buy what focus on prominent and the famous.

[00:21:13] Lawrence Cunningham: And so back in Peter’s day, he was one of the first to spot Dunkin Donuts, now called Dunkin it was a splash and it became popular pretty quickly. And he used that as an example of ordinary people’s, I know today it might be Starbucks. And that’s fine. Those are great. Disney is a perennial favorite of people.

[00:21:30] Lawrence Cunningham: So I know Mickey Mouse. I know the theme parks nowadays. Mattel owner of Barbie might be that kind of thing. These are not little furrowing animals down in the forest. These are big, well known and we have no problem answering your question there. You just read the paper. Get on your phone. These are screw things are usually going to be not consumer branded products, but organizations that help other businesses prosper.

[00:21:53] Lawrence Cunningham: So it might be the ingredient maker or the data management firm, the back office help that are essential to this consumer facing or the branded businesses. And so trying to develop a sense of sector that sort of the ingredients companies and trying to say what who among them are the.

[00:22:13] Lawrence Cunningham: incremental innovators. How do you do that? You have to read a lot. And one way to do it is you’re reading the annual reports of even those four famous companies, Dunkin, Starbucks, Disney, and the others. You’ll begin to learn. They rely on certain suppliers, certain vendors to deliver their dollar, their movie, or their products, consumer products.

[00:22:34] Lawrence Cunningham: And if you can back up that, their supply chain, say what kind of, what role do these little animals furrowing in the forest play? You find that there are some indispensable components of that supply chain that contribute enormous parts of the value to those front big marquee name companies.

[00:22:51] Lawrence Cunningham: And I think we give a couple of examples of companies like that in quality investing. And it’s, it is hunting it’s, there’s this little animal there. And a lot of those companies appreciate that security in obscurity. They’re very happy to do very well for themselves. They don’t want to make a fuss.

[00:23:08] Lawrence Cunningham: They don’t want to be on the front page of the newspaper or on your app. They like making this particular input, whether it’s. The ingredients in yogurt or the little metal devices on the end of your UBS ports, Amphenol is that company. And so read a lot and think what is essential to this visible product that stays quiet and stays obscure.

[00:23:30] Kyle Grieve: Excellent advice. So I want to move on a little bit more about Berkshire. So Berkshire has only paid a dividend once in its history in 1967. In the book, you mentioned that in 2014 and it’s book, sorry, I’m mentioning now is a margin of trust. You mentioned that shareholders overwhelmingly voted against another dividend when they had a vote.

[00:23:47] Kyle Grieve: Are these the only two times in Berkshire’s history that they voted on dividend payments, or have there been other instances as well? 

[00:23:55] Lawrence Cunningham: I think that Warren makes a joke about that 1967 dividend that he says when the board approved that dividend that day, he must have been in the bathroom.

[00:24:05] Lawrence Cunningham: Because he wouldn’t have approved it. I think he put two resolutions to shareholders over the years. One was 2014. It might have been about 10, 15 years before that. But both times he was responding to inquiries from shareholders, Berkshire shareholders, who had an appetite for liquidity. They’d like a dollar a quarter, 10 a quarter, and they wonder, would you be willing to do it?

[00:24:26] Lawrence Cunningham: And Warren has long explained that this is a basic capital allocation model is to try to put every corporate dollar to its best use. And in that model, a corporation might reinvest in its existing businesses with that dollar. It might make additional acquisitions of bolt on or tuck in businesses, or even add new businesses or invest that.

[00:24:47] Lawrence Cunningham: dollar in common stocks of other businesses, or it might buy back its own stock if that’s trading at a low price to value. And if they run out of uses in those areas that deliver a better return than the stockholders could get themselves, then pay the dividend. Since it’s a basic capital allocation model that Berkshire follows, and his view has always been that we do better holding each dollar than our shareholders could do.

[00:25:14] Lawrence Cunningham: We do better reinvesting the business, making acquisitions, and buying back our stock when the price is low compared to value. So our stockholders are better off leaving the dollar with us than if we paid it to them. And his second point on that was that the choice between a company buying shares back, and paying a dividend, it’s better to buy them back if they can be bought at a low price, because you’re then returning cash to shareholders who would like the liquidity.

[00:25:40] Lawrence Cunningham: They can sell some of their shares and they will, the tax paying recipients will have to pay tax on that. Whereas you pay a dividend, every shareholder has to take it, and every taxable shareholder has to pay the tax, even if they’d rather not have the liquidity and would rather not. have that tax exposure.

[00:25:58] Lawrence Cunningham: So that’s how he’s thought about it, how he’s explained it to his investors, and those two times when the shareholders got a chance to vote, as you say, overwhelmingly, the holders agreed with that policy, and they prefer Berkshire to keep it. 

[00:26:12] Kyle Grieve: And Now, obviously, Berkshire’s cash pile is absolutely massive.

[00:26:17] Kyle Grieve: I think it’s like 150 billion ish, maybe a little bit less. Now, I don’t talk to a lot of Berkshire shareholders and I know a lot of them probably still trust Warren very much and they probably should is he going to be able to reinvest all that money at these high rates? And do you think he’s ever going to pay a dividend or do you think it’s just You know, he purely is going to take the option of doing buybacks over dividends into the future, even if the cash keeps piling up.

[00:26:41] Lawrence Cunningham: That’s an enormous amount of cash, no matter how you look at it on its own. Just in, in raw terms, it’s a staggering sum. And even within an organization, Berkshire’s size. Maybe 800 billion in market capitalization. I’m not sure the latest figures, but even for a pretty big company like Berkshire, that’s a huge portion of assets and of overall net worth.

[00:27:03] Lawrence Cunningham: So it’s a burning question. The formula still does apply. What would the holders do with the money? Probably buy a S& P 500 and they’d be receiving that money after tax. And that return does struggle with even basic return that Berkshire’s wonderful businesses and its investees will return.

[00:27:22] Lawrence Cunningham: I think the equation, the test is met. They’re not failing that test. And what’s he doing? What they’re doing is waiting for that big opportunity. I guess they’re waiting for two things. One is, I should say one reason Berkshire has had a policy of holding abundant cash, now by abundant, I think the last figure he used for this purpose was 30 billion.

[00:27:48] Lawrence Cunningham: It may be 40 or 50 now, but it’s an abundant cash in order to pay insurance claims. If the businesses were hit, Berkshire writes a lot of super catastrophic insurance risks for a lot of catastrophic risks, earthquakes, hurricanes, floods, terrorism. And so if we got a huge Berkshire has always said, we want to be the Fort Knox.

[00:28:11] Lawrence Cunningham: In the insurance industry, and it brags that it claims that it has the strongest balance sheet of all the major property and capital insurers, that if the world was really overwhelmed, multiple disasters and human and natural, many insurance companies might go broke, Berkshire, he says, won’t and will pay every claim that comes to us.

[00:28:31] Lawrence Cunningham: So to be able to make that commitment at the scale of insurance that they write, you’d need. 20, 30, I don’t know what the number is today, but for 40, 50 billion. So at least some a quarter or a third of the cash that’s sitting there is has to be there even if some a hundred billion dollar acquisition opportunity came that they’d run out of money.

[00:28:51] Lawrence Cunningham: And that’s what they’re waiting for. Some amazing opportunity like that. Obviously there aren’t many companies in the world that would fit that, but there are a few. And You never know when they might come available. It’s good to have that opportunity, that capital there. But I do think it’s a problem.

[00:29:06] Lawrence Cunningham: It’s a high class problem, but it’s still a problem. And I think one of the great challenges once Warren leaves the scene will be for the successor board to make that determination. I was on it or advising them. I’d stick to the knitting. I’d stick to the Buffett philosophy, but you can bet that there will be greater agitation among some.

[00:29:26] Lawrence Cunningham: shareholders to break that pattern. So that’s, I think one of the, will be one of the most interesting things about Berkshire in the next 10 or 20 years. Excellent. 

[00:29:36] Kyle Grieve: So trust is an admirable trait that Warren has fostered at Berkshire Hathaway and through its subsidiaries. That trust has been responsible for much of Berkshire’s acquisition history.

[00:29:45] Kyle Grieve: Many potential acquiries end up on Buffett’s desk because they’re referred to by people inside and outside of Berkshire. But in Berkshire’s early days, did he resort to using brokers to source acquisitions? Or did he always have this network of people that he could call on to get them? 

[00:30:00] Lawrence Cunningham: Yes, it’s a great point that trust is the real secret sauce, I think, of Berkshire’s business methods and of Warren’s own personality, both in vindicating trust, that is when he says something, you can count on him doing it, and in discerning trustworthiness.

[00:30:16] Lawrence Cunningham: in others. He’s a pretty good gauge of who’s trustworthy and who isn’t, and he errs on the side of skepticism. Any whiff of doubt about a person, he says I can’t go into business with you. And these traits have been there since the beginning. He has preferred handshake. He has preferred to buy from a friend or a friend of a friend than through an investment banker or other paid advisor.

[00:30:40] Lawrence Cunningham: He knows plenty of bankers and advisors and likes them as human beings. And he’s not making a category criticism as such, but appreciates that when people are paid to deliver a particular result. They will try to deliver that particular result. And so a lot of his the earliest acquisitions were done through a network of friends.

[00:31:00] Lawrence Cunningham: The two most famous were the original, the acquisition of National Indemnity back in 1967 which he bought from a friend of a friend, Jack Ringwald. Maybe by then Warren was a direct friend, but. And they did it on a, basically a handshake and a one and a half page agreement. And then the other big famous one from that era was Nebraska.

[00:31:21] Lawrence Cunningham: And by the way, National Indemnity is one of the largest trade insurance company in the world today. And the other notable acquisition of that era of that type was Nebraska Furniture Mart, which he purchased from a local Omaha native that was in his circle. Mrs. Blumpkin, Rose Blumpkin, and again on a, not quite a napkin, but pretty close.

[00:31:40] Lawrence Cunningham: And that is how he’s preferred it. Now, as the acquisition, as Berkshire got bigger and is a publicly listed company, the companies that are buying are big public companies. There was always more space and sometimes need for having those advisors. And so some transactions did end up getting there through that more professional route, but always the favorites and the one he, the ones he likes to talk most about came through friends and family.

[00:32:08] Lawrence Cunningham: And it was just easier to it is easier to count on when you hear, Oh, this is the book value, or this is the growth rate, or these are the markets we think we can do better in, you can trust it more than a section 6. 75 of the agreement makes a representation that the gap financials have been audited and it is different and he’s managed to, you asked early on what’s different, why, how, why, how is Warren different he has cultivated a phenomenal network of business people, so he must get, I don’t know what the figure would be, dozens of acquisition opportunities a week.

[00:32:41] Lawrence Cunningham: So that is a little harder for the the rest of us to receive that volume. He’ll see everything within his potential wheelhouse, and it’s easier for him to run his business that way. Advisors are sometimes critical. But, within my footnote, I think if you’re a professional, engaged in building a business, or trying to grow a business in that dimension, having advisors.

[00:33:05] Lawrence Cunningham: is important, but what’s critical is having advisors you can trust. Our book Margin of Trust is partly about how you can prove that. 

[00:33:12] Kyle Grieve: Yeah. So I got some more questions on the book. So you mentioned in Margin of Trust that as a business grows in size, centralization begins creeping in. You mentioned Mark Leonard, which is dear to my heart because I’m a big fan of his work.

[00:33:24] Kyle Grieve: So anyways, you mentioned that he was doing a search for high performing companies at one point, and he said, and I quote, they eventually caved in to increase centralization. My hunch. is that it takes an unusually trusting culture and a long investing horizon to support a multitude of small businesses and their entrepreneurial leaders.

[00:33:42] Kyle Grieve: If trust falters, the business units can be choked by bureaucracy. If short term results are paramount, the siren song of consolidation synergies is powerful. Now, for a business running decentralized systems as part of their model, how can they best maintain trust with their subsidiaries to avoid the creep of centralization?

[00:34:02] Lawrence Cunningham: That’s beautifully put and poignant because you’re absolutely right. As an entrepreneur, you or I, or the group of us, we start to develop this product or Market this service and we’re excited about it and we want everybody to do as well as they can to reach their potential. So we give them lots of responsibility.

[00:34:20] Lawrence Cunningham: This person’s in charge of this business. This person’s in charge of these accounts and we just have everyone doing their best. And it’s a sort of a partnership and we all trust each other. We don’t have reports. We don’t have oversight. Two people signed it off and we just let it roll.

[00:34:34] Lawrence Cunningham: And then as you get bigger and bigger your interest in trying to impose a little control increases too. And so you have some oversight, supervision, reporting higher and things like that. So it is a natural thing to want to do. And you have to have a balance. You certainly can’t have an organization of a thousand people and each person could just do whatever they want and let us know how it goes.

[00:34:53] Lawrence Cunningham: You have to have some culture, some glue, some shared Sense of what an, what achievement would be, what the goal is. And so you do need to have a balance between autonomy and oversight or control. And I think though, a way to do that will vary with the personalities and the business. But what you mentioned Constellation, and I think it’s a neat example of a reference point certainly that would be generally useful to people, which is that the business is decentralized.

[00:35:22] Lawrence Cunningham: So it’s divided into, there are 1000 different. Businesses inside that company, each one with its own P and L each one managed by its own team and with enormous autonomy in their sphere of marketing, pricing, product, innovation, staffing, even compensation, incentives, work hours, environment, and they’re in a hundred different countries.

[00:35:49] Lawrence Cunningham: So that is also very important because locales differ in language and religion and geography. Just about every way. So this is an extremely decentralized model for really good reasons, and it’s very much a system of trust. And then the flip side, the way that the balance is. That there are also a set of business expectations that performance metrics that each of these thousand units say should be able to meet and said what’s nice about this business is that all of those thousand are in the market.

[00:36:23] Lawrence Cunningham: They sell software. And so the economics of software. tend to be similar even in different markets and different geographies and so on. So it’s possible even in a diffuse and sprawling organization like that to say, this is for a software business, revenue per employee, let’s say, should be within this range.

[00:36:42] Lawrence Cunningham: Expenses for product development should be within, compared to revenue, should be within this range. Numbers of levels of customer attrition should not be Worse than this, and you can go down a whole list. And so the balance is achieved by broadcasting these common expectations and then saying, you can meet them however you want.

[00:37:03] Lawrence Cunningham: This is, this will count in good software business. And so it’s wonderful. And as I said, each company does a little differently. It depends on the character, personalities, and the types of business at Berkshire Hathaway. Those 82 odd businesses are virtually all in different areas. There, there are five jewelers and five furniture stores, but they’re making consumer products, industrial goods, selling services, various kinds of insurance.

[00:37:26] Lawrence Cunningham: So the metrics of the performance expectations and how to measure them will be different. It’s very different to sell candy in a shop than it is to build the fuselage for large aircraft. So you can’t measure them the same way. They’re going to have different business cycles and all that, but you can nevertheless.

[00:37:43] Lawrence Cunningham: have relationships that acknowledge that you can do any manage the business any way you want, but we do expect results around these metrics around these areas. So that’s, I think the key is it’s account, it’s trust with accountability and. Or as Mikhail Gorbachev, I think, Ronald Reagan said of Mikhail Gorbachev back in the 80s, that they were working on very dangerous balancing of warheads and ballistic missiles and nuclear arms.

[00:38:12] Lawrence Cunningham: And Reagan said, I trust, but verify. Okay. You reduce those things. Good. Let me just take a quick inspection. And it’s a little like that in a business organization. It’s not. Kurt Blanche, full stop. It’s autonomy with discipline. I call it intelligent autonomy. I like it. 

[00:38:29] Kyle Grieve: So you also mentioned a wonderful quote in that same book, Margin of Trust, which is quote, all directors should act as if there is a single absentee owner and do everything reasonably possible to advance that owner’s long term interest.

[00:38:42] Kyle Grieve: You also mentioned that the CEO not be present during certain parts of board meetings. Why is it so hard for most businesses to adopt this strategy in regards to the board actually trying to look out for the shareholder’s best interest rather than maybe necessarily just the CEO’s best interest?

[00:38:58] Lawrence Cunningham: It’s a great question of the nature of boards. And I should say boards vary greatly across companies. And I think some may be More effective than other, the others less effective on that dimension. And but the reason it’s challenging in any event is that corporations face many different competing claims and have multiple different constituents.

[00:39:23] Lawrence Cunningham: And that’s always been true, but in the past five years, it’s been, that reality has been amplified and boards are now asked to do. Any number of virtuous things promoting certain level of worker diversity or environmental protection or employee security or customer economics and they faced obviously the pressures from the senior executives around the table about What their priorities might be.

[00:39:48] Lawrence Cunningham: So it can, it’s always been difficult for a director to prioritize owner interests, but it has been more difficult in the past three or five years. There’s the answer. I think it’s also been, the rationale is always also has been the same. It’s still hard to do and it’s harder now, but to see how what is best for owners will entail doing right by employees, customers, communities, the environment.

[00:40:14] Lawrence Cunningham: Suppliers, lenders, and everyone else. And so trying to sustain that owner mindset while recognizing the importance of all the other interests is a delicate thing. Not every director can grasp that, articulate it, or remind the CEOs who need it of that. That’s a big framing, Kyle. The second part of your question about the advice that directors should review the CEO’s performance without her or him being in the room.

[00:40:40] Lawrence Cunningham: Here’s a critical point because ultimately every, everything I just said that the board needs to be able to conceptualize that owner interests are derived from other constituent interests. The CEO has to understand, live that too. And that’s a real balancing act because we cannot allow the CEO to.

[00:40:58] Lawrence Cunningham: ignore, diminish owner interest by saying I’ve got to give the employees this significant raise I’ve got to give them a big raise. So my pay doesn’t look so bad. Or I can’t push that price increase through because we’re in a recession or we just pulled out of a pandemic. The CEO’s got to balance that matrix.

[00:41:18] Lawrence Cunningham: As well. And then all it has to do other owner oriented tasks well too, such as a rational capital allocation strategy of the sort we described. So measuring that person’s performance is a critical board function. It’s hard to do as it is and it’s really hard to do if that person’s sitting right there.

[00:41:36] Lawrence Cunningham: And you know this, it’s interesting. 20 years ago that was not a common practice. It was not a common practice. Asked the CEO to leave to have an executive session. But it is now and has been for, I probably. At least eight or 12 years, really common practice and no one objects, no CEO sins. I can’t have the board talking behind my back.

[00:41:55] Lawrence Cunningham: It’s that was, I think one of the more successful governance initiatives or improvements of this generation. We’ve got a lot of governance changes, some better, others not so good, but I’d say that’s probably. The most important, most valuable and successful one or one of the top ones in the past 10 or 20 years.

[00:42:14] Kyle Grieve: So in quality shareholders, you mentioned that Phil Fisher is one of Buffett’s biggest influencers had a great way of comparing companies with restaurants. Quote, just as there are different kinds of restaurants catering to different tastes, there are different kinds of companies catering to different shareholder preferences.

[00:42:31] Kyle Grieve: You mentioned three major types of shareholders, quality shareholders, which you refer to as Q’s in your book. So we’ll refer to them as that here as well, transients and indexers. So before we jump into some more details, would you outline some of the characteristics of each of these shareholder types to people in the audience who are unfamiliar with these terms?

[00:42:48] Lawrence Cunningham: Happy to, Kyle, and thank you so much for reading all of my books so carefully and having such profound questions about them, and thank you in particular on this Quality Shareholders Matrix, and I confess, as you did for me, that I owe this framework to Phil Fisher, who wrote a great book in 1958 called Common Stocks and Uncommon Profits, and Warren, called my attention, called the world’s attention to Phil’s book in, in outlining exactly this in his 1978 letter to Berkshire Hathaway shareholders, in which Warren said, at Berkshire, we want only quality shareholders.

[00:43:21] Lawrence Cunningham: And his definition that I pick up in answering your question now is the quality shareholders have a very long time horizon. Ideally, a holding period forever, and also a high degree of concentration, that is, they pick stocks, and they choose a particular stock because they understand that business, they care about that business, and they want that business, as a business, to prosper.

[00:43:45] Lawrence Cunningham: The two opposites of that are the two you mentioned, the transient shareholder is it’s the short term speculator. You can call them a lot of different things. It’s the day trader or nowadays with AI, the artificial intelligence and the nano trader programs, rapid buys and sells. And it’s plenty of professional arbitrageurs who simply are buying and selling.

[00:44:10] Lawrence Cunningham: Stocks or options on them in order to take advantage of short-term changes in the business or in the perception of the business or in regulations. And I collectively call that whole group transient because they’re not planning for whatever reason to hold the stock indefinitely. We’ve got typically a pretty short sense of getting in and out.

[00:44:28] Lawrence Cunningham: So then the opposite of the quality shareholders on a time horizon. Then the other opposite to the quality shareholder is the indexer. These are. Funds that became famous in the 1990s and now are the dominant players in equity investing. The fund that doesn’t pick stocks at all, but simply buys a little bit of every stock in a huge index, like the fortune, like the S& P 500 or the Russell 2000.

[00:44:52] Lawrence Cunningham: And they’re not picking stocks. at all. They’re picking an index and then buying and selling stocks in proportion to their market cap to hug the index or to replicate the index. There, there are some funds that try to do a little risk on that and they kick a few out, but by and large, they’re not quality shareholder Warren was trying to get who are focused on the economics and character of a particular business.

[00:45:16] Lawrence Cunningham: They’re just looking at the overall market too. And so those are the three primary types of shareholders out there in today’s. markets. And that book is all about those three categories on why the specific features of the quality shareholder, that long term focus cohort, and why that’s attractive as an, from an investor’s point of view and from a company’s point of view.

[00:45:37] Kyle Grieve: So quality shareholders seem to make up a minority of retail and professional investors. What is it about the investing industry think that prevents more retail and professional investors from taking advantage of being a quality shareholder? 

[00:45:49] Lawrence Cunningham: Yeah, I think there may be. It’s hard to measure. We tried to measure it inferentially and with a lot of different data sets and certainly no more than 25 percent of total market cap could be even as low as 15.

[00:45:59] Lawrence Cunningham: But the reason it’s difficult. And one way to think about it is how easy the other two behaviors are. Indexing is so attractive because you don’t have to do any work and you don’t have to pay much money and you get the market return. It’s an ingenious invention. Jack Bogle invented it. The late Jack Bogle, who founded Vanguard, had come up with the idea.

[00:46:19] Lawrence Cunningham: Yeah, talking to his professors at Princeton, but he wrote it up in his graduate dissertation and then turned around and opened up a shop. And it’s been the most successful form of investing ever. So now the giant funds, there, there’s three huge ones and hundreds of smaller ones, all still pretty big, and they don’t have to do anything.

[00:46:37] Lawrence Cunningham: They just have to run a model. You’ve got some back office stuff you got to buy and sell to keep, hug the index or get close, but you don’t have to think, you don’t have to think about, is this business going up or down? Is this manager a superior character or an imposter? You don’t have to think, you just buy the index, boom, and that’s, so it’s, and it doesn’t cost, it costs very little money to do.

[00:46:58] Lawrence Cunningham: And you get the market return that may be minus 18 as it was a couple of years ago, or it might be 34 once in a while, but mostly it’s around nine and that’s great. So it’s super easy and tempting. That’s why large portions of individuals in America have their retirement savings in an index fund.

[00:47:14] Lawrence Cunningham: It’s phenomenally intelligent and wonderful. The trader group, the transient group, that’s, we talked first or third question today, it’s fun. to buy and sell stocks, right? It’s neat to try to get in there and see if you can time something, see if you can get ahead of AMC, or if you can think what is the next big thing?

[00:47:34] Lawrence Cunningham: And then you say gee, I’m pretty sure this is now at the peak. Let’s sell it. Or the more sophisticated making bets on whether this new merger is going to go through or whether the antitrust authority is going to block it. It’s fun. to do that kind of stuff. And less exuberantly, it’s a lot of people are just, they want to try to get things done within a year or two or three.

[00:47:56] Lawrence Cunningham: And as soon as they’re going to take a big position and sell it, they’re not here. They’re not sticking around for five or 10 or 15 years. They’re not thinking that way. They’re not thinking about their retirement or their college, their kid’s college education or grandkids. So those are two reasons why quality sure ordering is less.

[00:48:10] Lawrence Cunningham: Popular indexing and trading are ones lucrative for doing nothing. The other is fun for doing a lot. And then just on the other side, quality shareholding to have the patience and the conviction requires the mental investment in order to decide, okay, I’m not going to sell quickly. You have to be able to stick it out.

[00:48:30] Lawrence Cunningham: You have to be able to ride through those bear markets and avoid being too. the optimistic and the bull. So that’s just hard mentally to do. And to focus, you have to be able to have at least some confidence that your analysis and your judgment of a relatively small number of picks is defensible.

[00:48:50] Lawrence Cunningham: It’s fair and right. And you’re, you won’t lose sleep and you won’t lose your spouse or your house. So it’s just, it’s hard, these activities. It’s hard to be disciplined, but. I hope you’ll ask me what’s the good side. What’s the upside? 

[00:49:05] Kyle Grieve: Absolutely. Let’s talk about that to close it off with what’s the upside of being a quality shareholder.

[00:49:10] Lawrence Cunningham: Thank you. Cause I think it pays off. I obviously compared to the indexer, the trap is you underperform, you make bad decisions and just can’t get it right. You underperform. The real upside is being able to discern high quality businesses run by high quality people and making investments in them at least a fair price and then holding it for a really long time.

[00:49:31] Lawrence Cunningham: And you can perform exceedingly well. And there are lots of examples of individual human beings who’ve done that. Famous examples. We list a whole bunch of in quality shareholders that we’ve got a whole index, a whole appendix of some of the famous people and then funds that they’ve gone on to create.

[00:49:49] Lawrence Cunningham: So I think there’s a lot of upside for the investor. And the related upside is especially as maybe not for. individual stock pickers with a relatively small nest egg, but for larger individuals who come to have significant positions in companies, they have a voice, they have an influence, and they can help companies.

[00:50:09] Lawrence Cunningham: Most shareholders don’t help companies. Those indexers… They don’t know, even those giant money managers, the trillion dollar money managers like, like Larry Finck at BlackRock, he can’t help Warren Buffett. He can’t help Steve Jobs. He can’t help Procter and Gamble. He can’t help the board at Cummins Engine.

[00:50:26] Lawrence Cunningham: He doesn’t have the first idea about any of their business. Doesn’t have any clue. When he’s going out and thinking about big time policy things like emissions disclosures and diversity, that’s not going to help Berkshire. deploy that 150 billion. It’s not gonna help NVIDIA innovate in AI. It’s not gonna help Cisco close that acquisition in cyber.

[00:50:48] Lawrence Cunningham: He doesn’t know the first thing about any of those things. Quality shareholders of those companies, those funds and individuals who spend their careers studying companies and then zeroing in on, say, some of those investments. They’re a brain trust. Warren has great shareholders and he’ll call them and say, or he’ll get those calls from them saying, here’s an opportunity.

[00:51:08] Lawrence Cunningham: Here’s a 30 billion acquisition for you or Steve Jobs. We’ll get to call you. We have the chip that you need, or there’s a way to get that chip to fix that chip. Or here’s your famous quality shareholders who have educated CEOs on capital allocation. Quality shareholders tend to be good at thinking fundamentally about how to use every corporate dollar.

[00:51:28] Lawrence Cunningham: And there are examples in that book of shareholders who helped CEOs learn about how to deploy capital. And that has helped the company help build a better business, help the employees, help the customers, help the holders. And the indexers can’t do that. And the traders don’t even care to try. So there’s a real.

[00:51:45] Lawrence Cunningham: social value in the quality shareholder cohort. They really help corporate America succeed in ways the transients of indexers simply don’t. 

[00:51:55] Kyle Grieve: Lawrence, thank you so much for joining me today. Before we say goodbye, where can the audience connect with you and learn more about you and your books?

[00:52:03] Lawrence Cunningham: LinkedIn is, that’s my favorite. Please do visit me there. DM me check out. And I want to thank you again, Kyle, for having me and for having read all those books and ask such excellent questions about them. I can’t thank you enough. 

[00:52:18] Kyle Grieve: Okay, folks, that’s it for today’s episode. I hope you enjoyed the show and I’ll see you back here very soon.

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