01 July 2024

In today’s episode, Patrick Donley (@JPatrickDonley) sits down with Shawn O’Malley, Chief Editor of our newsletter, We Study Markets, to discuss what his main takeaways were from doing a deep dive into The Essays of Warren Buffett by Lawrence Cunningham.

You’ll learn how Charlie Munger fits into the story of Berkshire, what allowed for Berkshire’s incredible success, how to properly value a company, how Buffett views gold and index funds, the most important aspect of Buffett’s character that stood out to Shawn, plus a whole lot more!

The Essays Of Warren Buffett: Lessons for Corporate America is Cunningham’s seminal work. 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.



  • Why Buffett recommends The Essays of Warren Buffett as one of his favorites.
  • How does Munger fit into the Berkshire Hathaway story and what his role was.
  • Why Munger thought buying Berkshire was a dumb decision.
  • What was it that allowed for Berkshire’s incredible success.
  • How Buffett thinks about risk in investing.
  • What Buffett says about index funds.
  • How to properly value a company.
  • Why Buffett has chosen not to pay a dividend on Berkshire shares.
  • How Buffett views gold as an investment.
  • What one aspect of Buffett’s character that stood out the most to Shawn.
  • And much, much more!


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

[00:00:02] Shawn O’Malley: And so Buffett remains bullish on American dynamism and not wanting to bet against where that innovation can take us. And I just wish more people could appreciate how fortunate we are. It’s a lot easier to look at your neighbor’s house and be jealous of it than it is to think about the incredible advantages afforded to us by living at this point in history, especially in the United States.

[00:00:26] Patrick Donley: Hey guys, in this week’s episode, I had the pleasure of sitting down and talking with my friend and colleague, Shawn O’Malley, Chief Editor of our newsletter. We Study Markets to discuss what his main takeaways were from doing a deep dive into The Essays of Warren Buffett by Lawrence Cunningham. In this episode, you’re going to learn how Charlie Munger fits into the story of Berkshire, what allowed for Berkshire’s incredible success, how to properly value a company, how Buffett views gold and index funds, the most important aspect of Buffett’s character that stood out to Shawn, plus a whole lot more.

[00:00:57] Patrick Donley: The Essays of Warren Buffett: Lessons for Corporate America, is Cunningham’s seminal work. He was a professor of corporate governance for 15 years at George Washington University, and he serves on the board of directors for several public businesses, such as Constellation Software and Markel Group.

[00:01:13] Patrick Donley: Buffett has been sharing his thoughts on business and investing to Berkshire Hathaway investors for years, and Cunningham has done a masterful job in distilling these ideas into a book that is comprehensive, non-repetitive, and easily digestible. This is the book that Buffett most frequently recommends to aspiring investors that want to learn how the sage of Omaha sees the world of investing. Without further delay, let’s dive into today’s episode with Shawn O’Malley to learn about The Essays of Warren Buffett.

[00:01:45] Intro: Celebrating 10 years, you are listening to Millennial Investing by The Investor’s Podcast Network. Since 2014, we interviewed successful entrepreneurs, business leaders, and investors to help educate and inspire the millennial generation. Now for your host, Patrick Donely.

[00:02:12] Patrick Donley: Hey everybody! Welcome to the Millennial Investing Podcast. I’m your host today, Patrick Donely, and joining me in the studio today is the editor of We Study Markets, Shawn O’Malley. Shawn, welcome to the show.

[00:02:22] Shawn O’Malley: Hey Patrick. Thanks for having me. I’m excited to chat.

[00:02:26] Patrick Donley: I am too. I think it was about a month ago we had you on.

[00:02:29] Patrick Donley: We talked broadly about a lot of different things. We touched on books a little bit. I think you mentioned Nassim Taleb as being an influence, but you have read really widely and one of the books you’ve read recently is The Essays of Warren Buffett by Lawrence Cunningham. So I wanted to really do a deep dive into your learnings on that book specifically.

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[00:02:49] Patrick Donley: And referencing the book, Buffett said that the author, Larry Cunningham, did a fantastic job at capturing Berkshire’s philosophy. He even said that if you were to pick one book, that this would be his recommendation of what to learn about Buffett and to learn about Berkshire. What do you think it is about this book that makes it such a unique book that Buffett loves?

[00:03:10] Shawn O’Malley: Well, he’s definitely biased and I’m sure if you asked him, he’d find some witty way to kind of humbly acknowledge that. That’s because Buffett essentially wrote the book over 40 plus years of annual letters to Berkshire shareholders describing the company’s operations. His investing philosophy is big picture views of the American economy, what works in business and what doesn’t and a whole lot more.

[00:03:33] Shawn O’Malley: Cunningham kind of painstakingly read through these letters, found a number of important themes and edited them together into what we call the essays of Warren Buffett, which is just this really wonderful book to read through. So the book is much bigger than just being a testament to Buffett’s track record though.

[00:03:48] Shawn O’Malley: It’s a chance to see the evolution and thinking of one of history’s greatest capitalists. And a wonderful accounting of what it’s worth for Buffett and his partner, Charlie Munger and their very long careers. And I just find it inspiring and, kind of our fast changing world today where new technology promises to up in our lives.

[00:04:09] Shawn O’Malley: And middlemen and outside consultants seek to extract fees from us along the way for managing our money. Buffett and Munger are a beacon of rationality and clarity that have offered wisdom and knowledge to generations of investors hoping to think for themselves.

[00:04:26] Patrick Donley: So you mentioned Charlie Munger and most of our audience is probably familiar with him, but it’s obvious that the book isn’t called the essays of Buffett and Munger.

[00:04:34] Patrick Donley: Munger died, I think in late 2023, something about a month shy of his, what would have been his hundredth birthday. How does he fit into this book and the entire story of Berkshire Hathaway?

[00:04:45] Shawn O’Malley: Yeah, it’s not included in the book, but in Berkshire’s latest shareholder letter for 2023, Buffett really doesn’t mince his words about Munger’s significance.

[00:04:55] Shawn O’Malley: He calls Munger the architect of today’s Berkshire Hathaway, with himself just being the general contractor hired to fulfill that vision on Munger’s behalf. And I’m quoting here, he says, Charlie never sought to take credit for his role as creator, but instead let me take the battles and receive the accolades. And I think to some extent that says a lot about their relationship.

[00:05:17] Shawn O’Malley: I’d say with pretty high conviction, that’s not just, false modesty from Buffett. Munger changed how Buffett thinks about investing and despite Buffett having already had a pretty fabulous track record, that subtle change allowed Buffett to adopt a new approach that ushered in decades of more success for Berkshire shareholders.

[00:05:39] Shawn O’Malley: I think you could just as easily call this book the essence of Warren Buffett and Charlie Munger, but it’s sort of a technicality just because the writings are from just Buffett as Berkshire CEO, but they’re definitely hugely shaped by Munger’s insights and their shared lessons learned about life and business and investing.

[00:05:59] Patrick Donley: So in that 2023 shareholder letter, Buffett mentioned that in 1965, Munger correctly called his decision to buy Berkshire Hathaway dumb, but he offered a solution for fixing it. And he told him to never buy a company like Berkshire again, but since he already owned it, that he should add to it his holdings by owning wonderful businesses at fair prices.

[00:06:21] Patrick Donley: Tell us a little bit more about why buying Berkshire was a dumb decision for Buffett. And then ultimately like how Munger changed. How Buffett thinks about investing and then ultimately how he has invested over the years.

[00:06:34] Shawn O’Malley: Yeah, it seems pretty crazy, doesn’t it? To say that anything fundamental about Berkshire Hathaway was dumb, given that it’s essentially has the best track record in history for creating value for shareholders over many decades.

[00:06:47] Shawn O’Malley: Since 1964, Berkshire’s compounded market value has grown over 4. 3 million percent versus something like 31,000 percent total return for the S&P 500 index, which is still pretty good by the way. But you know, that’s just incredible performance coming from Berkshire. And that wasn’t always the case.

[00:07:05] Shawn O’Malley: Berkshire got a second life when Buffett took control of the company, which at the time was just struggling. Textile business in a dying industry in the US, and I think that decision was a mistake in two keyways. The first starters for starters, Buffett’s decision to take a majority stake in the company was at least partially fueled by vengefulness.

[00:07:28] Shawn O’Malley: After Buffett had begun accumulating shares in Berkshire, the company CEO at the time personally gave Buffett his word. That the company would buy back shares from him at a price of 11 and 50 cents per share using cash from some recently sold textile mills. So Buffett agreed and was preparing to sell his shares back to the company to make a small profit.

[00:07:49] Shawn O’Malley: The problem was that when the offer arrived on Buffett’s desk, Berkshire only offered to buy his shares for about 11 and 38 cents, which is kind of a famous story now. And, driven by emotion and not really any kind of investing logic at all. He took offense over this difference of, less than 13 cents per share and completely pivoted toward really aggressively buying shares and Berkshire Hathaway, just so that, kind of out of spite.

[00:08:14] Shawn O’Malley: He could fire the CEO. And it was actually this great moment in 2014, where Buffett calls this decision, monumentally stupid, basically, because it was just entirely childish behavior. And in 2010, he said something similar and basically says that he hadn’t made this blunder of emotion. It wouldn’t really do the same company name as it is now, but whatever holding company he ran, if he’d taken that money and invested it into buying wonderful businesses, especially insurance businesses.

[00:08:41] Shawn O’Malley: That holding company would probably be worth twice as much as Berkshire Hathaway is today. And we’re talking about hundreds of billions of dollars. So you, when you think about it that way, you can actually see, why he considers this a pretty big mistake. So the decision itself to buy control over Berkshire was obviously flawed where Charlie Munger’s wisdom comes in is on that last point about choosing instead to buy great businesses.

[00:09:05] Shawn O’Malley: Buffett’s original interest in buying Berkshire shares followed the teachings of his professor, Benjamin Graham, who taught him about cigar butt investing, which I think is another kind of pretty well known story. But you know, for anyone who doesn’t know, it’s where you look for cigar butts left on the street with one last puff in them that you can essentially pick up for free.

[00:09:24] Shawn O’Malley: And that’s a metaphor for the type of opportunities that Buffett is looking for as an investor at this time, and he’s done pretty well doing it. He’s looking for, the struggling or dying businesses with shares priced so cheaply that you can get one last puff of profit from them extracted as an investor.

[00:09:41] Shawn O’Malley: And sometimes these cigar butt stocks would be cheaper than the per share value of their cash and intangible assets. So you could sell off your assets and use cash to buy back shares and, you could essentially buy a dollar’s worth of assets for 80 or 90 cents and, automatically realize that 10 or 20 percent return and that line works fine, but it’s not scalable.

[00:10:02] Shawn O’Malley: Those sorts of opportunities don’t really exist in the same way today. And even 60 years ago, there was a limit to how many you could find and just the amount of due diligence that was needed to kind of dig through those almost like corporate arbitrages and figure out, what the assets on this company’s balance sheets were worth.

[00:10:18] Shawn O’Malley: So Buffett had this problem where he had made a lot of money with cigar, but investing and he’s in the middle of his career and now he has a huge chunk of wealth. Concentrated and kind of the ultimate cigar, but company Berkshire Hathaway and this industry that, he knows nothing about.

[00:10:33] Shawn O’Malley: And so that’s when Munger comes into his life and gives him the solution that, this is, hey, going forward, focus on just getting wonderful businesses at fair prices instead of fair businesses at wonderful prices. And that’s just going to make your life a whole lot easier. Cause with truly great businesses, you can hold them forever and they’ll just keep compounding on your behalf.

[00:10:53] Shawn O’Malley: It’s more scalable, but it’s also just simpler. You only have to make one or two really great decisions a year and find those really great companies that you can own for a lifetime. And we’re just like at Buffett, we’re thinking companies like Apple, Coca Cola, American Express that have just been, titans of creating value for shareholders across several decades.

[00:11:13] Patrick Donley: So, with Munger’s help, Buffett starts focusing less on these cigar butt, ultra cheap stocks and instead starts thinking about owning companies that would be worthwhile to hold for decades, maybe even a lifetime. There’s obviously a lot more to the story though. What do you think has made Berkshire Hathaway such a special company?

[00:11:32] Shawn O’Malley: Yeah, I mean, it kind of pains me to say this. There’s definitely an element of luck involved. That’s not meant at all to kind of discount what Charlie and Warren have accomplished, but I think even they would acknowledge that for them to recreate the kind of success that they’ve had in their careers and another life.

[00:11:50] Shawn O’Malley: Starting from scratch, even with what they already know, it would just be very difficult and the odds are sort of stacked against you. Still, there are things that make Berkshire special. Part of that is Buffett’s focus on ensuring that Berkshire never incurs a permanent capital loss. It’s often said, I’m sure you’ve heard people say this, they have a fortress balance sheet, and that is intentional.

[00:12:12] Shawn O’Malley: That’s the DNA of the company is to be structured that way. So while Berkshire could have followed other companies and even do such returns further by relying more heavily on debt, that would have made Berkshire more vulnerable to downswings and the economy or financial crisis where Chances to borrow money dry up and force a dash for cash.

[00:12:31] Shawn O’Malley: I think you can pretty safely say that there’s not many examples in history of companies that went bankrupt with no debt. It’s pretty hard to do. But on the other hand, debt is a form of leverage that can accelerate a business’s growth, and that’s very addictive. And I think part of it for Buffett is to kind of acknowledge that returns could have been better in theory with that over time.

[00:12:51] Shawn O’Malley: But that’s saying, my life would be better if I just smoked, one cigarette a day. Like, it’s just a temptation that you don’t want to get into. And like, even a short absence of credit can bring a company to its knees. And like, just look at the 2008 financial crisis as evidence of that.

[00:13:05] Shawn O’Malley: So part of the success is just being able to survive longer than anyone else. And, in a given year, if you roll the dice enough, because investing is like inherently in the short term, a game of randomness, you could easily outperform Buffett on a year to year basis, but across a lifetime, the odds that you’re going to roll the dice in the right way to be able to beat somebody like him.

[00:13:28] Shawn O’Malley: Over decades, it’s just not realistic, but you’re eventually going to get wiped out. And really, to me, the difference is that Buffett is not rolling the dice. He knows the risks facing his businesses pretty much as well as anybody possibly could. And then he keeps this massive cash cushion to basically hedge against what he doesn’t know.

[00:13:46] Shawn O’Malley: And the reality that there are a lot of things he doesn’t know. And so this sort of opens a whole other can of worms about investing risk and how to think about that. And I think while most business schools and academics teach that risk can be measured by price volatility, it’s again, this is like well-known stuff, but to say that, like, obviously, Buffett does not see risk as being just like price swings risk to him is that a business’s intrinsic value will decline over time.

[00:14:12] Shawn O’Malley: Destroying the value of the capital that’s invested in it, which is, I keep saying capital impairment and how that is kind of especially permanent capital impairment. How bad is fundamentally what the risks you face as a capital allocator are in investing. So in terms of what else makes.

[00:14:27] Shawn O’Malley: Berkshire special, much of that has to do with, I think the top down standard that is set by Buffett and Munger, where they avoid as much as possible, these so called ABCs of business decay, which they talk about in the book, and those ABCs stand for arrogance, bureaucracy and complacency. So, for example, many CEOs and business leaders fall into this trap that Buffett calls the institutional imperative, where it’s far easier to maintain the status quo.

[00:14:52] Shawn O’Malley: Or follow others lead that it is to make bold changes. If you manage a company with a poor outlook, your options are basically either to reduce the size of this kingdom that you rule over as being a corporate executive by paying out cash to shareholders in the form of dividends. Or you can basically reinvest into that bad business and keep growing that bad business.

[00:15:14] Shawn O’Malley: Or you can try to pivot into an entirely new industry that you’re probably not really equipped to tackle. And so I think that’s how a lot of CEOs get trapped into just reinvesting in terrible businesses where in hindsight, it, so obvious, like, why would you keep plowing money into cable or textiles or newspapers?

[00:15:29] Shawn O’Malley: Like when these things are dying and there’s an element of ego there where you have to say like, well, for this CEO to make that decision, they would have to acknowledge business failures of the past and even a lack of foresight to anticipate some of the risks that were coming. And I think what’s special again about Berkshire is that with this conglomerate structure, you can really avoid that altogether.

[00:15:47] Shawn O’Malley: Buffett can allocate capital towards its most optimal uses without any biases. If anyone, any one of Berkshire’s businesses cannot effectively reinvest all of its operating earnings. It’s CEO has this added option of sending the cash flows upstream to Warren and Charlie will happily put it to use and hope probably to find a better use for it based on their track record.

[00:16:08] Shawn O’Malley: And I think that rationality and common sense just permeates Berkshire and ways that are uncommon across the rest of corporate America. And part of the reason is that, most major companies aren’t run by people who truly have skin in the game, like Berkshire Hathaway’s leadership does, CEOs and other executives are sort of often hired hands whose incentives really don’t perfectly align with shareholders’ interests.

[00:16:29] Shawn O’Malley: And that’s something Buffett has really talked about at length over the years. And when you look at Berkshire Buffett, as did Munger has almost his entire net worth and many of his relatives invested in Berkshire. So he benefits in the same proportion as everyone else who owns the stock. In the company.

[00:16:46] Shawn O’Malley: And as your CEO, of course, he acts accordingly. And that stands in really like stark contrast to most of the CEOs who get massive compensation packages of both cash and stock options, usually tied to performance goals. Instead of, thinking like long term owners of the business, they’re more likely to focus on what’s needed in the short term to hit those targets and unlock more compensation for themselves.

[00:17:09] Shawn O’Malley: But at Berkshire, no one is paid in stock because that dilutes the value of all of their shareholders stakes in the company. And, instead of management of subsidiary businesses, our instead management of subsidiary businesses are paid cash bonuses based on individual performance and heavily encouraged to use that cash to buy shares of Berkshire at the same prices available to everybody else in the market.

[00:17:32] Shawn O’Malley: And at the end of the book, there’s this essay from Charlie Munger where he highlights what he thinks has made Buffett and Berkshire so special by building up a unique blend of corporate ownership and control. Buffett could craft an equally unique kind of principles focused corporate culture. And part of that extends simply to just this Motto of creating win wins and treating business managers, how he would want to be treated, Buffett does not micromanage any of the management of Berkshire subsidiaries.

[00:18:03] Shawn O’Malley: He doesn’t even get set budgets from them. He just, shows some trust and in doing so he earns theirs. It’s really the same thing he’s done with shareholders over the years, which is why 40, 000 people crammed into a stadium in Omaha to listen to all day Q and a sessions with Buffett and Munger, because of that transparency, he’s offered to shareholders and the trust he’s built with them.

[00:18:26] Shawn O’Malley: Berkshire has probably the highest quality shareholder base of any major us company. One really crazy stat that stood out for me in the book is at one point, Buffett mentions that 98 percent of Berkshire shareholders are the same people who own the company at the start, or at the end of the year, 98 percent of Berkshire shareholders are the same people who own the company at the start of the year.

[00:18:49] Shawn O’Malley: And for 90 percent of those investors, Berkshire is their largest single stock holding. That’s just really rare. And you attract the shareholder base you deserve. And I think Berkshire reflects that. A focus on short term results would attract a very different Shareholder base and bring a lot more churn and who owns the company and like I said, it’s essentially no churn there and it’s a pretty good illustration of how lots of things have compounded favorably for Berkshire beyond just investment results.

[00:19:18] Shawn O’Malley: Goodwill customers, shareholders, regulators, and the public at large has all compounded to Berkshire’s benefit as well as trust with employees and even trust. From, CEOs and other business managers who feel comfortable selling their stake in their business to Berkshire and kind of sleep better at night, knowing that it’s in Buffett’s hands rather than in a competitor’s or in some wall street, private equity firms.

[00:19:44] Patrick Donley: You mentioned that Buffett thinks differently about risk than many academics and even many on wall street. Talk to us a little bit about what’s so unique about how he thinks about investing.

[00:19:56] Shawn O’Malley: If you’re to believe modern financial theory, then it’s essentially pointless to think about investing at all because, and they’re all known information is priced into stocks at all times.

[00:20:07] Shawn O’Malley: There’s going to be almost no chance that you can reliably beat the market averages because you have no special advantages working in your favor. Proponents of this idea would pretty much just tell you to buy a broad market index fund and accept mediocre returns by definition, right? You’re going to get the average of what the market delivers over time.

[00:20:25] Shawn O’Malley: And Buffett’s track record is sort of fundamentally a rejection of that premise. For those willing and able to think for themselves, Buffett shows that the markets aren’t perfectly efficient. And it’s possible to gain an edge over time. And I think to some extent, that’s because markets are driven by humans.

[00:20:42] Shawn O’Malley: Humans are emotional and emotions lead to stakes, which like, it’s kind of crazy that you even have to say that and point that out. Yeah. We seem so obvious, but you know, when you’re in this academic theoretical setting, that kind of stuff gets overlooked. And one of my favorite examples for this that really resonated is how.

[00:21:02] Shawn O’Malley: Conventional financial wisdom gets it wrong when it comes to one of Wall Street’s favorite buzzwords, beta. Beta is essentially used to compare how a company’s stock trades relative to the broader market averages. Companies with higher betas What in theory have more volatile price swings, which, most finance aficionados would tell them by definition makes them riskier.

[00:21:24] Shawn O’Malley: And as Buffett points out, in many different shareholder letters, this is just the exact wrong way to think about it. If a stock falls dramatically, its price is now much cheaper. Making it less risky, not more by buying at a lower price. You now have a greater margin of safety. If your thesis about the company’s quality is wrong, if anything, more volatile stocks give you more opportunities to buy ownership and the company on sale, it just seems so obvious, but that has not been my experience with how a lot of investors think about risk and the opportunities and financial markets.

[00:21:58] Shawn O’Malley: Like I can remember back to my business school classes where essentially the message was, if something has fallen a lot. It has negative momentum and therefore it is riskier to own and not thinking of it as like, no, like this is a piece of merchandise that just went on a 50 percent sale that is now significantly cheaper.

[00:22:16] Shawn O’Malley: And one of the, one of the great case studies that Buffett offers on this is the dot com era tech bubble. And it just kind of shows a lot of the flaws with the efficient markets hypothesis as it’s also known, which is this idea that if stock prices represented the discounted cash flows. That can be taken out of a business over time.

[00:22:33] Shawn O’Malley: How do we reconcile that with the crazy price swings and internet stocks in the 1990s stocks would routinely crash. They’d rise from the ashes and then they’d crash again all over the course of a couple of weeks. And so, it just begs the question of, is it really logical to. Except this kind of academic idea that, well, the real value of the business was swinging that much correspondingly with the stock prices.

[00:22:59] Shawn O’Malley: Is it really possible that from one week to the next, a company is suddenly worth 50 percent less? I don’t think so. And today I think it’s more accepted that markets aren’t perfectly efficient yet. Many investors don’t take the next logical step where they really assess the models and the ideas that they still use that are derivative of this idea that markets are perfectly efficient and really are kind of implicitly saying that they see price swings as risks in the underlying business, not emotional swings from folks who are irrationally optimistic or pessimistic about a company’s future.

[00:23:32] Shawn O’Malley: Prospects and with Buffett’s track record, he shows that even though price volatility is perceived as risk by most on wall street, the only risk is permanent impairment of capital. His journey has been volatile, but that’s why, with a concentrated portfolio and a deep understanding of his businesses, he can avoid that kind of impairment and compound at rates in excess of the market averages.

[00:23:57] Shawn O’Malley: Pretty reliably over time. I mean, and for years in Berkshire’s shareholder letters, Buffett has highlighted these flaws in mainstream financial thinking, but you could actually say in some ways it works against him to do that. If you have a bunch of, Investors who are essentially your competition and this intellectual game of stock investing, and they all subscribe to this idea that, all information is reflected into stock prices at all times, and they buy into, pretty much everything.

[00:24:22] Shawn O’Malley: Thinking that they don’t need to think for themselves, because like I said, all the information is reflected in stock prices and you have a huge leg up. You have this enduring advantage where you can recognize. That there are these inefficiencies in market pricing and capitalize on those. And again, it’s just this piercing rationality that really stands out with Buffett and Berkshire.

[00:24:42] Shawn O’Malley: And this is common sense stuff, but at the same time, it really demonstrates that expression that, common sense isn’t so common.

[00:24:50] Patrick Donley: There’s still something to be said for index funds and passive investing, even if we do reject the efficient markets hypothesis. Talk to me a little bit about how Buffett thinks about index funds.

[00:25:02] Shawn O’Malley: He would endorse them, and he does. Basically, if you can’t do the work to value companies, either for lack of knowledge or time, Buffett routinely recommends Broad index funds for those types of people. It’s a well-documented and very reasonable approach to investing. That said, I think Buffett makes some pretty compelling reasons to take the extra step and understanding and valuing great businesses.

[00:25:25] Shawn O’Malley: He gives us example where he suggests that you should look around your city and consider some of the wonderful businesses there are there. And if you had the chance to invest in them, you might jump on it. Yeah, and some of the popular bars and restaurants in town, even home builders, insurance companies, banks, that sort of thing.

[00:25:41] Shawn O’Malley: There’s so many different types of businesses that come to mind, but obviously they aren’t all created equally. And if you had the chance between owning a stake and a few of, clearly the most profitable and best businesses in the city that you live in. Versus, owning every business that operates in your city and kind of diluting the concentration of your ownership in those best companies, which one are you going to choose?

[00:26:02] Shawn O’Malley: And I guess the takeaway is, why do we, when we expand our universe of investing from, beyond just our own city, but we look Around the country and around the world. Why are we so happy to dilute our stakes in the best companies and instead own a much broader range for the sake of quote unquote diversification?

[00:26:21] Shawn O’Malley: So I think if you are going to focus on index investing, which again is perfectly valid strategy, the main thing to really focus on is removing. As many fees and frictional costs as you can, which is, it’s just good investing base. Generally, on that point, Buffett shows that there’s this, he has this hypothetical where one family owns every single us company and each generation, they get richer.

[00:26:43] Shawn O’Malley: And all the benefits of those businesses compounding their returns on capital are fully earned by the family. Obviously, eventually though, you probably expect that at some point, family members are going to get greedy. And look for ways where they want to outperform their relatives and get even richer than them.

[00:26:58] Shawn O’Malley: So they hire outside consultants to make the recommendations for stocks to buy and which ones to sell. And, for those recommendations, they have to pay a small fee. And as they trade more and more, they pay commissions each time. And while the family previously had the entire pie of financial wealth, now a small slice of that wealth paid out in fees and commissions belongs to these middlemen and consultants.

[00:27:20] Shawn O’Malley: And so as they hire more and more assistance, like financial advisors and hedge fund managers who all promised to help them create more wealth, they go from owning the entire pie of wealth that you could possibly own. To, carving out an increasingly bigger slice of that pie to these middlemen who are stacking up advisory fees and management fees and.

[00:27:41] Shawn O’Malley: Trading costs. It’s an extreme hypothetical, but the point remains, if you owned all of the financial assets in the world, the only thing that can prevent you from realizing the full returns on those earnings is personal costs to middlemen and fees. So the message remains the same, whether you own a hundred percent of every stock or just a fractional one, the difference between the returns delivered by the stocks you own and the rate at which you come down to your wealth.

[00:28:07] Shawn O’Malley: Are the frictional costs of having middlemen and the fees you pay to them. The lesson being that if you’re going to invest in index funds, make sure you’re reducing those costs as much as possible.

[00:28:19] Patrick Donley: Going back to the idea of trying to pick great businesses to own, which Buffett writes about in most of the shareholder letters, I wanted to get your thoughts on how somebody should or could or would go about trying to value these great businesses to own.

[00:28:35] Shawn O’Malley: I think my favorite example from the book comes from when Buffett quotes Aesop, who lived over 2,000 years ago, and you might recognize, he’s credited with the collection of stories known as Aesop’s Fables. Buffett says, in hindsight, that is, quote, a bird in the hand. Is worth 2 in the bush really perfectly encapsulates this idea of what it means to value a business and investing and also the time value of money concept.

[00:29:04] Shawn O’Malley: And that is, how many potential birds should you exchange for 1 bird? You already have. And actually, I really love this kind of alternative version of it that Buffett gives where he says, yeah, if you have trouble understanding what that means. Imagine, how many girls and how many phone numbers in the phone book are worth one girl in the convertible sitting next to you.

[00:29:22] Shawn O’Malley: It’s a pretty good way to think about, like, the tradeoffs of, like, what you currently have versus what you could theoretically have. Right? And so I guess, to value the bush, he gives these 3 questions to answer. And he says, how certain are you that there are birds in the bush? When will they emerge?

[00:29:37] Shawn O’Malley: And how many birds will there be? And then what is the risk free interest rate at the time? And so with that information, we could theoretically calculate the maximum value that you should pay for the Bush and the process is the same for value in companies. Things like dividend yield and growth rates, which, people love to fixate on and quote, aren’t actually fundamentally part of that valuation equation.

[00:30:00] Shawn O’Malley: They’re really only relevant insofar as they provide insights to the expected cash flows from that business. In other words, when you go to exchange the cash, you have today for shares in a company, you want to know the odds that the company will generate returns on your capital that pay off your investment in more.

[00:30:17] Shawn O’Malley: And how certain are you that the business will continue earning? Profits, how much profit will learn and over what time period? And then, what’s the opportunity cost of giving up your cash to invest in this company? These are all the sorts of questions you’re going to want to ask yourself. And the opportunity cost in this case is measured by the risk free interest rates.

[00:30:35] Shawn O’Malley: And that’s the easiest one to know, right? You can just look at what treasury bonds are paying and maybe the rate on your savings account. And you can kind of approximate that. The rest is a lot less certain, which is why, this becomes more of an art than a science. You probably have a reasonable range of values for the cash flows that you can project a business will produce over its lifetime, but you certainly cannot predict that.

[00:30:57] Shawn O’Malley: Exactly. So, in the same way, when you come up with an intrinsic value assessment of a company, it’s not going to be a specific number. It should be a plausible range. And for most companies, and this kind of taps into, Buffett famously puts things into the too hard basket, where if you can’t understand it, he’s just having to deal with it.

[00:31:16] Shawn O’Malley: And if you can’t come up with an actionable range of intrinsic values for your company, then just set it aside. And that’s perfectly okay. Buffett would tell us to focus just on the companies where we can calculate that intrinsic value number with the most confidence and with the narrowest range of intrinsic values, and then focus on buying those companies at discounts to their intrinsic value.

[00:31:38] Shawn O’Malley: But at the same time, him and Charlie don’t even agree about Berkshire’s own intrinsic value. And we’re talking about, two people that would know that better than anyone who are both geniuses in their own right and are been closely involved with the company for decades, and they still, can’t agree in a way where they would feel comfortable publishing an official intrinsic value number for the stock in the annual shareholder letters.

[00:32:00] Shawn O’Malley: So, in terms of assessing Berkshire’s intrinsic value, I think all you can really do is try to calculate it for yourself or look at when the company is buying that stock, which Buffett has promised only to do when the stock is at a discount to its intrinsic. I guess I want to do like a brief tangent here because.

[00:32:16] Shawn O’Malley: I know buybacks are always controversial to that last point, but I think the economics for companies buying back shares and reducing their shares outstanding is pretty straightforward. Just imagine that a business with three equal partners worth $3,000. If two of the partners go to buy out the third for $900, they both realize a gain of $50.

[00:32:38] Shawn O’Malley: Right? They paid $900 for a stake worth a thousand dollars and they split a hundred dollars difference. It’s the same thing when a company buys back. A share of its stock when they can do so at a discount to that intrinsic value of what the company is actually worth. And at the same time, they increase all ongoing shareholders’ ownership in the company and it can actually unlock value for them.

[00:32:59] Shawn O’Malley: But at the same time, what is price what’s smart at one price is it’s really stupid at another. Obviously, you wouldn’t pay $1,100 for a steak only worth a thousand dollars. That would be a bad move. So that’s where you really get into having that margin of safety when you buy back. Stocks at a discount to their intrinsic value.

[00:33:16] Shawn O’Malley: And I guess I’ll just add one more nugget here that in his letters, outline the five main risk factors for investing and try to value companies. And those boil down to similar to what we’re talking about with ASAP’s metaphor of. With what certainty you can evaluate a business’s economics, the certainty with which management can be expected to realize the business’s full value and wisely redeploy the cash flows that the business generates, whether management can be counted on to channel the business’s rewards to shareholders or themselves over time, the purchase price being offered.

[00:33:53] Shawn O’Malley: And the levels of taxation and inflation that would be experienced during your sort of investing time period. And I think this is really kind of agonizing stuff for academics who will find this hard to quantify in back tests, but to a real investor, it’s similar to the legal standard for obscenity, which is something along the lines of, you’ll know it when you see it.

[00:34:15] Shawn O’Malley: I think that when you find a company that you really understand the economics and you feel really comfortable with management and you can see that it’s generating a ton of cash and reinvesting it, well, you’re going to know it when you see it.

[00:34:28] Patrick Donley: One famous aspect of owning Berkshire stock that surprises a lot of investors is that the company pays no dividends. Could you tell us why Buffett doesn’t want Berkshire to pay dividends, even though his mentor, Ben Graham, use dividend history as an indicator of quality stocks to invest in.

[00:34:46] Shawn O’Malley: Yeah, you could get pretty technical with it, but it kind of boils down to the reality that Buffett thinks Berkshire can generate more value for shareholders by reinvesting a dollar of earnings.

[00:34:59] Shawn O’Malley: Rather than paying it out to shareholders who have to pay taxes on that dividend income and then reinvest what’s left over into to other stocks, it kind of at a minimum. It’s a way to avoid double taxation. Berkshire already pays corporate income taxes on its earnings. So if it paid you a dividend, you’d have to pay personal income taxes again on those same dollars.

[00:35:19] Shawn O’Malley: But if Berkshire retains that dollar and reinvest it. That no such double taxation occurs, at least for you as a shareholder. And more technically, it has to do with using a dollar of unrestricted earnings to create more than 1 of market value. And just to step back and kind of clarify that for a second, there’s essentially two types of earnings that Buffett describes restricted and unrestricted.

[00:35:45] Shawn O’Malley: And as a result, not every dollar of corporate earnings is created Restricted earnings are the portion of the company’s profit that you have to make, reinvest to maintain your market share and basically to keep the business functioning as it is. And so an example of that would be like, if you run a grocery store, you’re going to have to every couple of years refurbish it.

[00:36:04] Shawn O’Malley: Otherwise the store is going to deteriorate and you’re going to lose customers. So that’s also what people call maintenance capital. It’s what you would use those restricted earnings for, whereas any dollars not needed for that reinvestment. Our unrestricted earnings, and that’s where you get a lot more discretion with what you can do with those dollars.

[00:36:22] Shawn O’Malley: These can basically be used to either buy back shares, pay dividends, or reinvest into new projects or try to diversify into other businesses. But if you can take a dollar of those unrestricted earnings and create more than one dollar of market capitalization value for the company, then you’re creating value for shareholders.

[00:36:40] Shawn O’Malley: And based on Buffett’s track record, it’s pretty safe to say you shouldn’t be paying out dividends because you’re going to create more value and compounding the equity value of the company over time.

[00:36:49] Patrick Donley: I wanted to switch gears a little bit and talk about gold. Buffett’s been very critical about investing in gold, which a lot of people would see as a way to protect their wealth against currency debasement as a hedge against inflation.

[00:37:01] Patrick Donley: A lot of people see Bitcoin doing something similar, but Buffett is even more versed to Bitcoin, obviously. He’s at least willing to invest in gold mining businesses. I can’t imagine him investing in any Bitcoin mining businesses ever in his lifetime, for sure. But I wanted to hear your thoughts on how Buffett thinks about investing in gold, and what his stance is there.

[00:37:24] Shawn O’Malley: Part of Buffett’s issue with gold is that he hasn’t found a good way to value it. Aesop’s valuation metaphor about, a bird in the hand being worth two in the bush works with stocks and bonds because they produce cash flows that can be discounted into a value today. But unless you’re investing in a gold mining business, Gold itself doesn’t produce any cash flows, and it doesn’t help that gold doesn’t have any utility or very limited utility, right?

[00:37:49] Shawn O’Malley: There aren’t that many industrial uses for gold other than to just kind of look at it. I think Buffett calls it a shiny rock, and that isn’t to say that all commodities are lacking in utility. When you look at corn, it’s one of America’s most widely grown crops, and it’s basically used in everything from cereal to ethanol.

[00:38:07] Shawn O’Malley: So that pretty clearly has utility, maybe you still can’t value it in an intrinsic value way, but you know that we’re always going to have need for corn. And that means it’s going to at least always have some value when it comes to gold, though, you lose that kind of margin of safety with the utility that it offers, because you don’t know.

[00:38:27] Shawn O’Malley: What its role will be in the future, and you’re essentially hoping that we’re speculating that somebody in the future will want to pay more for this shiny rock. Then you bought it for and I just think that, at the core of Buffett’s investment philosophy, he would not consider that investing and it’s fine to speculate and gamble and roll the dice.

[00:38:47] Shawn O’Malley: It’s fun, but you’re funnily thinking as an investor and somebody who’s deciding to allocate capital towards productive resources in society. Gold just doesn’t really fit into that. And 1 of my favorite ways that Buffett conveys this is that in 1 of his letters, he basically writes that if you melted down all the world’s gold into a single cube.

[00:39:08] Shawn O’Malley: It would fit into a single baseball field. And I think it would pile up like 67 feet tall or something like that. And that massive gold cube would at the time Buffett wrote this letter would be worth 9. 6 trillion. And with all that gold that you could have bought. All of America’s farmland plus Exxon Mobil 16 times over and still had an extra trillion dollars lying around.

[00:39:34] Shawn O’Malley: So between those 2 options, what would you rather have? One that is likely but not guaranteed to hold its purchasing power and maybe somebody will pay more for it down the road or the other that is, pretty certainly going to compound It’s value over time. And I would say, Buffett believes that grows great companies, like owning the apples and Microsoft’s in the world.

[00:39:55] Shawn O’Malley: We’ll take those dollars and turn them into a lot more than owning gold ever could. And if you actually look at it today, I think all the gold in the world is worth something like 12 trillion or probably more, which would actually mean that with the S and P 500, I think the market capitalization of all the companies in the S and P 500, something like 45 trillion.

[00:40:12] Shawn O’Malley: So with all of the world’s gold today, you could buy one fourth. Of the ownership stakes in America’s biggest companies. And so again, it’s like, kind of the question is up to you. Like, would you rather own a fourth of all of America’s best businesses, or would you rather own a bunch of shiny gold?

[00:40:28] Patrick Donley: Shawn, this has been a lot of fun just digging into Warren Buffett and his investment wisdom. Was there any last thoughts that you wanted to share with us about the essays of Buffett, some kind of extra stuff that you gleaned?

[00:40:40] Shawn O’Malley: Buffett’s optimism, which is rare in our society today. Unfortunately, he’s seen a lot in his life. I think 93, he’s lived through World War II, Vietnam War, 9-11, global pandemic recently, financial crises.

[00:40:55] Shawn O’Malley: And yet the American tail end, as he calls it, has propelled our living standards forward to go from a rough collection of British colonies to where America is today. And less than 250 years is nothing short of miraculous and just Buffett’s lifetime per capita real incomes have grown by more than 6 times.

[00:41:16] Shawn O’Malley: That is pretty unprecedented. Historically, I think you could probably pretty safely say the average middle class American today enjoys luxuries that would have been unimaginable to history’s richest man. As I speak from to you from hundreds of miles away through a computer and the internet, right?

[00:41:33] Shawn O’Malley: I mean, this would have been unfathomable to John D Rockefeller. There’s no amount of money he could have paid a hundred years ago to even do something remotely similar to the conversation we’re having right now. And so Buffett remains bullish on American dynamism and not wanting to bet against where that innovation can take us.

[00:41:49] Shawn O’Malley: And I just wish more people could appreciate how fortunate we are. It’s a lot easier to look at your neighbor’s house and be jealous of it than it is to think about the incredible advantages afforded to us by living at this point in history, especially in the United States.

[00:42:04] Patrick Donley: There’s a lot of wisdom in this book. I really appreciate your insights today and your time. Thanks for doing a deep dive with us. And I look forward to doing more of these with you.

[00:42:12] Shawn O’Malley: It’s been fun. Thanks Patrick.

[00:42:14] Patrick Donley: Okay, folks, that’s all I had for today’s episode. I hope you enjoyed the show and I’ll see you back here real soon.

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