Warren Buffett Presentation

Background Information Session Sponsored By: Berkeley Investment Club http://groups.haas.berkeley.edu/hsbic/ Warren Buffett Trip

Goals and Purpose

We’re here today to give you an overview of Warren Buffett in preparation for our visit November 18-19 and to explain this record:

2007 Warren Buffet Trip

Agenda

Biographical

Childhood stories

College and graduate school

Buffett Associates

Berkshire-Hathaway

Investment Philosophy

Early influencers

Equity investing strategy

Investment tenets

Thoughts on risk

Thoughts on efficient markets

General Info

Born in Omaha in 1930.

Father, Howard Buffett, was a stockbroker and Republican congressman.

Buffett ran away once.

He bought his first stock, Cities Service Preferred, at $38 a share. It dropped to $27 a share, but then rose back to $40, at which point Buffett sold. Cities subsequently rose to $200 a share.

Paper Route

One of Buffett’s first jobs was as a delivery boy for the Washington Post.

Even with 500 papers to deliver, the process was so efficient that it only took a little more than an hour.

Buffett expanded into magazines, and eventually was earning $175 a month.

Buffett refused to let his dad pay the taxes. Instead, Buffett tracked his earnings and filed his own return.

Pinball Machine Business

As a high school senior, Buffett and a friend began buying used pinball machines and putting them in barbershops.

Buffett: “Eventually we were making $50 a week. I hadn't dreamed life could be so good.“

But the pinball machines were constantly breaking, and the barbershop owners kept pushing them to put in new machines.

“ We'd always tell them we'd take it up with the boss. We pretended like we were these hired hands that were carrying machines around and counting money.”

Wharton

Attended Wharton for a short time, but found it's curriculum lacking and too concerned with “fancy theories” and “ignorant of the practical details of making a profit.”

While there, Buffett did manage to make the cover a student magazine dressed as the model football fan—derby hat, raccoon coat, cigar in mouth, holding a banner and offering a flask to his date.

At his fraternity parties, he would entertain the crowd with dissertations on the gold standard. And the crowd loved it!

University of Nebraska at Lincoln

Buffett: “I didn’t feel that I was learning that much. Nebraska called, Wharton repelled.”

Much more active: took course loads of 5-6 classes, took a job as a paperboy supervisor, and revived his golf ball business.

He even started to date more: “The latest girl I have been dating casually mentioned to me that she played tennis, so thinking I would impress the little gal with a show of my cave-man masculinity, I offered to give her the opportunity to see me work out from across the net.

She trounced me.”

Columbia Business School

After graduating from Nebraska at age 19, Buffett applied to Harvard Business School and was rejected.

“ To tell you the truth, I was kind of snowed when I got rejected from Harvard.”

Instead, Buffett went to Columbia, where Benjamin Graham and David Dodd taught.

Graham was already the dean of the securities profession. Together with Dodd, he published Security Analysis, which was the seminal textbook in the field.

Buffett Associates Ltd

In 1956 Buffett started an investment partnership.

Raised $105,000 from family and friends.

Results: earned more than 30% annually from 1956 to 1969, when the general market earned only about 8% annually.

Began to consult with Charlie Munger.

In May 1969, he dissolved the partnership, as he was "unable to find any bargains in the current market".

Charlie Munger

Buffett’s partner and “right-hand man” in Berkshire.

Brilliant: graduated from Harvard Law School without a Bachelor's Degree.

Chairman of Wesco Financial Corporation, an 80.1%-owned subsidiary of Berkshire. Wesco is similar to Berkshire in that it controls several companies (Precision Steel, CORT Furniture Leasing) and also has equity investments in Coke, American Express, Wells Fargo, and P&G.

Big believer in the benefits of a concentrated portfolio.

Berkshire Hathaway

Originally was a textile manufacturer.

Made the first investment in 1965, and eventually bought the whole company in 1967.

Early investments included National Indemnity Insurance, See’s Candy, Washington Post, Capital Cities-ABC, and GEICO.

Salary as Chairman: $100,000

Currently has about $38 billion in cash, and $77 billion in equity investments. Stock market cap: $210 billion

Why Insurance?

In 1967, Buffett began diversifying Berkshire's business interests by purchasing two insurance companies: National Indemnity and National Fire and Marine. Soon added more insurance companies.

Buffett liked insurance companies because he received the policyholder premiums upfront, but wouldn’t have to pay out the claims until a much later time.

Essentially, Buffett became the investment manager for the insurance companies' premium-based capital (or "float").

Buffett’s Stocks (6/30/07) 2007 Warren Buffet Trip

Salomon Crisis

In 1987 Berkshire had invested $700 million in preferred stock at Salomon, which allowed Salomon to ward off Ronald Perelman, who was looking to take over the company.

Top management had stepped down over a trading violation—CEO John Gutfreund had kept the Board in the dark over both the violation and the subsequent investigation by the Treasury Department.

Buffett managed to convince the Treasury to reverse its ban on Salomon participating in the auctions (thus saving the company from certain bankruptcy).

Philanthropy

In 2006 Buffett gave away the bulk of his holdings—10 million shares, roughly $30 billion—to the Bill and Melinda Gates foundation.

Including gifts made to family foundations, the total amount given away was close to $40 billion in 2006 dollars. However, since Buffett has committed to give a set number of shares each year, if the price of Berkshire rises, the actual dollar amount given away will rise as well.

General Views

Ethics are paramount: “It takes 20 years to build a reputation and five minutes to ruin it.”

Not a fan of hedge funds and the high fees they charge.

Heavily favors the inheritance tax.

Favors expensing stock options.

Has stated that the U.S. dollar will weaken and lose value over the long-run due to the U.S.’s expanding trade deficits.

You Could Be The Next Warren Buffett! 2007 Warren Buffet Trip

In 2007 Buffett announced he was looking for the next CIO of Berkshire. Jokingly stated: “We're going to run this like 'American Idol' in the end”.

Looking for “independent thinking, emotional stability, and a keen understanding of both human and institutional behavior.”

The applications have been flowing in. A lawyer in Oregon recommended his four-year-old son, characterizing the toddler as a "great negotiator" on issues such as “bedtime, chores, allowance, baths, etc.”

Early Influencers – Ben Graham

Early in his career, Buffett said, “I’m 85% Ben Graham.”

1 st big contribution: Mr. Market

Irrational fellow who appears daily and names a price at which he will either sell you his interest or buy yours

Doesn't mind being ignored

Very emotional: at times he will be euphoric, and quote you high prices, and at times he will be depressed, and quote you low prices

Buffett: “It is his pocketbook, not his wisdom, that you will find useful”

Early Influencers – Ben Graham

2 nd big contribution: Margin of Safety

Graham believed that investors could reduce risk by investing in companies that are trading at a discount to their net asset value (total assets minus total liabilities). This discount (or “margin of safety”) protects the investor against unforeseeable risks.

Early Influencers – Phillip Fisher

Whereas Graham was most concerned with a quantitative measure of value, Fisher focused on qualitative metrics.

Scuttlebutt: interview company officers, employees, suppliers, customers, and competitors to find companies with significant competitive advantages and management teams that could effectively exploit these advantages.

Also like Fisher, Buffett is willing to invest in a small number of good companies, rather than diversify across a large number of companies he doesn't understand as well.

Goal as an Investor

Buffett: “ Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten, and twenty years from now.”

“ Put together a portfolio of companies whose aggregate earnings will march upwards over the years, and so also will the portfolio's market value.”

Equity Investing Strategy

Buffett: “ We want the business to be one

That we can understand;

With favorable long-term prospects;

Operated by honest and competent people; and

Available at a very attractive price.”

"We try to buy into businesses with favorable long-term economics. Our goal is to find an outstanding business at a sensible price, not a mediocre business at a bargain price."

“ In our opinion, the two are joined at the hip: Growth is always a component of value.”

Tenet #1: Understandable Businesses

Stick with stocks in your "circle of competence." If you don't understand the business, you can't value the stock.

Thinks of investment success as being not how much you know but how realistically you define what you don’t know.

Will improve your ability to ascertain whether the business has favorable long-term prospects.

Tenet #2: Favorable Long-term Prospects

Focus on companies with a clear, sustainable comparative advantage, or “moat”. A moat will help protect the company against competitors.

Look for high return on equity, a consistently strong free cash flow, and limited debt.

Act as if you “own a lifetime decision card with only 20 punches on it.” Each time you invest, you have one few investment available for next time. This will help you look for only the best opportunities.

Tenet #3: Good Management

Look for managers who treat the shareholders' capital with owner-like care and thoughtfulness.

When Buffett buys a business, he buys its management as well—Buffett does not get involved with day-to-day activities nor helps with major strategic decisions.

Buffett asks, “Is management rational?”, “Is the management candid,” and “does the management resist the institutional imperative?”

Tenet #4: Buy at an Attractive Price

Look at raw data, not analyst summaries. Focus on understanding the picture, not precise points. "It is better to be approximately right than precisely wrong.“

Understand that majority of stocks are not compelling so ignore them. But when you find stock you like, show conviction, and buy a ton of it.

Don't worry about macro trends. Focus on long-term business value--the size of the coupons down the road.

Time Horizon

Buffett: “If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes.“

“ When we own portions of outstanding business with outstanding managements, our favorite holding period is forever.”

Why Not Tech Stocks?

Buffett: “We have no insights into which participants in the tech field possess a truly durable competitive advantage.”

Buffett in 1999: “I think it’s much easier to predict the relative strength that Coke will have in the soft drink world than Microsoft will in the software world. That’s not to knock Microsoft. If I had to be on anyone, I’d bet on Microsoft. But I don’t have to bet.”

Thoughts on Efficient Markets

“ Most institutional investors in the early 1970s...were under the spell of academics at prestigious business schools who were preaching a newly-fashioned theory: the stock market was totally efficient. We are enormously indebted to those academics: what could be more advantageous in an intellectual contest--whether it be bridge chess, or stock selection--than to have opponents who have been taught that thinking is a waste of energy.“

“ Observing correctly that the market is frequently efficient, they went on to conclude incorrectly that it was always efficient. The difference between those propositions is night and day.”

Risk

Buffett: “We define risk, using dictionary terms, as the possibility of loss or injury.

Academics, however, life to define investment "risk" differently, averring that it is the relative volatility of a stock or portfolio (compared to the market).

For example, under beta-based theory, a stock that has dropped very sharply compared to the market…becomes riskier at the lower price that it was at the higher price. Would that description have then made sense to someone who was offered the entire company at a vastly-reduced price?”

Portfolio Concentration

Buffett: “We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it.”

“ Charlie and I decided long ago that in an investment lifetime it’s too hard to make hundreds of smart decisions. Therefore, we adopted a strategy that required our being smart—and not too smart at that—only a very few times. Indeed, we’ll settle for one good idea a year. (Charlie says it’s my turn.)”

Speculation

Buffett: “Consciously paying more for a stock than its calculated value—in the hope that it can be sold for a still-higher price—should be labeled speculation (which is neither illegal, immoral, nor—in our view—financially fattening).”

Cigar Butt Approach to Investing

Buffett: “If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible.”

“ Unless you are a liquidator, this kind of approach to buying a business is foolish.”

Portfolio Insurance

Buffett: “The less these companies are being valued at, the more vigorously they should be sold. “

“ After buying a farm, would a rational owner next order his real estate agent to start selling off pieces of it whenever a neighboring property was sold at a lower price?"

“ Volatility caused by money managers who speculate irrationally with huge sums will offer the true investor more chances to make intelligent investment moves.”