In an SEC Form 4 filing after the market closed on August 24, Berkshire Hathaway reported that it added $55 million to its stake in Phillips 66 (NYSE: PSX) on August 22, 23, and 24 at $77.04 – $78.16 per share. Berkshire Hathaway now owns 79.5 million shares of PSX, representing 15.1% of its outstanding shares. Berkshire’s PSX investment is valued at $6.2 billion at the August 24 closing price on the New York Stock Exchange of $77.68. Berkshire recently added $250 million to its stake in PSX from May 19 – June 13, 2016. Previously, Warren Buffett had disclosed that PSX was his investment and not that of his portfolio managers Todd Combs and Ted Weschler.
I was interviewed on KCBS on August 23, 2016 on Mylan’s 400% price increase of anti-allergy drug EpiPen.
Note: Last fall, Charlie Munger, Berkshire Hathaway’s vice chairman, described Valeant Pharmaceutical’s similar behavior of substantially increasing the prices of drugs that it had purchased from other pharmaceutical companies as “deeply immoral”.
In a SEC 13F filing after the market closed on August 15, Berkshire Hathaway reported a 55% increase (about $500 million) in its Apple (AAPL) stake and a 27% reduction (about $1 billion) in its Wal-Mart (WMT) holding. The Apple investment was likely made by Warren Buffett’s portfolio managers, Todd Combs or Ted Weschler. Wal-Mart has been an investment of Warren Buffett since 2005.
There was also a $200 million reduction (26%) in Suncor Energy (SU) and a $100 million addition (18%) in Liberty Global Class A (LBTYA). These are investments of Todd Combs or Ted Weschler.
I am quoted in a Bloomberg article on these portfolio changes:
“Apple’s stock came down substantially in the second quarter,” David Kass, a professor at the University of Maryland’s Robert H. Smith School of Business who has taken students to meet Buffett, said in a phone interview. “Value investors always like the price to go down because it gives them an opportunity to buy more.”
“It’s a little bit of fine tuning,” said University of Maryland’s Kass. Buffett and his deputies “do not make many changes to their portfolio.”
After the market closed on August 5, Berkshire Hathaway reported its financial results for the second quarter of 2016.
Operating earnings (Warren Buffett’s preferred measure of profits) rose by 18% during the second quarter as compared to the corresponding period last year. This represents a turnaround from the first quarter when operating profits declined by 12%. This increase was helped out by an improved performance at Geico, where premiums written rose by 11% resulting from growth in new policies and rate increases. There were also positive contributions in manufacturing from the recent acquisitions of Precision Castparts and Duracell. However, net earnings declined by 20% at Burlington Northern Santa Fe Railroad, as unit volume dropped by 7.5%. Profits also declined by 4% at Berkshire Hathaway Energy.
Overall, net income rose by 25%. However, this result which includes investment and derivative gains/losses, is largely ignored by Buffett “because the amounts of these in any given quarter or year are usually meaningless“.
Berkshire’s cash totaled $73 billion as of June 30, which included an $8 billion addition resulting from the redemption of the preferred shares of Kraft Heinz. Since Buffett sets aside $20 billion in cash at all times, approximately $50 billion is available for one or more large acquisitions.
Berkshire’s book value rose to $160,000 on June 30. At Berkshire’s closing price of 218,000 on August 5, its shares are now valued at 1.36 times book value. Buffett has previously announced his intention to buy back shares when the price to book value drops below 1.2.
I am quoted in the Omaha World-Herald on Berkshire Hathaway’s $303 million, five year, 15 percent term loan to Harley Davidson in 2009:
“I do not believe Buffett is having any second thoughts in his arrangement with Harley-Davidson,” said David Kass, a Berkshire shareholder and business professor at the University of Maryland. “He is probably very pleased with his 15 percent loan, which he perceived as having very little risk.”
U.S. News & World Report has published “8 Ways to Celebrate July 4 With Stocks”. I am quoted as follows:
Kraft Heinz Co. (ticker: KHC)
With barbecues firing up and people headed outdoors over the July 4 weekend, there will be plenty of demand for condiments and food. Kraft Heinz makes ketchup and mustard, Oscar Meyer meats and Ore-Ida French fries, so it hits a few popular products. It also has some savvy investors backing it. “Berkshire Hathaway (BRK.A, BRK.B) and 3G Capital each own about 25 percent of the company. The remaining 50 percent of its outstanding shares are publicly traded. This is a very well-run company with a dividend of about 3 percent,” says David Kass, a professor at University of Maryland’s Robert H. Smith School of Business.
Anheuser Busch (BUD)
Americans drink a lot of beer on July 4. In fact, Americans spent $1.4 billion on beer alone for the holiday in 2014, according to Nielsen. Anheuser Busch is even changing the labeling on its flagship beer cans this summer from “Budweiser” to “America,” Kass says. “Beer will be very popular at July 4 weekend cookouts. This well-managed publicly traded company is planning to merge with SABMiller and has a dividend of 3 percent.”
SMITH BRAIN TRUST — When the UK surprised pundits, pollsters and prediction markets by voting to leave the European Union on June 23, 2016, financial markets around the world plunged over the next two trading sessions, including 5 percent declines in the S&P 500 and the Dow Jones Industrial Average.With many investors selling shares as the outlook for the economies of the UK, Europe and the rest of the world darkened, how would Warren Buffett and his portfolio managers at Berkshire Hathaway respond?
Buffett gave a clue when telling CNBC prior to the vote how he’d react to Britons voting to leave the EU: “It won’t make any difference to what Berkshire does,” he said. “It wouldn’t change one iota what I’m doing in businesses or stocks.”
Fast forward to this week, with Money magazine reporting that “losses in Berkshire Hathaway’s equity holdings could reach nearly $7 billion, which on a portfolio of $128 billion as of March 31, works out to a loss of about 5.4 percent. That’s actually slightly better than the S&P 500 over the same period. What’s more, Buffett’s losses are only on paper, unless he actually sells his holdings, which he rarely does.”
Clinical Professor of Finance David Kass at the University of Maryland’s Robert H. Smith School of Business, gives more insight: “With over $60 billion of cash on Berkshire’s balance sheet, it is likely they invested some of these funds in individual stocks they had been following, which would have become more attractive after this sudden decline.”
Kass says Warren Buffett and his portfolio managers have very long time horizons of at least 10 years and view short-term external shocks to the financial markets as buying opportunities. “With the S&P 500 (dividends included) compounding at approximately 10 percent annually over decades, and the outlook for long-term growth continuing to be very bright, Berkshire would have viewed this short-term decline as an unexpected buying opportunity.”
Berkshire Hathaway Annual Meeting
April 30, 2016
(Notes taken by David Kass, Department of Finance, Robert H. Smith School of Business,
University of Maryland)
A humorous film was shown in which Arnold Schwarzenegger selects “Terminator” Charlie Munger over Warren Buffett as “The Berkshire Apprentice” (Celebrity Apprentice). There was also an animation of Warren Buffett and Charlie Munger, along with Ajit Jain and the Geico Gecko, in a spoof of the movie “Trading Places”.
Warren Buffett (age 85) and Charlie Munger (age 92) then walk on the stage and sit down. The format for asking questions was similar to the last seven annual meetings. One-third of the questions were selected by three business journalists: Andrew Ross Sorkin (CNBC and the New York Times), Becky Quick (CNBC), and Carol Loomis (Fortune). Shareholders had e-mailed over 2,000 questions to the journalists, who then selected 18 questions relating to Berkshire and its operations. The journalists who were seated on the stage, alternated with analysts Gregg Warren (Morningstar), Jonathan Brandt (Ruane, Cunniff, and Goldfarb), and Cliff Gallant (insurance analyst), and with shareholders in the audience in the asking of questions.
Approximately 40,000 were in attendance. This compared to 45,000 – 50,000 in 2015 (celebrating Warren Buffett’s 50 years at Berkshire Hathaway), 40,000 in 2014, 36,000 – 38,000 in 2010-2013, and 35,000 in 2009, 31,000 in 2008, 27,000 in 2007, and 24,000 in 2006.
Charlie Munger initially commented that if a woman has a choice between two old men, she should choose the one who is older.
Warren Buffett mentioned that Berkshire’s first quarter operating earnings declined as a result of insurance underwriting losses incurred from Texas hailstorms. Berkshire’s railroad also had a decline in earnings.
Questions were asked in the following order:
(1) Loomis: In your 1987 Letter to Shareholders you mentioned that Berkshire liked to invest in companies requiring only small amounts of capital. Now you are investing in companies with large capital needs. Why this change?
Buffett: Companies with little need for capital are harder to find. Berkshire Hathaway Energy and BNSF Railroad require lots of capital. We earn decent, but not extraordinary returns on capital.
Munger: When circumstances changed, we changed.
(2) Brandt: Why did you invest in Precision Castparts?
Munger: Precision Castparts has superior management and is a “no-brainer business”.
(3) Audience: What would you have done differently in search of happiness?
Buffett: I am 85 and love what I am doing. My favorite employer is myself and my partnership with Charlie.
Munger: I am 92 and have lots of ignorance to work on.
(4) Quick: Why did Berkshire sell Munich Re?
Buffett: There is excess capacity in the reinsurance market.
(5) Gallant: Why did Progressive do better than Geico in 2015?
Buffett: Last year the frequency and severity of accidents increased. Progressive was hit less than Geico and Allstate.
(6) Audience: What impact will the shift from push to pull marketing (Amazon) have on Berkshire?
Buffett: Geico was slow with the Internet, but they jumped in.
Munger: Our retailers are strong.
(7) Sorkin: Why should Berkshire shareholders feel proud to own Coca-Cola when sugar is so harmful to health?
Buffett: He gets 700 calories per day from Coke, or about 25% of his total calorie intake. Since Coke makes him happy, he will live longer.
Munger: This is a stupid question because it ignores the benefit while focusing only on the cost (detriment).
(8) Gregg Warren: Should Berkshire be generating more electricity from renewables?
Buffett: Berkshire does not need rate increases from renewables, but needs regulators to work with you. There are benefits to reducing carbon emissions world-wide.
Munger: We are doing more than our share and at lower prices.
(9) Audience: How do you value Bank of America and other commercial banks that Berkshire has investments in since they have significant exposure to derivatives?
Buffett: If there is a major discontinuity such as a nuclear attack, derivatives could cause a lot of problems. Large positions are dangerous. Berkshire has added to its position in Wells Fargo and will likely convert its preferred stock position in Bank of America to its common stock.
(10) Loomis: What happens to float investment income if the U.S. has negative interest rates?
Buffett: Some of our float is in Europe with negative interest rates. We can find things to do with our float. We’ve got $50 billion of short term government securities now and another $8.3 billion coming in June from Kraft Heinz preferred stock. Float is not worth as much to insurance companies with lower interest rates as it was 10 or 15 years ago. Our float is likely to be useful to us in the future. It’s shown as a liability on our balance sheet, but it is actually a huge asset.
(11) Brandt: The railroad industry is suffering with a decline in volume. Is this cyclical or secular and how does it affect BNSF?
Buffett: 20% of revenue comes from coal and its decline is secular. BNSF will earn a lot of money this year, but not as much as last year.
(12) Audience: How should children look at companies when every day they see in the media IPO’s and the business cycle getting shorter?
Buffett: When you buy a stock you are buying a business. You don’t get a quote every day on your farm or apartment house or a McDonald’s franchise. A lot of problems are caused by envy. You have to figure out what makes sense and follow your own course.
(13) Quick: Why are there new rules on solar energy in Nevada?
Buffett: For solar to be competitive it needs a subsidy. Who pays for the subsidy is the real question. Ninety nine percent of consumers were being asked to subsidize the 1% that had solar units by paying triple the market price at what we could otherwise buy electricity and sell it to the other 99%.
Greg Abel: We support renewables and solar energy. We want to purchase renewable energy at the market rate – not where 1% of the customers will benefit and the other 99% will not. By 2019 we will be replacing 76% of our coal units and replacing them with solar.
(14) Gallant: Is Berkshire making a long term statement about the price of oil with its recent oil investments?
Buffett: We have no idea about the future price of oil. Our oil-related investments are based on other considerations.
(15) Audience: Question about rising college education costs.
Buffett: More philanthropy should be devoted to financing college costs. There are very good state schools. We spend a lot of money on education in this country. We spend $600 billion educating 50 million kids from kindergarten to 12th grade. We have entitlements for the young. Nobody ever seems to bring that up. Working age people have an obligation to both the young and the old. I was a trustee at a college (Grinnell College) that saw the endowment go from $8 million to over $1 billion. I did not see the tuition come down or the number of students go up.
Munger: Nothing went up except the president’s salary.
Buffett: When you read the figures on the endowments at the big schools, some have reached very large numbers. The main objective is to have the endowment grow larger.
(16) Sorkin: What specific risks are there for Berkshire if Donald Trump becomes the President of the United States?
Buffett: That won’t be the main problem. Berkshire will do fine if either Donald Trump or Hillary Clinton becomes President. In my lifetime, the GDP per capita has gone up six to one. Our economy will keep working. Twenty years from now there will be far more output per capita in the U.S. The quality will get better. No Presidential candidate or President is going to end that. They can shape it in ways that are good or bad, but they can’t end it. The pace of innovation has never been better. Just think how differently you are living. You are making free choices today that were not available to you 20 years ago.
(17) Gregg Warren: Will there be mergers among railroads?
Matt Rose: Unlikely there will be mergers in the near future. Of our four constituencies, (customers, labor, communities, and shareholders), only shareholders have an interest.
(18) Audience: What are your views on investment banking as a result of greater regulation and Wells Fargo?
Buffett: Public policy since 2008 and 2009 has raised capital requirements for banks, but specifically it has resulted in making large banks less profitable than smaller banks. Wells Fargo is a very well run bank. We didn’t make any decisions to buy a single share because of its investment banking business (resulting from the Wachovia acquisition). They have a huge base of very cheap money. We made a major investment in preferred shares of Goldman Sachs. We continue to hold some shares from when we made the investment in 2008. I can’t recall us making an investment banking purchase (marketable security involving an investment bank.
Munger: Generally, we fear investment banks more than we love them.
(19) Loomis: What corporate defenses are in place to prevent activists from breaking up Berkshire in the future?
Buffett: As long as Berkshire is willing to buy back stock close to intrinsic value, there should not be a large discount to intrinsic value, so there would not be an advantage to breaking up Berkshire. In my own case, because the way my stock will be distributed after I die, it’s very likely that my estate for some years would be the largest shareholder of Berkshire in terms of votes. It is not something that I worry about.
(20) Brandt: What are Berkshire’s competitive advantages in its leasing business?
Buffett: We have a good truck leasing business and a good tank car leasing business. We have service advantages. We are not interested in leasing new cars or aircraft. Banks have an advantage in new car leasing because their costs are lower. Wells Fargo’s cost is around 10 basis points.
(21) Audience: If you had a silver bullet, which competitor would you take out and why?
Buffett: We have lots of tough competitors. We want our managers to think every day about how to achieve a stronger competitive position. We call it widening a moat. We had a department store in Baltimore. If we kept it, we would have gone out of business. Don’t try to fix something that is unfixable.
(22) Quick: Mr. Munger has said the Valeant business model is highly immoral. Has your view changed of Sequoia, which had a highly concentrated position in Valeant of more than 30% of the fund’s portfolio?
Buffett: Sequoia Fund had a great record until a year or so ago. Bill Ruane did a great job after he set up the fund in 1969 to accommodate investors from my partnership when it was closed in 1969. But the manager of Sequoia over the past two years took on an unusually large position in Valeant. That manager is no longer with the fund. Sequoia has good people now.
Munger: Valeant was a sewer. Those who created it deserve all the opprobrium that they got.
Warren Buffett $1 million charity bet with hedge funds vs. S&P 500 over 10 years.
Buffett: Over the past 8 years, the Vanguard S&P 500 Index fund was up 65.7% vs. five hedge funds (fund of funds) which were up 21.9%. We have two portfolio managers at Berkshire. They each manage $9 billion for us. If they had a 2 and 20 arrangement with Berkshire, they would be getting $180 million each merely for breathing annually. It’s a compensation scheme that is unbelievable to me.
Munger: There are a few people who are really good. It’s a tiny group of people. It’s like finding a needle in a haystack.
Buffett: There’s been far more money made on Wall Street by salesmanship abilities than investment abilities.
(23) Gallant: Berkshire has an online portal for commercial insurance business. Is there an opportunity to go direct?
Buffett: We actually have two online arrangements. I’m not sure whether they are both up yet. We do commercial auto through Geico as well. It amazed me how fast the inquiries on personal auto migrated from phone to the Internet, and I thought that the younger people would do it, and the older people would be slower. That has not been the case.
(24) Audience: What is the plan for how Berkshire will maintain its culture when Howard Buffett no longer fills the role?
Buffett: The culture will be maintained by successor board members, managers and shareholders. The main problem Berkshire will have will be its size. Size is the enemy of performance. There is also very little turnover. Without a retirement age, people are working because they love their jobs.
(25) Sorkin: Can you discuss the lack of diversity among the 25 people at headquarters and board members?
Buffett: We are looking for board members who are business savvy, shareholder oriented, and have special interest in Berkshire. AS far as the people on our corporate staff, I’m hoping when we take the Christmas picture this year, they are exactly the same 25 as last year. We have a cooperative atmosphere here where everyone helps each other. We don’t have any committees. We may have a PowerPoint some place. I haven’t seen it, and I wouldn’t know how to use it anyway. We just don’t make work activities.
Munger: Years ago I did some (legal) work for the Roman Catholic Archbishop of Los Angeles and my senior partner pompously said, “You don’t need to hire us to do this. There are plenty of good Catholic tax lawyers.” The archbishop looked at him like he was an idiot and said, “Mr. Pieler (sp?) last year I had some serious surgery, and I did not look around for the leading Catholic surgeon”. That’s the way I feel about board members.
(26) Gregg Warren: Intrinsic value continues to exceed book value, yet Berkshire has done very little share repurchases in the last four years, even in January and February when the stock price dipped below 1.2 time book value (the valuation Berkshire has set for repurchasing shares). Are we at a point to consider buying back shares?
Buffett: Berkshire’s stock price has come fairly close to 1.2 times book value, but I can almost guarantee you that it hasn’t hit 1.2 times book value, or we would have repurchased shares. We moved up our threshold from 1.1 to 1.2 because we had acquired more businesses over time where the differential between our carrying value and the intrinsic value really had widened from when we set the 1.1 times book value. Other companies buyback their stock without any regard to a threshold price. Can you imagine a company going out and saying we are going to buy a business, and we don’t care what the price is? That’s what companies do when they do not attach a metric to their buybacks.
(27) Audience: Nebraska Furniture Mart has been opened for a year in Dallas. How have its sales been?
Buffett: It’s our largest store by volume but we initially had a delivery problem. We had a similar problem initially in Kansas City. The deliveries have gotten far better, meeting our standards in Omaha.
(28) Loomis: You have expressed concern about cyber, biological, nuclear, and chemical attacks. Preventing catastrophe is not getting enough attention. The bill got bottled up in the Senate. Is it a good idea to fund a campaign and counter act industry lobbyists?
Buffett: In my opinion, there is no problem remotely like the problem of what I call CNBC – cyber, nuclear, biological and chemical attacks – either by rogue organizations, individuals, or rogue states. Government is our real protection. We came very close in the Cuban missile crisis. You can argue if Hitler hadn’t been so anti-Semitic, he could gotten the Atomic bomb before we did, but he drove out the best scientific minds.
(29) Brandt: How has Lubrizol performed?
Buffett: There are four companies in the additive business. It’s a very good business with no growth, but we are the leader. It has performed as we had expected. Lubrizol made one large acquisition which was a mistake. That was in the oil field specialty business. It was made at the peak of oil prices.
(30) Audience: Berkshire does not make investment decisions based on macroeconomic factors, but do you use microeconomic indicators from Berkshire’s many businesses?
Munger: There could hardly be anything more important than the microeconomic factors. That is business. Business and microeconomics is sort of the same term. Microeconomics is what we do and macroeconomics is what we put up with.
(31) Quick: How do you determine which investments you will make personally like Seritage Growth Properties and Phillips 66 as disclosed on Form 13-G’s versus the investments you make for Berkshire?
Buffett: I have never owned a share of Phillips 66. Seritage is a real estate investment trust that had a total market value of under $2 billion when I bought it. I have about 1% of my net worth outside of Berkshire and 99% in it. I can’t be doing things that Berkshire does. Seritage is not something of Berkshire size, and we’ve never owned a real estate investment trust in Berkshire. I could buy that and not worry about a conflict. My best ideas are off limits for me because they go to Berkshire if they are sizable enough. I try to stay away from anything that could conflict with Berkshire.
(32) Gallant: Berkshire is generating $10 – $12 billion per year in free cash flow. What is the outlook for free cash flow and deferred taxes?
Buffett: There’s a lot of deferred tax that is attributable to unrealized appreciation of securities. Let’s assume $6 billion of unrealized appreciation of securities and $21 billion in deferred tax. Over the years, float has added $80 billion plus to make available for investment beyond what are earnings allowed for. We are going to spend more than our depreciation in our businesses – the railroad and Berkshire Energy – for a long, long time. Our earnings of around $17 billion, plus our change in float, is the net available cash for Berkshire to invest. We can also sell securities or we can borrow. People didn’t appreciate the value of float.
(33) Audience: What has allowed you to think ahead of the crowd?
Buffett: I owe a great deal to Ben Graham in terms of investing and to Charlie in terms of learning about business. I spend a lifetime looking at businesses and why some work and why some don’t work — pattern recognition. It is important to recognize what you can’t do. We’ve generally tried to swing at things in our particular strike zone. You do have to have emotional control. We’ve seen very smart people do very stupid things with unnecessary risks.
Munger: There are a few simple tricks that work well. Temperament that has a combination of patience and opportunism in it is one. I think it is largely inherited, but it can be learned to some extent.
(34) Sorkin: Is your due diligence process, which is speedy and usually done within days, an advantage or risk on deals?
Buffett: What counts is whether you really have a fix on the basic economics or how the industry is going to develop or whether Amazon is likely to kill them in a few years. Assessing whether a manager who I’m going to hand a billion dollars to for his business will behave differently when he no longer owns it. Negotiations that drag out tend to blow up. People can get obstinate about small points. Tom Murphy taught me not to try to win every point in deal making. Make a decent deal.
(35) Gregg Warren: Has there been a change in succession planning with Ajit Jain taking over reinsurance from Tad Montross?
Buffett: Tad has done a sensational job for Berkshire. I tried to get him to stay longer. It makes sense to have the reinsurance operation under Ajit. Anything on insurance, Ajit can handle. In terms of succession we will discuss this at a board meeting on Monday. Five years from now, something else could make sense. There are no tea leaves to read in the fact that Ajit is supervising Gen Re from this point forward.
(36) Audience: Why doesn’t Berkshire have the highest credit rating?
Munger: The rating agencies are wrong.
Buffett: We don’t fit their model very well. When they come in the door, I always say let’s talk AAAA. I never get any place.
(37) Loomis: Berkshire formed a partnership with 3G in the Kraft Heinz deal. Why is 3G’s cost cutting leading to reduced volume and revenues at Kraft Heinz?
Buffett: Overall, the packaged goods industry will not go anyplace in terms of physical volume. It may decline a bit. I have never seen anyone run something more sensibly than 3G in terms of taking over operations and getting costs under control in a hurry.
Munger: Sometimes when you reduce volume, it’s very intelligent because you are losing money on the volume you’re discarding.
(38) Brandt: Are the economics of the $4 billion Van Tuyl deal better than it looks?
Buffett: You are right. It’s better than it looks. We have a billion dollars worth of securities that came with the $4.1 billion. Those billion dollars are available to us. The economics of Van Tuyl have worked out as expected. Van Tuyl has a first class CEO. Take a billion dollars off the purchase price for openers. There are some amortization charges of items that are allowable that make you see a fairly low income figure against what it appears the acquisition price was.
(39) Audience: When interest rates go from zero to negative in a country, how does that affect valuation?
Buffett: Going from 0% to – ½% is no different than going from 4% to 3 1/2%. It has a different feel to it if you have to pay a half appoint to somebody. If you have your base rate reduced by a ½ point, it’s of some significance, but it is not dramatic. What’s dramatic is the low interest environment generally. We have been with a low interest rate situation for a long time. You will pay more for a business when interest rates are zero than when they are 15% when Volcker was around. I paid a little more for Precision Castparts because interest rates are around zero than I would have if they had been 6%. I try not to pay too much more, but it has an effect. If interest rates continue at this rate for a long time, that will have an enormous effect on asset value.
Munger: I don’t think anyone knows much about negative interest rates. We never had them before. If you are not confused by negative interest rates, you did not think about it correctly.
(40) Quick: GEICO is working with IBM’s Watson. Can you comment on whether they will sell daa from their relationship to other insurance companies?
Buffett: Both parties thought about that matter, very intensively and extensively. Neither would be in a position to talk about it. I don’t like to not answer any questions, but here are some things it doesn’t pay to answer.
(41) Gallant: American Express will have to reinvent itself over time. Shouldn’t Berkshire reassess its investment position in American Express?
Buffett: We reassess reasons for owning all investments on an almost continuing basis. Usually we are in a general sense of agreement, but sometimes we are a fair distance apart. Payments are an area of intense interest to a lot of smart people with a lot of resources.
Munger: — And rapid change.
Buffett: I still feel good about owning American Express. Their position has been under attack for decades and will continue to be under attack.
Munger: A lot of great businesses are not quite as great as they used to be. The packaged goods business, the Procter & Gamble, and the General Mills, they are all weaker than they used to be at their peak.
Buffett: Auto companies.
Munger: When I think of the power of General Motors when I was young. They loomed over the economy like a colossus. It looked totally invincible with torrents of cash, and then it went bankrupt. So the world changes. We can’t make the portfolio change every time something is a little less advantage than it used to be.
Buffett: You have to be thinking all the time to see if something has changed the game in a big way. That’s not only true for American Express. It’s a tough game, but it is interesting.
Munger: Anyone in payments is facing threats today.
(42) Audience: A cattle rancher asked if cattle was a good investment.
Munger: I think it’s one of the worst businesses that I can imagine for somebody like us. Not only is it a bad business, but we have no aptitude for it. It has one good year every 20 years.
(43) Sorkin: With respect to incentives, how will you compensate the next Berkshire CEO?
Munger: I wouldn’t worry about the next CEO. Our incentive systems are different. One of our really interesting incentive systems is at GEICO. We don’t have a normal profit type of incentive for the people at GEICO.
Buffett: At GEICO we have two variables We have a grid which consists of growth in policies in force, on one axis, and then on the other grid, the profitability of the seasoned business. We spend a lot of money on advertising. The first year we put any business on the books, it’s going to reduce profits. I don’t want people to worry about profit that might be impaired by growing the business fast.
Munger: Other people might reward something like profits. They don’t take on new business because it hurts profits.
Buffett: Do you reward profits? It would be the dumbest thing you could do. You quit advertising and start shrinking the business a little. People know the very top person is getting paid based on the same two variables. Each business may have a different incentive program.
Munger: A lot of bad examples of incentives come from banking and investment banking. If you reward someone with some share of the profits, and the profits are being reported using accounting practices that cause profits to exist on paper that are not really happening, then people are doing the wrong thing, and it’s endangering the bank and hurting the country. That was a major part of the cause of the financial crisis. The banks were reporting a lot of income they weren’t making.
Buffett: There’s a lot of misbehavior. You saw it in pricing of stock options. I’d hear conversations in aboard room. They were issuing options at a terribly low price. What could be dumber than a company looking to issue shares at a low price?
Munger: We want to be simple and right.
(44) Gregg Warren: BNSF capital expenditures are about 20% of revenues. What are maintenance expenditures?
Buffett: We spent a lot of money in 2015 to correct problems. That was when we spent the $5.7 billion. I’d say that true maintenance is higher than 60% of that number.
(45) Audience: A lot of people are losing their jobs due to sharp declines in the price of crude oil. Will this influence monetary policy decisions?
Munger: Not much.
Buffett: It’s an important industry. The decline in the price of oil has had a lot of effects. It’s very good for the consumer but very bad for some businesses like the one we bought in Lubrizol and some others. It should be good for the United States overall. We are an importer. It’s good for the U.S. to have low prices for bananas so it is good to have low prices for oil. Oil extends into so many areas that it also hurts plenty when the price of oil falls. It particularly hurts capital investments. The consumer gets the benefit when they go to the filling station. The capital investment contraction is huge if you project out the lower price of oil for a while. The U.S. is better off and Saudi Arabia is worse off. Our economy has continued to make progress despite the oil price decline. Different regions suffer disproportionately.
(46) Loomis: Why does Berkshire have so much cash in its Manufacturing, Service, and Retailing section of the balance sheet?
Buffett: We have excess cash at every place at Berkshire. We will never go below $20 billion in cash. We will have more than $60 billion in cash when the Kraft Heinz preferred matures. We will go to a sweep account when rates make any difference to do it. When you are getting zero, it doesn’t make much difference where you get zero.
(47) Brandt: Does Berkshire not incur much in restructuring costs because most of your acquisitions are stand alone?
Munger: That’s a question like asking, “Why don’t you kill your mother to get the insurance money? We don’t do it. We are not interested in manipulating those numbers. We haven’t had a restructuring charge ever and we are not about to start.
Buffett: We do not report adjusted earnings. Things are good enough at Berkshire that we don’t need to inflate the figures.
(48) Audience: A question about the premium on Berkshire’s credit default swaps (CDS).
Buffett: We have one position left over from six or seven years ago. That involves us selling protection on zero coupon municipal bonds with a nominal maturity value. I think $7.7 billion or something like that. We are sitting with the position because we like the position. Our CDS – that’s an insurance premium against our debt that people buy. We did not collateralize the municipal contract. I think the counterparties have to buy protection on Berkshire credit through CDS. What goes on in the CDS market isn’t really of any interest to us.
Munger: We don’t fool around with our own credit default swaps.
Buffett: People were paying 5% in terms of betting that Berkshire would go broke. I couldn’t take advantage of it. I wanted to.
(49) Quick: Please comment on whether there’s another Ajit in the house.
Buffett: There’s not another Ajit in the house. When you are building capital value, think of the value Jeff Bezos to Amazon. The value of Dan Burke and Tom Murphy (CapCities/ABC) – they didn’t invent television. They just managed it so well. Really outstanding mangers are invaluable. We want to align ourselves with them. We want them to feel the way about Berkshire that we do.
(50) Gallant: Question about float.
Buffett: With today’s interest rates we cannot do very much. Over a long period, we will have the opportunity perhaps to come up with one or two things where we can deploy the funds at higher rates of return than today’s low interest rates.
Munger: We are willing to pay a little money now to have the certainty of having a lot of money available in case something really attractive comes up. It’s an option cost.
Buffett: The option came in handy in 2008-2009.
(51) Audience: How do you feel about the real estate market today?
Buffett: It is not as attractive as it was in 2012. I don’t see a nationwide bubble in in residential real estate now. In a place like Omaha, or most of the country, you are not paying bubble prices for residential real estate. I don’t think the next time around the problem is going to be a real estate bubble.
(52) Sorkin: What have been Todd and Ted’s biggest investment hits and failures?
Buffett: Their primary job is working on investments – -each has a $9 billion portfolio. One of them has 7 or 8 positions. The other has 13 or 14. They have a very similar approach to investing. They’ve both been enormously helpful in doing several things for which they don’t get paid a dime. They’re perfect cultural fits for Berkshire. They have a bigger universe to work with. They can look at ideas in which they can put $500 million to work. I’m trying to think of ways to invest sums in the billions. They have more extensive knowledge of activities in certain businesses and industries that have developed in the last 10-15 years. They are looking for businesses that they understand and where they can buy the stocks at a sensible price, and where they think the business will be earning significantly more money five or ten years from now.
Munger: We don’t want to talk about specific hits or failures.
Buffett: We file reports every 90 days to show that Berkshire does in marketable securities. We don’t get into identifying what they do individually.
(53) Gregg Warren: Where did the additional $3.5 billion in cash come from in the finance segment of the business?
Buffett: I can’t tell you where it came from. We were funneling money into the parent company and the finance company. That money was basically dedicated to making the $22 billion portion of the Precision Castparts purchase. We actually borrowed $12 billion. We pushed money from various sources into those two entities and eventually into the parent company to take care of the $22 billion that was coming due.
(54) Audience: How would you explain IBM’s moat?
Buffett: IBM has certain strengths and certain weaknesses. We don’t want to get into giving an investment analysis of any of the portfolio companies we own.
Munger: Coping with considerable change in the computer world. It’s attempting something that is big and interesting. It may work modestly or very well.
(55) Audience: In your annual shareholder letters and during interviews, your sense of humor always shines through. Where does your sense of humor come from?
Buffett: It’s the way I see the world. It’s a very interesting and very humorous place. I think Charlie has a better sense of humor than I do, and I will let him answer where he got his.
Munger: I think if you see the world accurately, it’s bound to be humorous because it’s ridiculous.
Buffett: Well, I think that is a good note to close on.
In an SEC Form 4 filing this evening, Berkshire Hathaway reported that it added $60 million to its stake in Phillips 66 (NYSE: PSX) on June 10 and 13 at $79.13 – $80.04 per share. Berkshire Hathaway now owns 78.8 million shares of PSX, representing 15% of its outstanding shares. Berkshire’s PSX investment is valued at $6.2 billion at today’s closing price on the New York Stock Exchange of $78.90. Berkshire has added $250 million to its stake in PSX from May 19 – June 13, 2016. Previously, Warren Buffett had disclosed that PSX was his investment and not that of his portfolio managers Todd Combs and Ted Weschler.