As I discussed in the first part of this series, I’m going to share my key takeaways from the old shareholder meetings. Personally, I’ve found the older meetings often deal with issues that are pertinent to shareholders and investors, as opposed to the life advice questions that have become more common in recent years. In these reviews, I’m going to select a handful of answers from each session that I think are most interesting and insightful for investors. For readers, hopefully this will provide the highlights from each session.
So, with that behind us, let’s look at the 1994 afternoon session.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Put options” data-reactid=”21″>Put options
Early in the session, Buffett was asked about his decision in the previous year to sell put options for 5 million shares of Coca-Cola (NYSE:KO), which generated $7.5 million in premiums. In his explanation for the decision, Buffett said:
“We have not done that very often, and we’re unlikely to do very much of it… If we like something well enough to write a put on it, we’re probably better off buying the security itself, and particularly since we can’t do it in the kind of quantities that really would make it meaningful to Berkshire. There are securities I would not mind writing puts for 10 million shares or something. It’s probably allowable for us to do it, but we’d probably have to do it through multiple brokers to get the job done. On balance, I don’t think it’s as useful a way to spend my time as just looking for securities to buy outright.“
I think Buffett’s conclusion is correct. In investing, there are plenty of ways to try and be “cute” with your decision-making. Options is one such way. And while I obviously wouldn’t argue that certain options strategies cannot be effective, I think Buffett hits the nail on the head: it can prove to be a distraction from the task at hand – buying and owning high-quality businesses for the long-term when they trade at a discount to intrinsic value. When you start nitpicking whether a stock is slightly overvalued, and use options to try and back into a position, you begin to miss the big picture. As Buffett says, it’s not as useful a way to spend your time as simply looking for the right securities to buy – and patiently waiting for the chance to do so at the right price.
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Later in the session, Buffett spoke about his approach to calculating asset values:
“In the 1992 annual report, we discuss that a fair amount. The economic value of any asset, essentially, is the present value, at the appropriate interest rate, of all the future streams of cash going in or out of the business. And there are all kinds of businesses that Charlie and I don’t think we have the faintest idea what that future stream will look like. And if we don’t have the faintest idea what the future stream will look like, we don’t have the faintest idea what it’s worth now. If you think you know what the price of a stock should be today, but you don’t think you have any idea what the stream of cash will be over the next 20 years, you’ve got cognitive dissonance. We are looking for things where we feel – with a fairly high degree of probability – that we can come within a range of looking at those numbers out over a period of time, and then we discount them back. We are more concerned with the certainty of those numbers than we are with getting the one that looks absolutely the cheapest, but based upon numbers that we don’t have great confidence in. And that’s basically what economic value is all about.”
Both of the highlighted quotes point to the fact that, first and foremost, Buffett focused on the return of his capital, not the return on his capital. He never overlooks downside risk, as captured in his famous quote: “The first rule in investment is don’t lose, and the second rule in investment is doesn’t forget the first rule – and that’s all the rules there are.”
It’s also interesting to consider the high bar that Buffett requires to justify an investment – the ability to roughly forecast cash flows many years into the future. If you take a look at a list of publicly traded companies, I bet you would find that this requirement disqualifies much of the list. Many, upon doing so, will decide that they need to loosen the rules. For what it’s worth, Buffett has told you that he does the opposite.
At the end of the session, Buffett discussed his thoughts on how he thinks about growth as part of company analysis – and why growth in and of itself isn’t necessarily a good thing:
“We are willing to buy companies that aren’t going to grow at all, assuming we get enough for our money when we do it. We look at projecting numbers out, as to what kind of cash we think we’ll get back over time. But, if you’re going to put $1 million in a savings account, would you rather have something that paid 10% a year and never changed, or would you rather have something that paid you 2% a year and increased at 10% a year? Well, you can work out the math to answer those questions. But you can certainly have a situation where there’s absolutely no growth in a business, and it’s a much better investment than some company that’s going to grow at very substantial rates, particularly if they’re going to need capital in order to grow. There’s a huge difference in the business that grows and requires a lot of capital to do so and the business that grows and doesn’t require capital. And I would say, generally, financial analysts do not give adequate weight to the difference in those. In fact, it’s amazing how little attention is paid to that. Believe me, if you’re investing, you should pay a lot of attention to it.”
There are multiple nuggets of wisdom in this answer.
The first relates to the importance of being able to quantify the growth you’re likely to achieve in the underlying results (profits) of a business and the price you’re asked to pay for that business. At some price, a low-growth business is a much better bet than a high-growth business – particularly if you can buy that low-growth business and use its cash flows to finance other intelligent investments (something Berkshire did with Blue Chip Stamps, See’s Candies and other acquisitions).
The other important consideration is how much it will “cost” the company to sustain growth. A company like Amazon (NASDAQ:AMZN), which has financed much of it’s growth through an attractive cash conversion cycle, is very different than a company like Under Armour (NYSE:UA), which had to finance its own growth (primarily in terms of investments in inventories).
As always, Buffett has an uncanny ability to recognize the most important variables and how they relate to the intrinsic value of a business. It’s a reminder that the investing is an art that cannot be simplified into a science through shortcuts like a PEG ratio.
Disclosure: Long Berkshire Hathaway’s Class B shares.
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