This weekend was Berkshire Hathaway's shareholders meeting. This is one of the few times when Buffett goes out to the public to let his shareholders and fans openly question him. This time the meeting format was a little different: half of the questions were vetted by financial journalists Carol Loomis, of Fortune; Becky Quick, of CNBC; and Andrew Sorkin, of the New York Times.
Warren and his not-so-well-known partner Charlie Munger fielded questions for over 6 hours. The most interesting ones had to do with the economy, Berkshire holdings, value investing, and accounting rules.
Economy and Inflation
On the economy front, Buffett answered to an 11-year-old boy who asked about what to expect for his future. Buffett told him the usual honest answer that he can't predict the future, but he doesn't see how it could be possible for the US to avoid inflation: "we're doing things now that will inevitably lead to inflation in the future", Buffett told the boy (as I recall him saying -- not a verbatim quote). Munger complemented that he still remembers the 2-cent stamp and the 5-cent 6 ounce bottle of Coca-cola and that inflation has always been with us, and it will continue to be, and as long as it's not massive and uncontrolled, we will be okay.
Berkshire holdings and activism from Buffett
A very interesting question and perhaps one that exposed one of Buffett's weaknesses in my opinion was about Moodys, the rating agency he owns 20% of. The question asked why he did interfere with Moodys inflated valuations of housing and mortgage-related securities. The question pondered, if he saw it coming -- which it wasn't clear he did -- why didn't he take an active role in telling Moodys (and perhaps S&P) about it. His answer was disappointing, but nonetheless honest. He said he's not an activist and has never been. He buys companies for their value and net worth and not with the intention of changing them. He thought and still thinks that Moodys is a very good company with good prospects, but his role is to allocate capital, not to manage companies, especially ones he doesn't own 100%.
I was disappointed because being such an honest person and so good in what he does, the normal thing to expect is that he would take a more active role in "fixing" mistakes, wrongdoing and excesses. I think I probably expect him to be a hero too, despite being the most successful investor of all times. Perhaps that's asking too much of him. It could even spoil him. Corporate activists have fame of being raiders and acting in self-interest. I disagree with this simplistic view by the media and I respect the famous activist Carl Icahn's position. But that's subject of another post.
Also, it wasn't clear whether or not Buffett really knew the housing excesses were really about to pop or not, so maybe it wasn't just that he didn't say or do anything, but that he, like most of us and most big banks, didn't see it coming.
Executive compensation and shaming mutual fund managers
Another question touched upon changes in executive compensation, and why he didn't take a more active role there, in the public companies he owns. He mentioned he had been on the board of 19 companies and that he didn't believe he could affect them much. He recalled being vocal about compensation when he was part of the compensation committee at some company I don't recall, but being kicked out of the compensation team ever since. Out of 19 boards, he was on only this one compensation committee and was never invited again.
His solution to exuberant executive compensation is to have large institutional investors -- the big mutual funds managers -- be more vocal about it. And that all it takes is for the public and the media to shame them into taking this active role on compensation. He said it would take only 3 to 4 big mutual funds to synchronize an attack on CEO and executive compensation to kick-start the process.
Fair enough. Here's my part of the bargain. Because of all of you, my four faithful readers, I can be considered part of the media too. So I'm now publicly embarrassing the managers of the top 3 mutual funds (by assets) for not taking a more active role in executive compensation. According to this article and others, the top 3 companies managing equities are American Funds, Fidelity and Vanguard. And according to Marketwatch the top 3 funds by assets are: AGTHX, FCNTX and VTSMX. Their manager's names are: Gordon Crawford and team, of American Funds; Will Danoff, of Fidelity Contrafund; and Gerard C. O Reilly, of Vanguard Total Stock Index. Shame on you!
Regarding value investing, a woman from Omaha asked how Buffett does it and whether it was true he didn't need a calculator or a computer to crunch the numbers. Buffett confirmed that he didn't do spreadsheets nor used calculators and that it doesn't make a difference whether the discount rate is 9.1% or 9.2%: "the numbers should jump at you", Warren said.
He repeated Ben Graham's words that too much IQ can actually interfere with good financial results in the markets. He pointed out examples of Long-Term Capital Management (LTCM), a hedge fund that blew up a few years back due to manager's exaggerated confidence in their abilities, given their 150 IQ, PhD and sophisticated computers (here's a video of Buffett commenting on this at a meeting with students).
Buffett repeated what he's said many times before, that investing is simple and one should only focus on their circle of competence and when in doubt throw wild ideas and complex companies in the "too hard" file and forget about them.
As part of a question I don't recall now, Munger made a bold remark about some Generally Accepted Accounting Principles (GAAP) having some rules that are bogus. The one he cited is a company being able to increase its equity because the price of their bonds went down and the company being able to report buying their debt at a discount as a "profit". Citibank recently did just that and the difference between the market value of their bonds and par was recorded as a profit. Of course, this is just a paper profit, since no cash flows to the company. In fact, there's an outlay of cash by the company, to purchase its debt back. So, if anything, this should be an expense, not a gain.
But the debt reduction is real, and hence why GAAP indicates this should be recorded as income. I don't know how to reconcile this fact with what Munger pointed out, that there was no cash being generated to the company. How should this be treated under a proper accounting system? Perhaps it should be booked now as an expense (the outlay of cash to repurchase the debt) and when the debt formally matures it should be treated as a capital gain. But if the entire amount of debt was repurchased, then it's hard to justify waiting many years for the now nonexistent debt to mature.
I've commented on other voodoo accounting practices being adopted by closed-end mutual funds for apparently no good reason.
An elaborate question given to the journalists asked whether Berkshire had changed the rules of the game. Its owner manual states that a dividend shall only be paid if for each dollar of earnings retained Berkshire does not accrue at least a dollar in share price over time. The manual says that so far that test has been met. The question points out that for the last 5 years, the retained earnings were not reflected in the share price nor in the book value of the company and that perhaps it would be time for Berkshire to pay a dividend after all.
Buffett answer poorly in my opinion. It was mostly a non-answer about 2008 being a bad, one-off year and that Berkshire did better than the S&P 500. I would have been satisfied if he had said he prefers to exclude 2008 and that he would re-think his decision by end of 2009. That would have been decent. But the comparison with the S&P 500 has nothing to do with whether or not $1 of retained earnings are reflected in the stock price or not. This seems to me like a change in the rules of the game.
I personally think that Buffett will face this question again and again and more strongly every time, given that the amount of growth everyone, including himself, expects from Berkshire is diminishing dramatically, given its size. I wouldn't be surprised if BRK paid a special dividend in the next 5 years and instated a permanent dividend policy within 10-15 years.
Berkshire is not immune to corporate activism. This year some shareholder brought to our attention possible employee mistreatment in Fruit of the Loom's factories in Honduras. A former employee, speaking in Spanish, commented on inhumane treatment, threats and other allegedly excesses of management in Honduras. A Fruit of the Loom manager spoke about the third party investigations, actions taken and firing of the people responsible. He said how things have improved since then, commented on some exaggeration by the woman reporting the facts and the closing of the factory since then, due to the downturn in the economy.
On the succession front, Buffett fielded questions about who would take over upon his death. This has become a trite subject by now and is not very interesting, since Buffett won't comment who the candidates are. The same 3 internal candidate remain for the CEO position and the same 4 internal/external candidates also remain for the position of Chief Investment Officer (CIO). When asked how the possible future CIOs did this year, Buffett said they did a little worse than the S&P, but that this didn't bother him, as over the long run, they should outperform the S&P.
Judging from Buffett's voice and some coughing, and Charlie falling asleep a few times during the meeting, their health is not what it used to be (whose is?). Despite that, if Buffett stops drinking five cans of Cherry Coke per day and eating burgers, he might live another 20 years.
Buffett also mentioned a few times about the 2008 letter to shareholders of JP Morgan Chase, by Jamie Dimon. I have not read it yet, but I will. Perhaps I'll have something to say about it here. Stay tuned.
Among the celebrities present, I saw Pat Dorsey, from Morningstar, author of books I highly recommend for the beginner investor: The Five Rules for Successful Stock Investing (the very first book on stock investing I bought) and The Little Book that Builds Wealth (next year I'll be sure to bring my copies of these books for Pat to sign and I'll hope he brings along his colleague Josh Peters, author of another book I like, The Ultimate Dividend Playbook).
Also present who I believe was Monish Pabrai, author of The Dhandho Investor (a popular book I have not read myself yet, except for a few excerpts). Of course, Bill Gates as a Berkshire director was there too as was Susan Decker, ex-Yahoo.
Pat Dorsey, from Morningstar.