Now here's a dose of reality you can take to the bank...er, I mean invest. Some excerpts from the Berkshire Hathaway annual meeting Q&A session. Answer by Charlie Munger (CM) and Warren Buffet (WB).
You had some really extraordinary things happening in credit markets, because people were panicking or they thought that other people were going to panic. We'll have other events like that again, not exactly the same. As Mark Twain said: "History doesn't repeat itself ... but it rhymes."
Q: Do you think gambling companies will have a great future?
WB: Gambling companies will have a great future as long as they're legal. People like to gamble and they do so in stocks, incidentally. Day-trading came very close to meeting the standards of gambling. The human propensity to gamble is huge. If the Super Bowl is on -- or even a bad game -- you enjoy more if there's a few bucks on the game. We insure against hurricanes, so I watch The Weather Channel.
When the states found out what a great source of revenue it is, they made it easier and easier to gamble. I put a slot machine on the third floor of my home and I could give my kids any amount (in dimes) and I would have it back by the evening.
To quite an extent, gambling is a tax on ignorance. If find it socially revolting when the government preys on the ignorance of its citizenry. When the government makes it easy for people to take their Social Security checks and pull [slot machine] handles, it relieves taxes on those who don't fall for it. It's not government at its best.
CM: The casinos use clever psychological tricks for people to hurt themselves. It's a dirty business and I don't think you'll find a casino soon in Berkshire Hathaway.
Q: Given your experience in underwriting insurance, any thoughts on helping to solve the health-care mess?
CM: It's too tough! Warren and I can't solve that one.
WB: We try to look for easy problems -- you can do that in investing. We don't go around looking for tough problems. We do very little in health insurance. If we were looking for solution in the private sector, we would look for one with very low distribution costs. Charlie's view reflects mine at present.
Q: You've repeated several times that you could earn annualized returns of 50% a year if you were managing small amounts of money -- how would you accomplish this? Buy-and-hold investing or through Ben Graham "cigar butts", arbitrage, etc.?
WB: If I were working with a small sum, I'd be doing very different things than the things I'm doing now. Your universe expands -- you have many, many options, if you're investing that small amount. You can earn very high returns with very small amounts of money. Not anybody can do it, but if you know something about value investing, you can do very well. If we were deploying $1million, we'd earn very high returns on capital. If Charlie and I were working with $500,000 to $1 million, we would find small things and they wouldn't all be stocks.
Q: What is your opinion on the subprime market?
WB: [Poor practices in the subprime market] resulted in a lot of people buying houses they shouldn't have. The individuals and, in some cases, the institutions are going to suffer in varying degrees. The question is whether this will spill over into the general economy. I would guess that if unemployment doesn't rise significantly and interest rates stay relatively low, it will be a problem for those involved, but it's unlikely that that factor alone triggers anything massive.
I looked at the 10-Qs and 10-Ks of some financial institutions recently and it appears that some of the borrowers were making low initial payments such that the value of their principal increased. Later on, these people were expected to make substantially higher payments. I think it's dumb lending and dumb borrowing (talking about negative-amortization loans). Those people and institutions were betting on prices continuing to go up. That worked for a while . . . until it didn't work. Then you have too much supply coming on the market. Demand dies off and supply is massive. You'll see plenty of misery (you're seeing some), but it's not likely to be a huge anchor to the economy.
CM: What we had was a combination of sin and folly. The accountants allowed the institutions to show profits on loans that no one in their right mind would have allowed to show a profit until the loan matured to a better condition. The minute you pay people high commissions to make loans to the "undeserving poor", or the "overstretched rich," you're in trouble. I don't see how those who did it can still shave in the morning, because the face looking back is evil and stupid.
WB: You have loans where some people weren't even making the first two or three payments -- that shouldn't happen. We saw a preview of this with the manufactured home industry years ago. Securitization has fed the problem. Discipline goes out the window. Don't think it will cause massive troubles though. But there are several areas of the country where real estate will be difficult.
Q: For a 23-year-old with ambitions, genetic wiring, seed capital, what opportunity areas do you see over next 25-50-100 years for the purpose of massive value creation?
WB: Read everything in sight, when you have chance to talk to someone like Lorimer Davidson, you learn more in hours than you do in university. We've made money in many ways, some we didn't expect. We just kept looking. You knew, say during the Long Term Capital Management crisis, there would be opportunities to make money. A very high percentage of opportunities. Can't lay out in advance, need a mental reservoir to prepare yourself. It's a way of being programmed.
CM: First place to look is the inefficient markets - don't guess where one thing is happening.
WB: Have a lot going in areas where there are few others. The RTC [Resolution Trust Corporation] was a perfect example -- selling an asset in which they had no economic interest, the seller was motivated just to sell, not realize value. Buyers were more motivated. There won't be a scarcity of opportunities in your life, though you might have days when it feels like it.
Q: You purchased $5.3 billion in shares in the first quarter in the face of rising equity markets. What does it say about your attitude towards hurdle rates?
WB: Stocks didn't rise in Q1 (they didn't go down either), although they did go up last month. Did we change our standards? I don't think so, but you can't be 100% sure. If you haven't had a date in a month, you can say you would have dated that girl on the first day (Laughter)... but I think we would have dated that girl.
We've got plenty of money available, and we would sell stocks if we really needed to buy a big business. We're as prepared as we would ever be. We want a very attractive business. TTI was a great business -- wish it was five times the size. We know the kind of people we want, the kind of business we want, and one way or another, we'll swing [the bat].
CM: One thing I can tell you is that we won't make the kind of returns on our current investments that we made 10 or 15 years ago. It's a different world.
WB: We won't come close!
Q: On the use of Beta ... Why would a rational investor substitute volatility (the opinion of the market) for their own intellect? Could you expand on your thoughts?
WB: Volatility does not measure risk. The problem is that the people who have written and taught about risk do not know how to measure risk. Beta is nice because it is mathematical, it is easy to calculate and it is wrong - past volatility does not determine the risk of investing. In early 1980s, farmland that had gone for 2,000 an acre, went for $600 an acre. Beta shot up. I was apparently buying a riskier asset at $600 than at $2,000. Real estate not frequently traded. Stocks give you the ability to measure this volatility nonsense.
Because people who teach finance use the mathematics that they have learned, they translate volatility into all types of measures of risks -- it's nonsense. Risk comes from the nature of certain types of business, and from not knowing what you're doing. If you understand the economics of the business that you're engaged in and you trust the people you are partnering with, you're not running significant risk.
I don't think I can recall a loss on marketable securities with Charlie, even though we have bought securities with very high betas. Volatility as risk has been very useful for those who teach, never useful for us.
CM: We would argue that it's at least 50% twaddle, though these people have very high IQs. One of the reasons we've done well is that we recognized early on that very smart people will do very dumb things and we tried to figure out why (and who, in order to avoid them).
WB: A roulette wheel will pay a lot of money to the one [player], but we'd love to own a lot of roulette wheels.
Q: I'm curious to know who are your present day heroes (beyond your father, Davy, and Ben Graham)?
WB: I've got a number of them and I'm not sure I want to name them, because the ones you don't name might feel left out. But the one thing is that none of those people have ever let me down.
Choosing your heroes is very important. Associate with people who are better than you. Marry up and hope you can find someone who doesn't mind marrying down.
CM: You're not restricted to the living in choosing your mentors. Some of the best people are dead.
Q: Ethanol thoughts?
CM: The idea of running automobiles on corn is one of the dumbest I've ever seen. You want a social safety net. The most basic safety net is food and now you're going to raise the cost of food? I love Nebraska, but this is not my home state's finest moment.
Q: [From a 10-year old girl] What are the best ways a 10-year-old can make money?
WB: I thought a lot about that as a 10-year-old. [There are statistics according to which the] younger you were when you did your first piece of business correlates with better business success later on, which sort of makes sense. I probably tried about 20 different businesses by the time I got out of high school. Do whatever you can do that people don't want to do and will pay you to do. Ten years old is probably too young for paper delivery, you might have to wait until you're 13 or 14. Ask people what other people who were that age did to make money.
CM: Make yourself a very reliable person and stay reliable your entire life and it will be very difficult for you not to do well.
Q: Dow Jones, Murdoch, what advice to give to long-suffering New York Times shareholders?
WB: I think the long-suffering shareholder has probably made a mistake -- we've said for a good many years that newspapers were overpriced as valuation was based on rear-view mirror, not window. The woes of the newspaper business are not connected to the difference in how they structure the equity at the New York Times or other places. Assume that Gutenberg, instead of inventing movable type decided to run a hedge fund to really make something of himself. If his descendant, Gutenberg the 28th, came along today with an idea to build expensive presses that run all night to deliver pieces of paper so they can read about what happened yesterday, I don't think we'd back him. The position of newspapers today still reflects past inertia and momentum. I don't care how smart you are, the forces you're going against are inexorable. Not much any genius can do about that. Used to sell 300,000 sets of World Book per year, they now sell about 22,000 sets -- not through any fault of World Book. Companies with no dual-share structures have suffered too -- look at Buffalo News, earnings are about 40% off the peak, and we have tremendous penetration and great management.
CM: The deal share structure was there at the beginning. It is a contractual agreement. To think that you can stamp your foot and cry for a change in the contract seems a little childish.
Annual and quarterly reports are here.