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WEB: comments on on leverage, character etc. from a 1991 lecture


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Insights from WEB on leverage, during a Q&A in 1991. It is interesting as to which names he uses as an example for his "character Investment" thesis ...


Spring, 1991:  Three Lectures by Warren Buffett to Notre Dame Faculty, MBA Students and Undergraduate Students (transcript at http://www.tilsonfunds.com/BuffettNotreDame.pdf)


Question from Audience:  …. On Donald Trump and the Perils of Leverage


Where did Donald Trump go wrong? The big problem with Donald Trump was he never went right. He basically overpaid for properties, but he got people to lend him the money. He was terrific at borrowing money. If you look at his assets, and what he paid for them, and what he borrowed to get them, there was never any real equity there. He owes, perhaps, $3.5 billion now, and, if you had to pick a figure as to the value of the assets, it might be more like $2.5 billion. He’s a billion in the hole, which is a lot better than being $100 in the hole because if you’re $100 in the hole, they come and take the TV set. If you’re a billion in the hole, they say “hang in there Donald.”


It’s interesting why smart people go astray. That’s one of the most interesting things in business. I’ve seen all sorts of people with terrific IQs that end up flopping in Wall Street or business because they beat themselves. They have 500 horsepower engines, and get 50 horsepower out of them. Or, worse than that, they have their foot on the brake and the accelerator at the same time. They really manage to screw themselves up.


I tried this with the last class. Let’s say each one of you could buy 10% of the earnings, forever, of anybody else in this room, except me. Let’s charge $50,000. And that means that if somebody gets out of here and earns $30,000 you get a $3,000 royalty off them. But, if they do extremely well, and become President of Coca Cola like Don Keough did, you’ll make a fortune.


How are you going to think, in terms of the rest of the people here, of which one you want to buy the 10% of? Let’s say we had Donald Trump here, and my friend Tom Murphy, who runs ABC, or Don Keough, and you’re really betting on the lifetime of each of them, and let’s say they’re all in equally good health. Would you give them an IQ test? Well, you’d want to be certain they have a certain amount of IQ. Would you want to measure how strongly motivated they were, how much they wanted to get rich? Donald Trump wanted to get rich. That might not be a great qualifier. What would you do to select that one person out of this whole crowd here, because there will be a huge difference in results here. There’s not a huge difference in IQ. But there will be a huge difference in results. I would venture to say, I don’t know how well this group knows each other, you come from two different schools, so I’d break it down into two groups, I would venture to say that your guesses would not be bad. They’d be better if you’d had more experience with the group, and if you’ve had more experience generally, but they will be way better than flipping coins. You would probably relate it to a lot of qualities, some of which would be straight from Ben Franklin – I would suggest that the big successes I’ve met had a fair amount of Ben Franklin in them. And Donald Trump did not.


One of the things you will find, which is interesting and people don’t think of it enough, with most businesses and with most individuals, life tends to snap you at your weakest link. So it isn’t the strongest link you’re looking for among the individuals in the room. It isn’t even the average strength of the chain. It’s the weakest link that causes the problem. It may be alcohol, it may be gambling, it may be a lot of things, it may be nothing, which is terrific. But it is a real weakest link problem.

When I look at our managers, I’m not trying to look at the guy who wakes up at night and says “E = MC 2” or something. I am looking for people that function very, very well. And that means not having any weak links. The two biggest weak links in my experience: I’ve seen more people fail because of liquor and leverage – leverage being borrowed money. Donald Trump failed because of leverage. He simply got infatuated with how much money he could borrow, and he did not give enough thought to how much money he could pay back. You really don’t need leverage in this world much. If you’re smart, you’re going to make a lot of money without borrowing. I’ve never borrowed a significant amount of money in my life. Never. Never will. I’ve got no interest in it. The other reason is I never thought I would be way happier when I had 2X instead of X. You ought to have a good time all the time as you go along. If you say “I’m taking this job – I don’t really like this job but in three years it will lead to this,” forget it. Find one you like right now. ……


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Good stuff. Lots of wisdom there.


Regarding leverage: I understand the dislike of debt; however, sometimes there just is no other way to get going or keep going. Real estate is especially tailor made for leverage. I can't understand why anyone would not use leverage for real estate.


Buffett had outside investor capital to help him get going. If you don't have outside investors, what do you use?


Buffett still had an obligation to these outside investors as well, not the same as debt holders, but an obligation nonetheless.

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