Buffett Questions for 2013 Annual Meeting

[racemize]

We can email questions to be asked by the three analysts, which I was planning on doing.  I thought it might be interesting to get a set of questions together from the board and send the top voted 1-3 questions to those analysts--e.g., it may give the questions more weight if it was voted for by a bunch of value investors.  Even if not, it might still be interesting to see what questions people have for Buffett and perhaps we could answer them ourselves.  Here are my two questions about Berkshire:

 

1) There are numerous different ways to calculate the intrinsic value of Berkshire Hathaway.  You [buffett] espouse applying a multiple to operating earnings of wholly owned subsidiaries and adding investments per share.  Another approach is to begin with book value and apply various adjustments, such as adding back some of the float liability due to its lack of cost.  These approaches give values much higher than recent prices.  However, another approach for valuing Berkshire is to begin with its book value, which is a conservative proxy for intrinsic value, and apply an expected growth rate over time, against a discount rate, to determine the highest multiple of book that can be paid and still achieve an acceptable return.  As you have repeatedly indicated, the 20% annualized returns on book value cannot be replicated going forward due to Berkshire's present size.  Accordingly, I estimate future annual book value gains may be in the 10-15% range, hopefully conservatively.  Against a discount rate of 10%, Berkshire can only be valued at book value for 10% annual returns and 1.5 of book for 15% annual returns, without an additional margin of safety.  These values seem to be somewhat at odds with 1.2 of book being significantly below intrinsic value, as you have stated.  Is this line of thinking flawed?

 

2) As Berkshire has begun buying and investing in capital intensive businesses such as MidAmerican and BNSF, you [buffett] have indicated that incremental capital is able to be invested at high (or at least acceptable) rates of return.  Could you please let us know what range of returns you expect with this additional capital?  In addition, these companies also generate a fair amount of profits themselves, so are they able to soak up much of the cash being generated by other businesses?

[Guest longinvestor]

Here is one:

 

1) Berkshire's future success will hinge more and more on the operating businesses as they grow in number and size with both capital investments and bolt-on aquisitions. Do you see the next CEO intervening in the businesses more than now. When / how would the CEO of Berkshire intervene when a business gets off the rails? (Ex: Netjets a couple of years ago)? How will this be instilled in the BRK culture given the largely "hands-off" management approach currently followed?

 

[CONeal]

Mine would be

 

With the influence of activist investors (ex Apple) and the market seeming to be more short term oriented, do you think another Berkshire could be built in this type of environment?  Please expand on your answer.

[ragu]

[...]1.5 of book for 15% annual returns, without an additional margin of safety. 

 

racemize,

 

FWIW (presuming my historical figures are correct), WEB is on the record implying that a 1.75 multiple of book for Berkshire as "not inappropriate" in a world of long-term interest rates between 6-7% if per-share intrinsic value increased annually at a rate of 15%.

 

Best,

Ragu

[racemize]

[...]1.5 of book for 15% annual returns, without an additional margin of safety. 

 

racemize,

 

FWIW (presuming my historical figures are correct), WEB is on the record implying that a 1.75 multiple of book for Berkshire as "not inappropriate" in a world of long-term interest rates between 6-7% if per-share intrinsic value increased annually at a rate of 15%.

 

Best,

Ragu

 

Thanks! Do you know where that came from?

 

I was just watching the CNBC videos at part I, and Buffett said something along the lines of: "1.2 is undervalued, could the real number be 1.35 or 1.3x of book?  I don't know what the value is but 1.2 is significantly undervalued."  The fact that he was in the 1.3 range was surprising to me--I thought he'd be near 1.4 or 1.5 honestly.

[ragu]

Thanks! Do you know where that came from?

 

1993 letter:

 

On the other hand, in a world of 6% or 7% long-term interest rates, Berkshire's market price was not inappropriate if - and you should understand that this is a huge if - Charlie Munger, Berkshire's Vice Chairman, and I can attain our long-standing goal of increasing Berkshire's per-share intrinsic value at an average annual rate of 15%.

 

1993 year-end BV/share: $8,854

Closing market price on February 28, 1994 (the day before the letter was published): $15,450

Price/book: 1.74

 

Of course, Berkshire itself has changed since then with the acquired operating businesses growing to be a significant portion of the company's value. Also, with the change in the accounting rules surrounding these acquired businesses (goodwill is no longer amortized annually, but only tested for impairments), the difference between book and intrinsic value isn't as wide as it might have been under the old rules.   

 

Best,

Ragu

[racemize]

I think that makes sense for a discount rate of 6-7%--using 10% appears to move it down to 1.5 of book, if I'm thinking about it the right way anyway.

[Guest longinvestor]

Here is another question,

 

A $1,000,000 stock price for one A share is a real possibility over the next decade or so. Given your thoughts of being inclusive of the small shareholders (like you shared during the BNI purchase) which created the <$100 B share, what are your thoughts around the BRK shareholder base when the Million dollar A share becomes a reality? Even today there are people who cannot mentally deal with a $100,000 dollar stock price. Will the Berkshire of tomorrow deal with this issue the same way you have?

[nkp007]

How have you comfortably made acquisitions of entire companies in the past without having account firms go through their books? How do you get comfortable waiving such due diligence?

[oddballstocks]

How have you comfortably made acquisitions of entire companies in the past without having account firms go through their books? How do you get comfortable waiving such due diligence?

 

This is a good one, and as CEO he has fiduciary duty to shareholders to make sure that we aren't taken advantage of.  What's an example of an acquisition that appeared better on paper but the results never materialized in reality?  What changes have taken place since that acquisition to ensure it doesn't happen again?

[SouthernYankee]

Beware, to those who believe in certain signs:

 

"A $1,000,000 stock price for one A share" = $666 (and change) for the "B" shares. Some say money is the root of all evil!  :D

 

Cheers!

[Mephistopheles]

If you weren't good friends with Bill Gates, would you invest in MSFT at these prices?

[racemize]

following on from another thread, how about:

 

Mr. Buffett, you have said in the past, in your letter regarding the stock market in 1999, "you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%".  Corporate Profits are now greater than 10% of GDP--how should we think about this?  Do you think there will be a compression in profit margins?

[rmitz]

following on from another thread, how about:

 

Mr. Buffett, you have said in the past, in your letter regarding the stock market in 1999, "you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%".  Corporate Profits are now greater than 10% of GDP--how should we think about this?  Do you think there will be a compression in profit margins?

 

Does anyone have data on the percentage of corporate profits of all corporations vs the GDP of the earth?  That would eliminate a rebuttal.  GDP also has some things in common with those accounting fictions Buffett was talking about in his letter this year.

[JBird]

A $1,000,000 stock price for one A share is a real possibility over the next decade or so. Given your thoughts of being inclusive of the small shareholders (like you shared during the BNI purchase) which created the <$100 B share, what are your thoughts around the BRK shareholder base when the Million dollar A share becomes a reality? Even today there are people who cannot mentally deal with a $100,000 dollar stock price. Will the Berkshire of tomorrow deal with this issue the same way you have?

 

Think about the quantitative implications of your question. If the intrinsic value of the A shares is currently around $200,000, what would it take for that value to get to $1,000,000 in a decade? Intrinsic value would have to grow at 17.4% per annum. Of course, Berkshire management knows that's an impossible feat.

 

Mr. Buffett, you have said in the past, in your letter regarding the stock market in 1999, "you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%".  Corporate Profits are now greater than 10% of GDP--how should we think about this?  Do you think there will be a compression in profit margins?

 

A great question.

[jay21]

He was talking about earnings growth being around 6%, no?

[Guest longinvestor]

A $1,000,000 stock price for one A share is a real possibility over the next decade or so Given your thoughts of being inclusive of the small shareholders (like you shared during the BNI purchase) which created the <$100 B share, what are your thoughts around the BRK shareholder base when the Million dollar A share becomes a reality? Even today there are people who cannot mentally deal with a $100,000 dollar stock price. Will the Berkshire of tomorrow deal with this issue the same way you have?

 

Think about the quantitative implications of your question. If the intrinsic value of the A shares is currently around $200,000, what would it take for that value to get to $1,000,000 in a decade? Intrinsic value would have to grow at 17.4% per annum. Of course, Berkshire management knows that's an impossible feat.

 

A great question.

 

No attempt on my part to get to mathematical precision, like 17.7%. I was not asking about intrinsic value, but share price. A $ 1 M share price is highly probable(almost certain) in a decade or so. BTW, how did you come up with the current intrinsic value of $200,000? Or that 17.7% growth is impossible? 

[JBird]

I use the two-column approach to valuing Berkshire. I value Berkshire's portfolio at 100 cents on the dollar and its non-insurance operating earnings at about 13x after-tax earnings. My estimate is that the A shares are worth around $190,000. I rounded up to 200 for the sake of simplicity.

 

If you're trying to reach a conclusion about the price of Berkshire in 10 years or so, would you look to something other than Berkshire's value? To your second question, Berkshire cannot compound at 17%+ for 10 years because the capital base is too big. Its investment portfolio will not grow at that rate, and neither will growth in non-insurance operating earnings (though it won't be far off).

 

Please don't take what I said as a personal criticism.

 

- J.D.

[Guest longinvestor]

I use the two-column approach to valuing Berkshire. I value Berkshire's portfolio at 100 cents on the dollar and its non-insurance operating earnings at about 13x after-tax earnings. My estimate is that the A shares are worth around $190,000. I rounded up to 200 for the sake of simplicity.

 

If you're trying to reach a conclusion about the price of Berkshire in 10 years or so, would you look to something other than Berkshire's value? To your second question, Berkshire cannot compound at 17%+ for 10 years because the capital base is too big. Its investment portfolio will not grow at that rate, and neither will growth in non-insurance operating earnings (though it won't be far off).

 

Please don't take what I said as a personal criticism.

 

- J.D.

 

Rate of return or IV or Share price or the time frame etc. were not the point of my question for the annual meeting.

 

Simply that when the A share hits $1 Million, it means only millionaires can be BRK shareholders (at least the A shareholder base, which is the bulk of them). The B shares were split for a special event, to allow BNI holders the opportunity to own BRK. Barring such future events, will the milestone of a Million dollar share price influence management differently than historically? A stock split, a C share etc?

That is my question. A million dollar share price will be without precedent in the market and will come attached with profound perceptions/connotations. Yeah, I have heard Warren talk about why stock splits mean nothing etc.

 

[thepupil]

I actually have thought about this too, but not in terms of $1,000,000 A share price, which is probably closer to 20 years away than 10. Think about the implied rate of return on BRK's non-cash and non short term fixed income investments if you think you can get to $1MM in close to 10 years; it would have to be nucking futs. Then again, I hope you are right!

 

What I have thought about is that each year more A shares convert to B shares, the A shares grow more relatively powerful since they have 6+ times the voting power.

 

The conversion can only go one way so over time. More and more long term holders will die or diversify, Warren's donated shares will likely be converted to facilitate sale as the B's become more  relatively liquid and the A's become an even more exclusive club. Institutional shareholders will gravitate incrementally towards the B's.

 

Over time the ratio of voting interest relative to economic interest of the A shares will start to get interesting, particularly after Buffett dies.

 

At the end of 2011 there were 938,244 A shares and 1,650,806 total A share equivalents. The A shares commanded a 56.84% economic interest and 89.77% of the voting power. By my calculations, conversions caused A shares share of economic interest to decline by 2.3% in 2012, but their voting power only declined by 0.91%.

 

Hypothetically, if 1/2 of the A shares converted tomorrow, the A shares would have a 27% economic interest, but still command 71% of voting power, if I am doing my calculation correctly ( 447K A shares +1.8B B shares /10000 = 626K total votes of which the A shares would have 447K)

 

At its most extreme, the A shares could convert to a point where a 13% economic interest commands 50.1% of the voting power.

 

All this is moot and probably not worth thinking about since Berkshire is a controlled company and will remain so, but I just think it will be interesting to watch over the years.

 

I wouldn't be surprised to see a meaningful premium develop in the A shares over time, since a liquidity discount can be arbitraged away and more  long term oriented holders may see it prudent to preserve their voting power

[JBird]

Thanks to Heilko for finding this SEC link.

 

http://www.sec.gov/Archives/edgar/data/1067983/000119312513109017/d467360ddef14a.htm

 

It shows that Warren owns just under 40% of the outstanding Class A stock.

[jay21]

Question:  Do you impose the same investment limitations on Tedd and Todd as yourself?  E.g. can one of them invest in MSFT?

 

Didn't Buffet also mention he won't invest in vice stocks like tobacco and alcohol?  Curios to see if he imposes that on them as well.

[Mephistopheles]

Question:  Do you impose the same investment limitations on Tedd and Todd as yourself?  E.g. can one of them invest in MSFT?

 

Didn't Buffet also mention he won't invest in vice stocks like tobacco and alcohol?  Curios to see if he imposes that on them as well.

 

Yes, for MSFT, neither Todd or Ted are allowed to buy it - Buffett mentioned that in an interview once. Not sure about the vice stocks. And I don't think that alcohol counts as a vice stock, at least for Buffett. They used to own Anheuser Busch several years ago. And they also own a liquor distributor. I think casinos and tobacco are the two that Buffett avoids.

[jay21]

Question:  Do you impose the same investment limitations on Tedd and Todd as yourself?  E.g. can one of them invest in MSFT?

 

Didn't Buffet also mention he won't invest in vice stocks like tobacco and alcohol?  Curios to see if he imposes that on them as well.

 

Yes, for MSFT, neither Todd or Ted are allowed to buy it - Buffett mentioned that in an interview once. Not sure about the vice stocks. And I don't think that alcohol counts as a vice stock, at least for Buffett. They used to own Anheuser Busch several years ago. And they also own a liquor distributor. I think casinos and tobacco are the two that Buffett avoids.

 

You're right.  I also remember him being long Diageo in the 1990s or whoever produced Guinness then.

[wknecht]

Question:  Do you impose the same investment limitations on Tedd and Todd as yourself?  E.g. can one of them invest in MSFT?

 

Didn't Buffet also mention he won't invest in vice stocks like tobacco and alcohol?  Curios to see if he imposes that on them as well.

I'm curious, when did Buffett mention vice stocks? Past AGMs? Don't recall this, though have heard him talk about how many letters from gamblers he gets (when talking about state lotteries).