Business and Life Lessons from Warren Buffett

2010-02-17T13:36:00.000-08:00

Buffett's Investment Record-Luck or Skill?

Nassim Taleb, author of Black Swan, was recently quoted as saying "I'm not saying Buffett doesn't have skill-I'm just saying we don't have enough evidence to say Buffett isn't doing it by chance."

For the record, over the past 45 years the book value of Berkshire Hathaway's stock has grown at a rate of 20% plus while the Standard & Poors 500 index has appreciated by a rate of 10% plus. It's difficult to understand what evidence Mr Taleb is missing.

I suggest that he read Mr. Buffett's article, The Superinvestors of Graham-and-Doddsville, an edited transcript of a talk he gave at Columbia University in 1984.

A few excerpts follow:

Is the Graham and Dodd "look for values with a significant margin of safety relative to prices" approach to security analysis out of date? Many of the professors who write textbooks today say yes. They argue that the stock market is efficient; that is, that stock prices reflect everything tat is known about a company's prospects and about the state of the economy. There are no undervalued stocks, these theorists argue, because there there are smart analysts who utilize all available information to ensure unfailingly appropriate prices. Investors who seem to beat the market year after year are just lucky......Well, maybe. But I want to present you with a group of investors who have, year in and year out, beaten the Standard & Poors 500 stock index.

The common intellectual theme of the investors of Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market.....Our Graham & Dodd investors, needless to say, do not discuss beta, the capital asset pricing model, or covariance in returns among securities. These are not subjects of interest to them. In fact, most of them would have difficulty defining these terms. The investors simply focus on two variables: price and value.

While they differ greatly in style, these investors are, mentally, always buying the business, not buying the stock.

I urge Mr. Taleb read the entire article, which many consider to be the best on investing ever written.

2010-02-06T13:51:00.000-08:00

Buffett on Corporate Debt

In a rare move, on February 4, Berkshire Hathaway issued $8 billion of new debt (5.75% notes due January 15, 1940) in connection with its acquisition of Burlington Northern Santa Fe Corp.

In her comments on the issuance, Margie Patel, a senior portfolio manager at Evergreen Investment in Boston, said: "Warren Buffett is taking advantage of an extremely attractive time to finance, with borrowing costs near all time lows due to narrow Treasury yields and an insatiable appetite evident among investors."
__________________________________________________
Romy Varghese and Kellie Geressy-Nelson, Wall Street Journal, February 5, 2010

Over the past 30 years, in his shareholder letters, Buffett has written about the appropriate type and the timing of the issuance of corporate debt.

"Except for token amounts....We are not interested in incurring any significant debt at Berkshire for acquisition or operating purposes. Conventional business wisdom, of course, would argue that we are being too conservative and that there are added profits that could be safely earned if we injected moderate leverage into our balance sheet."
___________________________________________
2005 Letter to Berkshire Hathaway Shareholders

"We use debt sparingly and, when we do borrow, we attempt to structure our loans on a long-term fixed-rate basis. We will reject interesting opportunities rather than over-leaverage our balance sheet. This conservatism has penalized our results but it the only behavior that leaves us comfortable, considering our fiduciary obligations to policyholders, lenders and the many equity holders who have committed unusually large portions of their net worth to our care. As one of the Indianapolis "500" winners said: "To finish first, you must first finish."
_______________________________________
1996 Letter to Berkshire Hathaway Shareholders

"In general, we continue to have an adversion to debt, particularly the short-term kind. But we are willing to incur modest amounts of debt when it is porperly structured and of significant benefit to shareholders."
_________________________________________________
1992 Letter to Berkshire Hathaway Shareholders

"Unlike many in the business world, we prefer to finance in anticipation of need rather than in reaction to it. A business obtains the best financial results possible by managing both sides of its balance sheet well. This means obtaining the highest-possible rturn on assets and the lowest-possible cost on liabilities. It would be convenient if opportunities for intelligent action on both fronts coincided. However, reason tells us that just the opposite is likely to be the case. Tight money conditions which translate into high costs for liabilities, will create the best opportunities for acquisitions, and cheap money will cause assets to be bid to the sky. Our conclusion: Action on the liability side should sometimes be taken independent of any action on the asset side."
__________________________________________________
1987 Letter to Berkshire Hathaway Shareholders

"Unlike most businessses, Berkshire did not finance because of any specific immediate needs. Rather, we borrowed because we think that, over a period far shorter than the life of the loan, we will have many opportunities may present themseves at a time when credit is extremely expensive-or even unavailable. At such a time we want to have plenty of financial firepower."
___________________________________________
1980 Letter to Berkshire Hathaway Shareholders

2010-02-03T02:09:00.000-08:00

"I want that CEO equation to be that if this place goes down or needs government help, I'm busted."

In his January 20, 2010 CNBC Squawk Box interview, Buffett presents his solution to change future behavior of bank management and directors.

"I think, and I'm not even sure how you draft this into statutes, but the banks that got into big trouble, it was management at the top. And a number of those went away rich. They didn't go away as rich as they were earlier, but I think that's terrible. I think, if I were on the board of directors of a bank, and you do this in conjunction with the government, but I think you should have something so that if a bank ever has to go to the Federal government, not to the FDIC because that's a form of insurance, but if they have to go to the Federal government to be saved, the CEO and any CEO of the previous two years before that, and his wife, they sign something so that they are essentially wiped out. If an institution that's so important to this country really causes the country great difficulty, I think the CEO, I want that CEO's equation to be that if this place goes down or needs government help, I'm busted. And I can't put it all in my wife's name and she's busted, too. And then I would have strict penalties for directors, probably five times their average compensation or something. I think that would do more to change behavior, the kind of behavior that gets us into trouble, then anything else you could do."
________________________________________________
CNBC Squawk Box Interview, January 20, 2010

2010-01-31T07:05:00.000-08:00

I'm Sorry

In yesterday's New York Times, Alina Tugend writes:

"There has been a fair amount in the news lately about apologies, particularly whether the chief executive officers of financial institutions have been contrite enough about the role they played in bringing about this recession......When you refuse to apologize for a wrong or are told by a lawyer or insurer not to do it "dismantles one of life's most basic moral lessons-owning up to our mistakes, Profeesor Cohen, of the University of Florida, says."
_____________________________________________
Alina Tugend, An Attempt to Revive The Lost Art of Apology, New York Times, January 30, 2010

Warren Buffett would agree. In 1991, in response to the impending collapse of Salomon Brothers
resulting from illegal trading, he says:

“ We did wrong. We ’ re going to show how we did wrong. We ’ ve signed the charge sheet. I would like to start by apologizing for the acts that have brought us here. The Nation has a right to expect its rules and laws will be obeyed. At Salomon, certain of these were broken.
I want employees to ask themselves whether they are willing to have any contemplated act appear on the front page of their local paper the next day, to be read by their spouses, children
and friends . . . . If they follow this test, they need not fear my other message to them: Lose money for the firm, and I will be understanding; lose a shred of reputation for the fi rm, and I
will be ruthless. ”
_______________________________________________
Roger Lowenstein, Buffett: The Making of an American Capitalist (New York: Random House, 1995)

2010-01-30T06:32:00.000-08:00

Women on Wall Street

In today's New York Times, Geraldine Fabricant writes:

"When Sallie Krawcheck was hired six months ago as president of global wealth and investment management at Bank of America, she was besieged with e-mail messages from current and former Wall Street women celebrating her return to the fray.

Ms. Krawcheck had been forced out as head of a comparable unit at Citigroup in August 2008, a highly publicized departure. Hers has been the only comeback among the three highest-ranking Wall Street women removed during the financial crisis.

I don’t think I set foot in a restaurant where some woman did not come up to me and thank me for getting knocked around and going back in,” Ms. Krawcheck, 45, recalled in an interview at Bank of America’s corporate office in New York. “It was unexpected and quite fantastic.”
The outpouring over Ms. Krawcheck’s return reflects deep anxiety among women in the financial industry that their career paths are narrowing even as business picks up again."
____________________________________________________
Geraldine Fabricant, Fewer Women Betting on Wall Street Careers, New York Times, January 30, 2010

Warren Buffett has always been very pro-woman. He was one of only a handful of men invited to speak at the The Fortune Most Powerful Women Summit, recently held in San Francisco. In a remarkable interview with Charlie Rose in 2004, Susie Buffett, Warren’s deceased wife, said:

“I find this a profound thing. I was talking to him one day on some racial issue, and he looked at me, and this Charlie, would have been 40 years ago. And he said to me, wait till women discover they’re the slaves of the world. Now how many men were cognitive of that and even women then? I am so impressed by that, and he’s very, very pro-women….He likes women. Yeah, he does, well why shouldn’t he?....My dad always said that women were the superior gender. And if women ruled the world, it would be a much better place. So I came from a father who loved women, and Warren feels that women all over the world get short-changed…. That’s why he is for eyerything that helps women be part of a level playing field.”
___________________________________________________
Susie Buffett, Charlie Rose Interview, PBS 2004

A few striking examples of Berkshire women executives follow:

"About 67 years ago, Mrs. Blumpkin, then 23 talked her way past a border guard to leave Russia for America, She had no formal education, not even at the grammar school level, and knew no English. After some years in this country, she learned the language when her older daughter taught her, every evening, the words she had learned in school during the day.

In 1937, after many years of selling used clothing, Mrs. Blumpkin had saved $500 with which to realize her dream of operating a furniture store. Upon seeing the American Furniture Mart in Chicago-then the center of the nation’s wholesale furniture activity-she decided to christen her dream Nebraska Furniture Mart.

She met every obstacle you would expect (and a few you wouldn’t) when a business endowed with only $500 and no locational or product advantage goes up against rich, long-entrenched competition. At one early point, when her tiny resources ran out, “Mrs B” (a personal trademark now as well recognized in Greater Omaha as Coca Cola or Sanka) coped in a way not taught at business schools: she simply sold the furniture and appliances from her home in order to pay creditors precisely as promised........

Today Nebraska Furniture Mart generates over $100 million of sales annually out of one 200,000 square-foot store. No other home furnishings store in the country comes close to that volume. That single store also sells more furniture, carpets, and appliances than do all Omaha competitors combined."
_______________________________________________
Warren Buffett, 2003 Berkshire Hathaway Shareholder Letter

"They would learn the essence of business. They would learn that taking care of customers is what it is all about. Taking care of them. I mean by that, giving them good deals, which nobody would touch. She did and working like crazy she was there day after day. She had a passion for it. The truth is, if you took the Fortune 500 CEO’s and I gave you the first draft pick on 10 of them, and I put them in competition with her; she would win." ________________________________________________
Warren Buffett, Charlie Rose Interview, PBS 2004

Susan came to Borsheims 25 years ago as a $4-an-hour saleswoman. Though she lacked a managerial background, I did not hesitate to make her CEO in 1994. She’s smart, she loves the business, and she loves her associates. That beats having an MBA degree any time.

(An aside: Charlie and I are not big fans of resumes. Instead, we focus on brains, passion and integrity. Another of our great managers is Cathy Barron Tamraz, who has significantly increased Business Wire’s earnings since we purchased it early in 2006. She is an owner’s dream. It is positively dangerous to stand between Cathy and a business prospect. Cathy, it should be noted, began her career as a cab driver.)
_________________________________________________
Warren Buffett, 2007 Letter to Berkshire Hathaway Shareholders

2010-01-26T15:25:00.000-08:00

A Tax Inefficient Sale

In his recent CNBC Squawk Box interview, Warren Buffett was sharply critical of Kraft management's decision to sell its pizza business to Nestle, and unnecessarily incurring a $1.2 billion tax bill to do so.

"Well, I think-I think Kraft has got a wonderful portfolio of businesses including their pizza business which Nestle now has, having paid $1.2 billion more for it than we received in terms of cash......

Well, when you look closely, you find $3.7 billion becomes $2.5 billion. And it was an enormously tax inefficient way to get rid of it. If you wanted to sell it, it was tax inefficient. Back when Kraft got rid of Post cereals, they did it in a tax efficient way. It's not that they don't know how to do it, but in this case, they did it in an enormously tax-inefficient way. When you have a business with virtually no basis, Procter & Gamble's gone through this, Kraft, other people. There are ways to handle spinoffs that avoid cutting the government in for almost one-third ownership of the business. And unfortunately, they headlined the $3.7 billion. I don't think I have read anyplace about the fact that they're only getting $2.5 billion. And it was Nestle that pointed out that this business does $2.1 billion in sales and makes $280 million. And giving up $280 million of earnings in a business that's been growing over the years for $2.5 billion of cash, I think, is a big mistake and I think it's a bigger mistake when you're paying -probably counting all of the costs involved including the undervaluation of the Kraft shares given, you're probably paying in the range of maybe 17 times earnings for Cadbury, I think is a big mistake."
_____________________________________________
CNBC Squawk Box Interview, January 20, 2010

2010-01-25T07:16:00.000-08:00

The Kraft Acquisition of Cadbury-Part 1

Last week, in an extraordinarily candid intrview on CNBC, Warren Buffett stated his views on a wide range of topics, including his strong disagreement with Kraft's board of directors' corporate governance and management's decisions in connection with the acquisition of Cadbury. His corporate governance concerns follow:

".....for the people that pay attention to corporate governance, Kraft issued a 78-page proxy statement close to a month ago. And the sole issue was the issuance of 370 million shares of Kraft stock. That was the only thing to be voted on. And in 78 pages, thay told you about a deal that wasn't going to happen, and they told you a lot of other things about how the directors recommended this and everything else. There's one thing they didn't tell you. They didn't tell you what the directors-how the directors felt about the value of Kraft stock. Now, after I came out and said the stock was undervalued, the directors immediately came out and said that they thought it was undervalued, too. What point could possibly be more important when asking shareholders to vote on issuing 370 million shares is the director's views on whether they were going to get fairer value for these shares? In other words, if the directors thought those shares were significantly undervalued, when they issued that proxy statement, I think they had the duty to tell shareholders that they felt that way. Otherwise, you know, the shareholdrs could assume that they were getting fairer value for the shares."
_____________________________________________________
CNBC Squawk Box Interview, January 20, 2010

2010-01-17T09:34:00.000-08:00

Wall Street Ethos

On January 14, Andrew Ross Sorkin reports on the exchange between Phil Angelides, chairman of the Financial Crisis Inquiry Commission and Lloyd C. Blankfein, chairman of Goldman's Sach's, at the Commission's hearings the day before.

Angelides "asked Mr. Blankfein to explain how his firm could have sold bundles of troubled mortgages at the same time it placed bets with Goldman's own money that their value would fall. Mr. Blankfein responded, Goldman's clients knew what they were buying and that his firm was simply providing a customer service. These are professional investors who want this exposure."

Sorkin concluded, "The exchange was partcularly revealing because it laid bare an essential truth about the Wall Street ethos: if there's a buyer-no matter how sophisticated-there's always a seller."
___________________________________________________
Andrew Ross Sorkin, Wall St. Ethos Under Scrutiny at Hearing, New York Times, January 14, 201o

Buffett would agree. Twenty-one years ago, he wrote:

"Our comments about investment bankers may seem harsh. But Charlie and I-in our hopelessly old-fashioned way-believe that they should perform a gatekeping role, guarding against the promotor's propensity to indulge in excess. Promotors, after all, have throughout time exercised the same judgment and restraint in accepting money that alcoholics have exercised in accepting liquor. At a minimum, therefore, the banker's conduct should rise to that of a responsible bartender who, when necessary, refuses the profit from the next drink to avoid sending a drunk out on the highway. In recent years, unfortunately, many lending investment firms have found bartender morality to be an intolerably restrictive standard. Lately, those who have traveled the right road in Wall Street have not encountered heavy traffic."
__________________________________________________
Warren Buffett, 1989 Letter to Berkshire Hathaway Shareholders

2010-01-01T08:13:00.000-08:00

In today's New York Times, reporter David Leonard writes about former assistant Treasury secretary Neel T. Kashkari, who directed the government's Troubled Asset Relief Program for banks, and his recent decision to join PIMCO, headed by Bill Gross. Much of the article describes Kashkari's relationship and dealings with Gross in 2008 and 2009 regarding the financial crisis.

According to Leonard, "several former Treasury officials said Gross had frequently been in touch with Mr. Kashkari and others in government about various initiatives. None of those officials or others suggesting there was anything improper about those contacts."

"Gross was one of those guys, along with Warren Buffett, who were really interested in trying to give us ideas and be helpful in resolving the crisis," said Robert F. Hoyt, a former Treasury Department general counsel under Treasury Secretary Paulson. "They would send memos to Treasury. They weren't ideas we ended up implementing, but they were interesting."

On October 6, 2008, Buffett wrote a very detailed, four-page letter to Paulson, proposing "a program that allows Treasury to buy more than the 700 billion of assets anticipated and allows it to do so in a way that dramatically reduces the risk-to amost zero-that Treasury will lose money on its purchases. Indeed, the program I recommend is likely to produce profits."

In his letter, Buffett personally commited $100 million ("constituting 20% of my net worth outside of my Berkshire holdings, which as you know are promised to charity") to the program.

I wonder if Paulson shared this letter with members of Congress.

While Kashkari supported an asset purchase plan, Paulson did not, deciding to invest the government funds directly in the banks, "considering it more important to stave off dissaster," according to Leonard.
________________________________________________________
Devin Leonard, After a Year of Tumult at Treasury, Former Bailout Chief Took a Quiet Path to Pimco, New York Times, January 1, 2010

2009-12-24T09:06:00.000-08:00

Berkshire Managers
"Our managers have produced extraordinary results by doing
rather ordinary things — but doing them exceptionally well. Our
managers protect their franchises, they control costs, they search for
new products and markets that build their existing strengths
and they don’t get diverted. They work exceptionally hard at the
details of their businesses, and it shows."
________________________________________
Warren Buffett, 1987 Letter to Berkshire Hathaway Shareholders

"So when I buy a business, I am usually buying the manager
with them, because I don’t know how to run the business. So
when someone comes along that wants to sell their business,
I have to look at them in the eye and I have to decide whether
they love the money or love the business. It’s okay to love the
money, but they have to love the business."
________________________________________
Warren Buffett, Inverview With Charlie Rose, PBS, May 2, 2004

"Our prototype for occupational fervor is the Catholic tailor who
used his small savings of many years to finance a pilgrimage to
the Vatican. When he returned, his parish held a special meeting
to get his first - hand account of the pope. “ Tell us,” said the eager
faithful,“ just what sort of fellow is he?” Our hero wasted no
words:“He’s a 44 medium.”
____________________________________
Warren Buffett, 1986 Letter to Berkshire Hathaway Shareholders

2009-12-16T04:19:00.000-08:00

Exceptional Compensation, But Only for Exceptional Performance

Eighteen years ago, Buffett wrote the following to Salomon, Inc, shareholders after Salomon's 1990-1991 illegal bond trading scandal:

"Most of you have read articles about the high levels of compensation
at Salomon Brothers. Some of you have also read
discussions of incentive compensation that I have written in
the Berkshire Hathaway annual report. In those, I have said
that I believe a rational incentive compensation plan to be an
excellent way to reward managers, and I have also embraced
the concept of truly extraordinary pay for extraordinary managerial
performance. I continue to subscribe to those views.
But the problem at Salomon Brothers has been a compensation
plan that was irrational in certain crucial respects.

One irrationality has been compensation levels that overall
have been too high in relation to overall results. For example, last
year the securities unit earned about 10% on equity capital — far
under the average earned by American business — yet 106 individuals
who worked for the unit earned $ 1 million or more. Many
of these people performed exceedingly well and clearly deserved
their pay. But the overall result made no sense: Though 1990
operating profits before compensation were flat versus 1989, pay
jumped by more than $ 120 million. And that, of course, meant
earnings for shareholders fell by the same amount.

In Salomon Brothers’ business, which combines leverage with
earnings volatility, it is particularly necessary and appropriate that
the financial equation applying personally to managers be comparable
to that applying to the ordinary shareholder. We wish to see
the unit ’ s managers become wealthy through ownership, not by
simply free - riding on the ownership of others, I think in fact that
ownership can in time bring our best managers substantial wealth,
perhaps in amounts well beyond what they now think possible.

To avoid dilution, the trustee of the EPP purchases stock for
the plan in the market and at some point in the future, the company
may itself elect to make stock repurchases to reduce the
shares outstanding. Within a relatively few years Salomon Inc. ’ s.
key employees could own 25% or more of the business, purchased
with their own compensation. The better job each employee does
for the company, the more stock he or she will own.

Our pay - for - performance philosophy will undoubtedly
cause some managers to leave. But very importantly, this same
philosophy may induce the top performers to stay, since these
people may identify themselves as .350 hitters about to be paid
appropriately instead of seeing their just rewards partially assigned
to lesser performers. Indeed, I am pleased to report that certain
of our very best managers have already asked that the EPP be
modified to allow them to substantially increase the proportion
of their earnings that can be invested through the plan.
Were an abnormal number of people to leave the firm, the
results would not necessarily be bad. Other men and women
who share our thinking and values would then be given added
responsibilities and opportunities. In the end we must have
people to match our principles, not the reverse.

Our goal is going to be that stated many decades ago by
J.P. Morgan, who wished to see his bank transact “ first - class
business — in a first - class way. ” We will judge ourselves in fact not
only by the business we do, but also by the business we decline
to do. As is the case at all large organizations, there will be mistakes
at Salomon and even failures, but to the best of our ability
we will acknowledge our errors quickly and correct them with
equal promptness…"
______________________________________________
Warren Buffett, Third Quarter, 1991 Letter to Salomon Inc. Shareholders

2009-12-13T07:00:00.000-08:00

You Don't Have to Swing at Every Ball

In his excellent account in yesterday's Wall Street Journal of Warren Buffett's investments the past year, Scott Patterson writes:
"Warren Buffett believes his best deals during the economy's biggest belly flop since the crash of 1929 may well turn out to be the ones he didn't do..... I don't think Buffett gets enough credit for all the pitches he doesn't swing at," says Paul Howard, an analyst at Janney Montgomery Scott. "And he gets a lot of pitches."
____________________________________________________
Scott Patterson, In Year of Investing Dangerously, Buffett Looked 'Into the Abyss', Wall Street Journal, December 12, 2009

Buffett would agree. He frequently refers to the following baseball hitting analogy when describing his investment philosophy.

"Ted Williams wrote a book called “ The Science of Hitting.” In that
book he had a grid of 77 little zones in the strike zone. He said if he
only swung at the balls in this one area, “the sweet spot,” he would bat
over 400; if he swung at the balls on the outside corner and low but
still a strike, he would bat at about 225. So he said everything in life
is about waiting for the right pitch. In baseball if you have 2 strikes
already and you get one of those 225 balls you still have to swing at
it because there aren’t any more balls. In investing, you never have to
swing. Now, if you swing and miss, it’s a strike, but if you wait and the
pitcher gets tired and he keeps throwing balls at you and finally you see
one right in your sweet spot and you understand and you swing at it
and you only have to do that a few times in a lifetime. You only have to
get a few hits, you don’t have to get up everyday and take five at bats
and swing at every ball."
___________________________________________________________________________
Warren Buffett, "In His Own Words-Conversation With Charlie Rose," PBS (May 2, 2004).

2009-12-04T12:31:00.000-08:00

Re Tiger Woods
Let's don't forget the following advice:
"It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently."
______________________________
Warren Buffett

2009-11-29T09:54:00.000-08:00

Hiring-An Unconventional Way
In a recent interview with the New york Times, William D. Green, chairman and CEO of Accenture said the following regarding his hiring practices:
"I was recruiting at Babson College. This was in 1991. The last recruit of the day — I get this résumé. I get the blue sheet attached to it, which is the form I’m supposed to fill out with all this stuff and his résumé attached to the top. His résumé is very light — no clubs, no sports, no nothing. Babson, 3.2. Studied finance. Work experience: Sam’s Diner, references on request.
It’s the last one of the day, and I’ve seen all these people come through strutting their stuff and they’ve got their portfolios and semester studying abroad. Here comes this guy. He sits. His name is Sam, and I say: “Sam, let me just ask you. What else were you doing while you were here?” He says: “Well, Sam’s Diner. That’s our family business, and I leave on Friday after classes, and I go and work till closing. I work all day Saturday till closing, and then I work Sunday until I close, and then I drive back to Babson.” I wrote, “Hire him,” on the blue sheet.
He’s still with us, because he had character. He faced a set of challenges. He figured out how to do both."
____________________________________________________
Corner Office, Adam Bryant Interview, New York Times, November 22, 2009

Buffett would not find this at all unusual.
"Susan came to Borsheim's 25 years ago as a $4-an hour saleswoman. Though she lacked a managerial background, I did not hesitate to make her CEO in 1994. She's smart, she loves the business, and she loves her associates. That beats having an MBA degree any time.
(An aside, Charlie and I are not big fans of resumes. Instead, we focus on brains, passion and integrity. Another of our great managers is Cathy Baron Tamraz, who has significantly increased Business Wire's earnings since we purchased it in early 2006. She is an owner's dream. It is positively dangerous to stand between Cathy and a business prospect. Cathy, it should be noted, began her career as a cab driver.)"
______________________________________________________
Warren Buffett, 2007 Letter to Berkshire Hathaway Shareholders

2009-11-21T06:11:00.000-08:00

Buffett and the Federal Estate Tax-Part II

To follow-up my November 15 post, the New York Times reported that "the Bill and Melinda Gates Foundation on November 19 announced the biggest education donation in a decade, $290 million, in support of three school districts and five charter school groups working to transform how teachers are evaluated and how they get tenure....The foundation's goal, its officials said, is to forge breakthroughs in how school systems recruit, retain and compensate teachers and how they assign them to schools. "It'll be difficult, once this work is finished, to say it can't happen in other places, because this work is going to provide some compelling arguments," said Vicki L. Phillips, an education director of the foundation."
__________________________________________
Sam Dillon, Gates Give $290 Million For Education, New York Times, November 20, 2009
Unlikely that, in the future, tax monies would be allocated to this important project.

2009-11-15T06:22:00.000-08:00

Buffett and The Federal Estate Tax

Last week on CNBC, I heard a knowlegeable Buffett observer say that Buffett's position on the Federal Estate Tax was hypocritical (he supports its retention) because of his estate's future tax savings resulting from his $30 plus billion gift to the Bill and Melinda Gates Foundation.

I don't believe the reduction of his estate's Federal Estate Tax liability was a principal motivating factor in his decision. Rather, I believe he determined that the billions of dollars otherwise going to the U.S. Treasury would be much more wisely spent by the Gates Foundation.

In the concluding paragraph in his June 26, 2006 gift letter to Bill and Melinda, he writes:

"Working through the Foundation, both of you have applied truly unusual intelligence, energy and heart to improving the lives of millions of fellow humans who have not been as lucky as the three of us. You have done this without regard to color, gender, religion or geography. I am delighted to add to the resources with which you carry on this work."

Very simply, I believe Buffett chose the Gates Foundation, rather than Congress, to spend these monies.....another example of his extraordinary capital allocation skills.

2009-11-13T10:29:00.000-08:00

Greed and Fear

"We are never going to get rid of greed. We are never going to get rid of fear," so said Warren Buffett yesterday at the Columbia Business School.

I believe one of Buffett's most under-recognized and under-appreciated strengths is his extraordinary ability to understand human behavior, especially in time of crisis. A striking example (including the prophetic "rhyme with 1929 prediction" made in May, 2007) follows:

"I mean it's just the scope of human beings to do crazy things, self-destructive things, things as a mob they do. You saw it on October 19, 1987...You saw Long-Term Capital Management. You've seen all kinds of things. There will be other things in the future. They will all have similar factors. The human factor will be at the bottom of them. They won't be exactly the same. But it's like Mark Twain said, "You know history doesn't repeat itself, but it rhymes." We will see some things that rhyme with 1929 or whatever else it may be.

Well I've seen all kinds of people with 160 IQ's with intense interest in the subject, lots of experience in the investment world. I've seen them self-destruct. And you have to have a certain amount of natural flow of juices just to be excited about the game and those participating. And the trick of course is to keep control of those juices. And most people, even smart people, have trouble getting caught up in the game and thinking I'll just dance one more dance like Cinderella at five minutes till twelve or something like that because they think they are smarter than the rest of the public.....Or they don't protect themselves against something that will come totally from right field. Long Term Capital Management is a good example of that."
_______________________________________________________________
Warren Buffett, "An Exclusive Conversation with Warren Buffett," Interview with Charlie Rose, (May 10, 2007).

2009-11-11T03:10:00.000-08:00

How to Run a Company in 50 Words or Less

"If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength. But if we treat customers with indifference or tolerate bloat, our businesses will wither. On a daily basis, the effects of our actions are imperceptible; cumulatively, though, their consequences are enormous."
______________________________________________________
Warren Buffett, 2005 Letter to Berkshire Hathaway Shareholders

2009-11-10T08:13:00.000-08:00

Burlington Northern Acquisition

One of the more noteworthy provisions of the Burlington Northern acquisition is that Berkshire will pay with about 40% stock (and 60% cash) for the railroad. Buffett has rarely made acquisitions with Berkshire stock. His self-admitted biggest mistake has been an acquisition with Berkshire stock

In 2007, he wrote:

"Finally, I made an even worse mistake when I said "yes" to Dexter, a shoe business I bought in 1993 for $433 million in Berkshire stock (25,203 shares of A). What I had assessed as durable competitive advantage vanished within a few years. But that's just the beginning: That move made the cost to Berkshire shareholders not $400 million, but rather $3.5 billion. In essence, I gave away 1.6% of a wonderful business-one now valued at $220 billion to buy a worthless business. To date, Dexter is the worst deal I've made."
_____________________________________________
Warren Buffett, 2007 Letter to Berkshire Hathaway Shareholders

2009-10-28T08:14:00.000-07:00

Corporate Expense Accounts-"A New Normal?"

In yesterday's New York Times, Joe Sharkey reports on Vince Vitti's book, Travelogy: Managing Travel Thru the Great Recession, "intended, Mr. Vitti says, for senior executives, chief financial officers who need to exercise far greater control and get more personally involved in expense account monitoring.....All the C.F.O. has to do is hang one or two people for expense account padding. Then everybody will straighten out, at least for a couple of years." ________________________________________

Joe Sharkey, Paying Closer Attention to Expense Accounts, New York Times, October 27, 2009

Warren Buffett's frugality and strict corporate cost controls are legendary, beginning 31 years ago.

"....our after-tax overhead costs are under 1% of our reported operating earnings and less than 1/2 of 1% of our look-through earnings. We have no legal, personnel, public relations, investor relations, or strategic planning departments. In turn this means we don't need support personnel such as guards, drivers, messengers, etc. Finally, except for Verne, we employ no consultants. Professor Parkinson would like our operation - though Charlie, I must say, still finds it outrageously fat.

At some companies, corporate expense runs 10% or more of operating earnings. The tithing that operations thus makes to headquarters not only hurts earnings, but more importantly slashes capital values. If the business that spends 10% on headquarters' costs achieves earnings at its operating levels identical to those achieved by the business that incurs costs of only 1%, shareholders of the first enterprise suffer a 9% loss in the value of their holdings simply because of corporate overhead. Charlie and I have observed no correlation between high corporate costs and good corporate performance. In fact, we see the simpler, low-cost operation as more likely to operate effectively than its bureaucratic brethren. We're admirers of the Wal-Mart, Nucor, Dover, GEICO, Golden West Financial and Price Co. models.
________________________________________________
Warren Buffett, 1992 Letter to Berkshire Hathaway Shareholders

"We cherish cost-consciousness at Berkshire. Our model is the widow who went to the local newspaper to place an obituary notice. Told there was a 25-cents-a-word charge, she requested "Fred Brown Died" She was then informed there was a seven-word minimum. "Okay" the bereaved woman replied, "make it "Fred Brown died, golf clubs for sale.'"
________________________________________________
Warren Buffett, 2002 Letter to Berkshire Hathaway Shareholders

"I can't resist one more Chandler quote: "Beginning this year about March 1st...we employed ten traveling salesmen by means of which, with systematic correspondence from the office, we covered almost the territory of the Union." "That's my kind of sales force."
_________________________________________________
Warren Buffett, 1996 Letter to Berkshire Hathaway Shareholders

"Our experience has been that the manager of an already high-cost operation frequently is uncommoningly resourceful in finding new ways to add to overhead, while the manager of a tightly-run operation usually continues to find additional methods to curtail costs, even when his costs are already well below those of his competitors."
_________________________________________________
Warren Buffett, 1978 Letter to Berkshire Hathaway Shareholders

2009-10-23T05:45:00.000-07:00

Executive Compensation-Part II

Check out Joe Nocera's excellent article on the aftermath of Kenneth Feinberg's, the pay czar, rulings on the compensation of the "25 most highly paid executives at the seven big companies that still hold billions of dollars in government assistance." According to Feinberg, "the strategic construct is that that their compensation should be tied to the performance of the company."

Nocera minimizes this "strategic construct" as differing only in degree from pay policies that already exist and not addressing "in what matters most." He writes:

"But there was always a loftier goal for Mr. Feinberg. When he first took this thankless assignment from the Treasury Department in June, the hope was that when he made his rulings, he would help change the etos of executive pay, not just the seven companies that came under his perview, but all across Wall Street and, for that matter, across corporate America. When asked by a CNBC reporter on Thursday whether he believed the pay structure he established would lead to changes across Wall Street, he replied, "I hope so."

But the truth is. It won't. No pay czar can do that. That's something only shareholders can do.

Nell Minow, the co-founder of the Corporate Library and a fierce proponent of executive compensation reform, didn’t even think that was particularly likely. “The only way you’re going to change things is to throw the bums out,” she said caustically.

The “bums” she had in mind, of course, were corporate directors, especially the ones who sat on the compensation committees. Right now, it seems likely that Congress will pass a “say on pay” bill, giving shareholders the right to vote thumbs-up or thumbs-down on executive pay. (It has already passed in the House of Representatives.) But that is just a starting point, since, after all, say-on-pay would be only an advisory vote, and wouldn’t be binding on the board.

Instead, Ms. Minow believes that shareholders need the ability to vote directors off the board if they feel they are doing a bad job — on executive pay or anything else. Right now, the deck is so stacked that it is nearly impossible, especially since many companies don’t allow simple, majority votes to elect (or reject) directors. But the most straightforward way to shrink the oversize pay of Wall Street executives — and, more generally, curb the excesses of executive pay — would be to make directors more accountable to the company’s shareholders.

As well-meaning as Mr. Feinberg is, and as diligently as he worked through his assigned task, he shouldn’t be the pay czar. No one person should be. That’s a job more properly reserved for shareholders. You know, the ones who own the company."
_______________________________________________
Joe Nocera, Pay Cuts, but Little Headway in What Matters Most, New York Times, October 23, 2009

Buffett has been saying this for years

"When the manager cares deeply and the directors don’t, what’s needed is a powerful countervailing force – and that’s the missing element in today’s corporate governance. Getting rid of mediocre CEOs and eliminating overreaching by the able ones requires action by owners – big owners. The logistics aren’t that tough: The ownership of stock has grown increasingly concentrated in recent decades, and today it would be easy for institutional managers to exert their will on problem situations. Twenty, or even fewer, of the largest institutions, acting together, could effectively reform corporate governance at a given company, simply by withholding their votes for directors who were tolerating odious behavior. In my view, this kind of concerted action is the only way that corporate stewardship can be meaningfully improved.

Unfortunately, certain major investing institutions have “glass house” problems in arguing for better governance elsewhere; they would shudder, for example, at the thought of their own performance and fees being closely inspected by their own boards. But Jack Bogle of Vanguard fame, Chris Davis of Davis Advisors, and Bill Miller of Legg Mason are now offering leadership in getting CEOs to treat their owners properly. Pension funds, as well as other fiduciaries, will reap better investment returns in the future if they support these men.

The acid test for reform will be CEO compensation. Managers will cheerfully agree to board
“diversity,” attest to SEC filings and adopt meaningless proposals relating to process. What many will fight, however, is a hard look at their own pay and perks.

In recent years compensation committees too often have been tail-wagging puppy dogs meekly following recommendations by consultants, a breed not known for allegiance to the faceless shareholders who pay their fees. (If you can’t tell whose side someone is on, they are not on yours.) True, each committee is required by the SEC to state its reasoning about pay in the proxy. But the words are usually boilerplate written by the company’s lawyers or its human-relations department.

This costly charade should cease. Directors should not serve on compensation committees unless they are themselves capable of negotiating on behalf of owners. They should explain both how they think about pay and how they measure performance. Dealing with shareholders’ money, moreover, they should behave as they would were it their own.

In the 1890s, Samuel Gompers described the goal of organized labor as “More!” In the 1990s,
America’s CEOs adopted his battle cry. The upshot is that CEOs have often amassed riches while their shareholders have experienced financial disasters. Directors should stop such piracy. There’s nothing wrong with paying well for truly exceptional business performance. But, for anything short of that, it’s time for directors to shout “Less!” It would be atravesty if the bloated pay of recent years became a baseline for future compensation. Compensation committees should go back to the drawing boards."
__________________________________________________
Warren Buffett, 2002 Letter to Berkshire Hathaway Shareholders

"Irrational and excessive comp practices will not be materially changed by disclosure or by
“independent” comp committee members. Indeed, I think it’s likely that the reason I was rejected for service on so many comp committees was that I was regarded as too independent. Compensation reform will only occur if the largest institutional shareholders – it would only take a few – demand a fresh look at the whole system. The consultants’ present drill of deftly selecting “peer” companies to compare with their clients will only perpetuate present excesses."
_______________________________________________
Warren Buffett, 2006 Letter to Berkshire Hathaway Shareholders

2009-10-21T14:46:00.000-07:00

Executive Compensation

In today's New York Times, it was reported that Credit Suisse will "radically change the way it paid its employees."

"The Credit Suisse plan will cover roughly 2,000 employees in the United States. Top executives will receive a greater portion of their total compensation in the form of their monthly cash salaries, while bonuses will be split evenly between cash and stock.

The stock will vest over four years, and the cash portion will pay out in three. But both components will be adjusted based on the bank's performance over that period, with a particular emphasis on its return on equity, a closely-watched financial measure. The performance of an executive's business will also be taken into account."
________________________________________________
Graham Bowley, Credit Suisse Overhauls Compensation, New York Times, October 21, 2009

Contrast this plan with that of Warren Buffett's long-time incentive compensation system for Berkshire Hathaway executives. No compensation plan consultants need apply.

"At Berkshire....I am a one man compensation committee who determines the salaries for the CEOs of around 40 significant operating businesses. How much time does this aspect of my job take? Virtually none. How many CEO's have voluntarily left us for other jobs in our 42-year history? Precisely none."
___________________________________________
Warren Buffett, 2006 Letter to Berkshire Hathaway Shareholders

"At Berkshire, we want to have compensation policies that are both easy to understand and in sync with what we wish our associates to accomplish."
_____________________________________________
Warren Buffett, 1999 Letter to Berkshire Hathaway Shareholders

"At Berkshire, however, we use an incentive compensation system that rewards key managers for meeting targets in their own baliwicks. If See's does well, that does not produce incentive compensation at the News-nor visa versa. Neither do we look at the price of Berkshire stock when we write bonus checks. We believe good unit performance should be rewarded whether Berkshire stock rises, falls, or stays even. Similarly, we think average performance should earn no special rewards even if our stock should soar.

The rewards that go with this system can be large.....We do not put a cap on bonuses, and the potential for rewards is not hierarchical. The manager of a relatively small unit can earn far more than the manager of a larger unit if results indicate he should. We believe, further, that such factors as seniority and age should not effect incentive compensation (though they sometimes influence basic compensation). A 20-year old who can hit .300 is as valuable as a 40- year old performing as well."

_______________________________________________
Warren Buffett, 1985 Letter to Berkshire Hathaway Shareholders

When we use incentives-and these can be very large-they are always tied to the operating results for which a given CEO has authority. We have no lottery tickets that carry payoffs unrelated to business performance. If a CEO bats .300, he gets paid for being a .300 hitter, even if circumstances outside of his control cause Berkshire to perform poorly. And if he bats .150, he doesn't get a payoff just because the successes of others have enabled Berkshire to prosper mightily. An example: We now own $61 billion of equities at Berkshire, whose value can easily rise or fall by 10% in a given year. Why in the world should the pay of our operating executives be affected by such $6 billion swings, however important the gain or loss may be for shareholders?

________________________________________________

Warren Buffett, 2006 Letter to Berkshire Hathaway Sharehoders

2009-10-18T13:10:00.001-07:00

Talented Managers And The Right Environment-Part II

In today's New York Times, Carol Bartz, CEO of Yahoo, answers the question, "What about leading others?"

"A lot of it is just picking the right team and picking people so much better than you are, and involving them in a decision."
___________________________________________________
Adam Bryant, Imagining a World of No Annual Reviews, Corner Office, October 18, 2009

2009-10-17T10:30:00.000-07:00

Talented Managers And The Right Environment

In today's New York Times, Ruth Reichl, former Editor-In-Chief of Gourmet magazine and producer of "Gourmet's Adventures With Ruth," offers her advice for running an enterprise:

"How you be a good boss is you find really talented people and you give them the means to work."
__________________________________________________
Mike Hale, Gourmet Brand Survives, On a New Platter for PBS, New York Times, October 17, 2009

Warren would agree.

"Charlie and I know that the right players will make almost any team manager look good. We subscribe to the philosophy of Ogilvy & Mather's founding genius, David Ogilvy: "If each of us hires people who are smaller than we are, we shall become a company of dwarfs. But, if each of us hires people who are bigger than we are, we shall become a company of giants."
_______________________________________________
Warren Buffett, 2002 Letter to Berkshire Hathaway Shareholders

"Usually the manager came with the companies we bought, having demonstrated their talents throughout careers that spanned a wide variety of circumstances. They were managerial stars long before they knew us, and our main contribution has been to not get in their way. This approach seems elementary: if my job were to manage a golf team--and if Jack Nicklaus or Arnold Palmer were to play for me--neither would get a lot of directives from me about how to swing."
_______________________________________________
Warren Buffett, 1987 Letter to Berkshire Hathaway Shareholders

"I believe the GEICO story demonstrates the benefits of Berkshire's approach. Charlie and I haven't taught Tony a thing--and never will--but we have created an environment that allows him to apply all of his talents to what's important. He does not have to devote his time or energy to board meetings, press interviews, presentations by investment bankers or talks with financial analysts. Furthermore, he need never spend a moment thinking about financing, credit ratings or "Street" expectations for earnings per share. Because of our ownership structure, he also knows that this operational framework will endure for decades to come. In this environment of freedom, both Tony and his company can convert their almost limitless potential into matching achievements.
_____________________________________________
Warren Buffett, 1998 Letter to Berkshire Hathaway Shareholders

2009-10-10T04:43:00.000-07:00

"CEO's Must Embrace Stewardship As a Way of Life and Treat Owners As Partners Not Patsies. It's Now Time for CEO's to Walk the Walk."

So said Warren Buffett seven years ago. Not written by a PR department, he has embraced and practiced this challenge to CEO's for his entire career.

"Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our shareholders as partners, and ourselves as managing partners.....We do not view the company itself as the owner of our business assets but instead view the company as a conduit through which our shareholders own the assets."
____________________________________________________
Warren Buffett, 1996 Letter to Berkshire Hathaway Shareholders

"Charlie and I cannot promise you results. But we can guarantee that your financial fortunes will move in lockstep with ours for whatever period of time you elect to be our partners. We have no interest in large salaries or options or other means of getting an "edge" over you. We want to make money only when our partners do and in exactly the same proportion. Moreover, when I do something dumb, I want you to be able to derive some solace from the fact that my financial suffering is proportional to yours."
_________________________________________________________
Warren Buffett, 1996 Letter to Berkshire Hathaway Shareholders

"At Berkshire , we believe that the company's money is the owners' money just as it would be in a closely-held corporation, partnership, or sole proprietorhip."
_________________________________________________________

Warren Buffett, 1993 Letter to Berkshire Hathaway Shareholders

2009-10-08T12:24:00.000-07:00

"Active" versus "Passive" Investing

Today, the Wall Street Journal reports on a recent study by Morningstar. Selected excerpts follow:

"While it has been established that most actively managed mutual funds lag behind their indexes over time, a new study further twists the knife: Active management suffers even more by comparison on a risk-adjusted basis.

The study found that in many cases where an actively managed fund beats its index on an absolute basis, the additional risk it took didn't justify the returns earned. Not only should that be a warning sign for investors -- because greater risk means greater volatility -- but it also suggests that fund managers aren't living up to what is expected of them.

The study by Morningstar Inc. found that, over the past three years, while about half of actively managed funds outperformed their respective Morningstar indexes -- which cover the nine different Morningstar investment styles -- only 37% did on a risk-, size- and style-adjusted basis. The numbers are similar for five and 10-year returns.

"It's not enough to beat an index in a way (that assumes more risk)," said Travis Pascavis, director of equity indexes at Morningstar. A riskier fund should provide greater returns, he added.....

The key to thinking of risk in terms of returns versus an index, he said, is that, in theory, if investors wanted to take on more risk for greater returns, they could simply buy an index fund and lever up their exposure. That would also increase returns while adding risk -- and do so at a cheaper cost than most actively managed funds. It is against this standard that actively managed funds should be judged, he said....

Mr. Pascavis said it is important for investors to be comfortable with the risk they are taking on when they buy a mutual fund. What is more, his study found that if a fund has higher risk, it is often a sign of an underperformer: Funds performing in the top 25% over the past three years had much lower risk and volatility than their peers.

"There is generally a positive relationship between risk and return, where better-performing funds are riskier; however, this has not been the case over the last three years," noted the study, which added that poor returns of the recent market likely helped less-risky funds.

Even in absolute terms, the results highlighted the shortcomings of many actively managed funds. Over the past five years across the nine Morningstar-style boxes -- value, core and growth in the small-cap, midcap and large-cap sectors -- only large-cap growth and midcap value saw more than half of active managers beat their indexes..... "
_____________________________________________
Sam Mamudi, Active Management Loses in Risk Study, New York Times, September 8, 2009

Buffett would agree with the findings of this study

"Let me add a few thoughts about your own investments. Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.

Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word "selected": You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.

To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About Market Prices.

Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value. Though it's seldom recognized, this is the exact approach that has produced gains for Berkshire shareholders......."

Warren Buffett, 1996 Letter to Berkshire Hathaway Shareholders

In January 2008, to prove his point, Buffett entered into a bet (each side put up $320,000, with the final proceeds going to the winner's favorite charity) with Protege partners, a fund-of-funds hedge fund, that their handpicked funds will not beat the S&P 500 index over the next 10 years. A principal of Protege said, "Fortunately, for us, we're betting against the S&P's performance. not Buffett's"

2009-09-28T11:31:00.000-07:00

Tell Me the Bad News Now

Yesterday, in a New York Times interview, Lawrence W. Kellner, Chairman and CEO of Continental Airlines, said:

“People have a tendency to deliver good news. I mean if somebody unscheduled pops up to my office, the odds are they’ve got a piece of good news and they’re eager to share it. But when something is going wrong, they have to feel they can flag it as quickly as when it’s going right, so that you can shift the organization and try to solve the problem. It’s a leadership structure that says, “Look, I don’t care how bad the situation is — the sooner you catch it, the better.” But if you’ve known about it for months and have been hoping against hope that all your other contingencies would solve the problem and you’ve burned up all our opportunities to solve it, I’m going to be a whole lot more unhappy.”
______________________________________________
Corner Office, “Bad News or Good, Tell Me Now,” New York Times, September 27, 2009

Warren would certainly agree. In recalling the 1990-1991 Salomon scandal, in a July 23, 2008 memo he told Berkshire Hathaway managers:

“…..let me know promptly if there’s any significant bad news. I can handle bad news but I don’t like to deal with it after it has festered for awhile. A reluctance to face up immediately to bad news is what turned a problem at Salomon from one that could have easily been disposed of into one that almost caused the demise of a firm with 8,000 employees.”
_______________________________________________

2009-09-24T02:51:00.000-07:00

The 2-and-20 Crowd

In his recent New York Times article, Andrew Ross Sorkin reports on a conversation he had with Guy Hands, a longtime private equity manager who “offered the most frank assessment of the private equity world-including his mistakes-I had ever heard from anyone still gainfully employed in the business.”

“We all had too much money. It was just too easy.” That’s the unvarnished appraisal of the private equity business by Guy Hands, perhaps best known for his unfortunate $4.73 billion purchase of the record company EMI in March 2007, the peak of the buyout boom — a bet that will almost certainly lose his investors and his firm, Terra Firma, a fortune.

That ill-timed acquisition aside, Mr. Hands’s surprisingly candid assessment of the private equity industry is worth sharing. He was in the midst of the industry’s growth to dizzying heights during the debt-fueled boom, and he is now having to deal with the aftermath of its shopping spree. Like others, he is desperately trying to keep businesses afloat and pay off the equivalent of huge monthly mortgage payments to the banks that financed them.

The problem, he said, was that the funds had grown so big that the 2 percent became just as important as the 20 percent.

"Clearly a large number of P.E. firms were totally overpaid at the peak of the market,” he said. “The fees were an entirely unwarranted windfall....."
_______________________________________
Andrew Ross Sorkin, A Financier Peels Back the Curtain, New York Times, September 22, 2009

Warren Buffett has long been critical of the private equity business.

“In 2006, promises and fees hit new highs. A flood of money went from institutional investors to the 2-and-20 crowd. For those innocent of this arrangement, let me explain: It’s a lopsided system whereby 2% of your principal is paid each year to the manager even if he accomplishes nothing – or, for that matter, loses you a bundle – and, additionally, 20% of your profit is paid to him if he succeeds, even if his success is due simply to a rising tide. For example, a manager who achieves a gross return of 10% in a year will keep 3.6 percentage points – two points off the top plus 20% of the residual 8 points – leaving only 6.4 percentage points for his investors. On a $3 billion fund, this 6.4% net “performance” will deliver the manager a cool $108 million. He will receive this bonanza even though an index fund might have returned 15% to investors in the same period and charged them only a token fee.

…. the 2-and-20 action spreads. Its effects bring to mind the old adage: When someone with experience proposes a deal to someone with money, too often the fellow with money ends up with the experience, and the fellow with experience ends up with the money.”
______________________________________________
Warren Buffett, 2006 Letter to Berkshire Hathaway Shareholders

"Some years back our competitors were known as “leveraged-buyout operators.” But LBO became a bad name. So in Orwellian fashion, the buyout firms decided to change their moniker. What they did not change, though, were the essential ingredients of their previous operations, including their cherished fee structures and love of leverage.

Their new label became “private equity,” a name that turns the facts upside-down: A purchase of a business by these firms almost invariably results in dramatic reductions in the equity portion of the acquiree’s capital structure compared to that previously existing. A number of these acquirees, purchased only two to three years ago, are now in mortal danger because of the debt piled on them by their private-equity buyers. Much of the bank debt is selling below 70¢ on the dollar, and the public debt has taken a far greater beating. The private equity firms, it should be noted, are not rushing in to inject the equity their wards now desperately need. Instead, they’re keeping their remaining funds very private."
______________________________________________
Warren Buffett, 2008 Letter to Berkshire Hathaway Shareholders

2009-09-22T03:59:00.000-07:00

Cash vs. Stock Acquisitions

Yesterday morning, it was reported that computer maker Dell will purchase information-technology company Perot Systems for $3.9 billion in cash. Buffett has always strongly preferred cash over stock acquisitions. In fact, he says his worst mistake was the stock acquisition of Dexter, a shoe business.

“From the economic standpoint of the acquiring company, the worst deal of all is a stock-for-stock acquisition. Here, a huge price is often paid without there being any step-up in the tax basis of either the stock of the acquiree or its assets. If the acquired entity is subsequently sold, its owner may owe a large capital gains tax (at a 35% or greater rate), even though the sale may truly be producing a major economic loss”
__________________________________________________
Warren Buffett, 1999 Letter to Berkshire Hathaway Shareholders

"Finally, I made an even worse mistake when I said “yes” to Dexter, a shoe business I bought in 1993 for $433 million in Berkshire stock (25,203 shares of A). What I had assessed as durable competitive advantage vanished within a few years. But that’s just the beginning: By using Berkshire stock, I compounded this error hugely. That move made the cost to Berkshire shareholders not $400 million, but rather $3.5 billion. In essence, I gave away 1.6% of a wonderful business – one now valued at $220 billion – to buy a worthless business.

To date, Dexter is the worst deal that I’ve made. But I’ll make more mistakes in the future – youcan bet on that. A line from Bobby Bare’s country song explains what too often happens with acquisitions: “I’ve never gone to bed with an ugly woman, but I’ve sure woke up with a few.”
______________________________________________
Warren Buffett, 2007 Letter to Berkshire Hathaway Shareholders

2009-09-20T13:08:00.000-07:00

Boardroom Atmosphere

In today’s New York Times, Gretchen Morgenson writes the following:

“ARE the days of the cocooned corporate director finally coming to an end? One can only hope. Even though directors — through the boards they sit on and the various committees they oversee — are supposed to keep wayward or incompetent chief executives at bay, all too often they are, in practice, just cronies of management.

For years, shareholders have done little to voice complaints about such cozy relationships, but it seems that the financial fiasco of the last few years, and the lackadaisical performance by directors at major banks that contributed to the meltdown, is encouraging investors to become more vocal.

Signs of such a welcome development can be seen in the results of this year’s director elections at annual corporate meetings. According to an early assessment of these shindigs, shareholders voiced significantly greater opposition to directors who were up for election this year than they did in 2008. Although such “no” votes aren’t binding, they send a powerful message that should reverberate throughout corporate board rooms.

Investors are clearly angry with their companies, and they have their reasons. Director accountability to the shareholders they are supposed to serve has been sorely lacking for decades. Even as they rubber stamp risky corporate practices and excessive executive pay, directors continue to win re-election to their increasingly lucrative board seats.

It is unfortunate that the only way to force some directors to live up to their duties is for shareholders to keep them worried about an embarrassing vote. But since that is the only weapon investors have, it’s gratifying that more of them seem ready to rumble.”
___________________________________________________
Gretchen Morgenson, Too Many ‘No’ Votes to Be Ignored, New York Times, September 20, 2009

As early as 1993, Warren Buffett has spoken out on the abuses of “Boardroom Atmosphere.” Following is only a short sample, chronologically, of his views:

“…Directors should behave as if there was a single absentee owner, whose long-term interest they should try to further in all proper ways….

And if able but greedy managers over-reach and try to dip too deeply into the shareholders’ pockets, directors must slap their hands……

The outside board members should establish standards for the CEO’s performance and should periodically meet, without his being present, to evaluate his performance against these standards."
______________________________________________
Warren Buffett, 1993 Letter to Berkshire Hathaway Shareholders

“Why have intelligent and decent directors failed so miserably? The answer lies not in inadequate laws-it’s always been clear that directors are obligated to represent the interests of shareholders-but rather in what I’d call “boardroom atmosphere.

It’s almost impossible, for example, in a boardroom populated by well-mannered people, to raise the question of whether the CEO should be replaced. It’s equally awkward to question a proposed acquisition that has been endorsed by the CEO, particularly when his inside staff and outside advisors are present and unanimously support his decision. (They wouldn’t be in the room if they didn’t.) Finally, when the compensation committee – armed, as always, with support from a high-paid consultant – reports on a mega grant of options to the CEO, it would be like belching at the dinner table for a director to suggest that the committee reconsider…..

. In recent years compensation committees too often have been tail-wagging puppy dogs meekly following recommendations by consultants, a breed not known for allegiance to the faceless shareholders who pay their fees. (If you can’t tell whose side someone is on, they are not on yours.) True, each committee is required by the SEC to state its reasoning about pay in the proxy. But the words are usually boilerplate written by the company’s lawyers or its human-relations department. This costly charade should cease.

The acid test for reform will be CEO compensation. Managers will cheerfully agree to board
“diversity,” attest to SEC filings and adopt meaningless proposals relating to process. What many will fight, however, is a hard look at their own pay and perks.

Directors should not serve on compensation committees unless they are themselves capable of negotiating on behalf of owners. They should explain both how they think about pay and how they measure performance. Dealing with shareholders’ money, moreover, they should behave as they would were it their own.

In the 1890s, Samuel Gompers described the goal of organized labor as “More!” In the 1990s,
America’s CEOs adopted his battle cry. The upshot is that CEOs have often amassed riches while their shareholders have experienced financial disasters.

Directors should stop such piracy. There’s nothing wrong with paying well for truly exceptional business performance. But, for anything short of that, it’s time for directors to shout “Less!” It would be a travesty if the bloated pay of recent years became a baseline for future compensation. Compensation committees should go back to the drawing boards."
_______________________________________________
Warren Buffett, 2002 Letter to Berkshire Hathaway Shareholders

“True independence-meaning the willingness to challenge a forceful CEO when something is wrong or foolish-is an enormously valuable trait in a director. It is also rare."
________________________________________________
Warren Buffett, 2003 Letter to Berkshire Hathaway Shareholders

“At Berkshire, board members travel the same road as shareholders.”
___________________________________________
Warren Buffett, 2004 Letter to Berkshire Hathaway Shareholders

2009-09-15T15:02:00.000-07:00

A Case Study of a Buffett Business Principle

As both a “student” and “teacher” of Warren Buffett’s business principles the past three years, I am continually amazed at their timelessness. I remember once reading that he said they’re not principles if they’re not timeless.

Twenty-four years ago, he wrote:

“ When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.”
___________________________________________________
Warren Buffett, 1985 Letter to Berkshire Hathaway Shareholders

Now, let’s fast forward to a recent article in the New York Times regarding Chrysler. Included below are selected excerpts from the article:

"FOR Steve Feinberg, the onetime owner of Chrysler, the past year has been a crawl toward defeat. He lost billions of dollars. He lost prestige. He lost his privacy. And he ended up a ward and supplicant of the federal government…..

Mr. Feinberg took over Chrysler almost exactly two years ago, promising to revive the company. Chrysler filed for bankruptcy protection at the end of April. So how he and his private equity firm, Cerberus Capital Management, chose to describe their journey with Chrysler is a delicate matter.

If he says he should have shelled out more money to help Chrysler, he could face the ire of investors who have already suffered heavy losses on his gambit. If he says he should have simply dumped Chrysler’s auto arm, while clinging to its more promising finance unit, he could be accused of caring more about his wallet than he did about Chrysler’s workers and the automaker’s role in the economy.

When Cerberus began poking around Detroit, some at the firm said that the American automobile industry was going to be the biggest turnaround story in history. In sessions with potential investors in the last few years, the Cerberus team came across as passionate, skilled and incredibly confident that they should succeed where others had failed.

Cerberus and its co-investors ultimately invested $7.4 billion in Chrysler, a sum now worth an estimated $1.4 billion. Ideally, Cerberus hoped to wed Chrysler’s finance arm to another finance company it controlled, GMAC. To that end, the risks in Chrysler’s auto business were something that the Cerberus team thought it could manage and that wouldn’t stand in the way of making billions of dollars for investors.

……GMAC and Chrysler became so weak that they needed $22.6 billion in government aid in the last year to stay afloat. For Chrysler and its workers, investors, business partners and customers, was all of that worth it?
According to Maryann Keller, a longtime auto analyst and consultant, the company that Mr. Feinberg took over was already suffering from myriad problems: a bad cost structure, a limited product line and no pipeline of more diverse offerings. In short, she says, Cerberus had simply bought a “basket case.”

Cerberus now values its Chrysler stake at 19 cents on the dollar. It is humbling and embarrassing figure for Mr. Feinberg. But its better than zero cents on the dollar, which is what his stake might have been worth had the government not bailed him out."
________________________________________________________________
Louise Story, For Private Equity, a Very Public Disaster, New York Times, August 9, 2009

The Fallout

"Investors in hedge funds run by Cerberus Capital Management LP, whose audacious multi-billion dollar bet in the U.S.auto industry went bust, are bolting for the door, clinching one of the highest-profile falls from grace of a superstar in the investment world.

Clients are withdrawing more than $5.5 billion, or nearly 71% of the hedge fund assets, in response to big investment losses and their own need for cash, according to people familiar with the matter."
________________________________________________________
Peter Lattman and Jenny Strasburg, Clients Flee Cerberus, Fallen Fund Titan, New York Times, August 29, 2009

2009-09-13T11:08:00.000-07:00

Financial Regulatory Reform

A Case Study You Won’t Believe

President Obama’s speech at Federal Hall in New York City on Monday “will focus on the need to take the next series of steps on financial regulatory reform to ensure what happened a year ago…doesn’t happen again and cause the type of havoc that we’ve seen in our economy,” said White House spokesman Robert Gibbs.

Hopefully, in considering the Obama administration’s proposed financial regulatory revamp, Congress will take note of, learn from, “and ensure the following doesn’t happen again.” In Buffett’s words:

“For a case study on regulatory effectiveness, let’s look harder at the Freddie and Fannie example. These giant institutions were created by Congress, which retained control over them, dictating what they could and could not do. To aid its oversight, Congress created OFHEO in 1992, admonishing it to make sure the two behemoths were behaving themselves. With that move, Fannie and Freddie became the most intensely-regulated companies of which I am aware, as measured by manpower assigned to the task.

On June 15, 2003, OFHEO (whose annual reports are available on the Internet) sent its 2002 report to Congress – specifically to its four bosses in the Senate and House, among them none other than Messrs. Sarbanes and Oxley. The report’s 127 pages included a self-congratulatory cover-line: “Celebrating 10 Years of Excellence.” The transmittal letter and report were delivered nine days after the CEO and CFO of Freddie had resigned in disgrace and the COO had been fired. No mention of their departures was made in the letter, even while the report concluded, as it always did, that “Both Enterprises were financially sound and well managed.”

In truth, both enterprises had engaged in massive accounting shenanigans for some time. Finally, in 2006, OFHEO issued a 340-page scathing chronicle of the sins of Fannie that, more or less, blamed the fiasco on every party but – you guessed it – Congress and OFHEO.”
_______________________________________________
Warren Buffett, 2008 Letter to Berkshire Hathaway Shareholders

P.S. Remarkably, the principal, if not sole, responsibility of over 100 OFHEO employees was to oversee the operations of Fannie Mae and Freddie Mac.

Hopefully, Congress will ask Buffett for his testimony and/or written recommendations.

To add insult to injury, read Gretchen Morgenson’s recent article in the New York Times, excerpted below:

“With all the turmoil of the financial crisis, you may have forgotten about the book-cooking that went on at Fannie Mae. Government inquiries found that between 1998 and 2004, senior executives at Fannie manipulated its results to hit earnings targets and generate $115 million in bonus compensation. Fannie had to restate its financial results by $6.3 billion. Almost two years later, in 2006, Fannie’s regulator concluded an investigation of the accounting with a scathing report. “The conduct of Mr. Raines, chief financial officer J. Timothy Howard, and other members of the inner circle of senior executives at Fannie Mae was inconsistent with the values of responsibility, accountability, and integrity,” it said.

That year, the government sued Mr. Raines, Mr. Howard and Leanne Spencer, Fannie’s former controller, seeking $100 million in fines and $115 million in restitution from bonuses the government contended were not earned. Without admitting wrongdoing, Mr. Raines, Mr. Howard and Ms. Spencer paid $31.4 million in 2008 to settle the litigation.

When these top executives left Fannie, the company was obligated to cover the legal costs associated with shareholder suits brought against them in the wake of the accounting scandal. Now those costs are ours. Between Sept. 6, 2008, and July 21, we taxpayers spent $2.43 million to defend Mr. Raines, $1.35 million for Mr. Howard, and $2.52 million to defend Ms. Spencer.……

An additional $16.8 was paid in the period to cover legal expenses of workers at the Office of Federal Housing Enterprise Oversight, Fannie’s former regulator. These costs are associated with defending the regulator in litigation against former Fannie executives….

A spokesman for the agency said it would not comment for this article.”
________________________________________________________________
Gretchen Morgenson, They Left Fannie Mae, but We Got the Legal Bills, New York Times, September 6, 2009

2009-09-09T06:36:00.001-07:00

Three years ago, I began teaching a course on Warren Buffett at the Washington University in St. Louis Lifelong Learning Institute. From day one, he has enthusiastically supported the course. He and I have regularly exchanged emails regarding the course. In January 2007, at his invitation, I traveled to Omaha and met him at his office. As busy as he is, he has always had time for me.

This blog will be about his wisdom, his ideas and his philosophy of life, including:

-The Berkshire Hathaway model of managing a business, large or small, employing his unconventional and “old fashioned” business management principles and practices (in Buffett’s words, “simple, old and few”). When you strip it all away, effective business management, the Warren Buffett way, is remarkably obvious and simple, and

-Using common sense, acquiring wisdom every day, having a passion for work and having fun and a sense of humor.

Can all of this be learned from one man? YES! There are some people who are simply so unique, so very special, that no words can do them justice. Buffett’s genius is his character. His integrity is unsurpassed. His patience, discipline and rationality are extraordinary. In the words of Charlie Rose, “It is his passion for his company, passion for his friends, passion for his work and a passion for living life. This is a man who has fun.”

Topics to be regularly covered will include:

Shareholders as Partners
Corporate Culture
Communication
Executive Behavior
Executive Compensation
Management Principles,Practices, and Mistakes
Life Choices
Stories and Humor
Investing
Charlie Munger
Ben Franklin

I look forward to hearing from you.