Warren Buffett and Charlie Munger are living legends. Like many investors, I read every Berkshire letter to shareholders and tune into the company's annual meeting for the question and answer session. The following are my notes from the 2017 Q&A session that was held on Saturday.
1. Recognition of Jack Bogle
To begin each Berkshire Hathaway shareholder meeting, Warren Buffett introduces each member of Berkshire’s board of directors, but this year he also recognized Jack Bogle, the founder of The Vanguard Group, as the person who has done more for individual investors than any other financial professional.
2. Focus on Great Businesses
Buffett and Munger said, after years of investing in businesses they considered undervalued but fixable, they have learned to invest in businesses that have superior economics and resistant to innovation. Attempts to fix unfixable businesses were horrible experiences and Buffett and Munger now avoid such bargain-priced companies.
3. A Common Question
What would you do differently were your business a private corporation, is a question Buffett likes to ask public company executives. Were Berkshire privately held, Buffett would make no change to its management.
4. Rationality Over Brilliance
Munger said many business people and investors struggle in their aspiration to be brilliant. Instead of gambling in pursuit of brilliant results, Munger said he and Buffett wait for market conditions to present rational opportunities. People prefer action, will be drawn to gambling, and inevitably their mistakes will cause poor financial results and thereby provide opportunities for rational investors.
5. Berkshire Hathaway’s Value Added to Society
One shareholder asked Buffett to explain what Berkshire contributes to society. GEICO provides low-cost car insurance. Dairy Queen provides products that make customers happy. Berkshire is a holding company that does not sell products, so what benefit would be forgone if Berkshire’s subsidiaries were independent?
a) Focus. Berkshire’s structure allows several large holdings to avoid investor relations responsibilities and other tasks required of publically traded companies. Buffett said, under the Berkshire umbrella, managers from Berkshire Hathaway Energy (BHE), Burlington Northern (BNSF), GEICO, and Precision Cast Parts (among others) have twenty percent more time to allocate to business operations.
b) Shelter from the Reactionary Behavior of Short-term Investors. As independent, publically-traded companies, Berkshire Hathaway subsidiaries may succumb to pressure to produce consistent short-term results, but the diverse portfolio of Berkshire’s subsidiaries obfuscates the short-term volatility in one constituent’s business results.
Buffett noted recent disclosures of GEICO’s competitors disclosed the pursuit of new policies were forgone due to the costs of initiation and the tendency of higher loss rates of new policies. By contrast, GEICO reported significant growth in new policies written, and Berkshire is well-positioned to benefit from higher-margin renewals in years to come.
c) Capital Allocation. Berkshire is an ultra-low cost source of financing for its subsidiaries, and Buffett has displayed unmatched patience and rationality with shareholders’ capital. Berkshire subsidiaries like BNSF and BHE have been able to retain earnings to fund capital investment without scrutiny from public investors who require dividends and share repurchases. If additional funding is required for large projects or bolt-on acquisitions, Berkshire is flush with cash.
d) An Example. Munger concisely explained he, Buffett, and Berkshire are model citizens of corporate America and examples for both investors and business executives. Widely regarded as an honest company, Berkshire is a model of corporate governance.
6. Health Care Costs Impair the Competitiveness of American Businesses
While corporate income tax rates are in the news, corporate income tax remittances have fallen over recent years, but healthcare costs, often paid by employers, depress the relative productivity of American labor. In many other developed nations, health care is provided by governments, not employers. Further, comparable healthcare in the United States is more expensive than in other countries. Regardless of the relative difference in monetary wages, domestic labor is more expensive due employee healthcare costs.
7. Buffett and Munger Hate EBITDA
To report favorable earnings companies may report earnings before interest, taxes, depreciation, and amortization (EBITDA). Buffett and Munger assailed the use of EBITDA because it excludes the very real cost of depreciation. Instead of recognizing the full cost of an asset in the period in which it is purchased, depreciation is used to expense the cost of capital investments across all periods in which the asset is in use. Thereby a firm can match the cost of an asset to the revenue generated during asset’s use. Excluding depreciation from analyses systematically understates the true cost of business operations.