Becky Quick  01:00

I’ve got a number of variations on this next question. Some are more polite than others. This one’s right about down the middle: “Just like many, I’m a proud Berkshire Hathaway shareholder. However, in comparing the performance of Berkshire with the S&P 500 over the last 5, 10, or 15 years, I’ve been disappointed in Berkshire’s underperformance. Even year-to-date, Berkshire is trailing the S&P 500 by 8%. To what would you attribute Berkshire’s underperformance? While I can’t imagine ever selling my Berkshire stock, at some point, money is money.”

Warren Buffett 01:28

The truth is that I recommend the S&P 500 to people, and I happen to believe that Berkshire is about as solid as any single investment can be, in terms of earning reasonable returns over time. But I would not want to bet my life on whether we’ll beat the S&P 500 over the next 10 years. I obviously think there’s a reasonable chance of doing it, and we’ve had periods. I don’t know how many out of the 55 years we’ve been doing it. I don’t know how many we’ve beaten or not.

I mentioned earlier that 1954 was my best year, but I was working absolutely with peanuts, unfortunately, and I think, if you work with small sums of money, I think there is some chance of a few people that really do bring something to the game. But I think it’s very, very hard. It’s certainly gotten tougher for us with larger funds. I would make no promise to anybody that we will do better than the S&P 500. But what I will promise them is that I’ve got 99% of my money in Berkshire. And most members of my family may not be quite that extreme, but they’re close to it. And I do care about what happens to Berkshire over the long period about as much as anybody could care about it. Caring doesn’t guarantee results, but it does guarantee attention. Greg?

Greg Abel  02:52

I would agree, Warren, that there’s never guarantees, but when I look at the assets we have in place, and the teams that are in place, I think that while you’re committed to Berkshire, we also have dedicated teams that equally are dedicated to Berkshire, and they’re sure going to give it their best effort every day. When I look at the assets and the people, I think we have, as you said, you can’t guarantee it, but we have a great chance of sure giving a good effort to perform it.

Warren Buffett 03:24

It’s hard to imagine getting a terrible result, but you know, anything could happen. What I do know is it would be easier to be running 5 million than our book net worth at Berkshire at the quarter, which I think was some $370 billion, which is down, but it’s still greater than the book net worth of any corporation in the United States. Maybe there’s some federal corporation that has more, but it may be the greatest in the world. I’m not sure. That makes life difficult in some ways, too.

Greg Abel  03:57

Right, and the potential of our operating businesses is substantial. We’ve talked about energy, you touched on it that that infrastructure is continuing to change. We’re ready for $100 billion of investment opportunities there. If we just look at the business over the next 10 years, and the infrastructure that’s required, and how it’s changing, substantial investments there just tell me we have very good prospects, and we’re well-positioned to pursue them. Which again, to me, when you look at our core business that you touched on in Burlington, the insurance and energy, our downside is very nicely protected. We have three really core great businesses.

Warren Buffett 04:41

Yeah, and we’re better positioned than anybody in the energy business just because we don’t have dividend requirements. We’ve retained $28 billion of earnings over 20 years. You can’t do it if you’re running a normal public company. We’ve got a huge appetite, and the country needs, the world needs it. Also, we are a very, very logical, well-structured, and well-managed company to participate in just huge requirements around the world. Now, if they’re slow, and they involve governments, and then state governments, and there’s a lot of…, It’s not anything that happens dramatically. It will happen, and Berkshire should participate in a huge way. We can do things in insurance that nobody else can do. That doesn’t mean much, many times, but occasionally it may be important. So there are some advantages to size and strength, but there are disadvantages to size too. If we find some great opportunity for a billion dollars to double our money, that’s a billion pre-tax, and that’s $790 million after-tax, and on a market value of $450 billion, or whatever it may be. That doesn’t amount to much, unfortunately. We’ll still try and do it if we can.

Greg Abel  06:02

Yeah.

Preston Pysh  06:03

So, for me this conversation answers a really great question, first of all, but I’m looking at the chart I made using TradingView, which I love using. Stig, I’m sharing my screen with you, so you can see what the chart, that I kind of created while I was listening to the audio clip, looks like.

With TradingView, you can go in and you can look at a company, but you can also denominate the company in whatever currency you want, or basically whatever ratio you want to compare it to. So, what I did is I went to TradingView, typed in Berkshire Hathaway (BRK.A), and then put a division symbol there, and then put what you want to compare it to.

I put the S&P 500, and when I did that, I saw this really interesting chart where you can see Berkshire Hathaway. I put it in a weekly view so I can look at 20 years on the chart, and you can see that before quantitative easing started– and, Stig, you can see I put quantitative easing there with the blue line. You can see that Berkshire is just crushing the S&P 500, and then, from quantitative easing till now, it’s completely just gone sideways. It hasn’t beat it. It hasn’t really done that much worse.

I guess you could say, from the bottom of the 2008 period that, in general, looking at the chart, it’s really flattened. I’m going to take a screen capture of the chart that we’re looking at right now as we’re talking about this, and we’re going to put it into our show notes so people can look at this chart that we’re talking about. I wonder if some of these macro factors, these central banking factors, are actually making their ability to compound that much harder, and they don’t even realize it. Or, it’s just such a nuanced thing that maybe nobody can understand why that’s playing out. But I just find the chart fascinating. I find it really interesting that from that point forward, they’ve had a difficulty to outperform. Stig, I’m curious to hear your thoughts.

Stig Brodersen  08:03

The way that I was thinking about this was not so much in terms of quantitive easing. Yet, we previously talked about how value has really been crossed during the Coronavirus crisis, which is also a part of the question, like how it’s performed just this year. And we’ve just seen the FAANG stocks performing really, really well compared to more traditional companies like Berkshire Hathaway. That was also what Buffett was getting at before when he talked about having the highest book value. And clearly, book value is not the same as the actual value, and Buffett has talked a lot about that. But things have just been very heavy for companies like Berkshire Hathaway, like with railroads and insurance, the two biggest companies within Berkshire Hathaway. So they haven’t been performing as well, and you know, we can compare that to a company like Apple.

In all fairness, Warren Buffett actually took a $70 billion stake into Apple, but generally, looking at Berkshire Hathaway, that’s not the type of company. So, just from that alone, and also knowing that the S&P 500 is so much driven by FAANG stocks, and have been for a long time, around the same time as QE, which is, to some extent, coincidental. I think that also plays a huge factor. We’ve just seen that. They really play out.

09:15

But I liked this question because I think a lot of investors are thinking of S&P 500 as the benchmark, and they want to know whether or not the S&P 500 will outperform that, so let’s talk about the valuation. When I look at the valuation of the two, let’s just first take the S&P 500. Right now, it’s trading at a Shiller PE of 26. We talked about the Shiller PE quite a few times here on the show, but it’s the average inflation-adjusted earnings from the previous 10 years. And then, because of the crisis that we’re seeing right now, we can definitely make the argument that the companies in the index generally will have a hard time sustaining their earnings, at least very soon. So, I would even say that the Shiller PE of 26 is sort of low compared to what it really is. And then, when you factor in that 15% unemployment, and then the stock market almost being expensive as it were before, to me, the S&P 500 actually still looks very, very expensive, especially if you think about the underlying assets.

10:19

So, instead, let’s look at Berkshire Hathaway. I know I’m talking about it from a position. As you know out there, Berkshire Hathaway is my biggest equity position, so take it for what it is. But if you look at Berkshire Hathaway’s cash and equity positions, it’s roughly $300 billion, and the mind cap is roughly $400 billion. So, you’re basically getting Berkshire’s operating businesses for $100 billion. So, how well has the business performed? Well, it’s around $24 billion over the past few years, and it clearly won’t be the same say in the next 12 months. But those 80 companies are very strong. Buying all the operating companies of Berkshire Hathaway for $100? I think that’s a steal. So, again, depending on your assumptions, I would say that Berkshire Hathaway is probably worth anywhere between $210 – $250, even when you factor in the crisis.

11:19

And here, I would really like to also give a handoff to the interview we did with Jake Taylor, the CEO of Farnam Street Investments in Episode 289. We’ll make sure to link to that in the show notes. There, he also gives his take on valuation. If anyone is then asking, “So, Stig, Berkshire Hathaway is trading at around $172, so let’s say we were doing a 20% or 30% discount. Does that mean that I want to jump into Berkshire Hathaway?” Perhaps I’ll add to it, perhaps not. But I think the most important thing is to go away from the premise of the question because the premise of the question was really about investing in Berkshire Hathaway or the S&P 500. I don’t necessarily think that’s the right question to ask. I can easily understand if people are asking that question, but I think you might want to think, what should my benchmark be? And what are your alternatives, really?

So, sorry, Preston. I saw you had a remark there?

Preston Pysh  12:18

No, so, I’m looking at the chart even more. And there are two periods on the chart that are really quite drastic in the drop of Berkshire Hathaway, compared to the S&P 500. Both of those major drops occurred at the same time that the government was conducting massive amounts of stimuli. I can’t say that there’s a correlation there. I just find it interesting that that’s the case.

And so, let’s just say that there is a correlation there. If you expect that there’s going to be a lot more stimuli moving forward, well, then that might be a concern for a holder of Berkshire Hathaway, but there’s nothing that I could do to show that that correlation is there based on the number of data points that we have. But there’s definitely something interesting going on with the chart, so I highly encourage people to take a look at the chart. It will be in our show notes.

Stig Brodersen  13:09

I think, to basically sum this up, there might be some sort of correlation of causality with what the Fed is doing. I think last time, we talked a lot about sound money. I think that if we do compare the S&P 500 to Berkshire, and we look at some of that performance, let’s just call it sound business. And I think one of the really, really good things to say about Berkshire Hathaway, regardless of the valuation, is that it’s a very, very sound business. And whenever I look at the discounted cash flows, short term, and long term, I just, I like Berkshire Hathaway better. For me, in terms of performance over the next decade, it just makes a lot more sense to me to make one bet, and not the other.

Preston Pysh  13:48

Okay, so let’s go ahead, and go on to the next question here.

Becky Quick  13:52

All right. This question comes from Adam Schwartz in Miami, Florida. He says, “Berkshire is the largest holding and his partnership, which also houses most of their net worth.” He says, “Berkshire’s invested in many capital-intensive businesses through the years, railroads as an example. How do you think about the inflationary or even deflationary risks for all of the capital intensive businesses? And could this prove to be an existential problem for businesses? Kind of referencing what you were just talking about, that eventually the bill for the debts being issued comes due, will it eventually come from all businesses through some combination of higher tax rates on corporations, increased wages for the lower and middle classes?

Warren Buffett 14:27

Well, I certainly think that increased corporate taxes are a much higher probability than having lower corporate taxes, so I think that we got handed, as a corporation, a big chunk of what used to be the government’s profits from our business a couple of years ago, and it would depend on, to some extent, which party is elected, and whether they have control of both houses, as well as the presidency, and who knows what else? We could very easily have higher corporate income taxes, and perhaps much higher corporate income taxes at some point.

In terms of capital-intensive businesses, they’re just not as good. If you can find an equally good business in terms of operations, that doesn’t require capital. Seeds never really required capital. They’d grow, but it just doesn’t. It didn’t take money to expand, and it just delivered enormous sums to us. And because we own it within Berkshire, to redeploy it elsewhere, didn’t require a lot of tax expense either, at the corporate level nor at the personal level.

So, you really want a business, and everybody wants a business, that doesn’t take any capital to speak of, and keeps growing without taking more capital as it grows. Now, our utility business and energy business requires more capital as it grows. Our railroad business, to some extent, requires more capital if it doesn’t grow, even. So, capital-intensive businesses, by their nature, are not as good as something where people pay in advance and don’t need the capital. If you look at where the top market value is in a $30 trillion market, the top four or five companies account for maybe $4 trillion or so of that $30 trillion. Basically, they don’t take much capital. That’s why they’re worth a lot of money. Because they make a lot of money, and they don’t require the money to any great extent in the business.

We own some businesses like that, but it’s certainly not the railroad and not the energy business. They’re good businesses. We love them, but if they didn’t take any capital, they’d be unbelievable. That’s what we’ve learned from the 50 or  60 years of operating businesses, that, if you can find a great business that doesn’t require capital when it grows, you’ve really got something. And to a certain extent, because insurance uses the kind of assets we would like to own anyway, our insurance business doesn’t really take capital. It requires having capital available, but we’re able to invest that money largely in things we’d like to own anyway. So we’re particularly well-suited for the insurance business, and it has really been the most important factor in our growth over the years, although a lot of other things contribute. Greg, you were in a capital intensive business. Tell us about it.

Greg Abel  17:46

Well, I think there’s no question. Obviously, we’d prefer to be in a less capital-intensive business, but there are unique opportunities there. The one I would touch on when I think of inflation, or even potentially, as we go through this crisis, and maybe a prolonged one, or depending on how long it takes to recover.

When we’re looking at energy or rail, we do have a certain amount of pricing power, and it’s through our regulatory formulas, or how our arrangements are with our customers. So, if we then were to move into an inflationary period, it’s not perfect protection, but those businesses generally can recover a significant portion of their costs. Even in an inflationary environment, they’ll still earn a reasonable return. They’re not going to be great returns, as you highlighted, Warren, but they’re still going to earn a reasonable return on their capital even in an inflationary period. There may be some lag, and some things like that, but they’re still going to be very sound investments.

Warren Buffett 18:48

So yeah, if there was 10:1 inflation, make it extreme, we’d be happy that we own the railroad. Very happy. We’ve been investing a lot of capital in it, but that business, in my view, is a very, very solid business for many, many, many, many decades to come. I said that, originally, we bought it with a 100-year time horizon, and I’ve extended that, so it will earn more dollars if there’s a lot of inflation. In real terms, who knows? But it would earn a lot more dollars and a lot of the energy projects within. But it’s better if we don’t have inflation, and it’s better if we don’t have capital. If we can find the same sort of businesses that aren’t as capital-intensive. We’ve got capital. We’re ideally positioned for capital-intensive businesses while other people have trouble raising capital for, but they’ve still got to promise decent returns.

Preston Pysh  19:08

So, I think this question is really kind of at the heart of everything that’s going on right now. This is a phenomenal question. It’s something that I read in Warren’s shareholder letters back in the early ’80s. It was this idea of owning intangible assets versus tangible assets because they have inflationary impacts. I might be misquoting this, but I think it was his 1983 shareholder letter, maybe that I read this from. It was in the early 80s. I do know that. He talks about this idea that if you own intangible assets, and inflation is happening, or there are these currency moves that are happening, you can just adjust the price of your product because it’s an intangible product, or the goodwill is naturally carried into that change in the inflationary impacts.

So, when you look at how he has positioned himself in the last 20 years, a lot of the businesses that he’s been forced to buy, because he has so much money, and he has these value investing principles, are capital-intensive businesses because you are going to buy Google, or some of these other businesses that have a lot of intangible assets, for a discount. You just weren’t. You were paying a premium for them, and then they just continue to devour everything technological in the world. And so, I can see how he’s got himself into the position that he’s at based on the poor values that he holds dear to him, but he was basically answering the question, saying, “Yeah, we’ve got a lot of capital-intensive businesses, and that’s not good. It’s really the essence of his response, in my opinion.

So Stig, what do you got? I’m curious to hear your thoughts.

Stig Brodersen  21:23

I love discussions about inflation, especially when it comes to Warren Buffett. He’s written some amazing articles about inflation, and what that means for stock investing, in general, and you can learn a lot from that. We’ll make sure to link to some of those writings, too.

Buffett talks about book value, and how that was the highest in America, if not in the entire world. He talked about Google or Apple convincing companies like that. They have so many intangibles that don’t have a big book value. That’s just not how you measure companies today. Book value is still important for a company, at least to some extent, for a company like Berkshire Hathaway, and more traditional companies. For intangible companies, it’s, more or less, irrelevant, and has a very, very different implication when you’re making your evaluations.

Now, I love that I have a chance to talk about inflation. Again. It’s very interesting Preston. I’ve been studying that a lot, and we talked to Jeff Booth here not too long ago, who talked about the major deflationary pressures that we may be seeing. I just want to clarify a few things when we do talk about inflation when we’re talking about this during crisis. What we typically see, in the time of crisis, is that there will be deflationary pressures because so much credit is pulled out of the system.

Now, that is not the same as saying, “Oh, now we’re just in time, generally, of deflation.” That’s very, very different. When credit freezes, you have these deflationary pressures, and it might be in a few quarters, it might be in a few years, but it’s typically very short-lived.

We have talked about Ray Dalio, and we have done that for good reason. I would recommend for everyone to not just read his previous books, but also like the articles he’s doing on LinkedIn right now. My wife always teases me whenever we go to bed because she would be reading her fun books, and I’ll be sitting there with Ray Dalio’s writing.

Preston Pysh  23:17

You nerd. You total nerd.

Stig Brodersen  23:21

I’m such a nerd, you know. I read about inflation and currencies before I go to bed. I mean, who wants to sit next to a nerd like that? Right?

Preston Pysh  23:30

And then you dream about it when you go to bed.

Stig Brodersen  23:32

And then the dream about it when I go to bed. It’s horrible.

Preston Pysh  23:35

I’m laughing because I’m right there with you, bud.

Stig Brodersen  23:39

I remember the last time we were hanging out with our wives, and we took them out for ice cream. The first thing I remember was that I was very impressed because you knew how to order ice cream in Korean, and I had no clue how to do that. So I do remember that. But I also remember that every chance we had to veer away from the conversation was probably about ice cream or something you know, like normal people talk about. People would say, “Let’s talk about AlphaGo!”, as, around that time, it was very popular. Meanwhile, we’re talking about inflation. We’re talking about… Oh my god. It’s lucky that we are married, huh? Preston we could never… *laughter*

24:13

Anyway, going back to Ray Dalio. So he had done this study of 750 currencies that have existed since 1700. Since then, only 20% of those currencies remain, and they’ve all been heavily devalued, including the US dollar. I don’t see that changing. I just think that’s very important to put into the mix. Short term, we might see a few changes in a few quarters, but no, long term, we’ll just continue to see that happening. But if you see how inflation has moved, like over the past centuries, it typically doesn’t go like that 2% a year. You know, whatever you hear about in the news. When you go in and see some of those graphs, you’ll see that it goes through major, major moves, then it’s sort of stabilizes, and then there’s a major move again, typically, because of something like World War or going off into a new monetary system, whatever the reason is. But that’s how it’s going up.

We’ll make sure to link some of that in the show notes. It’s probably easier to visualize than, actually listening to me sit and talk about it. I think that is so important to understand whenever you talk about inflation, whenever you hear 1% – 3%, or whatever, in the news.

25:26

So, sorry for being digressing. We talked about ice cream, and how big nerds we were, and Ray Dalio. I’ll try to bring the point back home to Berkshire Hathaway. Berkshire Hathaway does have a business that is somewhat inflation-protected, and they were talking about that, but it’s definitely not nearly as protected as it could be even though they do have pricing power, which helped mitigate some of that inflation in fact.

Preston Pysh  25:50

All right, let’s go to the next one here.

Becky Quick  25:53

All right. This question comes from Charlie Wang. He’s a shareholder in San Francisco. He says, “Given the unprecedented time of the economy and the debt level, could there be any risks and consequences of the US government defaulting on its bonds?”

Warren Buffett 26:07

No. If you print bonds in your own currency, what happens to the currency is going to be a question because you don’t default. The United States has been smart enough, and people have trusted us enough to issue its debt in its own currency. Argentina is now having a problem because the debt isn’t in its own currency, and lots of countries have had that problem and lots of countries will have that problem in the future. It is very painful to hold money in somebody else’s currency.

But listen, if I could issue a currency, Buffett bucks, and I had a printing press, and I could borrow money from that, I would never default. So what you end up getting in terms of purchasing power can be in doubt, but in terms of the US government, when Standard & Poor’s (S&P) downgraded the United States government some years back, to me, it did not make sense. I mean, in the end, how you can regard any corporation as stronger than the person who can print the money to pay you, I just don’t understand. So don’t worry about the government defaulting.

I think it’s kind of crazy, incidentally. This should be said. To have these limits on the debt, and all that sort of thing, and then it stopped government arguing about whether it’s going to increase the limits. “We’re going to increase the limits on the debt, but debt isn’t going to be paid, it’s got to be refunded.” And for anybody that thinks they’re going to bring down the national debt, there have been brief periods, I think, in the late 90s or thereabouts. The debt’s come down a little bit. The country is going to grow in terms of its debt-paying capacity. The trick is to keep borrowing in your own currency.

Preston Pysh  28:01

I have never disliked a Warren Buffett comment more than this one. I mean, I really, really dislike his response on this. But let me put it this way. He’s right in what he said, but it’s just the way that he said it. So, is the US going to default on their money or on their debt? Nope. They sure as heck aren’t. They’re going to print it, and they’re going to fulfill all of those debt obligations, and, boy, the people owning that are going to really hate that experience. He had a really key phrase in there. He said, “What you get in purchasing power can be in doubt.” He said it real fast. And he said it like it was a nothing burger, but it was the crux of the entire response.

Preston Pysh  28:51

So, let me just ask this question. If your purchasing power goes from 100 to zero, was that a default in phraseology, yes, that’s a freaking default man. You’ve lost everything, right? If your purchasing power goes from 100 down to 1, you lost all your purchasing power. It’s worthless. But in legal terms, did you default? Nope. You sure didn’t. That’s why I don’t like the way he responded to this question because he almost comes across as a lawyer, and he doesn’t really explain the essence of the question. The intention of the question is a good intended question, and I think he gave a really slimy response to it. So, Warren, you get an F from me on this.

Stig Brodersen  29:39

So, I found the response really interesting, and I found it interesting in the sense that all debt is not created equal. I think that’s one takeaway. And he also debunked the myth that all public debt should be paid back. Often, we tend to confuse government debt too much with private debt. There are definitely a lot of overlaps, but it’s also different. Basically, all nations have debt, one way or the other. There are a few exceptions, but now, the US clearly has to service the debt.

The wonderful thing, at least in the short term, is that being the dominant reserve currency, you can only do that as long as the world trusts you. That was sort of like what he was getting at there at the end when he was saying you have to borrow and print in the same currency, otherwise, it doesn’t make any sense. The US is in a situation where they can do that, then he mentioned Argentina. They can also print all the currency that they want, but it just won’t be valuable if it’s their own currency, and they’re borrowing USD.

30:38

Now, I’d like to talk about, can you pay off public debt, and you can’t. It rarely happens, but to do that, you have to grow the economy faster than your current account deficit. Now, the current account deficit primarily comes from trade deficits, at least in the case of the US, and then the interest payment of the already high debt.

The main issue is really that the US is a very rich country, and that’s actually great, but when you talk about public debt, it’s the drawback because everyone in rich countries, including ourselves, they want to consume, and we also want cheap goods. So, in reality, it is just very, very difficult to pay that off. Either you basically have to consume like a much poorer country, or you have to accept that the prices for all domestically produced goods would be significantly higher because that’s what happens whenever you start trading less. So you will have to sacrifice the standard of living, and Buffett clearly realizes that that won’t be possible. Now, politicians talk about it a lot. But no one really wants to make the sacrifice, so the second-order effect of that is really that you need to maintain the dollar as the global reserve currency, and you need to maintain that trust. As long as you don’t have that anymore, that’s when it’s going to be really, really ugly.

Preston Pysh  31:59

All right. Let’s go to the next question.

Becky Quick  32:02

So this question, I was looking for one of these because I got several questions that came in similar to this, and I was looking for one of these a moment ago. This one’s from Andrew Wenke. He says, “Can you ask Warren why he didn’t repurchase Berkshire shares in March when they dropped to a price that was 30% lower than the price that he had repurchased shares for in January and February?”

Warren Buffett 32:21

Yeah, it was a very, very, very short period where they were 30% less, but I don’t think Berkshire shares, relative to present value, are at a significantly different discount than they were when we were paying someone higher prices. Keynes said, “When the facts change, I change my mind. What do you do, sir?” We always think about it, but it’s far more compelling to buy Berkshire shares now than I would have felt three months or six months or nine months ago. It’s always a possibility. And we’ll see what happens. Greg, do you think about repurchasing shares?

Greg Abel  33:07

Generally. No, I think our approach, Warren, is the right approach. I can’t really add anything other than that the approach is the right approach. We approach it when we see that it’s the right thing for our shareholders to be repurchasing. that doesn’t mean we’re repurchasing all the time, or the view doesn’t change.

Warren Buffett 33:29

There could be a price relative to the value at the time, not as what it was worth a year ago. I mean, the value of certain things has decreased. Our airline position was a mistake. Berkshire is worth less today because I took that position than if I hadn’t, and there are other decisions like that. It is not more compelling to buy the shares now than it was when we were buying them. It’s no less compelling. I mean it was large, but the price has not gotten to a level, or has not been at a level where it really feels way better to us than other things, including the option value of money to step up in a big way.

Preston Pysh  34:16

I just want to start off by saying, as we’ve played all the questions we’re going to play for both episodes, I think Becky Quick should be the only person that’s allowed to ask questions at these meetings from now on. Like having gone to my fair share of these meetings and sat through them, dude, Becky crushed it with her questions. She was asking really good questions. When I go to the meetings, I’m always highly annoyed at half the questions that come up because they’re just so nonsensical, and have no value-added. I think Becky crushed this, so Becky Quick, I’m sure you’re not listening, but in the very odd chance that you are, bravo. Great job.

I don’t really have much to add on his response because I think he just totally sidestepped it, and I don’t think that he even provided a good response. I think they’re wanting him to get into why is he seeing the valuation different now than he was when he purchased it 30% higher, and he just didn’t want to even broach the subject, so I can’t really comment on it. It seemed to me like they might be interested in conducting repurchases here in the future, and so he was avoiding the question. But, Stig, I’m kind of curious to hear what you think.

Stig Brodersen  35:26

He typically always gets the “How do you value stocks?” question and the “What is Berkshire Hathaway worth now?” question, almost like saying, “Could you please save me a lot of time, so I don’t have to do the valuation? You could just give me a number, then I can just put in a limit.” And so, it’s interesting reading through Buffett’s latest filing. He bought most of his stocks back at $214. So, the person asking the question would be thinking, “Why is he not just buying a ton back right now?” There’s a lot of focus on that cash position he has, and a lot of people want him to pay out dividends. It isn’t interesting enough, not too many of the people who actually say that are shareholders. But a lot of people have wanted him to pay out dividends or buy bank shares. Especially in recent years, you’ve seen more and more of those questions popping up, which Becky Quick was also referring to. The amount of shares that he’s buying back is around 1.7% on an annual basis. That’s the buyback yield right now, given the current market cap.

36:23

Now Buffett sort of hinted at a few different things, like that the facts have changed. What I picked up from that was that you can’t really use the buyback price of, say, $214 too much as a benchmark because even though that Berkshire is now trading at cold tournaments, and lower, the value of the business has also changed, because the value of the discounted cash flows in the next few years has changed. That’s just basically what makes the biggest difference when you start discounting those cash flows and try to figure out what is the intrinsic value today. So, from a mathematical perspective, that is why something like a crisis actually has a somewhat significant impact even on the company that has been existing for as long as Berkshire Hathaway. But clearly, it’s not anywhere near 20% when that happens. But what I also read in his response was he talked about opportunity cost. It’s just very important to understand that yes, Berkshire Hathaway is cheaper, but if all other stocks and universal are also cheaper, you know, that’s whenever you need to figure out what you should do with your cash pile. So, I think that was one key takeaway I had.

37:30

The last thing was that it’s a very thinly-traded stock even at a time like this, so when the stock price went to about 30%, it looked like it was more or less overnight. It really wasn’t, but for a company the size of Berkshire Hathaway, it was almost like overnight. You can’t just go in and buy like all your stock at whenever it hits $162 before it bounces back.

37:52

Alright, those were the four questions that we selected from the Berkshire Hathaway annual shareholders meeting. We always thoroughly enjoy having these discussions and sharing them with you. But at this point in time the show, we’ll play a question from the audience, and this question comes from Jeff. Here we go.

Jeff Mason  38:09

Hi, Stig! Hi, Preston! My name is Jeff Mason, and I’m an investor in Victoria, British Columbia, Canada. I wanted to thank you both for all of the knowledge that you’ve shared and all the great guests you’ve had on your show. It’s really improved my confidence as an investor. My question relates to some advice that I’ve heard from the guests on your show, and I’ve also heard it in some of the great trading books. The advice is don’t sell your winners. I’ve tried to follow this advice in my own trading and investing, and I found them often disappointed. It doesn’t seem like very good advice. So my question to both of you is do you follow this advice? Do you sell your winners? In what situations would you definitely hold on to your winners as long as you can? And in what situations would you definitely sell them? Thanks so much, and have a great day.

Preston Pysh  38:59

Jeff, great question. I think, first of all, I look at a sell order as a point where I’m going to have liquidity, and then I have to have some other opportunity that’s going to outperform what I think the previous holding is going to do. If, let’s just say I own something. I have a massive gain, and if I sell it, I’m going to have massive capital gains associated with it. Let’s just say that that was a long-term holding, so whatever principle I get from the sale, I now have 15% less of that. That’s lost due to capital gains tax. When I employ that new capital, what kind of return am I expecting to get out of that? And then when’s it going to basically exceed the previous valuation that I had for the other business as far as the return goes? That’s kind of like the mathematics behind my thinking whenever I do exercise a sell order.

39:57

Another time that I’ll sell that doesn’t follow that model is if I think that there’s just something fundamentally wrong with the business, I think that there is some type of issue, and I just want to liquidate the position. That’s typical because there’s an impairment on their balance sheet for one of their major assets, or I think there’s some competitor that’s come in and is going to, basically, take all the market share, and it’s going to cause a lot of punishment for the pick.

40:25

Those are kind of the two main ways that I look at it. Now, how do I manage some of that risk? If you asked me 10 years ago, I would tell you that what I just described is was exclusively how I look at selling positions. Today, I would tell you that I also incorporate the momentum status.

We have a Momentum Tool on our TIP Finance. One of the nice things about this momentum tool is it looks at statistical volatility ranges of a pick, any pick, and it’s tailored towards that pick. Let’s say the S&P 500 is going up. It’s going within a certain volatility range, and then whenever it steps outside of that volatility range, the momentum tool detects it and indicates if it’s most likely going lower because it’s outside of this trading volatility range, and then it turns it into a red status. The way that the tool’s working is it’s basically selecting a stop limit for that underlying pick, and that stop limit is dynamic. As the price goes higher and higher, the stop limit keeps adjusting higher and higher.

I use that tool, especially for indexes, because it’s really hard to come up with an intrinsic value for the S&P 500 outside of just looking at the price-to-earnings. My opinion is that if the price goes through that volatility range and hits that stop limit on an index, it’s more macro-related than it is earnings-related or functioning of the business. I use that tool to also assist me in knowing when to stop holding a winner.

For example, like the S&P 500 on our TIP Momentum Tool has been green for a very long time, and it recently went red, then it just went back into a green status. There’s a tax realization to that, but there’s also the implication that I’m protecting my downside risk because if the market would crash 40% in a day, which you had in 1987, or some other events that were very deep, you’re protecting yourself from those types of events. So, I would add that in there as well as a way that I also protect my downside risk and that I continue to hold winners that just keep on running.

Stig Brodersen  42:32

I really like the question too. Actually, I would like to put into the mix a few fun facts about Buffett before I go into my own strategy, which is very similar to what you also described, Preston. But I think Buffett is one of the best examples of not selling your winners. The vast majority of Buffett’s portfolio is concentrated in just a few companies, including American Express, Apple, Bank of America, and Coca-Cola, which is a very famous example of a position that has worked out really, really well. All the investments that I have just mentioned have been very profitable. Aside from the Apple acquisition that was initiated back in 2016, those are all stocks that he has held for a very long time.

Now, I really agree with that sentiment, because in the sense that I rarely sell my winners too. Generally, jumping in and out of winners is hard, and if you find really good stocks that have compounders, you don’t want to jump in and out of it too often. Part of the concern is tax, as Preston mentioned before. If you live in the US, that’s 50%, so in that sense, you just have to be more right than wrong. So really, to sell your winners, it has to trade a lot higher than intrinsic value. So, say a company like in Berkshire Hathaway trading $172 today. If it would go to $300 tomorrow, yeah, clearly, I would take the tax loss on that, and sell my position. But the more capital gain that you have earned, the harder it simply becomes. Coca-Cola, being an example as I mentioned before, Buffett built that position for $1.3 billion. I think the last time I looked it up, it was trading around $18 billion, so it’s a lot of tax he has to pay, even though Coca-Cola, at times, have been quite expensive. It just doesn’t make any sense.

Preston Pysh  44:14

Stig, I just have something I want to add on to what you were saying there real fast. With the example that you provided with Berkshire Hathaway’s price, let’s just say it doubled. In the past 10 years ago, I would have said, “Yep, let’s sell it. Let’s move it into the other undervalued picks that I have.” And then if the price comes back down to where I think the valuation is, then I’ll start re-accumulating it. But today, I would tell you, if the price doubled, I would continue to hold it until I would see the price volatility go below the stop limit just because maybe the market is going to continue to rise. I mean, you saw this with Tesla, where the price just went crazy. It went up to like $600. That was maddening, the price was nuts, and then it ran to $1000. So, if you’re using a momentum indicator for the point where you’re going to exit the position that just keeps running, you would have continued to hold Tesla, it would have gone up to $1000, and then when it started to drop back down, call it at $800 or $700, or whatever it was, and your stop limit hits, that’s when I would sell. It’s that I allow it to keep running because I have no idea how much fear of missing out the market is going to price into that run, but then I rely on that volatility range to help me know when it’s time to pull out of that and then go into the other undervalued picks that I’m finding on the market.

Stig Brodersen  45:35

It’s really unfortunate that you talked about Tesla because we really had an interesting segment about the inefficiency of the stock market, and now we have primed everyone’s thinking about Tesla. I don’t know if I can bring that bring my point back home with that. But I guess my point is that the market is relatively efficient, at least over time. It has proven to be. And so, whenever I say that (and I’m using that as my premise, so please forget everything about Tesla that Preston just mentioned) when I’m doing this segment here, but sometimes when you do invest in a stock and it goes south, like really, really south, that momentum can really save you because guess what? You can be wrong. If you think you can’t be wrong, and whenever it drops 50 or 60%, that’s not because the market is terribly inefficient. That’s just because you’re wrong. You’re just analysis your facts just wrong. That’s why I think it’s so valuable to look away from tax year and have some sort of tool that can go in and say, “Hey, you might be right, the whole world might be wrong”, but you might want to take two seconds and reconsider perhaps you are wrong, and perhaps that’s the time where you need to get out of that stock.

Preston Pysh  46:49

This is a really simple math exercise, that I think many investors don’t understand. If the price goes down 50%, you need a 100% gain to get back to neutral to where you were. The way markets work is almost like if you went and you had to destroy a building, you can push a button, then the whole thing just falls apart really fast. But if you’re going to reconstruct it and build it back up, like you see these stadiums that they explode that they get rid of, it happens in an instant. You can destroy things in an instant, but then to rebuild it takes forever. That’s one of the other reasons why I really like to stop limits on momentum because it takes a lot of the emotional piece out of it that you naturally have when you buy a company, and it’s just saying, “Hey, statistically, there’s something that’s different. At this point in time, there’s something that’s different.” So, you can either keep following your emotions, or you can just look at it from a mathematical standpoint and protect your downside so that you’re not having to rebuild in the event that you’re wrong. And that rebuilding might take five years to get back to neutral. You can just you can take a systematic loss, move out on your next pick, and protect your downside risk.

So, when Buffett has his rules of rule one, don’t lose money, and rule two, refer back to rule number one, I think the essence of that statement is this idea that when you have a 50% downturn, it takes %100 to get it back. Or, if you have a 30% downturn, it takes X to get it back, which is way higher than 30%. So, that’s important for new investors. I think many new investors don’t understand the implications of that, especially if you’ve never lived through a significant downturn.

48:31

Alright, so Jeff, I’m really excited to tell you this because you’re going to get a year-long subscription to TIP Finance, where we have this Momentum Tool, and we have these stop limits that are published right there on the chart for every single pick that you’d lookup. We’re just really excited to be able to give this to you. So, for anybody else out there, if you want to get a question played on our show, go to asktheinvestors.com, you just click a little button, and you can record your question. If it gets played on the show, you get a 1-year subscription to our TIP Finance Tool. For anybody else out there, if you want to check out our tool, just go to Google, type in TIP Finance, it’ll be the first thing that comes up, and you guys can check out the tool there if you guys want to look at it.

Stig Brodersen  49:08

Alright, guys, this was a lot of fun. We would love to go to Omaha and meet up with you in person. That’s definitely the plan, to do that in 2021. Buffett actually mentioned during the meeting that it was still Charlie Munger’s plan to go there. It was just a bit too painful for him to go, be in front of cameras, and not doing the event, then go all the way back to LA. But guess what? The biggest news out of all that that I learned from this annual shareholders’ meeting was that Charlie Munger is using Zoom every single day. And if Charlie Munger is using Zoom every single day, what can we count on anymore? Like, what has the world come to? But guys, sorry for goofing out there again. This was all that Preston I had for this week’s episode of The Investor’s Podcast. We’ll see each other again next week!

Outro  49:57

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