1997: How can Buffett analyze a business in five minutes?

AUDIENCE MEMBER: Good day, gentlemen. My name is Bill Rodenberg (PH) from Dayton, Ohio. I’m a shareholder, and my daughter Sarah, who is 13, is also a shareholder. She chose not to join me in the limelight. I think the hot dogs had a higher appeal to her.

WARREN BUFFETT: Not to mention —

AUDIENCE MEMBER: And I’d like to say that it’s very reassuring to know that Uncle Warren and Uncle Charlie are taking care of her college fund. And it’s easy to sleep at night.

I have two questions, one related to a question my wife asked me, which I was unable to fake a good answer to, and a second one related to my daughter’s one share of Berkshire A.

My wife asked me, in the annual report you stated that if anyone out there has a good company like FlightSafety, please let you know and you’d be glad to look it over and give an answer within five minutes or less.

And her question is, how can he do that? Where does he get the information to make that decision? And how does he know that that information is valid?

My second question has to do with my daughter. She’s 13. In five years she’ll be off to college, perhaps UNL, perhaps not.

In any case, she’s going to face a significant capital gains when she sells that one share of stock.

WARREN BUFFETT: I hope so. (Laughter)

AUDIENCE MEMBER: You mentioned earlier, and I believe this is correct, you said that you could trade one share of A for 30 shares of B this afternoon. And I thought, wait a minute, I thought there was a limited window on that. We happened to be out of the country at the time that exchange took effect, and we missed it.

WARREN BUFFETT: No, the exchange exists forever. You can —

AUDIENCE MEMBER: Forever?

WARREN BUFFETT: You can always exchange a share of A for 30 shares of B. You cannot do it in reverse. You cannot shift 30 shares of B into one share of A. But there was no window or timetable on that.

The A stock is forever exchangeable for 30 shares of B. I don’t recommend that she does it, because it’s always an option, and in the meantime she gets the shareholder-designated contribution, and there’s always the chance that the A will sell slight — at a price slightly above 30 shares of B. It doesn’t do it very often and it won’t be very much if it does, but —

We didn’t want to create an incentive for people to exchange A for B, but we — they will always have the right to do so.

WARREN BUFFETT: The five minute test is a — you know — Charlie and I have — we’re familiar with virtually every company of a size that would interest us in the country. I mean, if you’ve been around for 40 or more years looking at businesses, it’s just like if you were looking at — you know, studying baseball players every day. You get to know all the players after a while. And that’s the way it works.

Then we have a bunch of filters we’ve developed in our minds over time. We don’t say they’re perfect filters. We don’t say that those filters don’t occasionally leave things out that should get through. But they’re very — they’re efficient.

And they work just as well as if we spent months and hired experts and did all kinds of things. So we really can tell you in five minutes whether we’re interesting in something, and —

We’d never owned shares in FlightSafety but we’d been familiar with the company for at least 20 years, wouldn’t you say, Charlie?

CHARLIE MUNGER: Sure, I had a partner who bought a lot of it 20 years ago. Yeah.

WARREN BUFFETT: Yeah. But that’s true of almost any business. And we know — we’ve got a fix on what we don’t understand, and then we don’t care to know any more about them, particularly, although we’ll pick up a little as we go along, maybe.

And then the ones that are — we’re capable of understanding, we’ve probably gotten about as far as we’ll get already. So we do know in five minutes.

Now, when we do something with FlightSafety, before the purchase and even for somewhat — a little after the purchase — I’d never been — I’d never set foot on a piece — they have 40 or so training centers around the world — I’d never set foot on one of them.

I’d never been to their headquarters. We never looked at a lease. We never look at title of the properties. I mean, we don’t do all of those things.

And I will say this: to date, that’s never cost us a penny. What costs us money is when we misassess the fundamental economic characteristics of the business.

But that is something we would not learn by what people generally consider due diligence. We could have lawyers look over all kinds of things, but that isn’t what makes a deal a good deal or a bad deal. And we don’t kid ourselves by having lots of studies made and lots of reports made. They’re going to support whatever they think the guy that pays them, you know, wants anyway. So they don’t mean anything. They’re nonsense.

But we do care about being right about the economic characteristics of the business, and that’s one thing we think we’ve got certain filters that tell us in certain cases that we know enough to assess. And then we make some mistakes.

Charlie?

CHARLIE MUNGER: I’ve got nothing to add to that, except that people underrate the importance of a few simple big ideas. And I think that to the extent Berkshire Hathaway is a didactic enterprise teaching the right systems of thought, I think that the chief lessons are that a few big ideas really work, as I think these filters of ours have worked pretty well. Because they’re so simple.

WARREN BUFFETT: Yeah, I think most of the people in this room, if they just focused on what made a good business or didn’t make a good business and thought about it a little while, they could develop a set of filters that would let them, in five minutes, figure out pretty well what made sense or didn’t make sense.

I mean, there may be some reason after five minutes we don’t get together on a deal of some sort, but —

Another thing you can usually tell — at least you can tell it in the extreme cases — you can tell whether you’ve got the kind of manager, very quickly, that you want to have. I mean, if you’ve got somebody that’s been batting .400 all their life, and fortunately age doesn’t change that picture, in terms of business performance, and they love what they do, it’s going to work.

If the seller cares a lot about the money, you’re probably not going to make a very good deal. If their real interest is going in the — is what they’re going to do with the money, they may fall out of love or have less interest in their business subsequently.

We love working with people who are just plain nuts about their businesses. And it works very well. And you can usually spot that.

Now, having said that, we’ll have a few people figuring out how to fake that attitude, you know, when they try and sell us some piece of junk here, but — (Laughter)

Charlie says we can get conned by some guy with a green eyeshade, you know, and a low-rent office and all that. But we won’t get taken in by the guy with the suede shoes. (Laughter)