1998: How should business valuation be taught in school?

AUDIENCE MEMBER: Hello, Mr. Buffett and Mr. Munger. My name’s James Claus (PH) from New York City. And I just wanted to ask you a question.

Both you and Mr. Munger have repeatedly said that you don’t believe that business valuation is being taught correctly at our universities, and as a Ph.D. student at Columbia Business School, that troubles me, understandably, because in a couple of years I’ll be joining the ranks of those teaching business valuation.

My question isn’t what sources, such as Graham or Fisher or Mr. Munger’s talks, you would point people that are teaching business valuation to, but do you have any counsel about the techniques of teaching business valuation?

WARREN BUFFETT: Well, I was lucky. I had a sensational teacher in Ben Graham, and we had a course there, there’s at least one fellow out in the audience here that attended with me. And Ben made it terribly interesting, because what we did was we walked into that class and we valued companies.

And he had various little games he would play with us. Sometimes he would have us evaluate company A and company B with a whole bunch of figures, and then we would find out that A and B were the same company at different points in its history, for example.

And then there were a lot of little games he played to get us to think about what were the key variables and how could we go off the track.

I remember one time Ben met with Charlie and me and about nine or so other people down in San Diego in 1968 or so, when he gave all of us a little true/false test, and we all thought we were pretty smart — we all flunked. But that was his way of teaching us that a smart man playing his own game and working at fooling you could do a pretty good job at it.

But I would, you know, if I were teaching a course on investments, there would be simply one valuation study after another with the students, trying to identify the key variables in that particular business, and evaluating how predictable they were first, because that is the first step.

If something is not very predictable, forget it. You know, you don’t have to be right about every company. You have to make a few good decisions in your lifetime.

But then when you find — the important thing is to know when you find one where you really do know the key variables — which ones are important — and you do think you’ve got a fix on them.

Where we’ve been — where we’ve done well, Charlie and I made a dozen or so very big decisions relative to net worth, but not as big as they should have been. And we’ve known we were right on those going in. I mean they just weren’t that complicated. And we knew we were focusing on the right variables and they were dominant.

And we knew that even though we couldn’t take it out to five decimal places or anything like that, we knew that in a general way we were right about them. And that’s what we look for. The fat pitch. And that’s what I would be teaching — trying to teach students to do. And I would not try to teach them to think they could do the impossible.

Charlie?

CHARLIE MUNGER: Yes. If you’re planning to teach business valuation, and what you hope to do is teach the way people teach real estate appraising. So you can take any company, and your students, after studying your course, will be able to give you an appraisal of that company, which will indicate, really, its future prospects compared to its market price, I think you’re attempting the impossible.

WARREN BUFFETT: Yeah, probably on the final exam I would take an internet company, and I would say the final exam, the question is, “How much is this worth?” And anybody that gave me an answer I would flunk. (Laughter)

CHARLIE MUNGER: Right. Right.

WARREN BUFFETT: Make grading papers easy, too. (Laughter)