1999: What's the risk/reward of investing directly in Chinese companies?

AUDIENCE MEMBER: Good morning. My name is Matt Haverty (PH). I’m from Kansas City.

Twenty years ago, China unleashed capitalism within its borders. Since then, I believe it has benefited more from that economic system than any major country in history.

I also believe that this momentum, combined with China’s size and demographics, will make it the most fertile economic environment in the world during the next few decades.

Nonetheless, there are many Chinese companies with easy-to-understand businesses and 20 percent per annum sales growth this decade, trading at five times or less last year’s earnings.

What is your assessment of the risk/reward of investing directly in Chinese companies?

WARREN BUFFETT: Well, I don’t know that much about them. But I — certainly if I could buy companies that were earning 20 percent on equity and had promises — gave promise — of being able to continue to do that while reemploying most of the capital, and they were selling at five times earnings, and I felt good about the quality of the earnings, you know, I would say that would have to be an interesting field.

My guess is that it’s not a large enough field, in terms of the ones that meet those tests you named, for Berkshire to profitably participate. And whether you could buy all of those companies from the U.S., I think there’d be a lot of — there could well be a lot of problems in that.

But I would say, any time you can buy good businesses — really good businesses — which we define as businesses who earn high returns on capital at five times earnings — and you believe in the quality of the earnings, and they can reemploy a significant portion of those earnings, additionally, at the 20 percent rate, you know, you will make a lot of money if you’re right in your assessment on that.

Charlie?

CHARLIE MUNGER: Yeah, I don’t know much about China. (Laughter)

WARREN BUFFETT: But that is not to knock it in any way, shape or form. Because I mean, in terms of — there could well be opportunities in areas like that, if you can identify those kind of businesses. We would have trouble identifying those businesses, ourselves.

But that doesn’t mean that, you know, you will have trouble or other people who are much more familiar with the economy there, would have trouble.

So, I encourage you to look at your own area of expertise in something like that. And you’ll do much better.

If the conditions you describe exist and you can identify the right company, you will do much better in that than you will in American markets, in my view.