2003: Why don't investors misprice conglomerates?

AUDIENCE MEMBER: Good afternoon. David Winters. Mountain Lakes, New Jersey. Thank you again for hosting the Berkshire weekend. It’s just great.

Interest rates are the lowest they’ve been in, I think, two generations. Equity values, in aggregate, are still high. Berkshire has meaningful free cash flow, a short-duration bond portfolio, and you’re a buyer of low-multiple, high-quality private businesses, and a few stocks.

Assuming that the stimulative economic policies to deal with the recession eventually cause interest rates to go up and, maybe, equity values to come down, Berkshire seems very well positioned to benefit. Would you comment?

And also, are there any concerns on both of your parts about investors inadequately understanding the conglomerate structure of Berkshire and, therefore, improperly pricing the shares?

WARREN BUFFETT: Well, to answer the second question first, we hope the latter wouldn’t be true, because we do our best to explain it. I mean I used 14,000 words in the last annual report, which caused certain members of my family to ask whether I was getting paid by the word. (Laughter)

The — we want you to understand Berkshire, and I hope that comes through. That’s why we have these kind of meetings. That’s why we spend a lot of time writing an annual report. We try to tell you what we would like if the position was reversed — if our positions were reversed.

And we think that the information in the annual report, if read by somebody that — they have to have some understanding of business and accounting, but if they don’t, you know, nothing is going to help, really, in terms of helping them with the business.

But we think if they have some understanding of it, we have given them the information that Charlie and I would need in order to come up with our rough ideas of a valuation of Berkshire, and we hope we get across what it’s all about.

You know, there are a lot of companies in Berkshire, but it’s not important that you understand the nuances of every single one. Looking at what happens in aggregate, in many cases, will be sufficient.

WARREN BUFFETT: In terms of how we’re positioned, you know, we have 16 billion of cash, not because we want 16 billion of cash, or because we expect interest rates to go up, or because we expect equities to go down.

We have 16 billion in cash because we don’t see anything that makes us want to part with that cash where we feel we’re getting enough for our money.

But we would spend — we spent a Monday morning on the right sort of business, or even if we could find equities that we liked, or if we could find — like last year we found some junk bonds we liked. We’re not finding them this year at all, because prices have changed dramatically.

So, we’re not really ever positioning ourselves. We’re simply trying to do the smartest thing we can every day when we come to the office. And if there’s nothing smart to do, cash is the default option.

Charlie?

CHARLIE MUNGER: In terms of future opportunities, the issue is, is it at all likely that there’ll be an opportunity like 1973-4, or 1982, even, when equities generally are just mouthwatering?

I think there’s a very excellent chance that neither Warren or I will live to see either of those occasions again.

If so, Berkshire’s not going to have a lot of no-brainer opportunities. We’re going to have to grind ahead the way we’ve been doing it recently, which is not all bad.

WARREN BUFFETT: It’s not impossible, though, we’ll get some mouthwatering opportunities. I mean you just don’t know in markets. It’s unbelievable what markets do over time.

And since you brought up interest rates, you know, in Japan the 10-year bond is selling to yield 5/8ths of 1 percent. Five-eighths of 1 percent.

I don’t think there’s anybody in our annual meeting of 20 years ago, certainly including Charlie and myself, who would have dreamt that a 10-year bond of a country, you know, running a significant deficit would be selling at 5/8ths of 1 percent.

I mean would you say so, Charlie? (Laughs)

CHARLIE MUNGER: Would I ever. But strange things happen.

WARREN BUFFETT: Strange things happen.

CHARLIE MUNGER: But if that could happen in Japan, something much less horrible for the investing class could happen in the United States. It’s not unthinkable.

I mean we could be in for a considerable period when the average intelligent, diversified investor in common stocks, using fancy paid advisors, just doesn’t do very well.

WARREN BUFFETT: But you could argue that if what we warned against, and hope doesn’t happen, with derivatives should happen, it might create enormous opportunities for us in some arena. I mean, you know, but we — wouldn’t be good for society, but it might very well turn out to be good for us.

If you get chaotic markets — you had a somewhat disorganized market in junk bonds last year, because there were a lot of them created much faster than the funds available to absorb them were coming in.

Now, this year you have just the opposite situation. You have money pouring in to junk bond funds. Billion dollars a week, roughly, and that’s changed the whole price situation. The world hasn’t changed that much. It’s just that the chaos has left the market for those instruments.