2008: Why doesn't Berkshire do more due diligence?

AUDIENCE MEMBER: Harry Beguy (PH), San Francisco.

Mr. Buffett, I was reading recently in Fortune magazine that when you invested $500 million in PetroChina back in 2001 or 2002, all you did was read the annual report.

Now, I was thinking that most professional investors with the kind of resources that you have would have liked to have done a lot more research and talked to management, maybe regulators, et cetera, et cetera.

The question I have is, how — what is it that you look for when you’re reading an annual report like that? How is it that you were able to, and did, make an investment purely on the back of reading that report?

WARREN BUFFETT: Yeah. Well, it was in 2002 and 2003, and the report came out in the spring, and I read it. And that’s the only thing I ever did. I never contacted any management. I never got a brokerage report. I never asked for anybody’s opinion.

But what I did do is I came to the conclusion that the company — and it’s not hard to understand crude oil production and refining and marketing and the chemical operation they have. I mean, you can do the same thing with Exxon or BP or any of them, and I do that with all — I look at them.

And I came to the conclusion it was worth a hundred billion, and then I checked the price and it was selling for 35 billion, roughly.

What’s the sense of talking to management? I mean, basically, if you talk to management of almost every company, they’ll say they think their stock is a wonderful buy, and they’ll give you all the good stuff and skip over things that — it just doesn’t make any difference.

Now, if I thought the company was worth 40 billion and had been selling for 35 billion, then at that point you have to start trying to refine your analysis more. But there’s no reason to refine your analysis.

I mean, I didn’t need to know whether it was worth 97 billion or 103 billion if I was buying it at 35 billion.

So any further refining of analysis would be a waste of time when what I should be doing is buying the stock.

So we really like things that you don’t have to carry out to three decimal places, you know.

If you have to carry it out to three decimal places, it’s not a good idea. And, you know, it — with something like PetroChina — it’s like if somebody walked in the door here and they weighed somewhere between 300 and 350 pounds. I might not know how much they weigh, but I would know they were fat. (Laughter)

That’s all I’m looking for, is something that’s financially fat. And whether PetroChina weighed 95 billion dollars or 105 billion didn’t make much difference. It was selling for 35 billion. If it had been selling for 90, it would have made a difference.

So if you can’t make a decision on something like PetroChina off the figures, forget about going further, and that’s basically what we did. It’s a straightforward report, just like reading another — just like reading Chevron’s or ConocoPhillips or something like that. Just as informative.

And you weren’t going to learn more, you know, by going out and deciding whether you thought — they’ve got one huge field in China where the life of it was 13 years or 14 years or something of the sort. They should hit you between the eyes.

Charlie?

CHARLIE MUNGER: Yeah. I would argue that we have lower due diligence expenses than anybody else in America — (laughter) — and that we have had less trouble because we had less expense.

I know of an investment operation in America that pays over $200 billion a year that —

WARREN BUFFETT: Two-hundred million.

CHARLIE MUNGER: 200.

WARREN BUFFETT: Million.

CHARLIE MUNGER: Yes. 200 million. Pardon me.

WARREN BUFFETT: Uh-huh.

CHARLIE MUNGER: — every year to its accountants, a lot to help them with due diligence.

And I think our operation is safer because we think like engineers. We want these margins of reliability. And they’re trying to do something really difficult, which is to have fine-grain judgments in very complex areas, and rely on other people to do it who are getting paid fees.

It’s a very dicey process to do that. I think it’s much safer to do our way.

WARREN BUFFETT: If you think the auditors know more about making an acquisition than you do, you ought to take up auditing and let them run the business, as far as we are concerned.

We are not — I mean, when we get a call on something like the Mars-Wrigley situation, if we don’t know enough about Mars and Wrigley by this point so that we have to go out — I still like to go out, of course, and sample all the bars.

So we have a 15 — I mean, I feel I owe that to the Berkshire shareholders (Laughter)

But I’m not going to look at their labor contracts or their leases or anything like that.

If the value of Wrigley depends on a specific lease someplace or a specific commitment to this or that, you know, or a given environmental problem, forget it, you know.

The — there are these overriding considerations that are enormously important, and then there’s a whole lot of trivia that doesn’t mean anything.

We have never made a — we’ve made plenty of big investment — I’ve made plenty of big investment mistakes. I’ve never made one, in my view, that would have been avoided by conventional due diligence.

And we would have spent a lot of money, and we would have wasted a lot of time and, in some cases, we would have missed deals, simply because we wouldn’t have committed fast enough.

We have a significant advantage, and it gets bigger as we get bigger, because, in terms of big deals, people rely more and more often on process, in that when people want to get a deal done, they want to know it’s going to be done, they will come to us.

I mean, the Mars people wanted to deal — in terms of this financing aspect of the Wrigley situation — they only wanted to deal with Berkshire because they knew we didn’t have any lawyers involved. I’ll admit to this group we didn’t even have any directors involved.

We just — you know, we got a call, it made sense, and we said yes. And when we say yes, we don’t say yes with a material adverse change clause. We don’t say yes, if financing is available. We just say yes.

So I can tell people when we make a deal that, if we’re going to have 6 1/2 billion available, it’s going to be available, you know, whether there’s a nuclear bomb goes off in New York City, or whether there’s a flu epidemic, or whether Ben Bernanke runs off to South America with Paris Hilton. (Laughter)

The check is going to clear.

And if you’re making a deal, you know, the guy that wants the 6 1/2 billion, that assurance is worth something. And you really can’t get anyplace — they say, “Well, I’ll do it, but I’ve got to have a due diligence team check this out and do all of that.” So it’s a real advantage to us, and I don’t think there’s any disadvantage to us.