University of Berkshire Hathaway: 30 Years of Lessons Learned from Warren Buffett & Charlie Munger at the Annual Shareholders Meeting

298 Pages·2007·1.53 MB·English

by  Daniel Pecaut

University of Berkshire Hathaway
30 Y L L
EARS OF ESSONS EARNED
FROM
W B
ARREN UFFETT
& C M
HARLIE UNGER

AT THE
A S M
NNUAL HAREHOLDERS EETING
Daniel Pecaut with
Corey Wrenn
Dedication
This book is dedicated to my hero, Russell B. Pecaut (1902–2000, Dow Jones
Industrial Average: 67–11,551). Papa, as we grandkids called him, was a good-
natured, honest, and unfailingly upbeat gentleman. He encouraged me greatly in
my career. He taught me that optimism is a choice and that your word is your
bond. This world could use a few more like Russell Pecaut. Papa, this one’s for
you.
—Daniel Pecaut
The Electronic Record
Asked why he is on TV so much, Buffett responded that he likes having the
electronic record, so there is no chance of him being misquoted or
misunderstood. If he’s on Charlie Rose, he knows the record will be
permanent and will be exactly what he said.
—EXCERPT FROM OUR NOTES AT THE 2010 SHAREHOLDERS MEETING
What follows in this book is not an electronic record. This is the result of
feverish note-taking during 30 years of Berkshire Hathaway’s annual
shareholders meetings. While we, the authors, believe these notes capture the
essential meaning and intention conveyed, we apologize in advance for any
misrepresentations.
Introduction
My dad was also my hero, just like the case with you. Dick clearly was a
terrific guy and a sound thinker. You were lucky to have him as a father,
teacher, and inspiration.
—WARREN E. BUFFETT
(written on the back of a Pecaut & Company newsletter)
After my dad, Dick Pecaut, passed away in 2009, I wrote a loving tribute to him
in my investment firm’s monthly newsletter. Days later, I received one of the
newsletters back. Handwritten, on the back of that newsletter, was a note from
the Oracle of Omaha, Warren Buffett. The man whose mindset, strategies, and
investing insights my business partner, Corey, and I have studied for three
decades. The man whose wisdom we are honored to share with you in the
coming pages.
Buffett’s short note served as a heartwarming footnote to my father’s life work
as an investment advisor. It also served as validation of both the newsletters that
make up this book and our work as investment advisors.
We have been longtime Berkshire Hathaway commentators. Our analyses of
its chairman, Warren Buffett, and vice chairman, Charlie Munger, have been
featured in the New York Times, Money Magazine, Schiff’s Insurance Observer,
and a host of other leading investment publications. One of our newsletters was
referenced in James O’Loughlin’s book, The Real Warren Buffett: Managing
Capital, Leading People.1
For years, we sent our newsletter, unsolicited, to Berkshire Hathaway’s
headquarters. But until this thoughtful reply, we never knew if anyone actually
opened the envelopes.2
Corey and I were electrified. Buffett read our newsletter! It was an
acknowledgment that our writings and insights on value investing are of interest
to the master himself. On a personal level, mourning my father, it was one of the
warmest and most affirming notes I have ever received. For that, I am eternally
grateful.
But it wasn’t always like this. We didn’t always receive personal notes from
the world’s greatest investor.
How Did We Get Here?
I graduated from Harvard in 1979 with a philosophy degree. While there, I took
only one economics course. I found it too theoretical, not anything like the
investing I saw happening in my family’s business.
My grandfather, father, and uncle had founded Pecaut & Company, a
stockbrokerage firm, in 1960. My grandfather, Russell, often marveled that they
made money from day one and never looked back.
My involvement in the family business began in the late 1970s, when I was
working summers in the back office. I did the grunt work, including updating the
S&P 500 tear sheets.
Back then, the S&P sent its clients color-coded binders that were alphabetized
like a set of encyclopedias. Every month, a packet would arrive in the mail with
colored sheets that matched the binders. Green sheets were large-company
stocks. Yellow sheets were small-company stocks. Blue sheets were for bonds.
Someone needed to manually update the binders by replacing old sheets with the
new. That was my job. I learned a lot by reading those sheets.
After graduating, I entered the firm as a full-time employee. I felt inadequate
and clueless. Our small, family-run operation had no formal training program or
structure. My dad rarely sat me down to discuss how things were going. I
tortured myself with my own self-judgment about how poorly I thought I was
doing. I learned by trial and error.
One error was option trading. It was quick and exciting. You could
theoretically triple your money in a short time. Do that a few times, and you’d
have a good year. I spent a year trying to develop a successful option trading
strategy. And at the end of the year? I had made about a hundred bucks.
Calculating that into the amount of time spent, I had made about 10 cents an
hour.
Clearly, that wasn’t worth it. Trading in the short-term may work for some
people, but it wasn’t for me. I needed a better approach.
Then, in 1982, I read the book The Money Masters by John Train, in which he
profiles nine brilliant investors, including John Templeton and Warren Buffett.
A light bulb came on when I finished the book. I said, “I’m going back to
school. These investors are my professors. My curriculum is everything they say
and write.” I was excited. I would study the most brilliant investors in the world
like they were my professors at Harvard. I was on fire to learn everything I could
about them and to figure out how to invest like them.
From that point forward, I saw my role in the firm primarily as a learning
organism. My thought was that the more I learned, the better my decision-
making would be, and the better I would serve our clients.
Over time, my favorite professors would include Sir John Templeton (of the
Templeton Growth Fund),3 George Michaelis of Source Capital (a top-
performing closed-end fund), Jean-Marie Eveillard (who ran what is now the
First Eagle Global Fund), Bob Rodriguez (of First Pacific Advisors), and Marty
Whitman (of Third Avenue Value Investors). These experts would all offer
tremendous insight and direction.
But of all the brilliant “professors,” none of them has been more instructive
than Warren Buffett and Charlie Munger of Berkshire Hathaway.
After realizing that Buffett was one of the guys to learn from, I devoured all
his annual letters to shareholders from Berkshire. When I met a friend who had
Buffett’s letters from his partnership prior to taking over Berkshire, I devoured
those, too. I loved reading them.
From where I lived, it was only a 90-minute drive to Omaha and Berkshire’s
annual meetings. But to attend, you had to be a shareholder.
Undaunted, I bought a single share of Berkshire Hathaway for $2,570 that
year. That share paved the way for over 30 years of first-class tuition from two
of the greatest professors you could ever hope to learn from.
The “University of Berkshire Hathaway”
I distinctly remember that first meeting in 1984. It was an electric yet cozy affair
at Omaha’s Joslyn Art Museum.
A local CPA I knew, Corey Wrenn, was taking tickets at the door.4 He was a
relatively new employee, hired by Berkshire’s audit department in 1983.
After graduating college and working two years in public accounting in Sioux
City, Iowa, Corey decided that wasn’t what he wanted to do his whole life.
While looking for another job, he received a call from a headhunter in Omaha
who told him that Berkshire Hathaway was looking for an internal auditor.
Corey asked, “Berkshire what?” The headhunter said, “It’s run by Warren
Buffett.” And Corey responded, “Warren who?” He had no idea who or what
they were. Nonetheless, he took the job and began working alongside the six or
seven other employees in the audit department, auditing Berkshire’s subsidiary
companies and preparing schedules used for quarterly financial statements and
for Buffett’s use.
I had felt a pang of jealousy when I found out he had been hired there. I envied
how he would be learning firsthand from Buffett.5
But I wasn’t focused on Corey at the time. My eyes were on the stage.
Warren Buffett and Charlie Munger sat on the auditorium’s stage in front of an
audience of 300 shareholders (which at the time I felt was large).
I realized that if I were going to learn, I would have to get up and ask what I
was wondering about. I wrote pages and pages of detailed questions with the
goal of getting to the microphone.
I nervously asked my one question. Their clarity of mind and high intellect
was clear from their answer. I thought, Wow. That was a fantastic answer. They
took my dumb question and turned it into a masterpiece.
I kept thinking, What took me so long to get here? Why haven’t I been here
before?
At that meeting, I learned that Berkshire owned 80% of Wesco Financial,
where Charlie Munger served as the chairman. So I flew out to Pasadena to
attend the Wesco meeting. It was a much smaller affair.
The first Wesco meeting I attended had only 15 people, and half worked for
the company. Once again, I had prepared questions. After asking three questions,
it was clear I would be asking a lot more.
I felt nervous. Munger has an imposing presence behind his thick Coke-bottle
lenses. He seemed like an old professor who doesn’t tolerate fools. I got up and
stammered, “I’m sorry, I’ve got a lot of questions. It looks like I’m asking all the
questions. I didn’t mean to take over the meeting.”
He was gracious, saying, “That’s what we’re here for. I’ll answer your
questions as long as you’ve got them. If people want to leave, they can leave.
But I’ll be here.”6
I thought, Wow. All right, then. Here we go. I don’t know how long it went,
but I was in heaven. There’s no doubt that having that level of expertise
delivered directly to me accelerated my learning.
The “University of Berkshire Hathaway” is what I nicknamed the accumulated
wisdom dispensed by Warren Buffett and Charlie Munger.
Each year’s curriculum consists of Berkshire Hathaway’s annual reports and
the lectures at its annual meetings. That course of study, now accessible in these
pages, has taught Corey and me far more about investing than any other source.
Pouring over Berkshire’s reports, reading Buffett’s annual letter, and listening
to Buffett and Munger at the annual meeting have all been central to our growth
as value investors. It is the core curriculum of our business education—one that
easily rivals most MBA programs.7 It is the cornerstone of our continuing
education.
It is, without a shadow of doubt, the best investment either of us has ever
made.
Once a year, you have arguably the greatest investment team of all time on
hand to answer your questions. It is a fantastic annual tutorial on the world of
business. Buffett admitted in the beginning that he was terrified of public
speaking. (He used to get physically ill at just the thought of it.)
Thankfully, over the years, Buffett and Munger have grown evermore
comfortable as educators. Today, they are excellent teachers. Their wisdom and
willingness to share make each annual meeting an invaluable installment in a
sublime lecture series.
The Unstoppable Rise of Berkshire Hathaway
Few on Wall Street would dispute the claim that Warren Buffett and Charlie
Munger are the greatest investors of our time. Their genius in identifying and
evaluating intangibles sets them apart.
As a value investor, your ideal situation is to find a company increasing its
intrinsic value. Ideally, the company would be one with a declining stock price,
thus creating an even better bargain as time unfolds. No one has employed these
principles more effectively than Buffett and Munger. Over the last 50 years, they
have consistently sought to own either all or part of good businesses, bought at
bargain prices. In addition, to succeed using this approach, one must control
one’s emotions. Buffett and Munger’s are set apart by their mastery at business
valuation and relentless rationality in implementing this approach.
The results of this have been awe-inspiring.
Under Buffett and Munger’s leadership, Berkshire Hathaway has become one
of the greatest business stories of the 20th and 21st centuries.
A Short History
Buffett was educated at the University of Nebraska. Afterward, he enrolled at
Columbia Business School. He went there to learn from the father of value
investing, Benjamin Graham. Buffett became Graham’s star student. Afterward,
Graham took him on at his investment partnership, Graham Newman.
Buffett used what he learned from that experience to start his own partnership
back in Omaha. He did phenomenally well from the very beginning. A $10,000
investment in his partnership in 1956 grew to $200,000 by 1969. That’s a 25.9%
compounded annualized return. Incredibly, the partnership never had a down
year, even though the market had six down years during that period.
In 1959, Buffett met Charlie Munger, who was also from Omaha, at a dinner
party. Each man instantly recognized the intelligence of the other. Munger had
worked in law, but Buffett convinced him that he should be in the investment
business if he wanted to make real money.8 Munger started his own investment
partnership, Wheeler, Munger & Co., in 1962. From then on, he and Buffett
worked on a number of investment ideas together, both formally and informally.
Berkshire Hathaway was originally a New England textile company. It was a
deeply discounted stock, with a book value of $19. Its net working capital was
over $11 a share. Buffett bought shares at around $7–$8 per share. Buffett was
buying shares at a discount to net cash and near-cash items.
The decline of the textile industry was underway. Berkshire Hathaway was
consolidating and selling assets. Then, with the cash, it was buying in its stock—
which was intelligent because the stock was so cheap. In 1963, Berkshire did a
massive buy-in of almost a third of its shares. The owners of Berkshire
Hathaway saw Buffett’s position and didn’t want him in their little fiefdom.
They called Buffett, offering to pay him $11.50 a share. He agreed. He’d make
about a 40% profit in a short period.
When the letter came for the offer, however, it was less than the agreed-on
amount—but only by pennies. Nevertheless, their dishonesty upset Buffett. They
were trying to chisel him out of 12.5 cents per share. So Buffett went the other
way and started buying increasingly more shares of Berkshire until he took
control. He then booted out the guy who had tried to chisel him out. In 1964,
Warren Buffett took control of that small New England textile firm, and it
became his new base for making investments.
At the time, the move made no sense. Buffett had bought a business in decline
that he didn’t know how to run. He later joked that he should have taken the
money. That would have been the smarter thing to do.
As it turned out, this textile company was an ideal vehicle for making
investments. With Berkshire Hathaway’s stock, Buffett had a publicly traded
corporation with captive capital. The benefits of this corporate structure for
managing money are significant.
In his previous partnership, if shareholders redeemed their shares, the money
would come right out of the till. Now, when shareholders sell their shares in
Berkshire Hathaway, that doesn’t affect its available capital. Capital doesn’t
leave the corporate shell unless Buffett pays a dividend. He could use this
captive permanent capital to invest long-term by buying businesses, in part or in
whole. Berkshire’s structure also allows for making opportunistic investments in
special situations.