Warren Buffett U.N.C. 1996 lecture | Part 4: The stock market

1996 U.N.C. Lecture Series continued...

6. What are some of your investment mistakes?

Warren Buffett says that anytime he has a lot of cash, he is prone to making investment mistakes. However, the type of mistakes he discusses are not found in any type of accounting.

"The nature of not doing very many things and being careful about them probably will keep you from making big errors of commission. Errors of omission are the ones that are the big sins"

Errors of omission are great opportunities that he should have taken advantage of when they arose, but did not and ultimately cost the shareholders billions of dollars. For example, he had the opportunity to take a huge position in The Walt Disney Company. He bought shares (5% of the company) costing a total of $4 million and sold it a year later for $6 million when at the time of the lecture, it would be worth approximately a billion. These are mistakes that investors don't see; mistakes he refers to as 'errors of omission'.

7. Why invest in U.S. Air given that the airline industry is such a challenging one?

Warren Buffett's response was 'temporary insanity'. It was a case of great manager, terrible industry. The manager was operating with revenues based on market factors, and costs that are not based on market factors and that's a recipe for disaster.

An important point to know is that the airline industry, collectively, has an overall negative return, and therefore has not returned any wealth to shareholders. Billions of dollars have been invested in this industry, but no value has been created collectively. This reminds me of a quote he made at some point in time;

"When the great manager enters a lousy business, it is the reputation of the business that remains."

Sometimes, no matter how great the manager is, it is the reputation of the business, or in this case, the industry that has a greater impact.

8. Question about the stock market...

His response was as consistent as always, and this is a very important concept to understand. It is simple, yet difficult to implement.

"I never think about what the stock market is going to do when thinking about an investment. I think about what the company is going to do over time. If something looks intelligent to do, I'm not going to forego it because someone else has an opinion on the stock market. I am not going to trade or give up something I know how to do because of some opinion of something I do not know how to do. And I do not know how to predict interest rates, I do not know how to predict stock market movements. All I know is that if I buy the right kind of business at the right price, with the right people, I will do well over time. And in stocks, it is very hard to know when something will happen, but it is easy to know what will happen.

...My attitude towards buying the whole company is the same towards buying a percentage of the company."

Related Posts:
Part 1: Qualities of Character

Warren Buffett U.N.C. 1996 lecture | Part 3: We want partners in Berkshire.


More questions from the U.N.C. Lecture Series.

3. Mr. Buffett, you invest in companies with managers you say you trust and admire. I would like to know who you trust and admire in business and politics today?

He mentions CEO of Cap Cities, Tom Murphy. He also admires the great two manager combination at The Coca Cola Company, (Roberto and Don) that took the market value from $5 billion to $60 billion in about 11 years. He also includes Bill Gates. Even though he understands nothing about Microsoft's business, he has great respect for Bill Gates as a businessman.

The most important advice he gave in his response to this question is:

"I think it is crazy to work with people that make your stomach churn, and if you are in a job like that, think about changing. Working with people you don't like in a business is kind of like marrying for money, which is probably a bad idea under normal circumstance, but it's crazy if you are rich. I work with people I like, I tap dance to work everyday and work with people who are terrific."

4. Have you considered splitting the stock?

Many have asked this question of Mr. Buffett previously and Berkshire has the highest price of any company that trades on the NYSE. His response was as always classic and consistent with his previous remarks.

"At Berkshire, I want to get people as shareholders, as partners of mine, who have the same expectations, same time horizons, the same methods of measurement that I have. It's crazy to go into business with people that have entirely different expectations than you have. The only way that I can affect that, since Berkshire is a public company, is through communication and policies. Therefore, I will try to have policies so that the right kind of people with similar expectations will be attracted to the company. I would like to have people as owners who would expect to own it the rest of their lives."

Essentially he goes on to say that by not splitting the stock, he eliminates people who are in the markets to trade actively, and these are not the people he would like as partners in Berkshire.

5. Discuss some of your investment mistakes.

Buffett says that he makes the most mistakes when he has a lot of cash available. Usually cash is king, but in more recent lectures, he states that cash is only king if it is being put to good use. Cash has no value if it just sits there doing nothing; it actually loses value.

Please refer to the video for the rest of his comments.

Warren Buffett U.N.C. 1996 lecture | part 2: How to choose great businesses

Part 2:

In the rest of the lecture, he entertains questions from students. This is the part he enjoys most and challenges them to make them difficult for him. These are the questions and my commentary on his responses from the next 9 minutes of the U.N.C. lecture.

1. How is financial analysis of companies, for example Coca Cola or Nebraska Furniture Mart, done by yourself and Charlie Munger?

Warren Buffett's consistent philosophy is apparent in his response to this question. He talks about the owner, Rose Bumpkin, of Nebraska Furniture Mart and how passionate she was about the business. After meeting her, he said there was not much else that he needed to do; he was fully confident that it was a great business that will do even better over time. Therefore, his focus is always on the quality of management, as it was the first item he mentioned in this case. Buying a business that is run by honest, passionate and capable management is very important.

"I think any good investment idea can be put into one paragraph."

He then says that he buys businesses that he understands. He believes very strongly in operating within his circle of competence.

"The most important thing in terms of your circle of competence is not how large the area of it is, but how good you have defined the perimeter."

He is able to understand some kinds of simple businesses and does not make investment decisions outside of his realm of knowledge. This has also been a key to his success. Investing in businesses you don't understand is almost always a bad idea.  What does it mean to understand a business? Consider these 15 questions that Philip Fisher uses to analyze and understand companies he may want to buy:

1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? A company seeking a sustained period of spectacular growth must have products that address large and expanding markets.


2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited? All markets eventually mature, and to maintain above-average growth over a period of decades, a company must continually develop new products to either expand existing markets or enter new ones.


3. How effective are the company's research-and-development efforts in relation to its size? To develop new products, a company's research-and-development (R&D) effort must be both efficient and effective.


4. Does the company have an above-average sales organization? Fisher wrote that in a competitive environment, few products or services are so compelling that they will sell to their maximum potential without expert merchandising.


5. Does the company have a worthwhile profit margin? Berkshire Hathaway's BRK.B vice-chairman Charlie Munger is fond of saying that if something is not worth doing, it is not worth doing well. Similarly, a company can show tremendous growth, but the growth must bring worthwhile profits to reward investors.


6. What is the company doing to maintain or improve profit margins? Fisher stated, "It is not the profit margin of the past but those of the future that are basically important to the investor." Because inflation increases a company's expenses and competitors will pressure profit margins, you should pay attention to a company's strategy for reducing costs and improving profit margins over the long haul.


7. Does the company have outstanding labor and personnel relations? According to Fisher, a company with good labor relations tends to be more profitable than one with mediocre relations because happy employees are likely to be more productive. There is no single yardstick to measure the state of a company's labor relations, but there are a few items investors should investigate. First, companies with good labor relations usually make every effort to settle employee grievances quickly. In addition, a company that makes above-average profits, even while paying above-average wages to its employees is likely to have good labor relations. Finally, investors should pay attention to the attitude of top management toward employees.


8. Does the company have outstanding executive relations? Just as having good employee relations is important, a company must also cultivate the right atmosphere in its executive suite. Fisher noted that in companies where the founding family retains control, family members should not be promoted ahead of more able executives. In addition, executive salaries should be at least in line with industry norms. Salaries should also be reviewed regularly so that merited pay increases are given without having to be demanded.


9. Does the company have depth to its management? As a company continues to grow over a span of decades, it is vital that a deep pool of management talent be properly developed. Fisher warned investors to avoid companies where top management is reluctant to delegate significant authority to lower-level managers.


10. How good are the company's cost analysis and accounting controls? A company cannot deliver outstanding results over the long term if it is unable to closely track costs in each step of its operations. Fisher stated that getting a precise handle on a company's cost analysis is difficult, but an investor can discern which companies are exceptionally deficient--these are the companies to avoid.


11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition? Fisher described this point as a catch-all because the "important clues" will vary widely among industries. The skill with which a retailer, like Wal-Mart WMT or Costco COST, handles its merchandising and inventory is of paramount importance. However, in an industry such as insurance, a completely different set of business factors is important. It is critical for an investor to understand which industry factors determine the success of a company and how that company stacks up in relation to its rivals.


12. Does the company have a short-range or long-range outlook in regard to profits? Fisher argued that investors should take a long-range view, and thus should favor companies that take a long-range view on profits. In addition, companies focused on meeting Wall Street's quarterly earnings estimates may forgo beneficial long-term actions if they cause a short-term hit to earnings. Even worse, management may be tempted to make aggressive accounting assumptions in order to report an acceptable quarterly profit number.


13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders' benefit from this anticipated growth? As an investor, you should seek companies with sufficient cash or borrowing capacity to fund growth without diluting the interests of its current owners with follow-on equity offerings.


14. Does management talk freely to investors about its affairs when things are going well but "clam up" when troubles and disappointments occur? Every business, no matter how wonderful, will occasionally face disappointments. Investors should seek out management that reports candidly to shareholders all aspects of the business, good or bad.


15. Does the company have a management of unquestionable integrity? The accounting scandals that led to the bankruptcies of Enron and WorldCom should highlight the importance of investing only with management teams of unquestionable integrity. Investors will be well-served by following Fisher's warning that regardless of how highly a company rates on the other 14 points, "If there is a serious question of the lack of a strong management sense of trusteeship for shareholders, the investor should never seriously consider participating in such an enterprise."

[Source Morningstar.com]

If you are able answer all these questions about a company, which would require thorough research of course, you are well on your way to fully understanding a business.
For more information on Philip Fisher's scuttlebutt approach, I highly recommend purchasing this book; Common Stocks and Uncommon Profits.

Buffett then talks about The Coca Cola Company. He refers to this company as a business he fully understands and indicates that it is increasing market share in virtually every country it operates in. These are the items he says one should look for:
i. Look to see if the product is somewhat durable.
ii. Whether the appeal is universal and,
iii. If the company has honest management.
He says The Coca Cola Company exhibits all these characteristics.

"Peter Lynch says buy a business that's so good that any idiot can run it because sooner or later one will."

He sums up his philosophy at Berkshire Hathaway in this one quote.

"All we are trying to do is to find businesses we think we understand, where we like the people running them and the price makes sense in relation to the future economics. And when I find that, I like to buy a lot of it and keep it. And they are hard enough to find that I don't believe in selling them very often because it is hard to find replacements."

2. How do you know when to sell a business?

"The question of selling a really good business is never. To sell off something that's a really wonderful business because the price looks a little high or something is almost always a mistake. It took me a long time to learn that. If you truly believe that the long-term economics of a business is terrific, it rarely makes sense to sell it."

Great content in this clip. Enjoy.

End of Part 2.

Morningstar 2008 C.E.O. of the year | Warren Buffett of Berkshire Hathaway Inc.

I thought this video by Morningstar to be an appropriate interruption of our U.N.C. lecture series. Morningstar is the most respected of companies that analyzes funds and I am not surprise to see that they announced today that Warren Buffett is their 2008 CEO of the year. Listen to the video below to see why.

Congratulations Mr. Buffett!

These are qualities Morningstar look for in the C.E.O.s of the year:

  1. C.E.O.s that have created long term values for their shareholders.

  2. C.E.O.s that are good independent thinkers.

  3. C.E.O.s that are shareholder-friendly; that view common shareholders as partners in their businesses.

When I looked at these criteria, I thought Warren Buffett epitomizes what it means to be a C.E.O. and that he should be the model for all C.E.O.s out there. Through his communication and policies to shareholders, it is very obvious that he works on our behalf. Congratulations to Mr. Buffett once again.

For more from Morningstar on why he earned this award in 2008, refer to link below.

Full Disclosure: Long BRK.B

Warren Buffett U.N.C. 1996 lecture | part 1: Qualities of character

This is undoubtedly one of my favorite videos on Warren Buffett. I have blogged about this lecture before, but I thought that the content was so amazing, that I had to break it up into pieces and really delve into the words of wisdom he imparts to these students so that we can all learn from it. I have listened to this many times, and now, I really pay attention to what he says so that I can reinforce my investment principles in this difficult, but exciting economic environment. I say exciting because this is a time where great investment opportunities can be found, as Warren indicated in his Op-Ed article in The New York Times. See my blog on this article; Buy American, I am.

So this lecture from the University of North Carolina in 1996 is divided into 6 parts. Therefore, for this series I will highlight the main content of the particular segment and allow you to pay attention to the videos to build your own knowledge on investing.

Part 1:

I will begin with part 1, where he talks about his involvement with Salomon Brothers in resolving some management issues and running the company. He was brought in to replace the current management and prevent the company from running into the ground. Therefore, he had to find someone who was qualified enough to run the company, that is, dealing with daily operations and making complex business decisions, since he would be preoccupied with regulators and such. He then gets into what was important for the students to know.

He met with 12 people, only knowing 4 of them by sight to interview for the position. This is what he looked at when considering.

He was not concerned about their grades in business school or even if they went to business school at all. He did not ask for their resumes; it did not make any difference. He knew they all had the I.Q. that was necessary to handle the job. He knew that they all were intelligent enough for the position because they could not have gotten to where they were without the understanding of the markets and how financial instruments work and so forth. He wanted to know how their machinery works. He says you can tell the people who are very full of themselves. You can detect the ones that would not have the courage in a difficult situation. He wanted people who were always willing to give others credit, or who wouldn't cut corners and who deliver all they promise and a little extra.

Warren Buffett continues to speak about the character and work ethic of the guy he hired for the position. Listen and tell me what you think about this section.

He then relays a story he always gives to students.

"If you looked under your seat today and one of you had this lucky ticket and the one with the lucky ticket got to pick one of your classmates. You had to pick one classmate and you had an hour to make the decision. You would then get 10% of the earnings of this classmate for the rest of his/her life. What would you think about in that hour? Would you think about the I.Q., the grades, who was the best looking? Probably not. A lot of things will go through your mind and you will be amazed about how you all will settle on relatively few individuals. You are not thinking about things that are impossible for you to achieve yourself. You are not thinking about who can jump seven feet, who can through a football 65 yards, who can recite Pi to 700 digits. You are thinking about a whole lot of qualities of character. The truth is, every one of those qualities is attainable. They are largely a matter of habit."

He mentioned that his old boss, Benjamin Graham, wrote down qualities that he admired in other people and qualities he found objectionable. He realized that none of the qualities he liked were not attainable. It was a matter of exhibiting those behaviors and not exhibiting the behaviors that he disliked. Warren Buffett says that this is easier to do when you are young, so he encourages the students to do so.

He ends with the following quote:

"Chains of habit are too light to be felt until they are too heavy to be broken."

End of Part 1

I decided to list some of the behaviors I admire and others I choose not to exhibit. What are some of yours? Feel free to drop a comment about them.

Behaviors I admire:

Behaviors I dislike:


Sponsored Links

Recommended Readings