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"People used to bring projects in all the time. I just thought about whether we wanted to be partners in the New Yorker. At the time I didn't. I thought it needed a new editor and I didn't know how to choose one. I sent them to see Fritz Beebe," said Graham.
The New Yorker was a lost opportunity, but probably not a huge loss. Failures and misfires were part of the record during this period. "Some major mistakes have been made during the decade, both in products and personnel," Buffett wrote in Berkshire's 1977 annual report. Yet, he added, "It's comforting to be in a business where some mistakes can be made and yet quite satisfactory overall performance can be achieved. In a sense, this is the opposite of our textile business where even very good management probably can average only modest results. One of the lessons your management has learned-and unfortunately, sometimes relearned-is the importance of being in businesses where tailwinds prevail rather than headwinds."9
Throughout the 1980s and straight through to the end of the century, Buffett and Munger showed a knack for getting a good deal. When they buy a company, the management usually stays with it and the acquisition requires very little effort, except for collecting profits and allocating the capital to its highest and best use.
"Our chief contribution to the businesses we acquire," said Munger, "is what we don't do." What they don't do is interfere with effective managers, especially those with certain characteristics.")
"There's integrity, intelligence, experience, and dedication," said Charlie. "That's what human enterprises need to run well. And we've been very lucky in getting this marvelous group of associates to work with all these years. It would be hard to do better, I think, than we've done."
Writing for an insurance publication, John Nauss, a Chartered Property and Casualty Underwriter, observed: "Warren and Charlie commented that they simply get out of the way and let their managers focus on running their businesses without interference or concern about other factors. But they do more. They create, perhaps, the best operating environment for businesses that exist anywhere. This environment includes wise evaluations without extensive meetings and documents (we know the business) as well as capital access, focused compensation, and freedom to do one's best." These methods, said Nauss, deserve greater attention from the business community."
BOTH CHARLIE AND WARREN SAY they set the example for Berkshire companies by keeping their own overhead costs at a minimum. Berkshires' headquarters are simple and the staff is small. The company's overhead ratio is !~s,,th that of many mutual funds.
"I don't know of anybody our size who has lower overhead than we do," Munger said. "And we like it that way. Once a company starts getting fancy," he said, "it's difficult to stop."
"In fact, Warren once considered buying a building on a distressed basis for about a quarter of what it would have cost to duplicate. And tempting as it was, he decided that it would give everybody bad ideas to have surroundings so opulent. So we continue to run our insurance operations from very modest quarters."12
At one time Berkshire was subpoenaed for its "staff papers" in connection with one of its acquisitions, but, said Munger, "There were no papers. There was no staff.""
But, as Munger so often says, what's right for Berkshire isn't necessarily right for all companies. "We've decentralized power in our operating businesses to a point just short of total abdication.... Our model's not right for everybody, but it's suited us and the kind of people who've joined us. But we don't have criticism for others-such as General Electric-who operate with plans, compare performance against plans, and all that sort of thing. That's just not our style." He added, "Berkshire's assets have been lovingly put together so as not to require continuing intelligence at headquarters."
Berkshire Hathaway is one of the best-performing stocks in the history of the market. Its shares have underperformed the S&P in only five of the past 34 years, and book value has never had a declining year. An investor who put $10,000 into Berkshire shares in 1965 would have been worth $51 million on December 1, 1998, versus a worth of $132,990 if the money had been invested in the S&P. In 1999, PaineWebber insurance analyst Alice Schroeder estimated Berkshire's intrinsic value at $92,253 per share. Using a more conservative approach, Seth Klarman of the Baupost Fund estimated Berkshire to be worth between $62,000 to $73,000 per share. At that time, the shares had retreated from their historic high in the $90,000 range, to around $65,600, and the price declined even lower before recovering.
Shareholders are understandably loyal to a company with such a record. Some families have invested with Buffett for two, three, and four generations. Not only did Dr. Ed Davis and his wife benefit from Berkshire Hathaway, so did the Davis children and their families. Willa and Lee Seemann have been with Berkshire since 1957. "People say the stock is so high-I say yea, and it's going higher. The way to make money is to get a damn good stock and stick with it," insisted Seemann.
JusT AS THE COLLECTION OF Berkshire holdings built over time, so has the crowd at the annual meeting. "I remember when the attendance at the Berkshire annual meeting was not much of anything," said Stan Lipsey. "Warren said `we'll have a board meeting (actually, just a lunch), and said come on up,"' and that was about it.
Otis Booth attended the meeting in 1970, when by happenstance he was returning from the East Coast and Buffett suggested he stop in Omaha. "There were only six or eight people present, Fred Stanback, Guerin, Munger, and a few others. We all went out to dinner later," Booth recalled.
Around 1990, Berkshire, Buffett, and to some extent Munger, began developing a noticeable reputation. "I heard Charlie say for the first time he was getting worried about adulators-movie star, rock star-type adulators. That was more than 10 years ago, when we met at the museum," said Lipsey. At that same meeting, Lipsey got more of a glimpse into Munger's character. "I had rented a normal-sized car, then I noticed Charlie had rented a smaller one."
The number of people attending Berkshire's annual meeting grew from 250 in 1985 to more than 11,000 in 1999. Most of Omaha gears up for the Berkshire weekend. Gorat's, Buffett's favorite steak house, ordered an extra 3,000 pounds of tenderloins and T-hones to feed the 1,500 people who were expected to dine there.14
In the audience at the Berkshire Hathaway meeting are apt to be some impressive, though barely noticeable, people. Among them-former FCC chairman Newton Minnow; Microsoft founder Bill Gates, and sometimes his father Bill Sr.; Disney's Michael Eisner; Abigail (Dear Abby) Van Buren, and Chicago billionaire Lester Crown.15
The rise in attendance isn't entirely unwelcome. Buffett enjoys seeing the shareholders and goes out of his way to put on a good show. The Berkshire Hathaway business meeting only lasts five to ten minutes, but the question-and-answer period can last up to six hours, with as many as 80 questions posed by shareholders. At the meeting, it is Munger's designated role to play stoic straight man to Buffett's one-liners. Nevertheless it was clear that Munger's influence on Berkshire continued to be strong. In 1997, Berkshire's Los Angeles lawyer Ron Olson was named to the Berkshire board.
Buffett and Munger hold court, dispensing corporate wisdom-and as Charlie likes to remind people-facing the world as it really is. A shareholder once complained that there were no great franchises like Coca Cola left, meaning that Berkshire's style would be cramped in the future. Munger replied, "Why should it be easy to do something that, if done well two or three times, will make your family rich for life?"'6
Munger, like Buffett, is a fan of Berkshire-owned products. He drinks Coca Cola, though not as much of it as Buffett does. Unlike Buffett, who is a teetotaler, Munger doesn't mind substituting his Coke with an occasional beer or glass of wine. At the 1994 annual meeting, Munger put in a plug for World Book Encyclopedias:
I give away more of that product than any other product that Berkshire Hathaway makes.... It's a perfectly fabulous human achievement. To edit something that is user-friendly with that much wisdom encapsulated is a fabulous thing.
While Munger can be as smug about the success
of Berkshire as its investors are, he can't resist telling everyone why they're there.
"It's wonderful that we all come here each year," Charlie told a group of friends at his own dinner party the weekend of the Berkshire annual meeting. "But why do we really do it? Yes, it's fun. But it's also a way of subtly saying, I'm very rich. It's also a way of subtly saying, I'm very smart."
Munger then went on to say that it was becoming a problem to Berkshire that many original shareholders were getting older and dividing up the shares among their heirs. It makes the shareholder base grow to unwieldy proportions. Charlie suggested that everyone bring their unmarried children and grandchildren to the annual meeting and hold mixer dances so the Berkshire heirs could meet and marry one another, thus keeping the shares within fewer families. Just another one of Charlie's semi-bewildering jokes.
WHILE BERKSHIRE HATHAWAY WAS GAINING size and influence and Munger was growing wealthier, his family was blissfully unaware of what was happening to their lives. As far as Emilie Munger was concerned, her father was chairman of Blue Chip Stamps, and Blue Chip Stamps were something you got at a store and pasted in a book.
"I don't remember when Berkshire started growing to a point at which he was in a different league," said Emilie. "I think my parents were really private. They didn't want publicity. My dad was a creature of habit so everything was exactly the same. We never had a feeling we were growing up in some rich household."
Though Charlie was becoming a celebrity in Omaha, in star-strewn Los Angeles and on the rest of the West Coast, he didn't attract much attention.
"Over time," said Emilie, "nothing changed about the way we were perceived. Not until I was in law school in 1989. I realized some group over at the business school recognized my name."
The lack of interest the Munger children showed in their father's career, said Emilie "probably had something to do with coming of age in the 1960s and 1970s. I went to a fairly liberal college-almost an antibusiness atmosphere. There was a lot of socialism. Evil corporate America. Our schools were more public service or public policy oriented. When Wendy and Molly went to school, it was really different."
If Emilie Munger's classmates had been inclined to study Berkshire and it's business practices, they no doubt would have been surprised that the company operates nothing like other corporate giants. Munger and Buffett have remained steadfast in keeping their own compensation low. Each takes $100,000 in salary, plus directors fees from various corporations not controlled by Berkshire. Munger's 1998 directors fees came to about $81,300. Their enormous wealth comes from their ownership shares of Berkshire, though that is more true for Buffett than it is for Munger. Buffett's proportional ownership is much larger, but Munger also follows a slightly different financial path.
"Charlie's family has 90 percent or more of its net worth in Berkshire shares," said Buffett. "My wife, Susie, and I have more than 99 percent."
Though Buffett says he almost never sells shares, Munger sometimes does. In fact between 1993 and 1997 he sold $25 million worth of Berkshire. Additionally, Munger has given away hundreds of shares, including a share to Robert Cialdini, author of the book Influence, just because he likes him and his work.
"I've given away a fair amount of Berkshire (stock) in the last couple of years," Munger said. "I gave away a lot ... because I thought it was the correct way to behave. And I've sold some because I've had businesses of my own."'s
THERE ARE LESSONS TO BE learned from his personal career and from the development of Berkshire Hathaway, and they are learnable, as long as people don't confuse simplicity with ease, says Munger, though he doesn't think everyone will learn them.
"People underrate the importance of a few simple big ideas. And I think to the extent Berkshire Hathaway is a didactic enterprise teaching the right systems of thought, the chief lesson is that a few big ideas really work. I think these filters of ours have worked pretty well-because they are so simple," says Munger.
Even so, Munger said of Berkshire, "I knew it would do well, but not this well. `9
Munger's children say they continue to benefit from their father's example. "It's a rich lesson to learn," said Molly Munger. "If you just keep pressing on and don't let anything that happens get to you, your life is so much better."
C H A P T E R S I X T E E N
BERKSHIRE IN
THE 1990sPOWER BUILDING
The game of investing is one of making better predictions about the future than other people. How are you going to do that? One way is to limit your tries to areas of competence. If you try to predict the future of everything, you attempt too much. You're going to fail through lack of specialization.'
Charlie Munger
NE OF CHARLIE'S MAXIMS ABOUT practicing law is the best source of legal work is the work on your desk," said Robert Denham, the Munger, Tolles & Olson attorney who handles much of Berkshire Hathaway's legal work. Following that philosophy, said Denham, his working relationship with Charlie, Warren, and Berkshire has "grown organically."
In fact, Munger, Tolles and its foremost client Berkshire grew together through the 1970s and 1980s. Building brick by brick, Berkshire emerged in the 1990s with its corporate identity and its position in the business world secured. From that time on, Munger and Buffett often found themselves either on the spot or in the spotlight. At the start of the 1990s, Berkshire owned a remarkable collection of businesses and a strong portfolio of securities. Not only did the operating businesses bring in large amounts of cash, the Berkshire insurance companies were building substantial amounts of float-all money for Buffett and Munger to work with. Acquisitions continued apace, and for the most part the investments were in high quality companies.
"Charlie made me focus on the merits of a great business with tremendously growing earning power," said Buffett, "but only when you can be sure of it-not like Texas Instruments or Polaroid, where the earning power was hypothetical."I
Buffett continued to practice some of the arbitrage techniques he learned from Ben Graham and occasionally made short-term investments. Berkshire bought RJR Nabisco junk bonds in 1989 through 1990, Wells Fargo Bank shares from 1989 through 1991, and in 1991 Berkshire acquired H.H. Brown Shoe Company, the leading North American shoe manufacturer, which in turn bought the Lowell Shoe Company.
In 1992, Buffett acquired 14 percent of the stock of General Dynamics, a company largely owned by his long-time friends, the Crown family of Chicago. General Dynamics' military business was badly wounded when the Cold War ended, and the management was drastically restructuring GD for its new, smaller book of businesses. Several things then happened in the world, including a civil war in Eastern Europe and a company-sponsored Dutch auction to buy back shares. GD's stock shot from Buffett's $11 purchase price to $43.50 and he later sold his shares at a substantial profit. The same year, Berkshire bought 82 percent of Central States Indemnity, a credit insurance company.
In 1993, Berkshire got FTC permission to raise its existing stake in Salomon Bros. to 25 percent, and the same year Berkshire expanded its shoe holdings by purchasing Dexter Shoe in a stock swap. In 1995, Berkshire added to its home furnishings and jewelry store business with the purchase of R.C. Willey Home Furnishings and Helzberg's Diamond Shops.
About this time Buffett and Munger began to draw fire from critics, the Wall Street Journal especially, for getting better deals on their investments than other investors would. The terms of the deals were particularly attractive in cases such as Salomon and USAir, where the investment was not acquired on the open market. In these situations, Berkshire was summoned by management as a white knight, either to save the company from a hostile takeover or to provide a desperately needed cash infusion. The deal was negotiated, often taking the form of preferred stock that had an interest rate component and a feature that allowed conversion to common stock at a specified price.
Munger defended such arrangements, saying that it is appropriate that Berkshire get terms not available to others, because Berkshire "brings
more to the party than just our money." Munger said Buffett provides advice and expertise, in addition to "patient" capital that allows management to pursue long-term strategies. And, pointed out Munger, other shareholders also benefit when the stock in these companies rise.3
This acquisition list includes only some of Berkshire's purchases during the early 1990s, but they demonstrate a pattern. Berkshire was sticking to the admittedly broad range of industries Buffett and Munger knew best, but with a particular emphasis on the insurance field.
Perhaps even more important, during the last decade of the century, Munger and Buffett were able to pursue their preferred strategy of swallowing companies whole whenever possible. When Berkshire owns a company entirely, the two are free to allocate the company's profits as they see fit. The structure of Berkshire's holdings made a dramatic transition. At the beginning of 1996, Berkshire's stock portfolio accounted for 76 percent of its $29.9 billion in assets. By the end of the first quarter of 1999, the stocks represented only 32 percent of assets, which by then had reached $124 billion. During those three years, Berkshire spent $27.3 billion to buy seven companies.4 At the 2000 annual meeting, Munger and Buffett explained that by owning companies in their entirety, they could minimize the impact of a whimsical stock market or Berkshire's share price.
Berkshire's approximately $36.6 million holdings in cash and equivalents and its AAA credit rating gave Munger and Buffett enormous buying power. PaineWebber insurance analysts Alice Schroeder and Gregory Lapin point out that Berkshire has become the "buyer of first resort" for business owners who want to continue to operate their companies, while at the same time freeing themselves from raising and allocating capital. The sellers also include privately or closely-held corporations where the major investors want the option of cashing out all or part of their equity at will. This is made possible when the owners swap their ownership for Berkshire shares with limited tax consequences, then later sell Berkshire stock when it meets their needs.