University of Florida

Welcome and an invitation to throw hard balls

After the moderator introduces him as the best long-term investor of our lifetime, Buffett says the highlight for him will be the students' questions, because he wants to talk about what is on their minds. He urges them to throw hard balls, since it is more fun when the pitches come in with some speed. Anything is allowed except last week's Texas A&M game. He says he will say a few words first and then spend the rest of the time on what the students want to ask.

Character, integrity and who you choose to be

Buffett tells the students they have the intelligence and energy to do well, but success takes more. He quotes Pete Kiewit of Omaha, who looked for integrity, intelligence and energy, and said that without the first the other two would kill a person. He then proposes an exercise: imagine buying 10 percent of one classmate for life. You would probably not pick the highest IQ or the best grades, but the one with leadership qualities, generosity and honesty, who gives credit to others. If you also had to go short 10 percent of another classmate, you would pick someone egotistical, greedy or slightly dishonest.

None of these qualities depends on talent such as throwing a football sixty yards. They are behavior, temperament and character, open to anyone, and easier to change at the students' age than at his, since the chains of habit are too light to be felt until they are too heavy to be broken. Ben Graham, in his low teens, looked at the people he admired and decided to behave like them. Write the qualities down, Buffett says, and make them habitual: you already own 100 percent of yourself, so you might as well be that person.

Japan and the cigar-butt approach

Asked about Japan, Buffett says he is not a macro person. Berkshire could borrow for ten years at 1 percent there, so he would only need to beat 1 percent with something yen-denominated, but so far he has found nothing. Japanese companies earn low returns on equity, many of them 4, 5 or 6 percent, and it is very hard to earn a lot as an investor in a business that earns little. He recalls his early cigar-butt approach, buying stocks selling below working capital, a soggy stock with one free puff left. It works, but time is the friend of the wonderful business and the enemy of the lousy one. As long as money costs 1 percent, he will keep looking.

The Long-Term Capital Management rescue

A student asks about the rumor that he helped rescue Long-Term Capital. Buffett points to a Fortune article and says he got a serious call on a Friday, just as he was leaving for a twelve-day trip with Gates to Alaska and on a private train. He knew many of the people, some from his Salomon days, and while the New York Fed orchestrated a rescue without federal money he stayed on the phone. On Wednesday he bid 250 million for essentially the net assets, with 3.75 billion on top: 3 billion from Berkshire, 700 million from AIG and 300 million from Goldman Sachs. In the end the bankers made the deal.

Why smart people do dumb things

Buffett finds the episode fascinating. The sixteen people at Long-Term Capital, including the Nobel winners Merton and Scholes, probably had as high an average IQ as any sixteen people in one business in the country. They had perhaps 350 or 400 years of combined experience, and most had virtually all their substantial net worth in the firm. Yet they essentially went broke. If he ever writes a book it will be called Why Smart People Do Dumb Things, and his partner says it should be autobiographical. To make money they did not have and did not need, they risked what they did have and did need.

Risking something important for something unimportant makes no sense, he says, whatever the IQ or the odds. He would not pull the trigger on a gun with a million chambers and one bullet for any sum. He asks what difference it makes whether you end the year with 110 million or 120 million. He blames overreliance on mathematics, since history does not tell you the probabilities of future financial events or the risk of going broke. Berkshire basically never borrows.

Money, happiness and work you love

Buffett argues his life is not so different from the students'. They wear similar clothes, eat at McDonald's or Dairy Queen and get decent medical care. The one difference is travel in his small plane, which takes money. What he gets to do that they cannot is work in a job he loves, though he loved it just as much when making a thousand dollars was a big deal. He urges them to take jobs they love, not ones that merely look good on a resume. After Columbia he offered to work for Graham for nothing, was told he was overpriced, and kept pestering until Graham hired him.

What makes a business worth owning: moats and castles

Asked what makes a company one he likes, Buffett starts with businesses he can understand, which narrows the field by about 90 percent. He wants a valuable castle run by an honest, hardworking and able duke, with a big moat around it. At GEICO the moat is low cost. Thirty years ago, he says, Kodak's moat was as wide as Coca-Cola's, because it had share of mind: a promise that the picture of your baby would still look good decades later. Kodak let the moat narrow, while Coke's is wider than thirty years ago.

He looks for such moats in simple products. He cannot say what Oracle, Lotus or Microsoft will look like in ten years, but he knows what chewing gum will look like. He wants no stock he would be unhappy to own if the New York Stock Exchange closed for five years, just as a farm owner is happy without a quote. Graham's core lesson, he says, is that you are buying part ownership in a business, not a stock. On a final exam, he would fail anyone who gave a value for an internet company.

See's Candies and share of mind

Asked how to judge a fair price, Buffett says that if he is terribly sure of a business it probably will not offer incredible returns, so he seeks no huge returns, only never to lose anything. He bought See's Candies in 1972 for 25 million, when it sold 16 million pounds at 1.95 dollars a pound and earned about 4 million before tax. He and Charlie asked whether there was untapped pricing power, and relied on share of mind in California, where people linked the box to a favorable memory. They have raised the price every year since, on the day after Christmas. He expects 60 million this year, still needing no capital. Most boxed chocolate is bought as a gift, and a husband will not hand over the cheap box on Valentine's Day.

Disney works the same way, he says: everyone has something in mind about Disney, so a parent buys its video rather than preview cheaper ones. Coca-Cola is tied to happiness around the world, and no amount of money could give RC Cola that image. At See's, a salesperson who smiles at the last customer in a long line widens the moat, and one who snarls narrows it. Asked whether he has bought when the numbers said no, he says the best buys have been when the numbers almost tell you not to.

How Buffett evaluates deals quickly

Buffett says he understands the qualitative side of a business almost the moment he gets the call, and almost every business Berkshire bought took five or ten minutes of analysis. If you do not know enough to understand a business instantly, you will not know enough in a month or two. The key is your circle of competence: its size matters less than staying inside it, even if it holds only 30 companies. In earlier years he used what Phil Fisher called scuttlebutt, talking to customers, ex-employees and suppliers. On price he does not negotiate much: if the number makes sense he buys, and if not, he was happy the day before.

Coca-Cola, the Asian crisis and long-term thinking

Asked how the Asian crisis will affect Coca-Cola, Buffett says he basically loves it, because the market will grow much faster internationally than in the United States over the next 20 years. A tough three months or three years will not be tough for 20. A key reason, he says, is that cola has no taste memory: the drink at five in the afternoon tastes as good as the one at nine in the morning, unlike cream soda or chocolate, which accumulate on you. That makes heavy users and high per-capita consumption.

Coca-Cola went public, he thinks, in 1919 at 40 dollars a share, and a year later it sold at 19. Yet one share bought at 40, with dividends reinvested, would be worth about 5 million dollars now. Price controls have followed even the best businesses. With a wonderful business you can figure out what will happen but not when, so focus on the what.

Learning from mistakes: omission, not commission

Asked about mistakes, Buffett says the biggest ones for him and Charlie Munger have been omissions: businesses they understood well enough to act on while they sat there sucking their thumbs. He cites healthcare stocks when the Clinton Health Care Program was proposed, and Fannie Mae in the mid-1980s. Among commissions, he bought US Air preferred when he had cash around, which he says makes him do something dumb, and came very close to losing it all. He and Munger do not look back, since life can only be lived forward.

The generic mistake is getting outside your circle of competence and buying on a tip. He wants to look in the mirror and say he is buying 100 shares of General Motors at 55 because of a reason, and a cocktail-party tip or a good-looking chart does not count. On interest rates, he says to focus on what is important and knowable: rates are important but not knowable, while Coca-Cola is knowable. Berkshire has never bought or passed on a business because of a macro feeling, and he would not have skipped See's in 1972 because price controls were coming.

Why Buffett avoids Wall Street

Asked about the benefit of being an out-of-towner, Buffett says he worked on Wall Street for a couple of years and likes it, but the best way to think about investments is to be in a room alone and think. In a market environment you get overstimulated and feel you must do something every day, when what you want is one good idea a year to ride to its full potential. Wall Street makes its money on activity, while you make yours on inactivity.

Asked about shares that pay no dividends, he says Berkshire does not and will not pay one, a promise he can keep. The real question is whether it can keep turning retained dollars into more than a dollar, and so far it has, so dividends would have been a mistake. It gets harder as the company grows, and the game runs out at some point. He and Munger take no options, and they judge themselves by performance.

Buying businesses to hold forever

Asked how he decides an investment has reached its full potential, Buffett says that ideally you buy where that will never happen. He wants businesses he would be happy to own virtually forever. He would rather preach to a church whose seats are filled by the same people every Sunday than one where half the congregation leaves each week. He never buys with a price target; he would not have bought See's for 25 million with a plan to sell it if someone offered 50 million. The question is whether the business will keep producing more money over time.

Asked about valuing Long-Term Capital, he first returns to Salomon, which he entered in September 1987 for a 9 percent security in a business whose common stock he would not have bought. He calls that generally a mistake. On arbitrage, he has done it for 45 years, in probably at least 300 situations, and Graham did it before him. Long-Term Capital's top ten positions were probably 90 percent of the money at risk; he knows something, though far from everything, about them, enough that he would feel okay buying at a big discount and holding on, though he might lose money. One of his first arbitrages was in cocoa beans in 1955, and he has not seen another cocoa bean deal since.

On diversification

Buffett gives a dual answer. For people who do not aim to do significantly better than the world, he believes in extreme diversification: 98 or 99 percent, maybe more, of investors should diversify extensively and not trade, which leads to a very low-cost index-fund decision. But once you decide to evaluate businesses with effort and intensity, he calls diversification a terrible mistake to any degree. If you really know businesses, you probably should not own more than six, and six wonderful ones are all the diversification you need. Very few people have gotten rich on their seventh-best idea, but a lot have gotten rich on their best.

Comparing great businesses: Coke, Procter & Gamble, McDonald's, Gillette

Asked to compare a company with Procter & Gamble, Buffett calls P&G a very good business. If he had to put his family's net worth in one business for 20 years, he would take P&G or Coke, and Coke a little more, because he feels better about its unit growth and pricing power over 20 or 30 years. With billions of servings a day, an extra penny is 10 million dollars a day, and Berkshire owns 8 percent, or 800,000 dollars a day. Getting another penny does not seem impossible to him, and he is sure Coke will sell many more servings too.

McDonald's, he says, has a lot going for it, particularly abroad, but it is a tougher business over time: people do not want to eat there every day, and it has become more price-promotional. He prefers products that sell by themselves, without promotions. If you had to bet on one fast-food company, he says, it would be McDonald's, aside from Dairy Queen, which he plugs shamelessly.

Electric utilities, company size and real estate

On electric utilities, Buffett says he does not understand how deregulation will develop. It destroys value for the high-cost producer, but he cannot tell who benefits and by how much, so he stays away. On large caps versus small caps, he does not care: the questions are whether he understands the business, likes the people, and sees an attractive price. Berkshire's size limits it to very big companies, but a business like See's would still be welcome.

On real estate, he says holding it in the normal corporate form has been a lousy way to own it because of double taxation. REITs avoid that but carry fairly high costs, and someone with a million or ten million dollars may be better off owning properties directly. Land companies get silly valuations from people who assume large holdings can be sold quickly. Berkshire would be open to very big transactions, but he has seen little that excites him.

Why Buffett wants stock prices to go down

Asked where the market is going, Buffett says he has no idea and never will. He prefers it going down, but his preferences mean nothing to the market, since a stock you own does not know you own it and does not care what you paid. Anyone who will be a net saver should prefer lower prices, just as someone who will eat hamburger wants it cheaper, and almost everyone in the room is more likely to be a net buyer of stocks over the next 10 years.

He says chapter 8 of Graham's The Intelligent Investor, on market fluctuations, and chapter 20, on the margin of safety, are the two most important essays ever written on investing. He read chapter 8 at 19, and says he would probably have gone another hundred years thinking it good when his stocks were going up. When the market falls, he looks harder at what he might buy that day, because there is more likely to be merchandise he can use his money on.

The ovarian lottery: on luck

The last question asks what he would do to have a happier life. Buffett says the only change might be a gene pool of people who live to 120, because he has been extraordinarily lucky. He asks the students to imagine, 24 hours before birth, a genie who lets them design the social, economic and governmental rules. The catch is that they will not know whether they will be born rich or poor, male or female, infirm or able-bodied, bright or not. They draw one ball from a barrel of 5.8 billion, which he calls the ovarian lottery. You would want a system producing lots of goods and services, but not leaving behind someone who got the wrong ball.

He says he is ideally wired for the system he fell into, allocating capital, which would not be worth much on a desert island. He asks whether you would put your ball back for one of a hundred random balls, of which roughly five would be American. Most, he thinks, would not, which puts everyone in the room in the luckiest 1 percent of the world. He would do almost exactly the same again, working only with people he likes, because making money with someone who made his stomach churn would be like marrying for money. He would not have bought US Air.