Buffett's Investments: The 'Great,' the 'Good' and the 'Gruesome'

Q&A May 03, 2021 at 02:22 PM

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Selling Apple stock — $7.4 billion worth — last year was "probably a mistake," Warren Buffett said at the Berkshire Hathaway annual shareholders meeting on Saturday, which, like last year's, was a virtual affair, only this time from Los Angeles. With him were partner and vice chairman Charlie Munger and vice chairmen Greg Abel and Ajit Jain.

In a CNBC interview Monday, Buffett, 90, revealed that Abel, 59, who heads Berkshire's non-insurance business, will be his successor.

The 50-plus-year-old conglomerate has only in the last few years begun to focus on investing in high tech. Apple occupies 44% of the portfolio.

Buffett also owns shares of Amazon — whose stock he began buying in 2019 — and cloud computing company Snowflake, in which Berkshire invested $735 million last September.

But that doesn't mean Buffett has abandoned his traditional strategy of owning lower-tech companies, as Adam Mead, CEO and chief investment officer of Mead Capital Management, who just released a 766-page book on Berkshire, points out in an interview with ThinkAdvisor.

In our conversation, he discusses Buffett's own labels for the Berkshire companies: "great," "good" and "gruesome."

"The Complete Financial History of Berkshire Hathaway: A Chronological Analysis of Warren Buffett and Charlie Munger's Conglomerate Masterpiece" (Harriman House-April 13), explores Berkshire's development year by year, with Mead digging deep into the firm's development from "a dying textile company" to the enviable success it is today.

One gem that it owns outright is See's Candies, which this year had its "best first quarter ever," CEO Pat Egan noted at Saturday's meeting.

A question about cryptocurrency, and Bitcoin, specifically, brought an "I'll dodge that" response from Buffett; but Munger, 97, had no hesitation, answering bluntly:

" …The whole damn development is disgusting and contrary to the interests of civilization," he said.

Last year, Buffett sold a number of stocks, including every airline equity and more of his long-held position in Wells Fargo, the latter now reportedly only 0.6% of the Berkshire portfolio.

In the interview, Mead opines on why Buffett's firm likely cannot grow at its former rate; the Oracle of Omaha's regret over not buying Google stock; Berkshire's roughest patch; and Buffett's writing $4 billion worth of credit default swaps during the 2008 financial crisis.

ThinkAdvisor interviewed Mead on April 26. He was speaking by phone from Derry, New Hampshire, where his practice is based. A former commercial loan officer, the advisor writes a monthly newsletter, Watchlistinvesting.com. He mentioned that after sending Buffett a copy of his book, he received a thank-you note, now framed, with "really good praise."

Here are highlights of our interview:

THINKADVISOR: In his 2007 shareholders letter, Chairman Warren Buffett described Berkshire Hathaway's businesses as "good," "great" and "gruesome." Please explain.

ADAM MEAD: He said that a "great" business earns good returns on capital and can grow; for example, See's Candies — though it doesn't grow as much as some others. A "good" business might earn a good return on capital, such as those in Berkshire's utilities sector. They have predictable, regulated returns; and as they add money to the business, there's a return on that additional capital. The "gruesome" ones are, for instance, Dexter Shoe Co. and what had been Berkshire's dying textile business. Dexter was almost like a shadow of that — production was in America and not as competitive with overseas manufacturing.

Do those three classifications ever change?

No. One company that went through all three was The Buffalo News. It was a "great" company; but as the years went by, competitive dynamics of the newspaper business changed, and it became a "good" company, which ended up a "gruesome" business. Last year Berkshire sold all their newspaper businesses because the industry had been decimated by competition, especially the internet.

Buffett reportedly has sold nearly all of his position in Wells Fargo after holding the stock since the 1980s. Please discuss.

Buffett and [vice chairman] Charlie Munger stood by Wells when it had the accounts-opening scandal. Their position was that Wells had learned its lesson — they paid the price for the [sales] incentives they had put in place. But, then, when other things were happening at Wells, they [finally] said, "We're not comfortable with this." And their attention shifted to Bank of America, which they saw as a better investment.

What's the lesson learned from Wells Fargo?

Maybe it's that you really have to continue to evaluate investments — which can and will change over time — even though you've held something for multiple decades. If the time comes to sell, that doesn't mean you don't sell it.

Has Heinz Kraft, of which Berkshire owns 26%, been a good investment?

Heinz is a very good business. But Buffett has readily admitted that they overpaid for Kraft. They paid a lot for it because they thought they could get better margins out of the business. That didn't happen to the full extent they would have liked. So the Heinz part was good, but the Kraft part was not so good. Taken together, though, they're still very good businesses.

Last year, many observers thought that Buffett had lost his mojo. Was there anything to that, do you think?

Yes and no. It's accurate only insofar as Berkshire's size prevents it from growing as much as it had in the past. Berkshire has largely continued the same playbook over the years. They stick to their knitting, [but] the world changes. So some thought Berkshire might have lost its way.

What about the growth aspect?

The universe of companies that fits their criteria has shrunk, and it's really hard to grow [a conglomerate so large] especially when they retain all their earnings and haven't paid out a dividend, although they repurchased shares this past year.

By "shrunk," do you mean that there aren't many lower tech companies around of the kind in which they like to invest?

Berkshire has this reputation for buying lower-tech companies. If they don't grow or if they're cyclical or boring, it really doesn't matter so much as how they're doing in terms of earning returns on the capital they've [deployed] — it's the cash that an investment can give you. Berkshire has picked up companies that might not be exciting — like Acme Brick, really low tech — but that throw off cash and are generally secure in their economic position.

But Berkshire now has big investments in high tech; Apple, in particular.

Yes. Apple was the largest investment in terms of actual dollars outlaid. There are certainly enough lower tech opportunities out there for them, too. But everything is valued sky-high, and Buffett won't commit capital if a company isn't at the right price. The discipline they have is superhuman. It's just a matter of Berkshire waiting out the current interest rates and valuation landscape.

Does Buffett regret not having invested in tech earlier?

He's said that he should have bought Google stock. So it's not just things that you do but the things you don't do, which is the full opportunity cost.

Do you figure he believes it's too late for him to buy Google now?

Maybe, maybe not. Google is similar to the situation with Apple, I think. Berkshire's buying Apple illustrates that you can be late — because the business is so good and will have such a high rate of compounding — and buy at a higher valuation but still do well. So, who knows — maybe they'll buy Google at some point.

What's been the main secret to Berkshire's success?

The real secret is in plain sight: Berkshire had a long runway to compound, a CEO in place for 55 years and continually operating within their circle of competence. It's a business masterpiece. They grew what they knew over time but maintained a level of conservatism as the years went along.

Discussing the Berkshire equity portfolio in 2004, you write that Buffett "characteristically set low expectations." He does that most of the time?

Dating back to his Buffett partnership days in the 1950s, he's always set the bar very low and has usually exceeded it. When he speaks to shareholders, it's "temper your expectations," even when things are doing pretty well. Buffett is so secure in his position that he doesn't need to [play] up the future to get investors excited about something.

You write that Buffett's legacy is "a formula for long-term sustainable success that maximizes human potential." What's the formula?

Berkshire looks for good old-fashioned values. They take the high road. They push the individuals [managing their companies] to go forward — they motivate them with autonomy and trust. They're careful whom they trust, but once they find someone they trust, they give them really wide discretion as to running their business.

What, specifically, is Charlie Munger's role in the company? He's now 97.

Charlie helped Buffett fully appreciate the value of really good businesses. He's a sounding board to widen Buffett's scope of view. He'll push Warren forward when he needs to do something: "You have to act quickly." Even Buffett needs a mentor to get [him] outside [his] own bubble and look at the whole picture. Munger is really great at that.

What's the roughest patch that Berkshire has experienced?

The early '80s through early '90s — a whole decade's worth of underwriting insurance losses that really challenged them. Berkshire is still very much an insurer. But in that decade, they had some mishaps. For example, they bought Home & Auto Insurance, outside of Chicago, and tried to replicate it in Miami. But that venture was disastrous.

What was the single worst investing mistake Buffett has made?

Dexter Shoe, probably. The value of the business quickly went down. A recent mistake was Precision Castparts, a business they bought for $35 billion in 2016. Buffett has said he overpaid. They wrote down the value by $10 billion.

One Berkshire strategy is buying companies that have little growth potential but that generate cash they can use. Examples are See's Candies and Scott Fetzer, one of whose largest divisions is World Book Encyclopedia. Please discuss.

They take the cash from a business that doesn't grow as long as the capital they invest in that business is still earning a good return. They do different things with the cash that are beneficial to growth. In a conglomerate structure, you can take that cash and move it elsewhere and re-invest it to its highest potential — and without tax consequences, though they have to pay income taxes on the profits.

It was surprising to read in your book that, in 2008 Buffett wrote $4 billion of credit default swaps. What brought that on?

He saw a huge mispricing in the market, and so they wrote a basket of credit default swaps. They wrote some put options on certain indexes. But the way they did that was different from what caused the [market] blowup. Because they largely didn't have any collateral requirements, no matter what happened, they wouldn't be forced to put up cash, which might have caused a drain on the business. There was a good probability that things would work out in their favor because markets were panicking and even the worst-case scenario was really just a moderate one in passing.

"It will be hard for corporate raiders to break up the conglomerate" after Buffett's death if Berkshire's successors follow the same strategies as he has and the company "doubles in size," you write. Why would it?

Berkshire has tied so many things together in such a way — some intentionally, some not — that will make it very hard to break up the company. If Berkshire becomes a trillion-dollar company, it would be very difficult to raise that much capital. Insiders and major shareholders would be against [a breakup]. So the numbers and the owners' feelings bode against breaking up Berkshire.

You say that Buffett has credited Munger and his blueprint for making Berkshire the success it's become, though Munger has operated in the background. How has he been compensated?

It has fluctuated over the years, but he's owned about 1.5% of Berkshire shares. As the company's value has grown, it has resulted in his net worth increasing quite substantially. Munger has always had projects he's involved with in his own right, too.

Does he receive a salary form Berkshire?

Both Munger and Buffett have taken a $100,000 yearly salary for at least the last 25 years. Both men are vastly underpaid compared to the rest of corporate America! But it's never been about the money for these guys. It's a way of doing things they'd like to do. Buffett has said that [Berkshire] gives him a platform — a bullhorn to speak to the world.

Pictured at top: Warren Buffett. (Photo: Bloomberg)

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