Key Lessons From Warren Buffett's March 11, 2011 Meeting With MBA Students

Includes: BRK.A, BRK.B
by: David Kass

Warren Buffett meets with MBA students six times each year. At each meeting, 20 MBA students from eight universities are invited to attend a two hour Q&A session. At the most recent meeting, on March 11, which included MBA students from the University of Maryland, a total of 21 questions were asked by the students. Mr. Buffett stated that he would answer questions on any topic "except what Berkshire was planning to buy or sell".

His responses to the student questions provide evidence of the careful and thoughtful approach followed by Berkshire Hathaway (BRK.A, BRK.B) in its allocation of capital, and why they were virtually the only major source of capital (other than the Federal Government) to companies such as Goldman Sachs (NYSE:GS) and General Electric (NYSE:GE) during the financial crisis.

The main points of his discussion that related to useful information for investors included:

(1) With respect to the financial crisis, Buffett learned how bad things could get. He knew there was a housing bubble, but was surprised by the speed at which it spread, the way the dominoes toppled, and the need for the government to act. "In September, when Lehman (LEH) went down, on that Sunday, if Ken Lewis (Bank of America (NYSE:BAC)) had not bought Merrill Lynch (MER), MER would have gone down on Monday. Everyone was terrified. No one trusted anyone else... People didn't trust each other. Banks didn't trust each other." Berkshire sold a $5 million Treasury Bill in December 2008, due in April 2009, for $5,000,070. The purchaser would get back $5 million at maturity and earn a negative return (losing $70). Bernanke, Paulson, and Geithner understood that speed was needed. There are certain Chairmen, Presidents, and Treasury Secretaries who might have frozen. If anyone had frozen for a few weeks, it would have been too late. Congress did not get it at first. When they initially voted down TARP, the Dow Jones Industrial Average tumbled 750 points that day. We came close to a financial Armageddon. This was potentially a lot more serious than the 1930's, although there was a worse social impact at that time. After LEH failed, money market funds held $3.5 trillion, which was equal to one-half of domestic deposits at banks. In three days, $175 billion (or 5% of money market funds) was removed from money market accounts. Only the government could have stepped in, which it did.

(2) Buffett does make mistakes from time to time, but overall has a good batting average. His "circle of competence" is growing over time. When investing in stocks, there are no called strikes. He waits for the pitch he wants. The mistakes he has made resulted from thinking he understood a business when he did not. He prefers "to learn from other people's mistakes" (not from his own). On Dexter Shoe, he issued shares in Berkshire that are today worth $3 billion. Dexter Shoe went to zero. One should focus on the future. "Don't dwell on mistakes."

(3) With respect to moral issues, he will buy marketable securities (stocks and bonds) of cigarette and liquor companies. Thirty years ago he was invited to a southern state to meet with management who wanted to sell a chewing tobacco company. The moat around the business was fabulous (brand loyalty). Pretax margins of 40% with low capital requirements. There was far less incidence of cancer from chewing tobacco than there was from cigarettes. Charlie Munger and Warren discussed whether or not to acquire this company. They decided against it. Berkshire owns stock in Wal-Mart (NYSE:WMT) which is the largest seller of cigarettes in the U.S. They own stock in a company that wholesales to Wal-Mart. They own shares in Costco (NASDAQ:COST) which is the third largest retailer of cigarettes. But they will draw a line at buying the entire business of a tobacco manufacturer.

(4) Buffett never wants his investments to keep him awake at night. In that regard, he was ultra-conservative during the financial crisis by selling part of his stake in Johnson & Johnson (NYSE:JNJ), even though he did not need to, in order to pay for the preferred stocks that he purchased (GS, GE etc.)

(5) In response to a question on oil, Buffett stated that the Middle East has been, and will continue to be, unstable. If the supply of oil from Saudi Arabia is disrupted, it will have big consequences. There are 500,000 oil wells in the U.S., producing an average of only 11 barrels per day. If oil prices have a sustained increase, there will be a windfall profits tax in the U.S. Therefore, higher oil prices are not a signal to buy oil stocks.

These responses by Buffett enhance his reputation as being second to none in the allocation of capital and being very effective as a CEO. They provide further support for BRK.A and BRK.B as excellent investments.

Disclosure: I am long BRK.B.

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