Sun, 5 May 2013
Berkshire's strong culture is a reminder that good management can help widen a moat, says Morningstar StockInvestor editor Matt Coffina.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I am here at the 2013 Berkshire Hathaway Annual Meeting. I am joined with Matt Coffina he is the editor of Morningstar StockInvestor. We are going to get his take on the meeting today.
Matt thanks for joining me.
Matt Coffina: Thanks for having me, Jeremy.
Glaser: So what are the big themes that kind of permeated the meeting's idea of culture and how much Buffett values that unique Berkshire culture? When you are thinking about investing in either Berkshire or any other stock for that matter, how do you think about something as intangible as the company's culture?
Coffina: I think management is really important in general and we've been trying to get at this more at Morningstar with our new Stewardship Ratings. So now we assign every company a rating of exemplary, standard, or poor. We're really trying to get at this idea of whether management is focused on strategic execution and if they have appropriate capital-allocation policies. But I think Warren Buffett really emphasizes it, so he gave the example of Iscar for example. Someone asked, what is Iscar's competitive advantage? And his answer was basically there is no structural advantage to the business, but they've outperformed all their competitors over the last 25 years just through consistent day-to-day operational execution.
There is a similar message with Berkshire itself. Somebody asked what's going to happen after Buffett's no longer the CEO. He said that he thinks that the culture of Berkshire is so deeply engrained at all the different levels of management that that culture is going to persist even without him there. It's something that's very hard to get your fingers on, but it can be very, very important. It can be a source of competitive advantage. We wouldn't give a company a moat just based on management because managers do change over time. It's not necessarily as sustainable an advantage as a structural business characteristic like a network effect. But it is extremely important and to the extent that I can buy companies with exemplary stewardship, I want to do that.
Glaser: A shareholder asked directly to Buffett how he would describe the moat around Berkshire to a 13-year-old, very basic terms. Did you buy his argument of why he thought Berkshire had a moat, or do you think there is more to it?
Coffina: So, I think he gave basically two reasons for Berkshire's competitive advantage. One is that they try not to be crazy when everyone else is being crazy; they try to stay sane in a crazy world. So we really saw this pay off for example during the 2008 financial crisis. A lot of firms needed liquidity, a lot of investors were running away from the markets, and a lot of banks were not willing to lend. And Berkshire was willing to step up and made some very attractive deals during that time. They have the liquidity and really more than anything the temperament to make those kind of deals happen.
The other source of advantage he gave was that over 40 years of doing business, they have always treated their partners right and their shareholders right, which means that they have a shareholder base that's willing to be patient to give management the benefit of the doubt, sometimes doing some deals that might take a little longer to play out.
And then from the partners' standpoint is that executives who want to get out of their businesses for whatever reason, such as they are retiring or they need liquidity, they look to Berkshire as a partner of choice because they are willing to let those managers continue to run their businesses as they like them to run. They know Berkshire is not going to come in and dismantle those businesses. So Berkshire is just a really good parent and a really good partner to have, and so they are one of the first calls that entrepreneurs make when they are looking to get out of the business they founded.
Glaser: In Buffett's recent deal to acquire half of Heinz along with a Brazilian private equity partner, he said that he paid maybe a little bit more than he would have liked but that was worth it to pay up for a good business. What do you think about that? I mean he basically said that he was able to stretch that valuation? Do you think that's a good idea for investors in common equities?
Coffina: I think that was a very large theme in the meeting and I think I only heard margin of safety mentioned once in the entire meeting. Buffett and Charlie Munger especially really seemed to be emphasizing this idea if you can pay up for quality. They say when they look back at their past record every time they paid a little bit more than they thought was appropriate for a great business that was going to stay a great business or get even stronger over time--what we call a positive moat trend in which the competitive advantage of strengthening--they haven't regretted paying up for those businesses. He gave the example of See's Candy. They paid about 5% more than he really wanted to pay for See's Candy at the time. But the investment was paid off many times over in the subsequent years that they've owned the company.
So it's OK sometimes to pay up for a really, really high-quality business. You don't necessarily need the same extent of margin of safety relative to what you think the company is worth today because as it continues to compound that intrinsic value over time, it'll be worth so much more in the future that 5% today might just turn out to be a rounding error.
Glaser: Another hot topic was the Fed's zero-interest-rate policy. What did Buffett say about how that will impact equities, and how do you think about Treasuries or the Fed's policy when making investment decisions?
Coffina: Buffett called rising interest rates like gravity for asset prices. I think it's something that's definitely worth keeping in mind. He also said that investor sentiment around these kinds of issues tends to change very quickly. So right now we have a lot of investors pouring into equities because of the low-interest-rate environment. It's very difficult to find appropriate yields anywhere else in the market. So that's pushing up stock prices. Something that investors need to be aware of is that sentiment could change certainly if interest rates start to rise. But even if investors get the sense that interest rates are going to rise, it's not necessarily a huge driver of our investment process to the extent that stocks were to sell off in a big way because of a rising-interest-rate environment. If they sold at a discount to intrinsic value I would be a buyer. But still certainly something worth keeping in mind.
I think a couple of stock names that I like specifically for a rising-interest-rate environment would include Wells Fargo, which is Buffett's top pick. They have been hurt by the current low-interest-rate environment. Rising interest rates will probably be actually good for them. Another name that comes to mind would be Charles Schwab, which is very leveraged to interest rates. Paychex is another example; they have a float that comes in. They invest in the near term; the low-interest-rate environment has really been hurting their float income.
So these are some businesses I think have a place in an investor's portfolio, if you want to protect against those rising rates with a company that will specifically benefit from that.
Glaser: Matt, thanks for your thoughts today.
Coffina: Thanks for having me.