Pat Dorsey: Hi, I'm Pat Dorsey, Director of Equity Research at Morningstar. As many of Morningstar.com's viewers know, myself and Paul Larson and some other folks from Morningstar's staff were out at the annual Berkshire Hathaway meeting a few weeks ago.
Took some video from there, trying to hit the high points of Buffett's views on Goldman, derivatives, that sort of thing. But, you know, in five hours of Q&A with two of the world's smartest investors, you get a lot of good stuff that we just couldn't cram into the videos we did a couple weeks ago.
I wanted to circle back, after I had a chance to go through my 20 pages of handwritten notes, and talk about some of the other issues that came up. Some of the other really, I thought, interesting insights that came from Buffett. As well as, specifically, some of the great little catch phrases that both he and Munger came up with during the meeting. I'll just go through these and hopefully they will add a little bit to your investing day.
So, the first one was in describing the prospects for financial reform in the U.S.; whether to bring back Glass-Steagall, which would have kept different parts for our financial system apart.
And the quote was, "If I were a benevolent despot, I would make Paul Volcker look like a sissy." Munger makes no bones about wanting to separate what he calls the "casino-like activities of investment banking" from the process of, as he puts it, "allocating capital across our civilization."
And also, in talking about investment banks, Munger said, "If you give humans the flexibility to do any damn thing they please, and unlimited access to credit, they will go plum crazy." Which is not a bad description of what actually happened a few years ago.
Then, a couple of very interesting discussions from Buffett, a few times, specifically hitting on currencies and the impact that rising sovereign debt levels are likely to have. One quote, "The events in the world of the past few years would make me more bearish on all currencies relative to the past."
And he followed that up later with talking about "the prospects for significant inflation have increased not just here, but around the world," and "You bet your life I'd bet on higher inflation, and maybe a lot higher."
Those are pretty direct words from someone, who, in the past has really avoided making big macroeconomic calls, and has sort of said that's not really his specialty. There's a theme that both he and Charlie Munger returned to several times during the meeting.
In another interview I read with Mr. Buffett, someone asked him, "So does this mean you're a gold bug?" And he said "Explicitly not," but that he thought the best hedge against inflation would be companies with pricing power, or companies with -- as we would call it -- wide economic moats.
"Companies that are able to raise prices ahead of inflation might be the best prospective hedge against inflation," and then, again, "I think currencies are a poorer bet than they've been for some time." So a theme that he really was hitting on quite strongly.
A great discussion at one point about how Berkshire manages the compensation for managers at its subsidiaries. In other words, all the various companies that Berkshire Hathaway owns. How does Buffett think about compensating those managers in an incentive-led fashion?
And what he talked about was, "If I owned a whole business, what is a sensible way to compensate them given the economic characteristics of the business?" Emphasizing that sort of "one size fits all," incenting people on growing earnings, or growing sales, or increasing margins doesn't make sense because every business is a little bit different and the economic drivers are different.
And then he then explicitly said, "The thing I want to pay managers for is widening the moat that separates their business from other businesses." Again, a thing that we focus on very much here at Morningstar, the importance of a company's competitive advantage relative to others.
Buffett saying that that's really what he wants to focus on when he thinks about how to incent the managers that work for Berkshire Hathaway.
A wonderful quote from Munger talking about investment banking in general, and sort of, basically, wealth creation across the economy, "We celebrate wealth only when it's been fairly won and wisely used." So good one to maybe put on the wall of your cube, I think.
Great discussion about the rising level of debt in municipalities and states in the U.S. We've heard a lot in recent times about California, New York, other states and municipalities being either bankrupt or in danger of becoming so.
Buffett being asked about "where does this all lead us to?" And the quote was pretty simple, "It will be very hard to turn away the governor of state X, when you've just bailed out GM." Which is not a bad point. So it's a way to think about what might happen down the road there.
Description of equities as the best of a bad lot asset choices right now; not exactly a ringing endorsement of the stock market, but perhaps a good endorsement of it relative to the other options that are available.
And then, there was a wonderful quote from Charlie Munger. A questioner took a little bit of issue with his optimism that he expressed, given risks of inflation, and rising debt around the world, and "how can you be so optimistic, Mr. Munger?"
The quote was fantastic. "If I can be an optimist when I am nearly dead, surely the rest of you can handle a little inflation." Not a bad way of putting perspective on things from an 87 year old guy.
A good example of the pressure exerted by extremely low rates on everything else is hard to underestimate. Don't underestimate the degree to which this has pushed up the stock market over the past year.
Again, sort of tempering optimism a little bit from the crowd. Yes, the economy has recovered, earnings are doing better, but don't underestimate the degree to which people may be moving into equities simply because the alternatives, i.e. money markets and T-bills, are offering such horribly low returns.
The discussion of investing and a concept that Buffett has often called "the circle of competence." In other words, stick within what you know. Don't try to buy lots of things outside of what you are good at.
And the quote was, "The key is not how big is your circle of competence, but do you know where the perimeter is?" Which I thought was a great way of thinking about things.
Even if you only know a small area of the stock market really well, you can do well within that as long as you know where you're limits are; as long as you know not to step outside of those boundaries.
Certainly, if you have the chance next May to get out to Omaha, Nebraska, I'd highly recommend it. Not often do you get to hear two of the world's smartest investors answer your questions for five hours straight with no charge but the airfare.
I'm Pat Dorsey. Thanks for watching.