There was a great question at one of the Berkshire Hathaway shareholder meetings years ago
The question asked by Berkshire shareholders was:
“Good morning, Mr. Buffett and Mr. Munger; my name is Steve Yates. I’m from Chicago. I’m a Berkshire shareholder, and this is my sixth year attending this meeting. Thank you for all your time and advice through the years; it’s been great. I’d also like to thank all those wonderful people who sold Berkshire this year for allowing us to purchase more of the world’s greatest company for dirt-cheap prices.”
Buffett responds: “We will convey your thanks to them.”
The shareholder continues: “I own another stock which sells for four times current trailing earnings. Every quarter we get a report earnings to go up, sales go up, cash flow goes up, the equity base expands, they gain market share, and the stock goes down. The company has a 60 percent five-year annualized growth rate and sells at four times earnings. I have two related questions. First, is this a growth stock or a value stock? and could you please give us your definitions of these terms? Second, the company sells recreational vehicles, and demographic trends in the recreation and leisure areas, RVs, cruise lines, golf equipment, etc., seem quite good. You see any opportunities for Berkshire here? Thanks.”
Warren Buffett: forget about value vs. growth investing
Buffett answers the question:
“Well, the question about growth and value is that we’ve addressed in past annual reports. They are not two distinct categories of business. Every business is worth the present. If you knew what it was going to be able to disgorge in cash between now and Judgment Day, you could come to a precise figure as to what it is worth today. Now elements of that can be the ability to use additional capital at good rates, and most growth companies, companies that are characterized as growth companies, have that as a characteristic. Still, there is no distinction in our minds between growth and value. Every business we look at as being a value proposition, the potential for growth, and the likelihood of good economics being attached to that growth are part of the equation in evaluation, but they’re all value.”
“They’re all valued decisions a company that pays no dividends growing a hundred percent a year, you know, is losing money now that’s a value decision you have to decide how much value you’re going to get. The first investment primer, when would you guess it was written? The first investment primer that I know of, and it was pretty good advice, was delivered in about 600 BC by Aesop. And Aesop, you’ll remember, said a bird in the hand is worth two in the bush. Incidentally, Aesop did not know it was 600 BC he was smart, but he wasn’t that smart.
“Now Aesop was on to something, but he didn’t finish it because there’s a couple of other questions that go along with that, but it is an investment equation. A bird in the hand is worth two in the bush. He forgot to say exactly when you were going to get the two in the bush, and he forgot to say what interest rates were that you had to measure this against. But if he’d given those two factors, he would have defined investment for the next 2600 years because a bird in the hand is, you know. You will trade a bird in the hand, which is investing you lay out cash today, and then the question is, as an investment decision, you have to evaluate how many birds are in the bush. You may think there are two birds in the bush or three birds in the bush, and you have to decide when they’re going to come out and when you’re going to acquire them. Now if interest rates are five percent, and you’re going to get two birds from the bush in five years, we’ll say versus one now; two birds in the bush are much better than a bird in the hand now, so you want to trade your bird in the hand, and say I’ll take two birds in the bush because that if you’re going to get them in five years that’s roughly 14 percent compounded annually; and interest rates are only five percent.”
“But if interest rates were 20 percent, you would decline to take two birds in the bush five years from now, you would say that’s not good enough because of 20 percent if I just keep this burden in my hand and compound it, I’ll have more birds than two birds in the bush in five years now what’s all that got to do with growth. Well, usually, growth people associate with a lot more birds in the bush, but you still have to decide when you’re going to get them, and you have to measure that against interest rates, and you have to measure it against other bushes and other you know other equations and that’s all investing is. It’s a value decision based on you know what it is worth, how many birds are in that bush when you’re going to get them, and what interest rates are. Now if you pay five hundred billion dollars, and when we buy a stock, we always think in terms of buying the whole enterprise because it enables us to think as businessmen rather than as stock speculators.”
“So let’s just take a company that has marvelous prospects, is paying you nothing now, and you buy it at a valuation of 500 billion. Now if you feel that 10% is the appropriate rate of return, and you can pick your figure, that means that if it pays you nothing this year but starts paying next year, it has to be able to pay you fifty-five billion in perpetuity each year. But if it’s not gonna pay until the third year, then it has to pay you sixty-point-five billion in perpetuity to justify the present price. Every year that you wait to take a bird out of the
bush means that you have to take out more birds; it’s that simple. And I question in my mind whether sometimes people who pay five
hundred billion dollars implicitly for a business by buying ten shares of stock at some price, I’m really thinking of the mathematics implicit in what they are doing to deliver.”
“Let’s just assume if there’s only going to be a one-year delay before the business starts paying out to you and you want to get a 10 percent return, then you pay 500 billion. That means 55 billion of cash that they have to be able to disgorge to you a year after year after year to do that; they have to make perhaps 80 billion dollars or close to a pre-tax. Now you might look around at the universe of businesses in this world and see how many are earning 80 billion pre-tax or 70 or 60 or 50 or 40 or 30, and you won’t find any. So it
requires a rather extraordinary change in profitability to give you enough birds out of that particular bush to make it worthwhile to give up the one that you have in your hand.”
“Second part of your question about whether we’d be willing to buy a wonderful business at four times earnings. I think I could get
even Charlie interested in that, but let’s hear it from Charlie.”
Charlie Munger responds, “I’d like to know what that is.”
Buffett interjects, “He was hoping you would ask that fella that’s got all his net worth in his stock and who has a captive audience tell us what it is, you gotta tell us we’re begging you.”
“You want the name of the company?” the shareholder asks.
“We want the name of the company; we’re dying to get the name; where do I get my pencil,” replies Buffett.
[The audience laughs]
“It’s called national RV, and it’s based in California, and they sell recreational vehicles.” the shareholder answers.
“Okay, well, you’ve got a crowd of people who have birds in the hand, and we will see what they do in terms of national RV. Charlie, do you have anything further on growth and value, etc. watch him carefully, folks.” Buffett jokingly warns the audience.
Charlie Munger on value investing
Charlie addresses the audience:
“Well, I agree that all intelligent investing is value investing. You have to acquire more than you really pay for, which is a value judgment, but you can look for more than you’re paying for in many different ways. You can use filters to sift the investment universe, and if you stick with stocks that can’t possibly be wonderful to just put away in your safe deposit box for 40 years but are underpriced, then you have to keep moving around all the time as they get closer to what you think the real value is you have to sell them and then find others, and so it’s an active kind of investing where you find a few great companies and sit on your ass because you’ve correctly predicted the future.”
