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Buffett party

As my flight neared Eppley airfield, Omaha, all I could see was farmland. It seemed an unlikely venue to encounter arguably the world’s greatest investor – Warren Buffett – at the Berkshire Hathaway annual shareholder meeting.

However, this detachment from the noise and frenetic activity of Wall Street or the City of London is one of the tenets of his approach.

Buffett likes to call this meeting the “Woodstock of capitalism”. As an active investment manager and an avid fan, I wanted to see the Sage of Omaha in person to improve my understanding of his investment philosophy.

Buffett has a significant influence on how I approach investment management. In essence, he distinguishes long-term investment from short-term speculative activities. He has a defined set of principles or tenets which ensure his portfolio of investments grows in value through the powerful dynamic of compounding returns over time.

In my youth, I went to see Led Zeppelin towards the end of their active period and was concerned that they might appear somewhat jaded. I expected the same with Buffett, who is 77 and for whom this was the 43rd Berkshire Hathaway AGM. In both cases, I found the acts on top form. In fact, I would say Buffett is now in his prime.

Both he and his sidekick Charlie Munger sparkled as they were asked questions ranging from: “How do I become a better investor?” to “What would you do if you were president of the US?’ and “What happens when we run out of oil?”

There were 33,000 shareholders at the meeting in a vast auditorium at the Qwest Center in Omaha. After the showing of a film, Buffett and Munger answered questions from 9.30am to after 3pm, trying to be as open and honest as possible.

After a long diatribe, which Buffett clearly did not follow, the first questioner simply asked: “How do I stop investing like a lemming?” The Sage referred to the book that most influenced him, The Intelligent Investor by Benjamin Graham, specifically to chapters eight and 11.

The key tenets set out in these chapters are, first, that you should consider a securities investment as buying part of a business and not just a stock, second, that you should consider the market as a mechanism that occasionally gives you the opportunity to buy a great business at an attractive price and, finally, that in assessing the price, you need to include a margin of safety in the valuation in case you are wrong.

It was clear from the many questions on sub-prime and the credit crunch that Buffett and Munger consider that the fear engendered by the consequences of stupidity in capital markets is a recurring and beneficial feature of capitalism. These periods tend to be particularly fertile periods to make investments.

They referred specifically to an 11 per cent yield they secured on a quasi-governmental bond they bid for in an auction reset and the monoline insurance business they have recently set up. The latter is securing business at double the premium of existing players, despite the existing insurance still being in place and the issuers being municipalities (similar to our county councils) and therefore reasonably safe.

In the last year, Berkshire Hathaway has invested over $19bn in stocks, bonds and options.

Buffett often refers to one of the characteristics of the businesses he invests in as that they are surrounded by a moat which makes it very difficult for competitors to attack their market over the years. A great example is the Nebraska Furniture Mart, which I visited during my stay. This resembles John Lewis in the UK in terms of the quality of its products and service levels but occupies a 77-acre site. It is a local business, not a national chain, but the scale of the local presence would make it difficult for competitors to run successful outlets nearby.

The original founder, Mrs Beaton, stepped down from her management role at the age of 103, which illustrates its longevity.

The subject of reliance on management ability is probably the most hotly debated among Buffet watchers. When describing a business, he refers to the moat being enduring enough that an idiot could be made chief executive officer and not destroy it. However, it is clear from his answers to many questions that management ability is important to him and he regards those that work for Berkshire Hathaway businesses as top quality.

He looks for a long and successful track record, integrity, passion and motivation above financial gain. Many of his managers are already independently wealthy by the time he buys their businesses. Munger went further by intimating that excessive executive pay tends to correlate with business underperformance.

I would recommend that anyone interested in investment should read this year’s letter to shareholders which can be found on the Berkshire Hathaway website. Buffett gives one of the most vivid descriptions of the cashflow attributes of his companies, which he referred to many times in the meeting. It illustrates clearly the attractiveness of equities over most other asset classes over any reasonable timespan. Munger summed it up by referring to their preference for companies that “drown in cash”.

The company cited as the ideal was See’s Candy. This is a relatively small company that is operating in a slowly growing, mature market. However, it absorbs very little capital and therefore generates high returns on its small capital base and throws off huge amounts of cash. Buffett likens it to putting cash into a bank account which already has a very high interest rate, where this rate will increase each year and you do not need to put in any more cash.

The final key point made at this year’s meeting related to diversification. Both Buffett and Munger indicated that they would be prepared to invest 75 per cent of their personal net worth in one idea if it was sufficiently attractive. Investment for diversification purposes was for “know nothing” investors. Those with the time and resources to commit to investing should focus on the few real opportunities that come along.

Much of what Buffett and Munger are trying to put in place are the ingredients that allow investors to benefit from the massive driver that is the compounding effect of interest over time. They want companies that are around long enough and managed well enough to allow this effect to work. They also need sufficient cash to be generated and that cash to be invested in similar businesses.

They recognise that value has to accrete to common equity holders, not managers or other stakeholders including intermediaries such as fund managers.

It is worth noting that Buffett’s annual salary is just $100,000 but his personal wealth has accumulated to an estimated $64bn due to the huge long-term share price appreciation that he and other common equity shareholders have seen at Berkshire Hathaway.

So what did I take away from the meeting that could actually be put into practice in the context of a UK investment portfolio?

First, it has helped me to further refine our approach and has reinforced the necessity of being disciplined in applying this approach.

Second, it brings home the fact that potentially interesting companies do not need to be vast multi-national corporations but can be powerful local businesses, perhaps operating under my nose.

Finally, many UK securities have suffered as much as their US counterparts due to the current market mood of fear and therefore now is potentially a particularly fruitful time for investment.

A few days later, I took off from Eppley airfield on a glorious sunny day feeling enlightened and refreshed. We endeavour at Credit Suisse Asset Management to utilise the principles and approach that work so well for Buffett in our range of UK retail income and growth funds. We make no claims that we can replicate his success but consider that trying to adhere to his philosophy will increase our chances of outperforming over time.


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