'I'll stick with what I understand'
Only a few days after he sat with TheMarker for a long interview did it become known that Warren Buffett's firm was undergoing a corporate earthquake, with the resignation of the man many thought would succeed him at Berkshire Hathaway. As Buffett clearly understands, his reputation depends as much on his integrity and fair play as on his business acumen.
It is only in retrospect that one can say it was possible to notice a certain cloud hanging over Warren Buffett's head during his visit to India and South Korea late last month. He was his usual kind and smiling self, had his picture taken dozens or hundreds of times with anyone who asked, shook hands with hundreds, answered the same questions with endless patience at press conferences, and told his set jokes and anecdotes for the thousandth time.
It was only on Wednesday afternoon last week, five days after he returned from a weeklong tour in Asia, that Buffett sat down to write the press release in which he announced the resignation of David Sokol, who until that moment had been seen as one of his possible successors.
Days earlier, it had been reported that Sokol had bought up significant quantities of stock in Lubrizol, a chemicals firm, for himself shortly before urging publicly held Berkshire Hathaway to purchase a controlling share in the company. The rise in Lubrizol's share price following its acquisition by Berkshire netted Sokol a profit of nearly $3 million.
In his statement, Buffett denied that his former associate had done anything illegal, but confirmed that he had accepted Sokol's resignation.
"This press release will be unusual," he wrote. "First, I will write it almost as if it were a letter. Second, it will contain two sets of facts, both about Dave Sokol, Chairman of several Berkshire subsidiaries. Late in the day on March 28, I received a letter of resignation from Dave, delivered by his assistant. His reasons were as follows:
"'As I have mentioned to you in the past, it is my goal to utilize the time remaining in my career to invest my family's resources in such a way as to create enduring equity value and hopefully an enterprise which will provide opportunity for my descendants and funding for my philanthropic interests. I have no more detailed plan than this because my obligations from Berkshire Hathaway have been my first and only business priority.'
"I had not asked for his resignation, and it came as a surprise to me," the press release continues. "Twice before, most recently two or so years ago, Dave had talked to me of resigning. In each case he had given me the same reasons that he laid out in his Monday letter ... Neither Dave nor I feel his Lubrizol purchases were in any way unlawful. He has told me that they were not a factor in his decision to resign.
"Dave's letter was a total surprise ... I had spoken with him the previous day about various operating matters and received no hint of his intention to resign. This time, however, I did not attempt to talk him out of his decision and accepted his resignation.
"Effective with Dave's resignation, Greg Abel, presently President and CEO of MidAmerican Holding Company, will become its Chairman; Todd Raba, President and CEO of Johns Manville, will become its Chairman; and Jordan Hansell, President of NetJets, will become its Chairman and CEO.
"I have held back nothing in this statement. Therefore, if questioned about this matter in the future, I will simply refer the questioner back to this release."
After reading this announcement, I began to reconstruct the events that took place during the Asia tour, on which I accompanied the Omaha businessman. When Buffett got off the plane on March 20 in Daegu, South Korea, he had on running shoes, rumpled gray sweatpants, and a sweatshirt that had seen better days. He was greeted in the arrivals hall by some 200 screaming Korean fans - evidently municipal workers. One of them had come prepared with a cardboard sign on which he had written, "Dear Warren Buffett. Please hug me once. I love you."
After two days in South Korea, Buffett was scheduled to have dinner with the chairman of one of the country's five major corporate groups, which handles a transaction volume of $64 billion a year. But a few minutes before the meeting Buffett announced that he would not be going. In hindsight, it is possible that he spent the freed-up time dealing with the Sokol affair.
The fog surrounding the identity of Buffett's successor was thick even before Sokol's surprising resignation. Buffett prefers to evade questions on this issue. Not long ago he told one newspaper he was contemplating the possibility of managing Berkshire Hathaway's investment portfolio even after his death, but was ultimately forced to give up the idea, though it would have given true and special meaning to the phrase "thinking outside the box."
Berkshire Hathaway stock currently trades on the stock exchange at a value of $206.8 billion. The Israeli company Iscar, which organized his Asia trip, represents about 1 percent of the firm's activity and at most 3 percent of its value. Despite this, the relationship between Buffett and Iscar's chairman, Eitan Wertheimer, is close; three of the handful of trips Buffett took outside the United States in the past five years were with Wertheimer and other executives at the company that manufactures precision cutting tools.
Berkshire Hathaway and Iscar maintain total silence on the financial results, but an examination by TheMarker found that in the five years since Iscar's acquisition, its income grew from $1.5 billion to around $2.5 billion. A billion or so dollars of this growth is internal, and another $400 million was the result of the acquisition of the Japanese company Tungaloy in September 2008.
The first question I addressed to Buffett concerned the management culture at Iscar.
Can you tell me something about the management style of Iscar when you compare it to other companies in your portfolio?
Buffett: "Well, we have so many companies, there are a lot of different styles. However you would define the Iscar management style, it would be incredibly successful. It's as well managed as any company I have ever seen. That's why I went into it."
In your annual letter to investors, you mentioned Eitan Wertheimer, Iscar's CEO Jacob Harpaz, and you also mentioned the CFO, Danny Goldman. When you look at the financial planning at Iscar, what do you see?
"I saw plenty of them even before we made the deal. I knew quite a bit less about making acquisitions internationally than I knew about making acquisitions within the United States - I knew the tax rules in the United States, but I don't know all that much about it internationally - so there were certain things that we needed to accomplish to make the acquisition feasible. I had talked to our lawyers in the U.S. about it and they didn't have a solution. I talked to Danny about it and he had a solution and it was plenty good."
You have said you don't want to invest in technology because you cannot look into the future and understand the business. Do you think you are missing something by forgoing the technology industry?
"The important thing is to know the perimeter of your circle of confidence and to play within that circle - the bigger the better ... There is no use letting your ego tell you that you are good at something that you are not. To the extent that I can draw that line accurately I'll do well, and to the extent that I won't, I won't. Take Apple: Could I have seen what happened five years ago? No. Steve Jobs saw it. It was in his mind and other people's. I'll stick with what I understand."
Can you describe an instance when you thought you understood something, some industry or some company, and you realized it was not in your circle of confidence?
"Well, I've made mistakes, and whether it was beyond my circle of confidence or whether I just didn't look enough at the facts is another question. I'll describe a shoe company that Berkshire bought many years ago that ended up being worth zero. Shoes should not be beyond my circle of confidence, but I just didn't do my homework. We have other shoe companies that are successful, but I have made plenty of mistakes. And one thing I can promise you is, I will make some more.
"Mistakes don't bother me. I try never to do anything that would jeopardize the well-being of the whole place. So I build into the decisions I make the fact that I am going to make mistakes."
Correct me if I am wrong, but I don't see any alternative-energy companies in your portfolio either.
"We have looked at some and I do consider those within my circle of confidence - and that includes energy, and oil and gas, and production and refining - [but] we have never bought control of them. We've owned a number of energy companies from time to time. But in terms of buying the entire business, we have not had one that came along that was attractive to me, but that could happen next year or the year after."
When you look to the future do you think we are going to see value creation in alternative-energy investment? Or will people lose money?
"Both. That's the nature of developing technologies and industries. A few people make it big: Just look at the auto industry. There were 2,000 auto companies in America at one time or another ... There were 400 airplane manufacturers in the United States over time. So whenever there is a major new development, like television sets, you name it, over the years, it attracts capital, energetic people and energetic minds, and most fail and a few succeed."
Maybe one reason to refrain from technology investments is that, while they may have good PR, in many companies - looking back 10 or 20 years - most of the value went to employees, the promoters or management. Not even very successful companies created much profit for shareholders. Maybe technology is not an industry for investors but rather for employees and managers?
"The people who bought into Google, Apple and Amazon have done really well, so my reluctance to invest is not based on the fact that I think they will take advantage of me, but more that I just don't know how to pick the winners."
When you choose investments, how important is it to you to understand the corporate governance and how the value is being distributed throughout the years among all stakeholders?
"It's important. If I were to buy a farm and have someone run it for me, the deal I would make with the farmer in terms of what percentage of the crop he would get would be important ... It's important not only in terms of how the profits will be shared, it's important in assessing the person's attitude. You want someone running a place who looks at you as a partner and not as an adversary, and at Berkshire Hathaway we really look at our shareholders as partners. I would rather have them do well than me do well. It comes out that we come out the same, but you want someone with a fiduciary sense, a sense of stewardship. We have been uncommonly lucky in attracting management like that. To some extent people flock to their own kind, and because we have that tradition, that culture, because people have joined us with that attitude, it feeds on itself, as does the reverse. If it's every man for himself, you get very few who will join that culture."
Ridiculously low salary
Warren Buffett draws a ridiculously low salary from the company of $100,000 a year, whereas the heads of companies of Buffett's sort take home annual salaries of millions and tens of millions a dollars.
How is compensation of your executives and managers different from what we read about in the Fortune 500 companies?
"I think we have a pretty rational compensation policy, but we have 70-plus companies. Some are in capital-intensive industries, some aren't; some of them are easy businesses, some of them are really tough businesses; some have huge capital turnover but low margins; some have slow capital turnover but wider margins. So we have never had a compensation consultant, though maybe one of the subsidiaries did. I don't spend 30 minutes a year on it, but they are fair-minded people and we have different arrangements at different companies because they are very different businesses. But it's not a big thing. People want to be treated fairly, but they also like running their own businesses, they like being appreciated. Those things count, too."
So, when they look to what has happened to compensation in the U.S. over the last 10 years, don't they sometimes feel frustrated because compensation has gone up so dramatically and people have gotten so enormously rich - just out of compensation, without taking into account stock opportunities?
"Nobody has left us in 46 years to go to a competitor. I mean, we have had to terminate a few over the years, very few, and at different ages. We have people working in their 80s, and some people don't last that long. It does vary with individuals, that is why we have no retirement age."
Buffett warned for years of the dangers inherent in the U.S. trade deficit, but did not have an in-depth grasp of the American housing bubble and the surrounding financial industry it gave rise to, so, like most of his friends, he was taken by surprise when the financial institutions ended up in a state of near-collapse and required an unprecedented government bailout.
Let's talk about the macroeconomy. A lot of people are concerned, with U.S. debt at about $15 trillion. But you are still very optimistic about America. How do you reconcile this?
"America, and a lot of other countries too, are remarkably resilient. I mean, we make all kinds of mistakes in our country, and we will continue to make them. But we are a country that has gone through a civil war, a country that has gone through 15 recessions, a great depression, a flu epidemic, a cold war.
"There are always problems, but there are always opportunities. The thing that really counts is having 309 million people or so with a great number of them trying to make their lives better and the lives of people around them better. Even in a rich family they may argue about who gets most of the income, and I am sure they do. We have a very rich family in the United States. The old would want more, the young would want more, the people who are in their productive years would like to give less to those who aren't. The pie will never be big enough to take care of everyone's desires, but the pie does get bigger.
"Most of the decisions over time are pretty rational. It's the nature of democracy that it's a pull and push, a tug over the pie. But the pie in the United States is about $47,000 per capita, so it's a pretty big pie, and it is a lot more fun arguing over a $47,000 pie than a $5,000 or $6,000 per capita pie. And when the pie gets to $100,000, we will still be arguing."
But today foreigners have a bigger claim on this pie. Compared with the past 10-20 years, foreigners hold more equity, and more stock and more debt of America.
"Foreigners across the world have about a $3-trillion net negative balance against the United States. There was a time when we had a net balance against the rest of the world. It's better not to have a $3-trillion negative balance, but we also have about a $60-trillion economy - we can handle it. I don't like policies that lead to that number increasing and I have written about it, but let's not get into that. Everything that we have is denominated in our own currency, and that's a tremendous advantage."
Do you think that having the Federal Reserve essentially printing money, by buying most of the treasuries over the last two or three years, will spur significant inflation?
"It certainly has that possibility. I just saw that the Fed was announcing that it was going to sell $10 billion a week of mortgages back. But by and large with the Fed being a major buyer - some would call it quantitative easing, others would call it modernization of debt - it certainly isn't a good thing to be doing for very long."
How do you defend yourself against such consequences of inflation?
"Well, when I was born, in 1930, the dollar bill of that moment is worth six cents today, so it isn't inflation that destroys the country. Every time I get worried about inflation I think about how 94 percent of that dollar bill from when I was born isn't worth anything, yet I seem to have done pretty well, so it can't destroy everything.
"Nevertheless, I worry about inflation, because it is such an easy solution to things in the short term. The ultimate defense against inflation is your own talent, your own earning power. I mean, the best doctor in town, the best lawyer in town, the best musician, the best anything, whatever it may be - they will always command their share of resources of their society ...
"Next to your own talent, the best thing to own is a business with talent. I mean, if you own Coca-Cola, it will always be able to command, whatever the currency, a certain portion of people's earnings or hourly earnings. So I always emphasize to students, develop your own talents, no one can take them away from you, no one can even tax you until you start bringing money in from them. And inflation can't take your own talent away from you. If you look at investments, the one thing you don't want to have is investments that are tied to a currency unit, as opposed to a producing business.
Outside the U.S.
You've taken to investing outside the United States. In some places like China, corporate governance is a significant issue. Do you feel the difficulty is compensated for by the growth in Asia and in the BRIC countries?
"I don't think it is so overwhelmingly different in other parts of the world. It's not so great in the United States. It is obviously something I look at in any investment, but if I am looking to buy stock in a company in Israel, or the UK, or Germany, or wherever the case may be, I don't find great differences. In fact, in some of those countries I would say management gets treated less lavishly than in the United States, so obviously if I find something offensive, I am not going to do it. But I find that sometimes, in terms of looking for marketable security investments, I have always looked around the world and I may have talked about it a little more lately and people may have been more cognizant of it - but for 50 years I have always looked at securities around the world."
But even today most of your portfolio is in the U.S. Yet places like South Korea, China, Indonesia and Vietnam are expected to achieve tremendous growth, looking ahead 10 or 20 years. Do you think this growth will translate into value for shareholders?
"I think the United States' prospects are pretty good. If someone told me I could only invest in the United States and I would have a $20-trillion market, I'd be happy. I like the idea of having more opportunities around the world, but you can get very rich investing just in the United States."
You keep saying in your annual letters over the last few years that now that you're managing such a big portfolio, you can't beat the market anymore.
"That's tough. I'd say I am hoping to get a couple percentage points more than the market."
Thirty-thousand people convene every year in Omaha at the Berkshire annual event. Why do people flock to invest with you if you say year after year that you can't beat the market?
"Most people can't do a couple percentage points better than the market. I'm telling people I still expect to do a little better than average, but nothing like I've done in the past. I wouldn't be running it if I thought I would be doing just average. I know that I can't do more than a couple points better than average. But it's better than most people do themselves. It may be better than I do."
But why do 30,000 people come every year to Nebraska?
"This year there may be 40,000! I think they come for several reasons. One, they come to have a good time ... They come because they feel part of something. When they own stock in Berkshire, they feel like they are partners, they're a real owner. In many cases it's a lifetime commitment, and not just buying stock that will blow up next week. It's a lifetime commitment; it's like buying a piece of a farm or a piece of a McDonald's franchise.
"They vary: Some are very sophisticated in business and some don't know anything about business, but just trust us. We try to have something for both sides. People who just trust us just come and they feel good about being there. I don't think they are interested in hearing the nuances of fiscal policy. At the other end of the spectrum, we will have a large mutual fund and 30 analysts. We get a lot of those people and it's fun for us, and I think it's fun for them to discuss some of the same stuff we are discussing here."
Shareholders vs. stakeholders
Let's talk about philanthropy and corporate social responsibility. Michael Porter, in a piece in the Harvard Business Review last month, wrote that capitalism and corporate responsibility need fixing. He advocates they stop fixating on their margins and start sharing value with the community and with the environment. Do you feel that companies can look at themselves as corporations for all stakeholders, not only shareholders?
"No, we look to shareholders. We also show shareholders what they gain from the business that looks at society, but that's certainly up to them. We certainly encourage behaving responsibly, but in terms of allocating the shareholders' funds to other causes, I do not feel that's our function in any way. Not at all. I do feel so with my own funds, and I know a number of our shareholders are incredibly philanthropic ... But I do not think it's my job to take the money of the owners and reallocate it according to my desires."
You talk a lot about investing in companies that have a "moat" around them. When I look around, specifically in our country, but probably it is also true in other places, like the U.S., some of the most significant moats built around companies are also linked to antitrust issues.
" We have a utility operation, a substantial one, in the United Kingdom. And they give us a monopoly in the distribution of power, but they also put a limit on what we can earn. That's perfectly reasonable. If you were given a monopoly by a sovereign then it should be ample enough to encourage investment, but not ample enough to gouge the public. That principle is pretty well established in the industries in which we operate.
"I don't even know how to use these products that Apple comes out with, but obviously they are blowing away the competition, but that's because they are a better product. Coca-Cola has been around since 1886. People like to drink it. We're not forcing anyone to drink it. So you can say it is a monopoly, but you have total choice. All the same, it would be really hard for me to stop drinking Coca-Cola after all these years. I don't see many monopolies. I see companies that have developed strong reputations for their companies or products.
"Wal-Mart is a terrific business. It competes every day with all kinds of competitors, and the fact is that they do their business well and got big and make good money, but they're not a monopoly in any respect. No one has to walk into a Wal-Mart store."
Does Wall Street bear a resemblance to the robber-baron era of a century ago?
"The robber-baron era operated by a different set of rules. We had to curb certain practices that give people economic power. I would say the rules have been refined over the past century or so to curb abusive practices. I don't think that means people don't do that now. I mean, they go to jail or they get fined very substantially if they do. I am sure price-fixing from 150 years ago, people still do it, but if they do it, they get caught and they go to jail."
When you look at the amount of leverage and power that the business sector had in Washington 100-150 years ago and you look at it today, what do you see?
"Well, if you go back 100, 150 years ago at the railroads, there was plenty of political influence from the rich. The rich, and the non-rich, will try and exert political influence.
"Every line in the tax code is there because someone was fighting for it. The people who care about that line are concentrated and focused on it, and people who are affected by that line are diffused and really not even aware of it. In a democracy there are always going to be a lot of attempts to use political influence. It is up to the democracy to prevent that from getting extreme for any group. Money plays a part, but a cohesive voting group takes a part, and the only thing more important than politics and money is votes."
Going back to philanthropy, you and your friend Bill Gates decided to give most of your money to philanthropy, and then a year ago, you decided to make it a public campaign. What made you do this?
"Well, we talked to people, wealthy people, we saw that they had a lot of common interests and questions about philanthropy and they would be interested in associating with others to learn about it. We also felt that, to the extent that a large number of wealthy people would pledge half their net worth to philanthropy, that that would have an influence on others.
"We all work from example in one way or another. It won't happen overnight, but if a large number of wealthy people explain why they do philanthropy and how they do it, it means that the people who become rich 40-50 years from now will perhaps be more inclined to think about philanthropy and will maybe engage in it earlier than would otherwise be the case. And we have had a good response."
Do you think that the rich should look at philanthropy the way they look at their businesses and expect the same effectiveness, management tools, strategies, direction, benchmarks and so forth?
"It's a tougher game. In business, you are looking for easy problems. In philanthropy you are looking for very tough problems. If you are doing serious, big philanthropy, you are looking at problems that defied intellect for a long time and people have known they were important. So you've got to expect way more failure.
"In my letter to my children, when I set up their philanthropic institutions, I said, if all your efforts are successful - then you are a failure, because it just means you are doing easy things that society would get done anyway. But aside from the fact that you're tackling way harder problems, the second problem is you do not have a market system feedback. You set up a hamburger stand, and you are turning out lousy hamburgers, you will know it by the end of the day. In philanthropy, if you are doing something dumb, you will have people encouraging you to do more of the dumb thing. So, it has no market feedback, and that's a huge issue."
So how can you measure your performance?
"You are also attacking things where you may not know your performance for 10-20 years. It's not like rolling out a marketing campaign on a new iPad, where you know instantly whether you've got something worthwhile. It's a tougher game in terms of measurements, in terms of percentages and in terms of successes. That doesn't mean that it isn't an important game or a worthwhile game."
'Bill Gates and I'
When you started investing more of your time in philanthropy and talking about it more, did you start to study it as you look at businesses? Did you develop models of looking at things, or did you just decide to give your money to professionals in that field and hope they are doing the right thing?
"Well, we thought about this, my wife and I jointly, already 50 years ago. I always felt I was going to be rich, and I would have everything that I needed, but I would also have a lot left over, and somebody would need it so we developed our philosophy on it when we were in our 20s. We didn't have any money, but we had a philosophy. My feeling was I would come on money at a far greater rate than most people, and therefore it paid to wait for what I could do with billions."
When you were in your 20s you thought about billions of dollars?
"Well, I did. She didn't believe me, but that's another question. But we talked about it a lot. I knew she would outlive me, women are very active, and she would handle it. But then when she died first, I had to change my plans and you go back to Adam Smith and the specialization of labor, and I felt just like people who felt I could manage their money better in making money.
"I felt like there were people who were set up and had the time and energy and the youth, in some cases, to do a better job managing the money effectively for other people than I could. It was a modification of something, when originally my wife would have done it."
What do you recommend to your wealthy friends when they start thinking about philanthropy?
"I tell them that they are better off making their decisions early on than later. Rich people live longer than most people and it's the last will that counts. And if you are going to be 95 with a young blonde sitting on your lap, it is probably not the best time to be thinking about what you are going to be doing with your money. So think about it earlier on and decide really what your plans are.
"And I say, take care of everything you need yourself. The people I am talking about have a lot left over. Then try and figure out the way to improve the lot of the people in this world. If people have been touched by a given illness in their family, they are going to focus on that. If the school they went to made a real difference in their life, they are going to want to focus on that.
"Bill and I make no recommendations to people as to what they do even when they do it, although I would be inclined to say there is some advantage in doing it earlier. In my case, by 10 years after they settle on my death, all my money will be spent. It can't go to institutions where they put it in endowments, it has to be spent. I would rather have the people I've selected during my lifetime handling it than some unknown person 30 or 40 years hence."
And how do your kids feel about it?
"My kids feel terrific about it. For one thing, I have included them in it. They, in effect, each have a foundation, each one of the three. he spending power of having a billion dollars in it roughly; they get to give away $50 or $60 million a year.
"All three of them not only work with the money, they work with their own energies and I am not on the board of any of their foundations and I don't judge whether A does better than B. I am very confident about all three of them, and I am enormously pleased with how it has gone so far."
How did technology change your lifestyle?
"I love a computer. One of the trick questions Bill Gates and I ask when we're doing a performance together is which one of us spends more time on the computer, excluding e-mail. The answer is me. I play bridge all the time on the computer and I am always looking up stuff.
"Another thing I point out, I love playing for my own use, and it may cost me a million or a million and a half a year. Having a computer, I don't know what it costs me a year, but probably 50 bucks a year. If I had to give up one or the other, I would probably give up the playing."
Do you use e-mail?
"No. E-mails come to me through my assistant. I am not interested in doing e-mails, but I love having them available."