242: Should You Let Warren Buffett Manage Your Money?

Automatic TRANSCRIPT

Walk in the money for the rest of us. This is the personal finance show on money. How it works? How to invest it and how to live without worrying about it? I'm your host, David Stein. Today's episode to forty two it's title, should you let Warren Buffett manage your money. Mass month. I got an Email from listener hairy. He wrote why not just by Berkshire Hathaway stock and let Warren Buffett manage your money. I admit I had never really looked at or a valuated berkshire-hathaway as a money manager for seventeen years. I worked as an institutional investment advisor. One of the things that I did is I evaluated investment managers. I would go on site. I would meet with them when I first joined our company we had what were known as the three Ps when evaluating particular manager, we look at their people the process and their performance laters. I spent years analyzing managers, I put it more in terms of attributes with my investment firm continues to us we look at conviction consistency pragmatism investment culture, risk control and active return. But really those three Ps are very good foundation. So this episode we're going to look at Berkshire Hathaway as an investment manager that we can hire by buying their stock. They have A-Shares which are really expensive three hundred and three thousand dollars per share or b B-shares which sell for two hundred dollars a share. So you could hire berkshire-hathaway for two hundred dollars to manage your money. First. Let's focus on people when you are researching and money manager you want to know who the team is selecting the securities. What's the experience, how do they work? Well, together, what's their investment culture? You go to the twenty eighteen annual report of Berkshire Hathaway, they list out their senior executives Warren Buffett. He's eight years old. He's the chairman and chief executive officer, Ben. There in that former role since one thousand nine hundred seventy next is Charles t Munger he's ninety five vice chairman since nineteen seventy eight. Then there's two new roles that, but it was really excited about in his annual letter he wrote before moving on and went to give you some good news. Really good news that is not reflected in our financial statements. It concerns the management changes we made in early twenty eighteen when I Jane was put in charge of all insurance activities and Greg able was given a thorny over all other operations. These moves were overdue. Berkshire is now far better managed than went. I alone was supervising operations Jeet and Greg have rare talents and Berkshire blood flows through their veins. They've had an adjustment in terms of their team with the addition, or at least the more formal roles of able and Jane when we met with and did conducted. Due diligence on investment managers that we ultimately would recommend to their clients. One of the sensitive issues was as the founding partners got older is what's succession plan. How will the next generation calm and continue the investment process? Buffet hasn't really outlined a true succession plan when he or Munger retire. He wrote in the annual letter for fifty four years, Charlie and I have loved our jobs daily. We do what we find interesting working with people we like and trust. And now our new management structure has made her life even more enjoyable with the whole and samba that is with a Gede and Greg running operations, a great collection of businesses, a Nagra castration, it cadre of talented managers and a rock, solid culture. Your company is in good shape for whatever the future brings throughout that letter. They talk about how Buffett and Munger evaluate companies evaluate stocks to purchase, and what becomes pretty clear if we're looking at Berkshire Hathaway as a money manager that able Jane are responsible for the operation in the operating companies that Berkshire. Owns. But in terms of new acquisitions, particularly new stock acquisitions that will talk about in terms of the process, it's very much Buffett and Munger doing the analysis which in terms of evaluating money manager that that that level concentration would cause us some concern in terms of people the lack of succession plan, and the fact that the senior team that is evaluating and making those investment decisions is what they're stoled. They're very good at what they do. They've been doing it for a very long time. But at some point they're not going to be there. And if you're hiring money manager, like Berkshire Hathaway you want that team to be there in that process to continue. Let's take a look at Berkshire Hathaway's investment process. What we're trying to identify here is in. Terms of how a money manager is researching securities do they have some type of informational edge a competitive advantage that allows them to identify mispricing price occurs that are selling for less than their intrinsic value. So that the manager can outperform a passive index fund. Are you paying your hiring money manager? You're paying a fee for them to to make good security selections that can outperform the market. So we wanna know how what's the process? How do they go about doing that? In the two thousand eighteen annual letter buffet wrote let me remind you of our prime goal in the development of your capital, the twenty I like about buffet he recognizes he's a steward of his shareholders capital. He talks about here's what you own. Here's what we're doing in deploying your capital. So it goes on and says the prime goal is to by Abeille manage businesses in whole or part that possess favorable and durable economic characteristics. We also need to make these purchases at sensible prices. Sometimes we can buy control of companies that meet our test far more often we find the attributes we seek in publicly traded businesses in which we normally acquire a five to ten percent interest. Sometimes they can buy the whole thing. They're buying businesses with. Favorable endurable economic characteristics. And they buy them at sensible prices buffet points out in the annual letter that Berkshire has more from a company who that was primarily invested in marketable stocks to one that owns operating businesses. And he says he expects the company to continue that reshaping in an irregular manner. Because he's he's finding a challenge the ability to purchase entire company's hits the prices are too high. And so they're finding more opportunity in buying individual stocks, but he really likes to buy businesses. He wrote even at our ages of eight and ninety five I'm the young one that prospect, a buying entire business is what causes my heart and Charlie's to beat faster. Just writing about the possibility of a huge purchase. Has caused my pulse rate to soar, unfortunately, they're just not been able to define that. They have a lot of money the cash there's over a hundred billion dollars in cash that Berkshire owns now not all that they some of its working capital, but they have the ability to to purchase shoot stakes if they can find that. But he says the immediate prospects for that are not good prices are sky high for businesses possessing decent long-term prospect that disappointing reality means that twenty nineteen we'll likely see again, expanding our holdings of marketable equities. We continue nevertheless to hope for an elephant sized acquisition. One of the challenges with with Berkshire Hathaway in looking at them as a money manager. Is it have a lot of capital if billions of dollars they have to put the work, which means it's harder to find those opportunities is not as small cap equity manager that's managing less than a billion dollars. This is a company was seven hundred billion dollars in assets and a hundred billion dollars in cash trying to deploy it they have to deployed at scale. So makes a difference. And they're having trouble finding those private businesses. So they're buying more marketable securities because they can put that capital to work. So how did they go about evaluating these companies in the twenty thirteen annual letter buffer wrote when Charlie I buy stocks, which we think of as small portions of businesses are analysis is very similar to that which we use in buying entire businesses. We I have to decide whether we can sensibly estimate an earnings range for five years out or more. If the answer's yes, we will buy the stock or business if it sells at a reasonable price in relation to the bottom boundary of our estimate. If however we lack the ability to estimate future earnings, which is usually the case, we simply move onto other prospects so buffet among other analyzing stocks, and they're coming up with earnings estimates. And deciding if the current valuation is justified by this earnings fact, is it cheaper is the intrinsic valued less. Expensive than what would be indicated by their ex patient expectations of earnings, very simple process hard to do which is why they're extremely talented at it. But that's what they're doing. One of Berkshire Hathaway's competitive advantage is this two prong approach to allocating capita. They can buy entire businesses or they can evaluate stocks and by five to ten percent of a business. That's the process when I was evaluating money managers. I would often ask to give me examples of investments that worked out with their gladly able to share. But more importantly, give these provide some examples of mistakes that you made and what you learn from them. And there's a very large mistake that Berkshire Hathaway has made in the last few years it involves craft Hines a food and beverage company in the twenty thirteen letter buffet wrote we've completed two large acquisitions spending almost eighteen billion dollars to purchase all of envy energy and a major interest in h j Heinz this purchase of h j Heinz was the largest acquisition. Berkshire Hathaway had made since two thousand ten when they purchased. Burlington Northern Santa. Affair railroads. Buffet continue both companies fit as well. And we'll be prospering based century from now with the Hines purchase. More of a we created a partnership template that may be used by Berkshire in future acquisitions of size. Here we teamed up with investors at three g capital, a firm led by my friend or hey Paulo. Lemon in this case then in order to because of the need to define these elephants sized transaction. They partnered with a private equity firm to purchase a controlling stake in a company. But the points out that that this Hines acquisition was similar to private equity transaction, but there was a crucial difference. He wrote. Berkshire never intend to sell a share the company what we like rather is to buy more and that could happen. Then in two thousand fifteen base j Hines merged with Kraft Foods to become the fifth largest, food and beverage company. That was in two thousand fifteen last week Kraft Heinz stock shares fell thirty percent. After they announced that fifteen billion dollar writedown, they cut their dividend payment and disclosed that they were subject to a pro by the security and Exchange Commission in regards to their accounting policies. Now that combined companies Kraft Heinz is worth half of what it was worth. When it started trading. Berkshire owns twenty six point seven percent of craft Hines. They took a three billion dollars impairment charge on their investment. And it was one of the largest quarterly losses in Berkshire's history. On CNBC buffet said flat out we overpaid for craft and we were wrong in a couple ways on crafts Heinz. He said we both missed judged the retail versus brand fight as to who would be gaining ground on the other. He mentioned that that Hines had been craft hundreds of years plus advertising. That are built into people's habits. And now they're seeing pressure from Costco's Kirkland brand buffet mentioned that Kirk Lynn or Costco, has seven hundred and fifty outlets, but they're Kirk limp. Brand Brandis fifty percent more business then crafts Hines, but he minute they overpaid. He said anything almost anything at a price can be good. But everything at a certain price can be bad. If you pay too much, you pay too much, and that doesn't change the business does not earn more because you pay more for it. So we bench they pay too much. And what are they going to do? Now, he says we don't pull the plug. They're going to stay invested in craft Hines. But this is important to recognize that that buffet among they're not infallible. They make mistakes, all and vestment. Managers skilled investment managers makes mistakes and the best manageable. Admit when they have made a mistake. The question is will they make better investments going forward to the ability to do that? And how well have they done in the past? What's the performance in? What is the proof that they are successful investment manager? And before we look at that proof. Let's pause and share some words from this week sponsors. When you're selling online getting orders out the door quickly can be tough. That's why you need ship station dot com. It's the fast and easy way to manage ship. 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Beginning of every annual report for Berkshire Hathaway, there's a table that shows the annual performance of Berkshire Hathaway stock relative to the SP five hundred as a measure of large company stocks. It's a US stocks. It's an it's a good comparison buffet writes just look at the fifty four year history laid out on page, two overtime. Berkshire stock price will provide the best measure of business performance, and it's done credible. The overall gain since nineteen sixty four is over two point four million percent Quaid's to twenty point five percent. Annualized return? Compared to nine point seven percent who the S and P five hundred. So it's a double that in two if that could continue that be wonderful, but we have to look at performance during a period when Berkshire Hathaway is much larger has billions of dollars of capital that it needs to invest, and so I use that same table to calculate returns over five ten fifteen and twenty years twenty year annualized berkshires stock has returned seven point six percent. Versus five point six percent for the annualized for this five hundred on an annualized basis. So not double. It's it's done. Two percentage points better on the fifteen year period to return nine percent annualized versus seven point eight percent for the S P five hundred for the ten year. It's underperformed it returned twelve point two percent vs. Thirteen point one percent for the S and P five hundred index, but it's outperformed of the most recent five year period Levin point four percent versus eight point five percent for the SP five hundred as an investor your option. You can't really invest in the five hundred you would invest in something like the vanguard total stock market index ETF VDI over that ten year period that did thirteen point three percent versus thirteen point one percent per this five hundred and then again, Berkshire to twelve point two percent. But that was through year end given this situation with Kraft Heinz. And the right down. And that Berkshire owns twenty six percent of the company and it fell thirty percent. If we look at performance through last Friday so February actually through yesterday, I'm recording this on Tuesday, February twenty six th through Monday, February twenty fifth and twenty nine thousand nine the fifteen year annualized return for Berkshire stock is eight point one percent versus the vanguard total stock market index fund has returned eight point seven. So it's it's trailed over the past fifteen years now when we we do that calculation through year end berkshires outperformed and that that's another evidence of of how n periods sensitive performance measure men is and so you need to look at it over different timeframes. But the reality is berkshires it's harder to outperform their a bigger company. And we see this with investment managers all the time as they become successful. They attract more assets, and it becomes more difficult to replicate that performance. So it it will be challenging going forward for Berkshire to outperform to the level that they did certainly not double what the S and P five hundred index is done, but the fast last five years, they've certainly they've outperformed by three percentage points, and that's excellent. Would I invest with Berkshire Hathaway if they were if this was a money manager, and I was meeting with them at their offices kicking the tires trying to understand the people the process the performance. Actually wouldn't. The big red flags would be the lack of a succession plan that this senior investment professionals are eighty eight and ninety five they're still in the trenches. They're the ones making the decisions doing the analysis of purchasing individual stocks. They have other senior professionals that are running the operating businesses, but at least from the annual letters. It's not clear that there's somebody else making those decisions. The second red flag is there's just too much money under management. That they've too much capital to deploy in that will lead to lower performance in the future now will outperform hopefully, credibly, well, but just objectively looking at them as a money manager. I wouldn't hire them to do that. But typically if buffet is not there anymore. Or among I'm gonna at some point. They just won't be fit says. But what would he do? Twenty thirteen. He says my money. I should add is where my mouth is what I advise here is essentially identical to certain instructions, I've laid out in my will my advice to the trustee could not be more simple. Put ten percent of the cash in short term government bonds and ninety percent and very low cost S and P five hundred index fund. I suggest Vanguards I believe that trust long-term results from this policy will be superior to those attained by most investors, whether pension funds institutions or individuals who employ hi fi managers. So even buffet didn't recommend his own stock upon his passing. He recommended an index fund. Which is interesting because Buffett is says diversification is a protection against ignorance, it makes very little sense for those who know what they're doing buffet among a class of their own brilliant, investors. Most of us are not. Buffett says the goal of the non-professional should not be depict winners. Neither he nor his helpers can do that. But should rather be own a cross section of businesses that in aggregate are bound to do. Well, a low cost S and P five hundred index fund will achieve this goal in closing buffet shared some other fundamentals of investing in his twenty thirteen annual letter you said you don't need to be an expert in order to achieve satisfactory investment returns. But if you aren't you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don't swing for the fences. When promise quick profits respond with a quick. No. And that's why I invest I don't try to invest like buffet I invest in diversified ETS. Sometimes I'll use active managers if I believe they have an informational edge. I continue to look at them. But the bulk of my assets are diversified index funds because I'm not an expert in estimating the earnings of individual companies and determining that they're selling for less than their intrinsic value. The also points out the importance of fact, figuring out the earnings, and what is the cash flow and basing our investment decision on those earnings estimates as opposed to focusing on just the price of the asset will go up for whatever reason he wrote if you instead focus on the perspective price change of a contemplative purchase, your speculating. There's nothing improper about that. I know whoever that I am unable to speculate successfully. And I am skeptical of those who claim to sustain success that doing so half of all coin flippers will win their first tossed. None of those winners has an expectation of profit. If he continues to play the game. And the fact that he'd given acid has appreciated in the past is never a reason to buy it. So we should never buy anything. Just because we think it'll go up in price and that for for certain assets. That's all we have crypto currency gold antiques. Art, it simply because there's no income no effective way to estimate its shoot your cash flow and earnings then it, that's what makes it a speculation. It's simply assuming somebody will pay more in the future. And it's not bad. It's just that should not be the bulk of our portfolio. Most of it should be investments that have earnings and cash flow that then is upset to forty two shooed you have Warren Buffett manage your money. I'd say no despite how good they have done. Are you want to two hundred dollars? You could use the Robin Hood app and buy a few shares of Berkshire be tried out. See how it goes? But not for the large percent of your portfolio. I wouldn't do that. Show notes for this sort of money for the rest of us dot com. 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