Berkshire Hathaway 1994 Annual Meeting Audience Question # 3

Minimum after tax free cash flow yield Warren would look for when buying a business

Warren Buffett:

Zone 3.

Audience Member:

Good morning. My name is Howard Bask and I’m from Kansas City. And I’ve got a theoretical value question for you.

If you were to buy a business and you bought it at its intrinsic value, what’s the minimum after tax free cash flow yield you’d need to get?

Warren Buffett:

Well, your question is if we were buying all of a business and we’re buying at what we thought was intrinsic value, what was the minimum…

Audience Member:

Correct.

Warren Buffett:

Present earning power or what the present… the minimum discount rate of future streams?

Audience Member:

No, what’s the minimum current after-tax free cash flow yield you’d…

Warren Buffett:

We could conceivably buy a business…

I don’t think we would be likely to… but we could we could conceivably buy a business that had no current after-tax cash flow.

But, we would have to think it had a tremendous future.

But we would not find… obviously the current figures, particularly in the kind of businesses we buy, tend to be representative, we think, of what’s going to happen in the future.

But that would not necessarily have to be the case. You can argue, for example, in buying stocks, we bought GEICO at a time when it was losing significant money. We didn’t expect it to continue to lose significant money.

But if we think the present value of the future earning power is attractive enough compared to the purchase price, we would not be overwhelmed by what the first year’s figure would be.

Charlie, you want to add to that?

Charlie Munger:

Yeah. We don’t care what we report in the first year or two of… after buying anything.

Audience Member:

…on average over the years… (The audience was off mic so this part was not clear)

Warren Buffett:

Well, I would say that in a world of 7 percent long-term bond rates that we would certainly want to think we were discounting future after-tax streams of cash at least a 10 percent rate.

But that will depend on the certainty we feel about the business. The more certain we feel about a business, the closer we are willing to play it.

We have to feel pretty certain about any business before we’re even interested at all. But there are still degrees of certainty, and…

If we thought we were getting a stream of cash over the next 30 years that we felt extremely certain about, we would use a discount rate that would be somewhat less than if it was one where we thought we might get some surprises in five or 10 years… possibility existed. Charlie?

Charlie Munger:

Nothing to add.

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