Berkshire Hathaway 2009 Annual Meeting Audience Question # 12

Berkshire was cheaper in relation to its intrinsic value at the end of 2008, than 2007

Warren Buffett:

OK, area 6. I recommend this fudge, incidentally. It’s terrific. I’m having a good time.

Audience Member:

Good morning. I’m Steve Fulton from Louisville, Kentucky. I gave up box tickets to the Kentucky Derby this afternoon to come out and ask you this question. Thank you for this opportunity.

My question relates to how you view, or what your view is of the market’s valuation of Berkshire’s shares.

You commonly comment that Berkshire has two primary components of value: the investments that they own… the stocks, the bonds, and similar… and the earnings from the non-insurance operating companies that you’ve got.

And when you compare 2007 to 2008, the investments were down about 13 percent. And the earnings were down about 4 percent. But the value that the market was placing on the shares was down about 31 percent. And I was curious as to your comments on that valuation.

Warren Buffett:

Yeah, well, I think you put your finger on something.

We do think that the… we think, obviously, the investments are worth what they’re carried for, or we wouldn’t own them.
In fact, we think they’re worth more money than they’re carried for at any given time because we think, on balance, they’re underpriced. So we have no problem with that number.

We define our earning power… we leave out insurance underwriting profit or loss, on the theory that insurance is… if it breaks even… will give us float, which we will invest. And on balance, I actually think that insurance probably will produce some underwriting profit. So I think we even understate it a little bit in that respect.

But we think the earning power of those businesses was not as good last year as normal. It won’t be as good this year as normal.

But we think those are pretty good businesses overall. A few of them have got problems. And… but most of them will do well. And I think a few of them will do sensationally.

So, I think it’s perfectly reasonable to look at Berkshire as the sum of two parts. A lot of liquid marketable securities… or maybe not so liquid, but at least fairly priced, or maybe even undervalued, securities… and a lot of earning power, which we are going to try and increase over time.

And if you look at it that way, you would come to the conclusion that Berkshire was cheaper in relation to its intrinsic value at the end of 2008 than it was at the end of 2007. But you would also come to the conclusion that was true of most securities. In other words, the whole level of securities.

And every stock is affected by what every other stock sells for. I mean, if the value of ABC stock goes down, XYZ, absent any other variables, but XYZ is worth less.

If you can buy stocks at eight times earnings, good companies, you know, or nine times earnings, you know, they… it reduces the value of Berkshire, as opposed to when stocks were selling, well, at 18 or 20 times earnings. I’m pulling those numbers out of the air.

But everything is affected by everything else in the financial world.

When you say a bird in the hand is worth two in the bush, you’re comparing it… you’ve got to compare that to every other bush that’s available.

So, you’re correct that Berkshire was cheaper in relation to intrinsic value at the end of 2008, than 2007, at least in my opinion.

And that that those two variables will count. We’ll report them to you regularly. And over time, we would hope that both increase.

And we particularly hope the operating earnings aspect increases, because that’s our major focus. We would like to move money into good operating businesses over time and build that number a lot.

Charlie?

Charlie Munger:

Well, I would argue that last year was a bad year for a float business. It was naturally going to make the owner of the float appear, briefly, to be at a disadvantage.

But long-term, having a large float, which you’re getting at a cost of less than zero, is going to be a big advantage. And I wouldn’t get too excited about the fact that the stock goes down.

I happen to know that there was one buyer there who rather inartistically bought about 10,000 shares when Berkshire was driven to its absolute peak. And how much significance does that have in the big scheme of things over the long term?

What matters are things like this: our casualty insurance business is probably the best big casualty business in the world… our utility subsidiary, well, if there’s a better one, I don’t know it… and if I had to bet on one carbide cutting tool business in the world,

I’d bet on ISCAR against any other comer.

And I could go down the list a long way. I think those things are going to matter greatly over the long term. And if you think that it’s easy to get in that kind of a position, the kind of position that Berkshire occupies, you are living in a different world from the one I inhabit.

Warren Buffett:

Yeah, our insurance business now, it is a remarkable business. And it’s got some remarkable managers.

There’s one interesting thing that’s happened. In September, when we had a financial meltdown and, really, almost the ultimate… it was almost the China Syndrome-type thing… Americans started behaving differently.

Probably people around the world, but I certainly know in terms of our businesses, it was like a bell had been rung. And one manifestation of it was kind of interesting.

Whereas it hurt very much our jewelry business, our carpet business, it hurt NetJets, it hurt all the businesses. Hurt American Express, for example. You know, the average ticket went down almost 10 percent.

I mean, it just was like that, that people’s behavior changed. But one of the things it did, was it also caused the phones to start ringing even more at GEICO.

And we didn’t change our advertising, particularly. Our price advantage, relative to other companies, didn’t change that much. But all of a sudden, just… it was remarkable. Thousands and thousands and thousands of more people came to our website or phoned us every week.

So, it… all of a sudden, saving $100 or $150 or whatever it might be, became important. Not only the people who were watching our ads that day, but just with the people that it was lurking in the back of their minds. They went to geico.com.

So in the first four months of this year… last year, we added about 665,000 policy holders. That’s a lot of people. It made us, by far, the fastest growing auto insurer among the big companies.

First four months of this year, we’ve added 505,000 in four months. It’s the behavioral changes. And that franchise, that competitive advantage, has been built up over decades.

And Tony Nicely has nurtured it like nobody else could, just day after day, office after office, associate after associate. But then it just pays off huge when the time comes.

Because we can… we are the low-cost producer among big auto insurance companies. That means we can offer the best value.

And now people are value conscious.

So these things are going on all the time with our subsidiaries, with those managers. And it’s… it builds a lot of value over time.

I mean, every GEICO policy holder is a real asset to the company. I could give you an estimated value. But I don’t think it’d necessarily be smart. But they’re worth real money.

And, we are now the third largest auto insurer in the country. I think we’ll end up the year maybe at 8 1/2 percent of the market.

And it was 2 and a small fraction percent back in 1993 when Tony took charge of the business. And the fundamentals are in place… to take us much higher.

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