Berkshire Hathaway 2013 Annual Meeting Audience Question # 37

Evaluate a business by its entirety, not just by its financials

Warren Buffett:

Station 1.

Audience Member:

Hi, Warren and Charlie. My name is Vincent Wong from Seattle.

When people analyze a stock, a lot of them look at quantitative metrics, such as P/E ratio, return on equity, debts-to-asset ratio, et cetera.

So, Mr. Buffett, when you analyze a stock for purchase, what’s your top five quantitative metrics that you looked at, and what’s your preferred number for each metric? Thank you.

Warren Buffett:

Well, we’re looking at quantitative and quality… we aren’t looking at the aspects of the stock, we’re looking at the aspects of a business.

It’s very important to have that mindset, that we are buying businesses, whether we’re buying 100 shares of something or whether we’re buying the entire company. We always think of them as businesses.

So when Charlie and I leaf through Value Line or look at annual reports that come across our desk or read the paper, whatever it may be, that, for one thing, we have a… we do have this cumulative knowledge of a good many industries and a good many companies, not all by a long shot.

And different numbers are of different importance… or various numbers are of different importance… depending on the kind of business.

I mean, if you were a basketball coach, you know, you would… if you were walking down the street and some guy comes up that’s 5′4″ and says, you know, “You ought to sign me up because you ought to see me handle the ball,” you would probably have a certain prejudice against it. But there might be some… one player out there it made sense on.

But on balance, we would say, “Well, good luck, son, but, you know, we’re looking for 7- footers.” And then if we find 7-footers, we have to worry about whether we can get them halfway coordinated and keep them in school, a few things like that.

But we see certain things that shout out to us, look further or think further.

And over the years, we’ve accumulated this background of knowledge on various kinds of businesses, and we also have come up with the conclusion that we can’t make an intelligent analysis out of… about all kinds of businesses.

And then, usually, some little fact slips into view that causes us to rethink something. It was mentioned how I got the idea about buying the Bank of America… or making an offer to Bank of

America on a preferred stock… when I was in the bathtub, which is true.

But the bathtub really was not the key factor.

The truth is, I read a book more than 50 years ago called “Biography of a Bank.” It was a great book, about A.P. Giannini and the history of the bank. (you can get a copy of the book here)

And I have followed the Bank of America, and I’ve followed other banks, you know, for 50 years.

Charlie and I have bought banks. We used to trudge around Chicago trying to buy more banks in the late ’60s.

And so, we have certain things we think about, in terms of a bank, that are different than we think about when we’re buying ISCAR. And so there is not one-size-fits-all.

We have certain things we think about when we’re buying an insurance company, certain things we think about when we’re buying a company dependent upon… that depended upon… brands.

Some brands travel very well, Coca-Cola being a terrific example, and some brands
don’t travel.

And, you know, we just keep learning about things like that, and then every now and then we find some opportunity.

The Bank of America… whenever it was… in 2011… was subject to a lot of rumors, terrible… I mean, lots… big short interest, morale was terrible, and everything else. It just struck me that an investment by Berkshire might be helpful to the bank and might make sense for us.

And I’d never met Brian Moynihan at that point… maybe I’d met him at some function, some party of something, but I had no memory of it… and I didn’t have his phone number but I gave him a call. And things like that happen.

And it’s not because I calculate some price… precise… P/E ratio or price-book value ratio or whatever it might be.

It is because I have some idea of what the company might look like in five or ten years, and I have a reasonable amount of confidence in that judgment, and there’s a disparity in price and value, and it’s big.

Charlie, would you like to elaborate?

Charlie Munger:

We don’t know how to buy stocks just by looking at financial figures and making judgments based on the ratios.

We may be influenced a little by some of that data, but we need to know more about how the company actually functions. And anything a computer could be functioned to do, in terms of screening… I know I never do it. Do you use a computer to screen anything?

Warren Buffett:

No. I don’t know how to.

Charlie Munger:

No. Bill’s still trying to explain it to me.

Warren Buffett:

I… we… you can… it’s a little hard to be precise on, because we don’t really use screens… (the sound in this part of the video is inaudible) were screening everything. But it’s not like we sit there and say, you know, we want to look at things that are below the price of book value, or low P/Es, or something of the sort.

We are looking at businesses exactly like we’d look at them if somebody came in and offered us the entire business, and then we try to think, what is this place going to look like in five or ten years, and how sure are we of it.

And most… a lot of companies, you know, we just don’t know the answer to it. We do not know which auto company is going to, you know, be knocking the ball out of the park ten years from now or which one is going to be hanging on by its fingernails.

You know, we watched the auto business for 50 years, a very interesting business, but we don’t know how to… we don’t know how to foresee the future well enough on something like that.

Charlie Munger:

We think that the Burlington Northern will have a computer… a competitive…advantage 15 years from now, with a high degree of confidence. We would never have that degree of confidence about Apple, no matter what their financial statement showed.

Warren Buffett:

No.

Charlie Munger:

It’s just… it’s too hard.

Warren Buffett:

Yeah. We don’t know about an oil company ten years from now, you know, in terms of what the product will be selling for or anything.

I would say we’re… you know, we’re virtually 100 percent confident about a Burlington Northern, or a GEICO, or some other companies that I won’t name.

Charlie Munger:

People with very high IQs who are good at math naturally look for a system where they can just look at the math and know what security to buy. It’s not that easy.

You really have to understand the company and its competitive position, and the reasons why its competitive position is what it is, and that is often not disclosed by the math.

Warren Buffett:

Yeah. It’s not what I learned from Ben Graham, although the fundamentals of looking at stocks as businesses, and the attitude toward the market and all that, is absolutely still part of the catechism.

But I wouldn’t… I don’t know exactly how I would manage money if I was just trying to do it by the numbers that…

Charlie Munger:

You’d do it poorly.

Warren Buffett:

Yeah. That takes care of that.

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