Berkshire Hathaway 2017 Annual Meeting Audience Question # 10

How interest rates affect the calculation of intrinsic value

Warren Buffett:

OK, Carol?

Carol Loomis:

This question is from Franz Tramberger of Austria. And it concerns intrinsic value, which is neither… Warren may rather… he may amend this, my definition here, but… which is neither a company’s accounting value nor its stock market value, but is rather its estimated real value.

So the question is, “At what rate has Berkshire compounded intrinsic value over the last 10 years? And at what rate, including your explanation for it please, do you think intrinsic value can be compounded over the next 10 years?”

Warren Buffett:

Yeah. Intrinsic value, you know, can only be calculated… or gains… you know, in retrospect.

But the intrinsic value pure definition would be the cash to be generated between now and Judgment Day, discounted at an interest rate that seems appropriate at the time. And that’s varied enormously over a 30 or 40-year period.

If you pick out 10 years, and you’re back to May of 2007, you know, we had some unpleasant things coming up. But we’ve… I would say that we’ve probably compounded it at about 10 percent.

And I think that’s going to be tough to achieve, in fact almost impossible to achieve, if we continued in this interest rate environment.

That’s the number one… if you asked me to give the answer to the question, if I could only pick one statistic to ask you about the future before I gave the answer, I would not ask you about GDP growth. I would not ask you about who was going to be president.

I would… a million things… I would ask you what the interest rate is going to be over the next 20 years on average, the 10-year or whatever you wanted to do.

And if you assume our present interest rate structure is likely to be the average over 10 or 20 years, then I would say it’d be very difficult to get to 10 percent.

On the other hand, if I were to pick with a whole range of probabilities on interest rates, I would say that that rate might be… it might be somewhat aspirational. And it might well… it might be doable.

And if you would say, “Well, we can’t continue these interest rates for a long time,” I would ask you to look at Japan, you know, where 25 years ago, we couldn’t see how their interest rates could be sustained. And we’re still looking at the same thing.

So I do not think it’s easy to predict the course of interest rates at all. And unfortunately, predicting that is embedded in giving a good answer to you.

I would say the chances of getting a terrible result in Berkshire are probably as low as about anything you can find. Chance of getting a sensational result are also about as low as anything you can find. So if I… I would… I…

My best guess would be in the 10 percent range, but that assumes somewhat higher interest rates… not dramatically higher… but somewhat higher interest rates in the next 10 or 20 years than we’ve experienced in the last seven years.


Charlie Munger:

Well, there’s no question about the fact that the future, with our present size is, in terms of percentages of rates of return, is going to be less glorious than our past. And we keep saying that. And now we’re proving it.

Warren Buffett:

Do you want to end on that note, Charlie? Or would you care to…

Charlie Munger:

Well, I do think Warren’s right about one thing. I think we have a collection of businesses that on average has better investment values than, say, the S&P average. So I don’t think you shareholders have a terrible problem.

Warren Buffett:

And I would say we probably… well, I’m certain… we have… we do have more of a shareholder orientation than the S&P 500 as a whole. I mean, for… you know, the…

This company has a culture where decisions are made for… as an owner, as a private owner would make them. And frankly, that’s a luxury we have that many companies don’t have. I mean, they’re under pressures today, sometimes, to do things.

One of the questions I ask the CEO of every public company that I meet is, “What would you be doing differently if you owned it all yourself?” And the answer, you know, is usually this, that, and a couple of other things.

If you would ask us, the answer is, you know, we’re doing exactly what we would do if we owned them all… all the stock ourselves. And I think that’s a small plus over time.

Anything further, Charlie?

Charlie Munger:

I think we have one other advantage. A lot of other people are trying to be brilliant. And we’re just trying to stay rational. And… it’s a big advantage. Trying to be brilliant is dangerous, particularly when you’re gambling.

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