Berkshire Hathaway 2017 Annual Meeting Audience Question # 49

The valuation of a business is not reducible to any formula

Warren Buffett:

OK. Section 5.

Audience Member:

Thank you, and good afternoon. I’m Adam Bergman with Sterling Capital in Virginia Beach, Virginia.

Earlier today, Mr. Munger commented on the valuation of China versus the U.S. market.

My question for you is, are market cap to GDP and cyclically adjusted P/E still valid ways to consider market valuation? And how do those influence Berkshire’s investment decisions?

Thank you.

Warren Buffett:

Charlie, I think… well, I expect that I guess Charlie’s overall valued in China.

I would say that both of the standards you mention are not paramount at all in our valuation of securities. It’s harder…

People are always looking for a formula. And there is an ultimate formula, but the trouble is you don’t know what to stick in for the variables. But the…

And, you know, that’s the value of anything, being the present value of all the cash it’s ever going to distribute. But the P/E ratios… I mean, every number has some degree of meaning, means more sometimes than others.

Valuation of a business is… it’s not reducible to any formula where you can actually put in the variables perfectly.

And both of the things that you mentioned get… themselves, get bandied around a lot.

It’s not that they’re unimportant. But sometimes they’re… they can be very important.

Sometimes they can be almost totally unimportant. It’s just not quite as simple as having one or two formulas and, then, saying the market is undervalued or overvalued or a company is undervalued or overvalued.

The most important thing is future interest rates. And, you know, and people frequently plug in the current interest rate saying that’s the best they can do. After all, it does reflect a market’s judgment.

And, you know, the 30-year bond should tell you what people who are willing to put out money for 30 years and have no risk of dollar gain or dollar loss at the end of the 30-year period.

But what better figure can you come up with? I’m not sure I can come up with a better figure.

But that doesn’t mean I want use the current figure, either. So, I would say that…

I think Charlie’s answer will be that he does not come up with China versus the U.S. market based on what you’ve mentioned as yardsticks. But, no, Charlie, you tell them.

Charlie Munger:

All I meant was that… I said before that the first rule of fishing is to fish where the fish are… is that a good fisherman can find more fish in China if your… if fish is the stock market. That’s all I meant.

Warren Buffett:

Yeah. One… I’m going to go back to one…

Charlie Munger:

It’s a happier hunting ground.

Warren Buffett:

This doesn’t really directly relate. Just going… I want to go back to one question that was mentioned earlier.

I really think if you want to be a good evaluator of businesses… an investor… you really ought to figure out a way, without too much personal damage, to run a lousy business for a while.

I think you learn a whole lot more about business by actually struggling with a terrible business for a couple of years than you run by… than you learn by getting into a very good one where the business itself is so good that you can’t mess it up.

I don’t know what… I don’t know whether Charlie has a view on that or not. But it’s certainly
…it’s… it was a big part of our learning experience. And I think a bigger part, in a sense, than running… being involved… with good businesses was actually being involved in some bad businesses and just seeing…

Charlie Munger:

How awful it was.

Warren Buffett:

… how awful it is, and how little you can do about it, and how IQ does not solve the problem, and a whole bunch of things.

It’s a useful experience. But I wouldn’t advise too much of it. Would you think so, Charlie? Or…

Charlie Munger:

It was very useful to us. There’s nothing like personal, painful experience if you want to learn. And we certainly had our share of it.

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