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Q: Question about investing in Ethanol Buffett: We don't know how to figure out what the returns on invested capital would be for an ethanol project over the next 5 to 10 years. It a lot easier to predict how many people will be drinking Cokes or eating candy. It is easy to raise money for ethanol projects today because its a hot area. This probably a reason to be cautious. My son heads the state of Nebraska Ethanol board and if he starts getting richer than me, I'd be interested. Its pretty clear that ethanol and interest in Ethanol will be growing in the years to come but I don't see that path to developing a sustainable competitive advantage since it is a commodity business Munger: .It take more energy to create ethanol than the ethanol itself so I think it is a stupid way to meet our energy needs (its more inefficient) Q: Question about whether there is a commodities bubble Buffett: .Commodities markets like energy, precious metals and oil have all had big moves in price. Copper has been the biggest of all. Most trends start out based in fundamentals related to supply and demand, but eventually there comes a point when speculation begins to take over. "What the wise man does in the beginning, the fool does in the end". Price action eventually attracts speculation and eventually the speculators dominate the price action. I would guess that there has been significant speculation in commodities. We bought our Silver position too early and we sold too early. We are not that great at taking advantage of trends. In our investments, if we get the fundamentals right, we generally will make some money. But booms get wild towards the tail end. Its like Cindarella at the ball before the clock strikes midnight. You know that everything is definitely going to turn to pumpkins and mice so Cindarella should leave in advance. But you are having so much fun and the temptation is there to stay for just ONE MORE dance. The other big problem is that there are no clocks on the wall to tell you when the party will end. Just like with Internet stocks in 2000 and uranium in the 1050s, its easy to get caught when everything turns back to pumpkins and mice again.
Q: Question about opportunities to invest in Emerging Markets like South America Buffett: .Since we have to put a lot of money to work, emerging markets are not that feasible for us. For a good opportunity we want to put several hundred million dollars into it, and that would move prices too much in most emerging markets. We invested in PetroChina 5 years ago and despite the relatively large size of the company we only got to buy a $400 million stake that is now worth a couple billion. We aren't afraid of China, but if we decide to do something there, it has to be at a higher return since we don't know as much about the game there. Opportunities in emerging markets have to be cheaper than the US to be attractive to us to make up for our ignorance of tax laws, government regulation, etc. Q: Question about the outlook for manufactured housing Buffett: .Manufactured housing is an interesting business. Volume today is lower than it was 30 years ago even though the quality of the homes is better. A while back, 20% of homes that we built were manufactured housing, but last year it was only 6 to 7% of new homes. Manufactured homes only cost about $45 per square foot but there is quite a bit of resistance to manufactured housing because of restrictive zoning laws supported by local builders. In some areas, entire subdivisions are being built using manufactured homes. A few years ago, these homes were being sold irresponsibly. Dealers would get a down payment and rest of money was loaned. Since the loans were being securitized and sold to investors, there was an absence of discipline in terms of extending credit. Also, unless the borrower owns the land under the home, the financing of a manufactured home should be much shorter term. The uneconomic practices of the industry eventually came home to roost and led to a hangover that we are still working through. The market will get bigger eventually. Our major subsidiary in this sector, Clayton Homes, has a much better track record that most of the other competitors. Munger: One issue for manufactured homes is that builders of stick built (i.e. those built on site) have become much more efficient. This efficiency was enhanced by products and technologies like those made by our subsidiary MiTek. Still, over time, manufactured housing will get bigger and better and take a greater share of the market. Buffett: .I think the industry will deliver 200,000 years per year someday, but not in the next couple of years. One of the key issues is how to set up the transaction so that the asset backing the loan is worth more in 5 to 10 years than the loan that is financing it. Clayton could be the biggest homebuilder by units in the US in a few years time. It is interesting to note that some of the sins that hurt manufactured homes so badly a few years ago are being repeated in the last couple of years in the stick-built homes market. Today there is uneconomic credit being extended and odds are that it will eventually lead to trouble in that sector as well. Poor lending always has consequences, but it can take years for the symptoms and problems to appear. Commercial finance when through a similar phase in the late 1980s and early 90s. It has happened in commercial finance and then manufactured housing and now in residential real estate finance. Go through the Qs and Ks of residential lenders today and you'll see that the balances of interest accrued but not yet paid is increasing and the numbers are big! Munger: bad accounting is facilitating a lot of this uneconomic behavior Q: Question about residential real estate market in the US Buffett: .I once invested in property in California and it took 20 years to get my money back. After developing the property we got back $5 to $6 million. It was in a great climate, good location and on the water. Even in real estate and land that is well located and attractive, there can be large swings in value. On our residential real estate brokerage business (Home Services of America), we are seeing a broad based slowdown in just about every market. Those markets which were previously the hottest are slowing the most, especially the high end properties and especially areas in which people purchased for speculation/investment rather than to live in as a primary residence. In some areas where there wasn't much speculation and where affordability is still high, there wont be much of a contraction. For people you live in a property, if the price falls, there tendency will be to keep paying the mortgage anyway, but investors/speculators wont have the same staying power. In real estate, downward price adjustments come more slowly, because owners can be in denial or because they figure that they will get lucky and find that one buyer who is willing to pay their price. The housing boom has been great for home furnishings retailers like Nebraska Furniture Mart. During the Annual meeting weekend, we should do about $30 million in sales (about the level of a normal month of volume). The equivalent number was only $5.5 million in 1997 and $17 million in 2003
Q: Question about the $40 billion of cash and whether it should be invested or paid out to shareholders in the form of a special dividend Buffett: .At the end of March, we had $37 billion. Since a normalized level (for example to make sure we can handle any large super-catastrophe insurance claims) would be about $10 billion, we could invest the rest. We just spent $4 billion on the ISCAR acquisition. I'm looking at one idea that is a low probability but that could use us $15 billion of cash. I don't know whether it will come to fruition [Ed note: Could he be talking about Wrigley - WWY? - just a wild guess with not evidence to back it up. However, $15 billion would be a 10 to 12% premium to the current market capitalization and Wrigley is just the type of franchise that would be interesting to Buffett. Also, there are not that many companies of this size that meet his criteria]. We don't like holding cash earning a low return, but we like making dumb investments even less because given my personality, I tend to hold on to things so if I make a bad investment, we will be stock with it forever. Its likely that three years from now, we will have a lot less cash because we will have found attractive investments in the interim. We have a great credit profile and this (and the cash) is a strength that gets us more insurance business, but we don't need to be THIS liquid.. Munger: Go back to our annual report 10 years ago. You'll notice that in the decade since, we have managed to bring a lot of great companies into Berkshire so we are not entirely gloomy about our prospects going forward. Q: Question about Coca-Cola Company and Berkshire's position in it Buffett: .Coke is a great company. It sold 21 billion cases in 2005 and that number goes up every single year. In 1997/98 the stock was trading at $80 per share [Ed not, KO is now trading at around $44 per share - declined 45% or so]. In 2005, the company earned $2.17 per share and the earning in 2005 were of a higher quality than back in late 1990s. Each year, Coca cola grows its share of the pie of liquids that people consume around the world. The company earned about $6 billion on tangible assets of around $6 billion, so a 100% pre-tax return on tangible capital employed make Coke a pretty attractive/exceptional business franchise.
However, it is clear that in the last 1990s, the stock price was crazy and
it is not the company or its mangement's fault that the stock price got so
far ahead of itself. Long-term, its a wonderful business because
volumes can grow about 5% every year even though global population on grows
2%. Its my fault that we did no sell any stock when the price was
irrationally high, but I tend to stick to things and we'll own Coke many
years from now. |
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