Are Your Beliefs Blown Up Yet?
Board: Berkshire Hathaway
Well this one is going to be hard. Munger said that a year gone by without blowing up one of your most sacred, best-held beliefs means a wasted year. And I would submit that to achieve just one means trying on tons more. Most of your best held beliefs are such that you have thought them through time and time again and over time you even get emotionally attached. How many times do we see writers or journalists or politicians or CEOs commit to something and even after all contrary evidence they just can't let go. Commitment bias. The human urge is to double down. With that preamble, I am going to try to blow up my best stock idea - Berkshire Hathaway. Many of us here are emotionally attached to the company and we have utmost respect for our leadership team. Some of you have held the stock for nearly half a century. In blowing up a beloved idea I conclude that the best way to go about it is to try to detach, remove emotion, and viciously attack one's assumptions. The facts or what we think are facts we all know but facts do change and our interpretation of those facts are a dynamic process. My experience working a few years in military intelligence is that the analytical mistakes most often derive from flawed or altered assumptions (opinions). No matter how many numbers or how many statistics mankind tries to throw at a problem - there are ALWAYS underlying assumptions that come with the data. That’s also almost always the best place to attack. To be fair, one’s assumptions might just be flawed from the beginning and should have never existed in the first place. Some of mine may be like that or perhaps I misinterpreted Buffett or Munger in the past and was flawed from the beginning.
That said, I am going to list TEN of my most hard-core basic assumptions for Berkshire and others will no doubt see some error on my part. They are not rank ordered in importance. I ask (beg) that if you find fault with mine then please whack away and challenge - after all, I'm trying to blow up my belief structure and Happy Talk isn't going to cut it. If I’m wrong, then it certainly helps to know! The only way to do this is to be brutally honest… As the Geico commercial that drives me up the wall says, Hit it Mr. Butters:
ASSUMPTION #1 - Warren Buffett is rational, wise, and has the best interests of Berkshire Hathaway in mind.
CHALLENGE TO ASSUMPTION #1 - One of my absolute, unshakeable, best held beliefs and truths (born out by tons of factual evidence) is that WEB is a rational, careful, logical man and will conduct his affairs as such. He has historically had an unwavering concern about both his and Berkshire's reputation. "We can not afford to lose one SHRED of reputation." By that he's mostly talking about ethics of course but I think it also goes a bit beyond just ethics - business and personal reputation. With that said, his NY Times OpEd on tax policy, apparent permission for an unpopular Obama administration to attach his name to a tax policy, and open commitment to do campaign fund raisers struck me to the core. It seems blatantly partisan (by definition - not rational) and in my opinion opens him up and to a lesser extent Berkshire to being a lightening rod for criticism - that just can‘t be good for business. The ensuing and still unfolding outcome was obvious from the moment it began....
RESULT - My basic assumption of his rationality and logic just blew up into a million Glenn Beck videos and blog jokes. I keep having this vision: Two outs. Bottom of the 9th and bases loaded folks!! What a game! Berkshire leads 4-1 and Buffett needs one more out to seal the victory. Glenn Beck batting, full count!! Buffett winds, he pitches.......and ...…(SMACK!!)....... Oh My!!! Loooooooonnnnggggg DRIVE! DEEEEEEEEP LEFT! It could be!! It...it.... It IS!!! It's GONE! A GRAND SLAM by Glenn Beck! GAME OVER! Look at the replay - Looks like an 82 mph Fat Pitch down the middle of the plate that anyone could hit!!
(warning for Berkshire fans - ask the children to leave the room - it's bloody and gruesome)
That’s a reputation hit played out to probably half of America and it’s going to last for the next 18 months or so. Fun times.
ASSUMPTION #2 - The massive stash of cash and bonds will be unleashed into the teeth of chaos and aggressively buy great companies at attractive prices and set Berkshire up for a decade or more.
CHALLENGE TO ASSUMPTION #2 - The market meltdown of 2008-2009 was the EXACT scenario I had been waiting for - for years! Anyone following Buffett and Munger’s speeches and writings knew it was coming and that it would hit the financial sector hard and bring down the whole market. It unfolded as predicted. I remember my excitement at watching all the CNBC prattling optimists melting down on TV. They were in panic. It was perfect!! Berkshire was going to seize the day!! Yet - With no notice, no warning, and a less than thorough explanation, our reserve cash requirement was apparently doubled from $10 to $20 billion. What!!? There goes $10 billion. The bonds! The bonds! Munger had previously mentioned that we could unwind bonds. Of course! Billions would be unleashed into the panic and fear!! Didn’t happen. The warrants, in Buffett's defense were great deals and were a master stroke. By their nature, they are a temporary thing and are being unwound. They did not fundamentally alter our cash/bond “problem“ and transform the company. We still retain the equity upside of course. Yet, I left March 2009 disappointed in our performance overall - and not just a little. And if BRK could not move in a big way then (regulatory interference?) then that removes a big reason why I have maintained such a large ownership position. Buffett subsequently announced buy of BNI in November 09. Was that why they held back? Did Buffett get a call from regulators which forced his hand about reserving? I don’t know. My #2 Assumption is on shaky ground.
RESULT - Assumption #2 is less than certain and the whole thesis is in question
ASSUMPTION #3 - The S&P contrcts are a great deal and though adding to volatility will have great results for Berkshire.
CHALLENGE TO ASSUMPTION #3 - Baseline assumption was that it is a great deal and over time will add a lot of money to Berkshire through compounding the premium. Buffett promised it would result in volatile reporting. That's been true in spades. I assumed that this would have negligible negative impact. Since we entered into these contracts our debt has been downgraded in large part due to volatility and possibility that we lose. Credit Default Swaps are now a larger part of our existence than before. BRK’s reported (paper) earnings are now tied a lot closer to overall market performance and that will be true for a long, long time. I am confident that we make a lot of money over time, but hate the symptoms they bring.
RESULT - Assumption #3 has certainly not been a non-event. Only time will tell whether the payoff of compounding adequately compensates us for the turmoil they have caused to our credit.
ASSUMPTION #4 - Burlington Northern will greatly add to our reported operating earnings, give us a great hedge against rising commodity prices, and fundamentally transform the company.
CHALLENGE TO ASSUMPTION #4 - N/A
RESULT - A great move for Buffett and for Berkshire shareholders. Am still waiting for all those hedge fund managers to publicly announce and recant their flawed analysis. They sure look stupid don’t they?
ASSUMPTION #5 - Perhaps Buffett’s greatest attribute is his ability to judge people. He is able to quickly and accurately judge character which removes layers legal expense and pain. Surrounding himself and the company with great people is perhaps Berkshire’s greatest advantage and key to Berkshire’s success and longterm prospects.
CHALLENGE TO ASSUMPTION #5 - We now have seen General Re senior executives doing nefarious things and criminally charged. We have culture run amok at Net Jets after the CEO let the culture get out of control. We have David Sokol. We have the shocking opt out of Lu (why?). And of course we also don’t know what we don’t know. Berkshire is a large, sprawling organization filled with thousands of people. Stuff happens. But judging those senior executives falls squarely to Buffett. We have at least four significant issues. - all handled well IMHO - but it raises concerns and challenges the assumption that the post Buffett era will be smooth sailing. The equity/bond portfolio managers? That is still developing as I type and seems to be progressing well. I love that Buffett is picking “No Name” guys and sticking it to the big name, high profile types who would love to do it.
RESULT - I definitely have reservations where before I did not. The absolute best skill of the CEO successor will be in picking the right people. That’s not so easy to see and measure. We just won’t know what we have until years after all is settled. A flaw in that area can have huge, legal, bad consequences.
ASSUMPTION #6 - The Equity/Bond portfolio managers will do well, but not as well as what Buffett would have done.
CHALLENGE TO ASSUMPTION #6 - N/A
RESULT - Way too soon to tell. I do think the relevance of these two has been diminished. If WEB couldn't buy stocks in the best opportunity in a lifetime then what benefit do these guys bring? Even if they're superstars which is still an open question their impact has been reduced IMHO.
ASSUMPTION #7 - Berkshire will allocate capital considering full opportunity cost comparisons and in a rational and meaningful way that best postures us for longterm out-performance.
CHALLENGE TO ASSUMPTION #7 - What’s good for Coke and PG and Johnson & Johnson et al isn’t OK for Berkshire? The stock is getting absolutely hammered, is straddling book value and if it’s the best company on earth as Buffett seems to think then it strikes one as questionable not to do meaningful share repurchases. As a shareholder I want the company to wisely deploy capital at meaningful times. No time like now or March 09 not to do share buybacks. I have never fully understood explanation as to why this doesn’t happen. Still makes no sense to me.
RESULT - Existing shareholders can pound sand and that’s just the way it’s going to be
ASSUMPTION #8 - Berkshire’s stable of insurance businesses will continue to write their policies with rational pricing and seize opportunity accordingly (Hurricane Katrina was absolute perfect execution).
CHALLENGE TO ASSUMPTION #8 - N/A
RESULT - Things have greatly improved with management overhaul at General Re and there is little reason to think that overall Berkshire won’t continue to have world class insurance underwriting for a long long time.
ASSUMPTION #9 - Berkshire is in large part a product of its strategic operating environment. All of the laws, regulations, rules, traditions, norms, stable currency policies and everything else that defines civil, capitalist society are such that Berkshire could grow into what it is today and continue to do so.
CHALLENGE TO ASSUMPTION #9 - I do not want to dive into a political, partisan dog fight but would hope that people can step back and take it all in and be objective. I have had major concerns in this area for years and believe that the entire system faces some dire threats - politically, ideologically, militarily, systemically. The risk profiles in all of these areas have increased DRAMATICALLY in my view as our former, stable, ASSUMED, world readjusts to a global power vacuum and China rises and Europe collapses and fiat currencies are depreciated to compensate. Anyone thought of massive solar flashes that crash the US power grid for months? All sorts of good juicy stuff.
RESULT - The environment is far less stable, far more unpredictable, far more dangerous. It’s Nassim Taleb’s Black Swan on roids. As our preexisting order is replaced by something less certain, I think it naïve to assume that it won’t impact us. We all have a right to be concerned and we have a duty to challenge the status quo thinking that all is OK. It’s the Optimists who died says Admiral Stockdale. Get a grip on reality.
ASSUMPTION #10 - As Berkshire grows it will become more of an international company
CHALLENGE TO ASSUMPTION #10 - I still consider the addition of Iscar to be the most exciting thing to happen to the company in my lifetime. I just love it. My hope for our new CEO is Wertheimer whom I consider to be our most talented Executive. He would be the perfect CEO to transform Berkshire into more of a global operation. I like everything about him from what I’ve read. Yet, since we’ve purchased Iscar Berkshire has become even more tied to the US currency (BNI had a lot to do with this). Munich Re notwithstanding a lot of new stock purchases have been domestic. Lu dropped out which removes my hope for seizing Chinese opportunities. I don’t like the recent trend.
RESULT - Trend is still very US focused and domestic. There is a definite American bias. Buffett’s trips to Europe to seek private business opportunities resulted in nothing I can think of. It’s disappointing.
CONCLUSION - That’s my list. Others will certainly have other Assumptions to add and will be able to attack my opinions on many of the above. I would add that by their very nature Assumptions are Opinions for better or worse. I think it best that things like this constantly evolve as time passes and new facts come to bear. I conclude that my preexisting assumptions WRT Berkshire, taken in aggregate, have been altered enough to change my overall opinion. I do not think that I was able to "Blow Up" Berkshire on this round. I believe that the RISK to the company - both internally and externally - has increased and not by a small amount. Especially with #9. That doesn’t mean that it’s still not the best company in the world or that it won’t turn out to be a “satisfactory investment” as Munger might say. It just means that I conclude that the risk of that not happening has increased. Fire away,