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Special Report

A Quick Q & A With Warren Buffett

The day before Berkshire Hathaway’s annual meeting, Warren Buffett and Charlie Munger headed to Borsheim's, the massive Omaha jewelry store owned by Berkshire. They answered questions, mingled with shareholders, and signed autographs. (As Buffett noted in Berkshire's latest annual report, Charlie only smiles if the paper he signs is a Borsheim's sales ticket.) After an afternoon press conference, Buffett and Munger slipped into the office of Susan Jacques, the CEO of Borsheim's, for some one-on-one interviews. Morningstar quizzed the two men on their investment philosophy.

What is it that really piques your interest in a stock? What tells you that it could be interesting?
Buffett:
We’re so limited now because we can only go into very big companies. Charlie and I are probably familiar with every company in the United States--in a general way--that we can have the kind of position we would need to have [to make a difference in Berkshire Hathaway’s performance]. We look for the ones where we think we know what they’re going to look like in 10 years. If the price gets attractive and we know a little about the management, and we’re quite sure--within a range--what they’re going to look like in 10 years, we’re in our area. We buy them when the prices are right, like Coca-Cola was some years back.

Do you have advice for the individual investor to help them narrow the stock universe?
Buffett:
They ought to think about what he or she understands. Let’s just say they were going to put their whole family’s net worth in a single business. Would that be a business they would consider? Or would they say, “Gee, I don’t know enough about that business to go into it?” If so, they should go on to something else. It’s buying a piece of a business. If they were going to buy into a local service station or convenience store, what would they think about? They would think about the competition, the competitive position both of the industry and the specific location, the person they have running it and all that. There are all kinds of businesses that Charlie and I don’t understand, but that doesn’t cause us to stay up at night. It just means we go on to the next one, and that's what the individual investor should do.

So if they're walking through the mall and they see a store they like, or if they happen to like Nike shoes for example, these would be great places to start? Instead of doing a computer screen and narrowing it down?
Buffett:
A computer screen doesn’t tell you anything. It might tell you about P/Es or something like that, but in the end you have to understand the business. If there are certain businesses in that mall they think they understand and they’re public companies, and they can learn more and more about them.... We used to talk to competitors. To  understand Coca-Cola, I have to understand Pepsi, RC, Dr. Pepper.

Munger: And Cott. Cott is the one you have to understand more than anything else. [Note: Cott is a Canadian company specializing on low-priced, private-label soft drinks.]   

The next question has to do with reinvesting capital. You take pretty much 100% of the cash flow out of the businesses you own...
Buffett:
We have a lot of money coming in.

...and you reallocate the capital. Especially since it is so difficult to find new companies to add to the portfolio, why not reinvest more in some of the existing companies you have in order to grow?
Buffett:
That’s the best thing to do. If you’re talking about the operating businesses, we’re pouring it into a company like FlightSafety, for example, in terms of [buying flight] simulators. We’re pouring it into promotion at GEICO. [Note: FlightSafety, a subsidiary of Berkshire Hathaway, provides training to operators of planes and ships. GEICO is the seventh largest auto insurer in the United States.] But for a lot of them there’s not much we can do .

See's Candies for example? [Note: See's, which specializes in boxed chocolates, is another Berkshire subsidiary.]
Buffett:
We’ve tried 50 different ways to put money into See’s. We actually bought a $13 million or $14 million building in Los Angeles--350,000 square feet--last year. If we knew a way to put additional money into See’s and produce returns a quarter of what we’re getting out of the existing business, we would do it in a second. We love it. We play around with different ideas, but we don’t know how to do it. We do know how to do it at GEICO, and we know how to do it at FlightSafety. But with some businesses we haven’t figured it out yet. 

Munger: By the way, we really shouldn’t complain about this because we’ve carefully selected a bunch of businesses that just drown in money every year.

That's why we wondered what you do with all that money!
Buffett:
That’s our job, and right now we’re not doing much with that job.

Do you ask your operating managers to think about these questions?
Buffett:
Oh sure. I just sent out a report to one of them at another company who’s done a great job making small add-on acquisitions. We want them to do it. But we don’t want them to do it at any cost and just to feel that it’s a blanket mission. We do want them to be alert to that sort of thing. Any time they can make a small deal that enhances their position at a reasonable price, we write them a check that day. 

Can we ask you a question on corporate governance? You've been very vocal about shareholder rights and shareholders thinking like owners. Morningstar's very well known for mutual funds, so I wonder if you have any observations about mutual-fund shareholders, their rights, and the way they're been treated?
Buffett:
I think the independent directors have been anything but independent. They wrote the Investment Company Act in 1940 and made these provisions for independent directors on the theory that they would be the watchdog for all these people pooling their money. The behavior of independent directors in aggregate since 1940 has been to rubber stamp every deal that’s come along from management--whether management was good, bad, or indifferent. Not negotiate for fee reductions and so on. I’m a huge admirer of John Bogle and what he’s written. A long time ago an attorney said that in selecting directors for mutual funds, the management companies were looking for Cocker Spaniels and not Dobermans. I’d say they found a lot of Cocker Spaniels out there.

Thank you very much.