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Buffett advice: Buy smart...and low

Warren Buffett said investors should think independently when making buying choices.
The Korean market trumps American banks.
Jason Zweig, Money Magazine senior writer/columnist
Last Updated: May 6, 2008: 1:15 PM EDT
OMAHA (Money Magazine) -- On Sunday, May 4, I attended the press conference where Berkshire
Hathaway Chief Executive Warren Buffett and vice chairman Charlie Munger took questions from
print reporters for two hours, then went off and did more interviews for TV.
Buffett, who composes his thoughts at blazing speed and speaks in long and complex paragraphs,
spent the entire weekend talking. Munger, who is as laconic as Buffett is loquacious, saves his
voice - speaking, as always, only a handful of words at a time.
Buffett and Munger, aged 77 and 84 respectively, have the mental energy and sharpness of
someone half their age.
Here are some highlights.
Building a philosopy
In response to a question from Barbara Kiviat of Time on how he and Munger control their
emotions, Buffett replied: "[It] comes about from having an investment philosophy grounded in the
idea that a stock is a piece of a business. If you look at it that way, there's no reason to get excited
whether some analyst is recommending it or the company is splitting the shares two-for-one, or
whatever. The only way to drive the extraneous thoughts out of your mind is to have a philosophy.
And for us that philosophy comes from Benjamin Graham and The Intelligent Investor, especially
chapters 8 and 20. It's not very complicated stuff."
"You have to have the right temperament. I tell the students who come visit me that if you have
more than 120 or 130 I.Q. points, you can afford to give the rest away. You don't need
extraordinary intelligence to succeed as an investor. You need a philosophy and the ability to think
independently...It doesn't make any difference what other people think of a stock. What matters is
whether you know enough to evaluate the business," he opined.
"You should be able to write down on a yellow sheet of paper, 'I'm buying General Motors at $22,
and GM has [566] million shares for a total market value of $13 billion, and GM is worth a lot more
than $13 billion because _______________." And if you can't finish that sentence, then you don't
buy the stock. [Note: Buffett mentioned GM for illustrative purposes only.] All this requires some
temperamental detachment from other people's behavior. Both Charlie and I have a natural instinct
in that direction. We value our opinions more than others' -- perhaps to an extreme!"
Kiviat followed up by asking whether they mind being regarded as "a bastion of calm" by others.
Buffett simply stated, "I think they're probably right," while Munger was more loquacious: "Not only
are they right, but it's a huge advantage to us to get the reputation of being wiser and stronger than
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other places. Would any of you object to being considered wiser and stronger when you're trying to
get anything in life? The key is not to be seduced by crazy ideas, but instead just stick to the
fundamentals year after year. Academia doesn't get too interested in us -- we're too simple. What
would the professors do? A great many of the formulas [they use to analyze securities and markets]
are dead wrong. They exist purely to give the intellectual class something to do. We don't do
anything just exercise our intellectual proclivity for mathematical formulas."
Then Buffet said one of the most remarkable things I've ever heard him say: "There's no reason we
should become fearful if a stock goes down. If a stock goes down 50%, I'd look forward to it. In fact,
I would offer you a significant sum of money if you could give me the opportunity for all of my stocks
to go down 50% over the next month."
Look at that sentence again. What Buffett is actually saying is that most people's emotions work
backwards: They get greedy when stock prices go up and fearful when they go down. Instead, if you
are a true investor, you should shop for stocks the same way you shop for anything else: Look for
sale prices, and never regard falling prices as inherently bad news. Instead, falling prices create the
opportunity to buy even more of something that was already worth owning.
In that single sentence Buffett captured the difference between investing and speculating: An
investor, like Buffett, wants the price of a stock to fall below the value of its underlying business so
he can buy even more and hold for as long as possible. A speculator (like Jim Cramer) only wants
the price of a stock to go up, with no regard for the value of the underlying business at all, so he
can sell as fast as possible. To the investor, the market's opinions do not matter. To the speculator,
they are the only thing that matters.
Bond insurers beware
In what may spell trouble for bond insurers MBIA and AMBAC, Buffett said, "We see every day that
people are coming to us and paying more than they paid the original bond insurer to see that they
have an insurer." Berkshire wrote $400 million in municipal-bond insurance in the first quarter of
2008 and is already licensed to operate in 49 states. "This is entirely a secondary-market
business," said Buffett, "where people are telling us, 'We'll pay you just to back them up.' "
Note carefully what is going on here: People who already have insurance on a very low-risk
investment (municipal bonds) are coming to Buffett and asking him to ensure that their existing
insurance will be adequate. It is like a man who is already wearing a belt paying you to put a pair of
suspenders on him. This is the kind of business that Buffett loves. Without naming names, he
criticized MBIA and AMBAC for ravaging their own capital by insuring too much dicey mortgage
debt: "If they keep writing the business at any price, eventually the secondary market is likely to
reflect that in the price [of bonds that carry their insurance]. And if you're writing business to pay for
yesterday's losses, you'll be sorry."
Then Buffett marveled at the fact that "You have one bond insurer whose stock went from $96 to $4
[AMBAC (ABK)] and they're still rated AAA. The other one issued 14% paper with Treasuries at 4%
[MBIA (MBI)] and they're still rated AAA." At that point, Munger elicited laughter from the room by
intoning, "The rating agencies, with 20-20 hindsight, could have done better."
Korea and China vs. U.S. regional banks
When a Korean journalist asked whether Berkshire would buy any other Korean companies in
addition to its existing holding in steelmaker Posco, Buffett revealed that he had bought "a number
of" Korean stocks for his personal portfolio "a few years ago," when "that stock market got about as
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cheap as any market I've seen in my lifetime."
But most Korean stocks are too small to have a significant impact on Berkshire's portfolio, so
Buffett and Munger don't expect to put much money there. Nevertheless, "Korea represents sound
value," said Munger, and Buffett added: "It's one of the better stock markets in the world."
Later, in answering a question about whether the credit crisis has turned regional bank stocks into
good values, Buffett said: "It's hard to get much conviction on how [the management] will behave
and whether they tell the truth. There's a lot of leeway [in the accounting procedures and the
reported financial statements]. Talking to the CEOs isn't very useful. When they're lying, they
believe it themselves a lot of the time. I want to see how people behave in different situations."
In short, Buffett is not bullish on regional banks. Munger, however, was more upbeat: "For
somebody who's very diligent, you've identified a prospecting territory that has some promise. It
wouldn't necessarily work for us [because BRK needs to buy very large blocks of stock], but it might
work for others."
Buffett wasn't done criticizing the impervious financial statements of US banks: "If you had $1
million," he retorted to Munger, "it would be easier to go through a manual of Korean stocks than to
select a few good American banks." This time Munger agreed: "I'd take the Korean stock market so
much faster than the American banks that it'd make your head spin."
I don't think, by the way, that Buffett and Munger were trying to say that the Korean stock market is
a steal. They were, instead, merely pointing out that investors need to think for themselves and to
cast a wide net. If you run out today and buy a bunch of Korean stocks without researching them
first, you're not following Buffett and Munger's advice, you're violating it.
A Chinese reporter asked whether Berkshire will be buying more stocks in China now that its market
has fallen by almost half, and what the next year will hold for Chinese investors. Buffett's answer
held a lesson for investors based anywhere. "We're not in the business of forecasting what the
market will do in the next year," said Buffett. "But if a market goes down, we like that. There's no
way Charlie and I get upset when stocks go down. We like it, because falling prices give us the
opportunity to buy more good businesses at better prices."
"We don't predict stock prices," he went on to day. "All we know is, the lower they go, the more
interesting they get. I think it was Agatha Christie, who was married to an archeologist, who said: 'I
don't mind getting older, because the older I get, the more interested my husband becomes in me.'
Well, the lower stock prices go, the more interested we get in them...We are not looking at any
stocks in China now, but China will always be on our radar screen."
Valuing stocks
Asked how he evaluates financial stocks when so many have balance sheets complicated by
derivatives, Buffett said: "There are some that I can't value. I probably couldn't value them even if I
worked there, even if I were in charge, and even if I had a year to do it. It's just too complicated
[with such large positions in complex derivatives]....Most of them, I'm agnostic. I guess that means I
don't trust them. When you're buying stock in a financial institution, you should have a reason to be
quite comfortable with the risk-assessment capabilities of the people in charge...to have a real fix
on the people running the institution. We can't do that with a lot of [banks]. We just can't figure out
what they're doing most of the time.... [the accounting doesn't] really spell out where the institution
stands. So you'd better know more about the people running it than any set of figures can give you."
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Buffett added that not long ago, he read the 270-page 10-K annual report of a bank he was curious
about. "After a couple of hours," he said, "I had about 25 pages marked with big question marks that
I couldn't answer." (This raises the obvious question: If Warren Buffett can't understand the financial
statements of big banks with derivatives, who can?)
Munger summed up the complexity of derivatives this way: "Wall Street is always going to go where
the money is and not worry about the consequences. First they invent things they shouldn't sell to
anybody, then they end up selling them to their grandmothers."
Munger commented later, "Many of the present troubles were richly deserved. A lot of financial
institutions behaved with a combination of stupidity and over-reaching, and that's not a good
combination. I think the world is right to exact a large penalty. Capitalism wouldn't exist without
failure."
Added Buffett: "Capitalism without failure is like Christianity without hell. These institutions not only
brewed the Kool-Aid but drank it. [Some of the banks and mortgage companies] were like an
arsonist who got caught in the house after he set it on fire."
Munger's final word on the subject: "In some of these institutions, the main product is not banking,
it's testosterone."
First Published: May 5, 2008: 2:03 PM EDT



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