[MUSIC PLAYING] SPEAKER 1: Hello, everyone. Welcome to another great
episode of Talks at Google. We have a really special guest
here today, Mr. Tom Russo. He needs no introduction. Mr. Tom Russo of Gardner,
Russo and Gardner is an exceptional
value investor. He graduated from
Dartmouth College with a degree in
history and Stanford with degrees in
law and business. He has previously spoken
at Google about investing. From the last time he
was here last summer, he was awarded the Graham and
Dodd, Murray, Greenwald Prize for Value Investing. He also serves as
a charter member of the Advisory Board
of the Heilbrunn Center at the Columbia
School of Business. Today he will touch upon
two very important aspects of his investing. First, the reduction
of agency costs. The only thing
that comes to mind when people say agency costs
is Mr. Warren Buffett's quote, "Lethargy bordering on sloth-- TOM RUSSO: [LAUGHS] SPEAKER 1: --remains
the cornerstone of our investment style." Mr. Russo is an exemplar of
the buy and hold strategy and has held many of his
positions for decades. Secondly, he will talk about
the capacity to reinvest. In doing so, he'll
touch upon factors which form a sort of
a checklist for him as he makes his decisions. It gives me great pleasure
to introduce Tom Russo. TOM RUSSO: Thank you
very much indeed. [APPLAUSE] Speaking here-- it
reminds me of what it must have been like at the
catacombs of ancient Rome, where there were
people sort of who were underground because of
the Roman army marching above. And they were pursuing their
own novel view of the world, and the concept that within
the one company in the world has more information
than anywhere else, there's a group
of people here who believe that information can
help you invest wisely as a way to add value, compared to the
migration towards passive, the passive investors
who are the, in fact, Roman army above us. Here we said, we'll
talk about why it is that you can
hope to make money by investing with a
substantial point of view. So it's fun to be here. I'm delighted to have
been asked to join, again. I'm going to really just
jump right in and spend a little time on
what I typically spend most of my time
talking about, which is a three part
process of what it is that I look for in investing. Because I've given a bit
of the same talk earlier, and Sarab thought it might
be interesting to touch on some other thoughts. So in addition to what we'll
go through at the start, I've supplemented the comments
with things I most worry about. And they're in the
form of a checklist, and then mistakes
that I've made. Hopefully, we'll
run out of time, and I won't get to the
mistakes that I've made. But to start off, I
had the great fortune of having grown up in
the investment business. After Dartmouth College,
I worked on Wall Street during a period of time when
inflation was notorious. It was 1977 to 1979, 1980. And interest rates
went from 6% to 18%. And you know, you're
seared as an investor by what you experience when
you're first starting out. That was an
extraordinary experience. I suspect those
in your generation who fall prey to
bitcoin may end up seeing similar painful moments
in the investment business. And you'll learn very
good lessons from that. But watching the
fixed income markets really writhe during my
training was terrific. I went back to Stanford
business and law school and had the great good
fortune at both schools to have spent time
with two legends. At Stanford Law
School, Charlie Munger was on the board of visitors. And I had a chance
to meet with him when I was launching my
investing career, and he was very influential. Then Warren Buffett came to
our value investing seminar. And I think that's
really the thing that confirmed for me the
approach to investing would be characterized
by sloth and lethargy, and all of the other
sins of inactivity. Because what they described
was an investment process which was very long term minded. And you know, if you look at
the first slide, when I arrived, Warren was really just moving
from the world of $0.50 dollar bill investing to
franchise investments. Franchise investing,
where there is economic goodwill
that yields a return above what a commodity would. And so the $0.50 dollar bill
approach that typified early value investors doesn't scale. And it's taxable. And the first point Warren made
to our class was the government only gives you one
break as an investor. That's the tax deferral
on unrealized gains. And so if you can find a
business that has the ability to reinvest its current cash
flow into creating greater wealth, and you don't
have to sell those shares, you don't have to pay tax. That's very profound. Most people with very
high turnover portfolios just don't get it. So that's one thing. The second point is,
though, if you're going to depend on
that reinvestment, then the person who runs
the business for you, the actual management,
has to be trustworthy. They're your
agents, managements, and if they don't
represent your interests, then the process won't work. They must be owner minded. And then the next
thing you'll need if you're going to
buy and hold, is you have to have a
business that has a competitive mode, a business
that will absorb reinvestment, and return you for it. And so, for example,
with Berkshire, he started out with
a textile mill. And it absorbed
a lot of capital. And it destroyed
value along the way. And so what you're
looking for is a business that has the
capacity for reinvestment. And you really start-- it has to have a durable,
competitive edge. And for me, for some people,
that edge is technology. I guess the assembled masses
here would have a technology orientation. For me, it's consumer brands. Consumer brands have
the great benefit of having the
consumer believe there to be no adequate substitute. Once I was at a conference
in the spirits industry, and I described why it was that
I liked the spirits industry so well. And I said it was because if
somebody offered you a drink and they asked what you
wanted-- if you said a Jack Daniel's and they
came back and said, no we only have Jim Beam-- the proper answer in
the world that I inhabit is, no, thank you. I would rather have water
than what is not my brand. That brand loyalty is
terrifically important. And so, if you're going to
have the capacity to reinvest, if you have a brand, and you
can invest behind expanding that brand into different
adjacent categories or geographies, it's
extremely valuable. And for me, my goal is
to find global brands. Because there you
have the ability to expand into the
parts of the world that themselves should grow. If you think about the
developing and emerging markets, via
population growth, you have consumer disposable
income growth. You have GDP growth. You have the growth
of infrastructure for distribution. You have all of
that ahead of us. And that's really the
area that, for me, welcomes our investments. You also have a very
interesting factor that the brands that
I typically favor are brands that are kind
of leftover from the West during a period of time
when it was colonial. We own Nestle. We own Unilever. We own Heineken. We own Cadbury. These were products that
went around the world, but in a very thin way. They're the products
of people who lived in countries
that they controlled, but they alone could afford. Say, oh, gosh, [INAUDIBLE]
or Nescafe or Maggie Soup-- those were products
that the countries in which we do a lot of
business today were present. They were advertised, but
they were very expensive. They were very inaccessible. And they were, because
of both, they've become very aspirational. And so as markets around the
world now begin to prosper-- that second spouse
begins to work, they have a more
modern lifestyle-- where they reach
is to the products that they once aspired
to have a chance. And we tend to, then, own
businesses that have massive amounts of free cash flow from
the mature Western markets, where it cannot be
deployed profitably. But they have the
great good fortune of unmet demand in the
developing markets. And so the organic
reinvestment is so much safer than trying to
redeploy your capital into some wholly new product
in some wholly new geography. Our job is simply to
reactivate more deeply. Now that requires--
to do it right, you need multinational and
multi-lingual management. And then multicultural, I
should say multi-lingual and multicultural. Now for example, if I
asked this audience here how many people speak
more than one language? This is Google. How many speak more than two? The hands keep going up? Over three? OK, so it's an
extraordinary capacity. At Kraft Foods, for example,
they speak 0.9 languages. In Nestle's headquarters,
the senior management speak four or five languages. And the ability for that to
help them move around the world is extremely valuable, as
you will have experienced here given your skills. Multicultural is a
little more nuanced. For example, in an audience
like this in the US, I can usually safely say,
without any answers coming back to me, who's your
favorite cricket player? I think in this audience I
must have a high percentage who could answer the question. Well, that's a big deal. You know, 1.7 billion people
will go to bed tonight thinking fond thoughts of just
one thing, which is cricket. And as an American trying
to travel the world, your effectiveness just
doesn't have the same impact if you don't have those
references and those talents. But few companies
in the world take the re-investment possibilities
and invest the right amount. And that's really
because of agency costs. The inability to
invest the right amount arises in part from the fact
that American companies, typically American companies--
that's why 70% of my assets are invested in non-US based
companies, because I think we are much more apt to
find the talent base, the historic brands in parts
of the world through companies that are headquartered in
Europe than in the US-- the US doesn't have the same
dynastic history. And they certainly
suffer from one thing, which is the vast reliance on
stock options as compensation. And stock options,
unfortunately, deliver one variable to
the investment process that shouldn't really
necessarily be a factor. And that's time. For a stock option
to reward you, it has to be worth
something on a given day. And so the managements
whose fortunes depend heavily on stock options
become very attuned to days. This day they'll either
be worth something, or they'll be worthless. And in the process
of making sure that the shares can be worth
as much as humanly possible at any given time, managements
of US-based companies all too often fall prey to
Wall Street, who promises them a high valuation
if they only agree to make the quarterly
earnings every quarter. I was talking to somebody
recently about this subject, about the need to show
quarterly earnings. And he raised his
hands, and said, I used to work for a Silicon
Valley-based company. I will not name it, because
I will be blackballed, but anyways, a Silicon
Valley company. And they said every
quarter, about a month left in the quarter, we'd
get the directive, which is-- stop spending money. Because blank, the
head of the company, wants to make his
quarterly bonus hurdle, and we need to show profits. Now when you're in a company-- I hope, I certainly expect
that not to be the case here-- I don't suspect they
take away ping pong balls or bananas or cappuccinos
as you near quarter. And I hope not,
because that would show that the firm's still
vigorously on the right path. But when you find
that companies gauge their spending off
of reported income, which Wall Street suggests that
if you only make the number-- and the number's
a reported income number, which is completely
fictitious, anyways-- if you make that number they
will recommend your shares. The shares will be worth
more, because the multiple will apply to this
fictional number called earnings per share. And you'll have a
higher valuation. That game is extraordinarily
corrosive for businesses trying to build long term wealth. Because what you really want
to do is just the opposite. So to make the investments
that are proper, the trouble is, is that
when they start out they're extremely burdensome
on reported profits. And so what you'd need
to have are managements that have the capacity to
make the right investments for the very longest
term without fear of losing their jobs, or
without fear of takeovers. And because of that,
most public companies don't have control over
the share registry. And if they do invest
the right amount for the very longest
term, they end up at risk in the short term-- the loss of their job, the
loss of corporate control. And so in our portfolios,
I was once characterized as an investor by four numbers. One of them is 70%
of our holdings are non-US, companies that are
headquartered away from the US. 70% of the companies are
in the top 10 holdings. We're very
concentrated investors. The top three holdings,
on behalf of my clients, are 30% of the assets. So we're very concentrated. And 65% of our
companies are still controlled by the
founding families. And what that
means is that, when it's right to
spend, to activate, let's say Life Boy
in India, or it's right to spend to
activate more [INAUDIBLE] or more Maggie Noodle Soup,
they will spend that money. Assured that if you
build a new factory-- these factories tend
to be very lumpy. In Nestle's case, for example,
it costs about $350 million to build a Maggie factory
or a powdered milk factory or a decaffeinated
coffee factory. Well, each of those are core
pillars to their business. And when they build
something like that, typically they
end up building it when the initially
installed capacity is running at over capacity. And you all understand. If you're running
at over capacity, you are overstating
profitability. Because you've more than fully
absorbed the fixed costs, and you're operating
at efficiency ratios that are not sustainable
for the long term. And so ideally, if you're one
of our portfolio companies, we want you to pour
money into these markets to chase after the
initiated demand. And you have to build
a second factory. Well, the moment you
start down that path, you start to accrue
enormous amount of expenses in and around the
process of building. But the real trick is that,
very soon after it switches on, you're going to take the factory
that might have been running at 120% of capacity at
unsustainable margins, and you're going to bring
over half the volume. And both your factories are
now running at half capacity. Well, you've just blown a
hole through your margins. And it's not until
each of those factories then themselves become
fully absorbed that you're going to be back in business. However, the fact that the
reported profits dropped as they did, though
bothersome to some, for us, trained under Buffett with
the idea of the capacity to suffer through such
burdens on reported profits when developing
wealth, the wealth picks up as those businesses
come back into full absorption. And suddenly you
realize that you've met the demand you
created and you're ready to build a third factory,
let's say, or a fourth. In order to survive
to that outcome, management has to be protected. And the best way that I've
found to help protect management against those adverse outcomes
is through family control. So whether it's Brown-Forman,
which is controlled by the Brown family, whose
discipline over the years-- I've owned the shares--
to roll out Jack Daniel's, their core product globally,
has richly rewarded us. Think of 1986 when
we bought the shares. They had collapsed because of
a mistake in the acquisition. And they were only left
with Jack Daniel's, which was about a four
million case brand per year, making them $300 and
some million a year. And they had a 400,000 case
Jack Daniel's business globally. The family, who had lost
a considerable amount of their fortune as a
result of mismanagement, dedicated themselves to rolling
Jack Daniel's out globally, with all the expense
that it suggested. Their earnings would
go down substantially as they took their US-based
Jack Daniel's profits and directed that
money and the expenses attached to it to developing
a taste for Jack Daniel's around the world. That was back in 1986. Today, they still do four
million cases in the US. It's gone up in profitability
because the cases today are more valuable in the
US, because consumers have returned to bourbon. And they like to have honey
or they like to have fire. They like to have all
sorts of flavoring. And they're making more
money off their US business. But the US business
did not grow. The value of the
investment in Brown-Forman arose from the fact
that the global consumer could be romanced with the
brand and the product and all the rest through heavy
investments upfront. But once the consumer
accepts the product, they develop a lifetime value. Because they'll drink
x bottles a year with x margin per person, and
you can calculate the return on that investment. You can assure yourself that
you'll have nothing but losses up front. But over time, you
absorb those losses, and you're back in business. And in the case of Jack
Daniel's the 400,000 cases in the rest of the world
today are 13 million cases. And they make about $100 a case. So they've picked up value,
earnings of about $1.3 billion. And it's really only
been permitted them because during the period of
investment, they were allowed-- they had management
who ran the business, had the capacity to
suffer through censure by sell-side analysts who were
disappointed that they were no longer making the numbers. And they actually had threats
from outside activists to come in and try to dislodge
corporate control with family control, which is
existing in something like 65% of my portfolio. The families can say to those
who wish to disrupt, go away. We wish to have a
profitable dynastic future. And we don't really care about
quarterly or annual earnings. That's an extremely valuable
pond in which we fish. So the capacity
to suffer concept was sort of first delivered
to me through Berkshire. And if you take a
look, well, I think we've pretty much
gone over that. But take a look at Berkshire. There are a couple of examples
there which are so instructive. In Geico's case, they
bought Geico and only had a million policyholders. A policyholder at
Geico is worth $2,000. That's the net present value
of all of their future streams of earnings. And it's a very high
number because there's high persistency at Geico. Very few people cancel. And so if you have a client
insured, they're worth $2,000. And when they
bought the business, there were only a
million of them. So the business was worth
$2 billion, plus or minus. The trouble is when
you bring on stream a new insured, the
first year they have a loss of $250 per insured. They make $150 annually
off of an insured. But bringing one
onboard loses them $250. So if you think about
the math, when Warren bought the business, they
had a million policyholders earning $150. That's $150 million of profit. So if the next year they
wanted to grow the business by a million
policyholders, look what happens to reported profits. It goes to minus $100 million. The $150 that they
were earning suddenly gets overwhelmed
by the $250 million that attaches to the
million new insured. Now Warren bought the business. They only had a million insured. Now 14 years later, he said in
his annual report, that Geico, for all of those
who are his partners and want to understand
what it is that they own, because Warren has
said that he would like to always buy shares of
Berkshire at the right price. Berkshire would love to
repurchase its shares. The trouble is
that Warren doesn't want to buy from someone who's
uninformed about its worth. So periodically, he gives us
through the annual report gems like he did three years ago
when he said, and by the way, Geico is worth $20 billion
more than what we paid for it. And the reason was is
that, since he acquired it, at the cost of income,
he started to push hard. He took his advertising from $30
million to $900 million a year. You know that, because every
commercial on television is a caveman or a gecko
or something else. He grew the insured
base down to over $11 and 1/2-- no, I'm sorry. Excuse me. It's at $13 million today. And so he's added 11 million,
12 million policyholders times $2,000 dollars per person. That's $24 billion
dollars today. What's very interesting is
this year, because there are lots of catastrophes all
over the country, weather related, Berkshire's
competitors-- their dire, sort of
life battle competitors, decided not to renew
business this year and not to go
after new business. Because they were showing
losses in other businesses and they wanted
to report numbers that satisfied the sell
side who had expectations about what they should do. In the environment where the
losses elsewhere were so grave, they backed away. Warren picked up a million and
a half policyholders this year, because he has no care
whatsoever about his reported profits. Now he's fortunate, because he
controls 40% of the company. And other people friendly
to him control the rest. Nobody's going to
take over Berkshire if they under report
profits in Geico because they've
taken on the business that their competitors
forwent because they had to show numbers
differently than Berkshire. Berkshire has created
the world that it occupies by focusing only on
value and not reported profits. Anyone else could do it, but it
takes the kind of discipline. And Berkshire thrives on that. Another example-- equity
index put options-- this is an interesting one. When 2000-- let's
take a look here. This is it. If you look here, it's
very hard to read. Anyways, Berkshire--
some 10, 15 years back-- had the opportunity to receive
from an insurance conglomerate $5 billion of premium, with the
obligation that he would make good any decline in the value of
that portfolio from $37 billion dollars to any number below. For $5 billion in cash,
which they gave Berkshire, Berkshire pledged
to make them whole, whatever the decline took. Now nobody else
could make a pledge that the insured, the person
actually seeking insurance would actually trust. Because few would keep
enough liquidity around that, if the markets really
did melt down to zero, that they could actually
be good for the money. Well, Berkshire has $110 billion
of cash on the balance sheet and has kept a huge cash
hoard the entire time. So the insured paid
him $5 billion, which is way too much money-- in part because he alone
will have the money to make good on the commitment
if it happened that the equity markets went to zero globally. He also was paid
far too much money because no other insurance
company would bid the business. Because once they've established
that they have an obligation to make whole anything
below $37 billion, they face mark to market. And what that means--
mark to market-- means that if equity markets
around the world declined, he'd have to pass the amount
of his obligations increase through the income statement. And so-- I bet this has
a little red button here. I can probably
point to it anyway. If you look at
something like 2008, you'll see in one of the years
he passed through his income statement a $6 billion
quote, unquote "loss." It really isn't a loss. He had 10 or 15 years yet
before the contract matured. It was just a valuation mark. No other insurance
company, publicly held, could withstand that
type of a markdown based on mark to market. And so I think Berkshire
succeeded in that investment largely because
they did not have competitors willing to
take on the same risk. Let's go back a second here. All right. Berkshire-- OK,
let's take a look. OK. Well, we're going to move on
to the second topic, which is one of the things
I really do focus on. Obviously, the numbers-- in some
ways, the factors I most fear are businesses which
fail in the areas that I most esteem in Berkshire. And so at the start
would be agency costs. And I can assure you that
probably 90% of the investments I look at, I just pass on. Because I just don't trust that
the people who run the business will have our interests at
heart and make investments for the longest term. And one of the
examples I'd say is if a business is focused
on the near term, they'll either do
one of two things. They'll either fear
saying no to Wall Street when the right answer is yes, or
saying yes to Wall Street when the right answer is no. I'll give you an
example of this, and it is sort of an
interesting one on many levels, but it has to do with Heineken. I first bought Heineken in 1986. It was a mature Western market. 25% of the profitability
of Heineken was from the United States. And they had no exposure in
developing emerging markets. Today, they have 75% of their
business in developing emerging markets. 5% of the profits
comes from the US. And the two most profitable
markets are Mexico first and Vietnam second. So the business has
completely transformed itself by virtue of their
willingness to suffer through the burden on investment
along the way for the past 25 years since I've held the stock. Well, a couple of
years ago, they had a chance to buy a
Brazilian brewer, which would have doubled their size. They have a 12% market share. This business had 16%. And AB InBev, Budweiser's
parent company, had the rest. Wall Street clamored for
them to buy that business. Because it would give them
extra scale in that market. Problem was the price. It was a $5 billion acquisition. Wall Street clamored on
them to say yes, do it. Heineken ran the
numbers and said, no. Walked away. Four years later, the buyer,
Kiran, came back to the market and said, not a good
business, not suitable for us. We'd like to sell it. Wall Street, having
watched it underperform for that period of time,
said absolutely don't even go close to it. No, don't even think about
buying that business. Heineken took a look at. Thought-- looked
pretty interesting. They bought it for
$720 million dollars. Now you can make a lot
of money buying something for $720 instead of $5 billion. And Wall Street-- and
Heineken is 51% controlled in shareholdings by the family. So when first pressured
to buy it for $5 billion, the family said no. It's stupid. Doesn't make any sense. At $720, when they were
threatened if they bought it, they'd be downgraded
by every analyst-- who cares? It's $720 million for 18--
it was 16% of the market. The real trick was that,
having bought it at $720, they now recognize they
have a billion dollars that will be passed through the
income statement putting it together. They have to move factories
and breweries around. They have to redo their
distribution agreements. They're going to be spending
a tremendous amount of money, and that's going to burden
the income statement for the foreseeable future. And that burden is what
Wall Street really hates. And that's why they recommended
around the news of this event that they've gone mad. They're entering
in the market that cost somebody else $3
billion, $4 billion. And the share price weakened. Along came another
company called SAB Miller, South African
Breweries Miller Beer. And they were being
pursued by Budweiser. And of course, what
do they do, well, they lob a takeover offer
to buy Heineken. The shares had gone down. And the market was disappointed
they bought the Brazilians. They sent a letter
to Heineken saying we'd like to take you over
for a very high price. Heineken said no,
thanks, goodbye. They have 50.1
percent of the vote, and they don't have to worry
about Wall Street's pressure. Now in this context,
they've already become as profitable
and as large as they have because
of their capacity to suffer through the upfront
cost of their investments. But this episode, they said no
when Wall Street clamored yes. They said yes when
Wall Street said no. And then as a result of
that, the bad reception when the shares went down. They were offered a take
over to which they said no. And we will continue
to hold the shares. I've held them since 1986. And I think that's a pretty
good example of how that works. So let's jump on
to the section that is what I most worry about. Here we go--
factors I most fear. The first one is the first and
only, really, is agency costs. Huh. Have we lost it? Yeah, there it is. And you know the
list is enormous, the businesses that I've
owned that have suffered and we've actually sold them
because of agency costs. Citibank, at one
point, had a business whereby they would underwrite
bonds even if the market had no interest in them. And they'd put them in something
called the side pocket, SIV. And in a sense, the
bankers were issuing debt on behalf of businesses
which had no buyers. And so they created a vehicle
alongside the balance sheet of Citibank in which they
would park these unsold bonds. At the end of the
year, the management would get their bonuses for
having produced the bonds. And at some point,
off balance sheet, they sat festering
and the burden, ultimately, on Citibank. And when I was described
that condition, I sold the shares immediately. Citibank turned out to be a
complete disaster thereafter. It dropped by 98% since
we sold those shares. And it was a complete disaster,
but for one thing for us personally-- is
that through it we met a man named Ajay Banga,
who's the CEO of MasterCard. And we bought MasterCard soon
thereafter for $20 a share. It's now $170. It's been the best investment
that we've probably made. And the investment
really was based on the character and caliber
of this business leader, who was exceptional and unrivaled. We did not buy MasterCard
at the first iteration. But it was a tremendous
dividend that came as a result of
our activities there. International Speedway is
a business that we owned. And a family, called
the France family, owned the NASCAR franchise. And international Speedway
was a public vehicle which owned tracks. And just like Coca-Cola has
a conflict with its bottlers, to have the bottlers spend
more money so Coke the brand could become more
valuable, in this case, International Speedway
embarked upon a shareholder driven mandate to build more
tracks around the country. NASCAR is a great business. You know, it's basically
a branding opportunity for companies that want
to reach middle America, and it was regionally
defined historically. And they went on a
hunt for new locations. And they built
seven more places. Ultimately, they
threatened the franchise because of oversaturation. And at the end of
it all, they were trying to build for $500
million a racetrack in Staten Island over a waste dump. And of course, a completely
ridiculous extension at that point, benefiting
the family because they get more revenue
because of more sites. But destroying value all along
at the company International Speedway. That was a misalignment
of interests, and you can see those. Second thing I fear the most is
lack of natural reinvestment. As I said, the
businesses that we own have a very natural
reinvestment, which is they just go
back to the markets where they've
longstandedly existed, and invest to build
distribution, marketing brand awareness, and all the rest. So we own Wells Fargo. It's a domestic business. At some point, we will sell it,
because it doesn't really have the reinvestment opportunities. We call that
opportunity white space. And to give you an
order of magnitude, we own several
brewers in Africa. There's 400 million barrels
of beer consumed a year. And the businesses that
we collectively own only manufacture 100 million
of those barrels. There's 300 million
barrels that are available as a natural
opportunity to reinvest. What I fear most is
the understanding that some companies don't
know what is enough. Berkshire's excellent at that. And it made us a
tremendous amount of money knowing that a certain
investment is very, very valuable, and not to
reach for something that's beyond the
realization potential. So for example, in the one I'm
thinking of with Berkshire, understanding what is enough-- in the midst of the
financial crisis of 2010, they issued a $6
billion preferred to-- or they bought $6.2 billion
preferred from Bank of America. This is 6%. They were only making half
a percent on their cash, so a big improvement off the cash. But really, what they
got from it was-- in return for their
goodwill that's conferred upon them by
virtue of their credit review of Bank of America--
was valuable enough that Bank of America gave
Berkshire 700 million call options at $7 a share,
which was the then market price that lasted for 10 years. That has made
Berkshire $22 billion. So a modest looking preferred
6%, beneficial for them because there's a tax shield
by dividends, but still modest. With that warrant attached,
turns $6 billion dollars into $28. It's extraordinary. Now you know, other people at
the same time reach for yield. But if you reach for
yield, and it's too high, chances are you'll get what
the yield suggests, which is more risk than you care for. Anyway, so by far and away,
the next factor I fear is corruption. And I'll give you a
couple of fun examples. In response. Most of Richemont's competitors,
luxury goods company, most of their
competitors in Russia did business with a facilitator. And the facilitator was
really the Chechnyan mob. And the way that
works is, you know, they'll get you into
anything upfront. But then they're
your silent partner for the rest of your time. And Richemont has
enough money that they don't need a silent partner. They were shown a building. There's a twin building
on the main boulevard for shopping for luxury. And they were
shown one that they could move into immediately
for $500,000 a year rent. The next door was
the same building, kind of in poor repair. The one that they could go
into was fully repaired. The next door one they bought
for $25 million dollars. Instead of taking a
half a million a year lease for the whole building,
they paid $25 million for the building
that they bought. They wanted independence. And it had an upfront cost. They did nothing but lose money. But over time, they
owned their future. The people who take
the early bait, come in to get active
quickly in that market, rue the fact that they
ever met the group. Because for the rest
of time, they'll take more and more
and more money. It's the mob. And Richemont not caring
about near term income, because it's controlled
by the Rupert family-- they want wealth, not
reported profits-- paid way over the top. But they bought certainty. I visited Heineken
in St. Petersburg. And they had a factory that-- this corruption-- that they
had to hire a local mob "for security", quote, unquote. Because it's very hard
under IFRS to stash bribes in an income statement. So you figure out
something like security. So they had hired this group
to deliver 50 people walking around with machine guns in
this warehouse full of beer that they just brewed. And then they all
wore brown shirts. And inside, there were a group
of people with machine guns who had white shirts. I said, why are the white shirt
people with machine guns-- well, those are
the people we hire to protect against the
mob who we have to pay. This is a difficult
way to do business. And unfortunately,
it's all too common. We still hold
Heineken, despite that. But it gives you a sense of
what we're attuned to at least. Agency costs, you
know the story there. Excise tax-- that's
very interesting. Our businesses have a
price in elastic demand. That means that
governments understand that they can raise the
price on our products and the consumers
will keep consuming. Whether it's cigarettes, beer,
or spirits, that's the case. However, around
the world there's a new product, which is
this thing here which Philip Morris has invented. Which is a heat not burned
cigarette replacement. They developed this over
the past four years. They spent $2.5 billion
dollars developing this, destroying their reported
profits for 2 and 1/2 years. But they realized
that if they didn't transition from
traditional cigarettes to the next generation,
someone else would. And so they invested to destroy
their own business ultimately, and came up with this thing. Since they've launched
it, five million Japanese have converted fully
to this product and they've given up
combusted cigarettes. So it's a very big deal. And when they launch
throughout the world, they're given a big
discount in excise taxes. And that excise tax
discount is what helps underwrite the cost
of developing this product and sending it worldwide. So taxes are usually
confiscatory and drive away pricing pop elasticity. But in some instances,
they'll adopt something like this product with an idea
towards helping the society. So we just go on, regulation-- you know, you see it
all over the world. In India, you cannot
import spirits. If there's one thing that in
India is a bankable outcome, it is their passion for scotch
whisky as a broad statement. And let me ask
here, of any Indians here, what is it
that would be most likely to travel home through
duty free with an Indian? It's one thing. You all have the same idea? It's Johnny Walker
Black Label two bottles. It's Black Label. That's just it. The Indians drink 125 million
cases of scotch-like products. But the tariff barriers are so
horrific that you can't really bring in scotch. That's why it's a
duty free thing. Scotland produces 75
million barrels a year. And we own three-- we own four Scotch producers. And we believe that over time
that regulation, because of WTO and all of the other
forces that open up markets that want to themselves
be open to trade elsewhere, that we will see a world where
Indians will get really what they prefer, which is a high
quality imported heritage beverage. And the target market--
there's 125 million cases. And so regulation
prevents it now. In India, we own shares
of United Brewery. We own 50% of United
Brewery through Heineken. It's very hard to get
economics right for breweries, because you have to have a
brewery in each province. And obviously, breweries scale
at a much different level than the provincial demand. And there are only 13,000 legal
outlets for beer in India. It's 1.4 billion people. And so all of those forces
that relate to regulation will, over time,
open up, and I think lead to our business's success. We talked about taxation. We have-- oh, it's very
funny, with different culture references. A Chinese company came
about, maybe eight years ago, created by two people who had
studied and trained in the US. I met with them. They sold leaf and paper
for the cigarette industry. They went public. I met with them. They spoke perfect English. They knew everything about
accounting, all the rest. And I thought, gosh,
that's amazing. Because for 25 years, I've
met with the management, senior management
of Japan Tobacco, third largest tobacco
company in the world. We still talk to them
through interpreters. 25 years later, they still-- there's a fiction
of interpreters. You know, and it really makes
a big difference in terms of your ability to understand. I visited Korea and met with a
man from Latte Confectionery, to give you an example of
how cultural differences can play against you. I asked the interpreter to
ask the CFO who we're with, what the future cash flow looked
like for the next and coming years. And they spoke Korean
together for about 40 minutes. And the answer came back better. The answer came back,
you know, better. OK. I can't invest on that. And the last example, and
again, it's just a story. But it's true and fun. I went to see Asahi Beer. And I spoke through an
interpreter for four hours just like that. And complete-- same kind
of conclusionary answers came back. And we finished a
miserable experience. And afterwards, we
swapped business cards. And the man who
received the card said, oh, you're from Lancaster. I grew up in Reading. Now he's in Japan. And he's the Director
of Investor Relations for Asahi Beer, Japanese beer. But he spent eight
years of his life as a teenager living 20 minutes
from where our offices are in Pennsylvania. And he spent four hours
of my life torturing me with a translator, only
to finish up by saying, oh, I grew up in Lancaster. You're in Reading. And so that's something that I
fear the most is the inability to get information. And then a quick look
at some mistakes. Newspapers-- I lost a lot
of money on newspapers. They just completely
missed you guys. Newspapers co-opted radio
when it first came about. They co-opted
television stations. They understood that they
needed to buy up cable business. They did everything related
to media and entertainment and advertising to keep
the power and the franchise within their own industry. And along came eBay
and Amazon, early days. And they went straight
to newspapers, and said, let's partner. You've got the market. We've got the next gen. Let's
do it together, perfect. And the newspapers have
become so monopolistic fat and lethargic and slothful
that they said, no, we want to keep it ourselves. But they just
blinked in this case. And we sold all
of our newspapers. And it was a disappointment. These are mistakes of comission. I actually own those. And mistakes of omission
are interesting. Mastercard, at the
IPO we did not buy it. They lacked a dynamic leader. Ajay Banga came along later on. It went up fivefold
after the IPO. We did not own it. Then it dropped 80% back to
something close to the start. And we bought it the
second time around. But only because of
the quality of the CEO who came in, who's one of
the most masterful leaders in business now. He's Indian. He started-- excelled
at the finest school and is extraordinarily talented. I omitted to buy Moutai. I saw someone--
are you from China? China-- so Moutai. The shares collapsed
five years ago and when Xi went after
banqueting and luxury in his attempt to get
rid of corruption. The shares collapsed and
have advanced eight-fold over the past four years. And the market value of
Moutai might be $400 billion. They make 70-- and what's the
number they make $7 billion or some number that
is just unfathomable. But it's a brand
that I didn't buy, because I assumed at some
point that as China became a more open nation with
more people traveling around the world
they would surely leave that product, which no
one can drink outside of China, and aspire to the things that
the rest of the world like. And it hasn't
happened, and they've made an extraordinary fortune. And the other thing is it was
controlled by the Communist Party and the army. And I just felt like that
would be a fairly high level of agency cost. I passed Alibaba at
the IPO agency cost. I mean, what could
be more strong than to know that Alibaba's
Jack Ma already took $6 billion illicitly from Yahoo
through AliPay? So that seemed like it was
probably a strike against them. But it's done extremely well. And Google-- I haven't purchased
their shares, even though I am extraordinarily
impressed with their ability to recruit the best and the
brightest, you included. And the notion of
allowing those here to share and participate
in developing products without a lot of ownership
amongst age groups or divisions-- so it's
an extraordinary company. I take my hat off to you. I should have bought the
shares a long time ago. But I'll say open
minded on them. You know, I think I'm going
to call that-- oh, no, I have something at the end here. Let's go back quickly. I'll share with you a couple of
the things that I think about as I reflect over investments,
courtesy of these two gentlemen. So you can look at
Charlie Munger's musings-- "invert, invert, invert." I suspect most of you
know all of these points because you're
students of investing. But that invert is very
similar to what Warren said when he said if something's
not worth doing at all, don't do it. Invert means go to where
you want to end up, and then reason backwards
the most efficient way to get there. And just don't go
to the other places along the way that tie
up most people's bother. Figure it out,
and then work back from the outcome you desire. Warren-- Charlie
talked once about-- this is very profound. They owned 7% of
Freddie Mac, which was the largest mortgage
insurance company, government-sponsored entity. And I was at the annual
meeting for Charlie's company. And someone said
why did you sell it? Because a guy who
actually quite a whiner-- he was whining at
Charlie Munger, saying the stock was
at 47 when you sold it. It's now 70. Why did you sell that? And should we think
about replacing you as the investment officer? And Charlie was a bit peeved. And he looked out at this
guy, waited for a long time. And he said in response to the
question, why did you sell it, he said because we felt
like it, simple as that. It's such a powerful answer. It turns out that
there were reasons. They had put junk bonds
in their portfolio. They had retained
mortgages instead of just securitizing them. And they were
going into subprime to sort of generate unnatural
reinvestment when they should have been patient, anyways. All those were going on. But he basically
said, you know, we spent all of our lifetime
trying to figure out businesses. And when you have a response
based on your judgment that you can't actually
put your finger on, you're still supposed
to act on it. Most people overly
value knowledge, thinking that it is
the trump card when beliefs well-informed are
really what you have to act on. But basically what
Charlie said is they felt uncomfortable
some reason, but just the general development. And so they sold $7
billion worth of a stock. Now, most people would be fired
if they operated with what seems so thin as a reason. But you spend your life
developing judgment. And then failure to act
on it because you're still waiting for more
information is dangerous. The world is full of an 80/20
rule, and in many instances 80% is enough. So that's one. Warren and Charlie
were asked this year at the meeting why they didn't
do something that was quite dangerous to their capital. And they said basically
it's because they want to be rational, not brilliant. Another firm, an
insurance business, did something that
cost them $3 billion. Warren didn't. And the reason was that
the other firm was looking for something that
would be brilliant and Warren and Charlie
passed because they just needed the very simple
test of being irrational. I think I'm going to stop. [INAUDIBLE] asked me to
give one last thing, which is my own lessons learned. And I say that the first
one is compound interest. And that's a career story. You'll start your
career out now. And 20 years from now, it'll
depend on those little steps that you take well that over
time add up to big results. And you'll see
people in business early on who take
big steps early on. And you should know
that along the way, they'll probably
fall along the side. And staying the
course and building a platform that's very
cumulative is a good character. You know, Buffett says it. I think it's true. Reputation takes a
lifetime to build, and you can destroy
it in a minute. So I mean, that's clear. And he also says
how many people he finds in his life who spend a
lifetime sort of gaining wealth and do so at the risk of
their reputation, which at the end, when they're
rich, the only thing they care about is their reputation. So just make sure
that you recognize that if you give it
up, you're not going to get it back very easily. Capacity to do nothing
is vastly, vastly underappreciated. But sloth and lethargy, as they
say at Berkshire-- but for me, just not acting as
often I suppose. I turned over-- I have a
slide I didn't show you. Last year, our portfolio
return was 1.8%, 1.8%. And then, my business
school professor who sent me down this journey
of value investing globally, said everybody should make
sure that you have a folly. Something that makes no sense
that just adds enjoyment, pure, and that can't be justified. Those are some things
I leave you with. Those are from-- courtesy of
what you learn as you go along. There's a little time
left for questions. I hope you have some, and
I'm sorry if I ran late. Yep? Yeah. [APPLAUSE] Thank you. AUDIENCE: So I'd love to hear,
Tom, more about the five C's. And maybe if we could just
start with the last one. What is a folly of yours? TOM RUSSO: I say art, probably. My wife and I both like art. We like art by
artists who we know. We don't participate, you know. I think in art there's
a component that's it's just inspirational. And we stay within
that, rather than enter the world of commercial
art, which is what draws many people to it. That would be one thing that's
quite of interest to us. I'd say certainly a
folly is my tennis game. Because the prospects of it
adding much value over time is quite low. But I'm still quite interested. So those are the two. AUDIENCE: And Tom,
I remember when speaking on the
phone you also said about the importance
of character. TOM RUSSO: Yeah. AUDIENCE: And how even more than
let's say talent and intellect, you consider character
and culture to be key. I was wondering in terms
of life experiences that you draw from,
inspirations that you draw from, if you could talk to
us a little bit more. Especially because, not only
here, but a lot of people on the video are going to be
youngsters who are looking at your talk for inspiration. So that would appeal to them. TOM RUSSO: Well,
all's I can say is, when you get
cultures right, they have an extraordinary benefit. And Nestle would be the
place where I learned this. And it was a business that
just had a shared vision and had the ability to
align decisions along what was asked of them as
a culture, as well as the economic promise of it. I suspect that that culture
here is extraordinary. And as I said, I was here five
years ago when I first spoke. And I was with the group
after the presentation. And a very young person
who found his way, as so many do here,
with enormous talent provided an answer to a
question of a person in his mid to late 40s who just had
suggested he was stumped. And this very young
person said, have you considered the following? And you know, the
room was silent. There were sort of 12
people in the room. I thought, oh, this kid's going
to get his legs chopped off. And the older guy said,
no, but it's a great idea. And so he said that
in front of all of us, recognizing that he
didn't have that insight. This guy did. He was half his age. And he felt perfectly
comfortable applauding that as a possible source
of a solution. It's a very valuable
cultural thing. It does not exist
in most companies. Most companies are terribly
territorial over ideas, very loath to shed
praise broadly, and really loathe to extend
a hand to someone else. This is an
extraordinary character, and one that I would
hope is preservable. So that's a plug for yourselves. But it's an important one. AUDIENCE: And on
compound interest, I remember you had said to
me something along the lines of the returns being so back
ended that for the first, maybe decade or two of your
career, you didn't get a lot of recognition. I mean, stuff that
just comes to you. Maybe if you could talk to
us a little bit about that, people might find that
inspiring as well. TOM RUSSO: No, I must say, I
was at the hotel this morning. I came upon this. Well, that's sort
of interesting. He was a classmate of
mine in business school. And he didn't start out
owning the Warriors. But he ended up
owning the Warriors. And he's interviewed in here. And he said, when he
was eight or nine, he came upon the first indoor
basketball court he ever had. And he said someday
I may own it. But he started out in business. And it was just like this. But with the right direction
and a couple of good breaks and character that protected
him from overreaching too soon, he ends up with his dream. And I thought that
was quite telling. And I was impressed to see it. But I think the
remarkable notion is that a series of small
things add up over time and can richly reward. AUDIENCE: Was that
your experience, too? TOM RUSSO: Absolutely. I mean, I was with some
investors recently who had, over the past decade,
extraordinarily sort of visible and dynamic and
active businesses, and they've all, at some
level or other, sort of shut them down or restricted
them, moved them back. And he said, well,
what's the difference? How can you still be doing this,
and you don't even do anything? You know, you don't buy stocks. You hold companies
for a long time. And I sort of gave
the same answer. It was just by just
staying to the same thing we've been able to,
I think, find some interesting businesses that,
because of their own culture and character have been able
to redeploy capital internally without worrying about
quarterly numbers that's allowed it to stretch out
and deliver value over time. But you'll see a handful
of businesses like that. Yes? AUDIENCE: Is age of a business
a factor into when you decide to invest in something? Because there's all this talk
of getting into things early and then it's a very scary
aspect to start off with, because a lot of things just end
up being Wall Street gimmicks. TOM RUSSO: Yes. AUDIENCE: And so is
age a factor when you look at investable business? TOM RUSSO: So for me, I
oversee about $14 billion. And so I don't really have
the luxury of deploying that into businesses that are
really young, other than you and Amazon. I mean, there's this
extraordinary phenomenon right now where dynamic new
businesses are also enjoying extraordinary high valuations. So I have the
liquidity and the right to invest in these new
businesses and haven't yet. I'm impressed. And I see within
them something more than what I have been
led to believe up until recently, which is that,
oh, these are mere technology businesses. It's just much more disruptive,
more deeply disruptive. But size usually would keep
me out of new companies. But that's no justification here
because your caps are so large. And I think the four
leading members of things have a market capitalization. What you have is $2
trillion or something? AUDIENCE: [INAUDIBLE]. TOM RUSSO: More
than $2 trillion. So there's plenty
for me to find. So also new is the kind of
the threatened destroyer of our businesses
in many instances. Think about Jack Daniels. And suddenly you have Bulleit
and you have Hudson Whiskey. And the more difficult
the search of discovery is for something
that's new and new, the more it's rewarded today. And so across all
of our investments, we actually are engaged in
mortal warfare against the new, while at the same time trying
to reinterpret that which made those businesses which
we rely upon once great will allow them to
continue to stay great. So they have to become
new in themselves. And that's what this
thing was all about. Here's a tobacco company which
is the most profitable company in the world coming up
with a product that's destined to eliminate the
business which they've relied upon for so long. One of the musings that
Charlie Munger has, which I think is so profound,
about Berkshire Hathaway is he said, at some
point, that which made us great at Berkshire
is most likely not to be that which
will keep us great or allow us to
become more great. I actually don't
have it up there. But no, I see it. It's that which made
Berkshire great. It's right in the middle. And you know, he's
94, and understands that if you don't modify what's
gotten you well-served today, you run the risk of
missing the next turn. We've run over. Yes, do you have a question? AUDIENCE: You said you did not
have a very good experience in the newspaper
industry, right? TOM RUSSO: Yes. AUDIENCE: So what are your
learnings from that experience. And how do you suggest us
to evaluate media companies? TOM RUSSO: Well, it really
is just an excessive amount of contentedness that
the industry fell into when they finally
had all basically merged into single newspaper towns. And I have a funny view on this. I sort of take it back to
almost the time of Watergate, when newspapers played
such an important role. "The Washington Post"
played such a important role in breaking open a
political scandal that the role of newspapers at
that moment sort of changed. And they really took
a turn towards sort of trying to find the next
story, the next story, along those big
headline grabbing ways. And the best
newspapers, the ones that really make money
and that are really part of the community
are those which are focused intently on local. And so they have seven pictures
of the high school football team engaged. And they have stories about who
was arrested, who was married, who died. It's the stuff of the
communities that really create. But the lure of Pulitzer
Prize-winning kind of expose journalism became
hyper-charged after Watergate. And I think that that
shriveled, just sort of shredded the
intimate relationship that a paper had with its town. And the papers that
still exist are those-- and they still make some money. But they're a lot thinner,
and they focus on the area. Now advertising, as you better
than anyone else would know, is becoming a really
fascinating story of sort of personal testimonials
and a personal search for something that you can
friend and then tell others about. And that is very interesting. Because newspapers as
they were historically set up as advertising
vehicles, the advertising paid for the content. And the content is
what drew the eyeballs that advertisers cared about. Today the advertising is very
specific, very purposeful. And so the ancillary
advertising that arose from just the
presence of having content that you wanted to see
and you accidentally saw an advertisement next
to it is very old-fashioned. Advertising these days
is placed with a purpose, and it's often itself. You know, it's not collateral. And accordingly, it's
becoming far more effective. Because the idea is
that information informs that you were about to buy a
red sweater, because of all of the prior steps you've taken. And you know, the guy who
sells red sweaters wants to know about that on time. And so that's a very
different world. It's very powerful. SPEAKER 1: And with that,
I think we're out of time. Thank you so much, Mr. Russo. Thank you. [APPLAUSE] TOM RUSSO: Pleasure.
