Troll with cudgel

Trolling Buffett: On the 21st Anniversary of Attending My First Berkshire Hathaway Annual Meeting

In 2001, I attended my first Berkshire Hathaway meeting. It set in motion the first of several related events that dramatically changed my path as an investor. Please check out the additional material on the Always Invert community page, which includes the actual full video recording of that meeting.

Twenty-one years ago today I attended my first Berkshire Hathaway annual meeting at the old Omaha civic center. Many things made that first meeting memorable and occasionally entertaining. 

Five hours of Q&A requires some pacing and diversion. For the few unfamiliar with the format, Warren transmorgifies mediocre shareholder questions by expanding them well beyond the limitations of the original inquiry. Charlie plays the part of the foil to keep these marathon sessions entertaining and off-balance.

Sprinkled amongst it all are the occasional moments of levity, which ironically are among the few direct quotes that stick with me years later. That year, it was Buffett’s crack that: 

"The most important factor in your longevity is the age of your parents. So when my mom turned 80, I bought her an exercise bike."

My Job Offer to Trade Derivatives for Berkshire

I can recall exactly what drew me to my first meeting and what kept me coming back year-after-year. A few years earlier I’d turned down a job in one of their subsidiaries. My role, believe it or not, would be to trade financial derivatives. Kid you not. 

This despite Warren Buffett’s famous (and prescient) declaration in 2002 that derivatives were “financial weapons of mass destruction”. If you’re interested in that back story, I’ve provided additional perspective in the community link. On a personal level, that 1998 offer transformed my interest in Berkshire from casual to curious.

Anyway, back to 2001. As a shareholder, I had recently received the annual report which was accompanied by a transcript of the previous year’s meeting. It provided my first glimpse into the considerable value of the Q&A dialogue. Indeed, it was as intellectually honest as anything I had read about investing.

That was what drew me to attend my first meeting.

Answering the Troll

What drew me back was a comment that he made to the most obnoxious questioner of the day. A shareholder got up and ranted about while it was one thing for Buffett and Munger to shy away from technology stocks, they had absolutely no excuse in selling their shares in Fannie Mae and Freddie Mac—companies that were clearly in Warren’s and Charlie’s circle of competence, only to subsequently have those stocks rocket higher. 

The shareholder called them out as complete idiots and phonies. I can’t even recall if he gave them any credit for the incredible returns those investments made before the share sales. If he did, it was only to double down on the proof that they should have known better, which made the sale and subsequent tax bill all the more egregious.

The questioner came across as a complete jackass, no doubt. Surprisingly, one of the few trolls over the many years and thousand or so questions I’ve witnessed given the rate of 50+ annual questions over 20+ years.

I was a bit surprised when Buffet didn’t even try to defend himself despite the half dozen justifications that immediately came to my mind. Instead, according to my notes:

"FNMA and FHLMC — We thought the risk profile had changed. Overall, we are highly sensitive to risk in financial institutions. Financial institutions have problems that tend not to reveal themselves until it is too late—it is just their nature. So, when we have concerns with their practices, we tend to get very cautious."

Beginning of TL;DR Section: 

This next part gets a bit technical, so feel free to breeze right on by.

It just so happened that throughout the previous week, I had been working on a complex multi-legged trade that was dependent on the shape of the swap curve for agency securities, i.e., those issued by Freddie Mac and Fannie Mae. For five years or more, basically ever since I began paying attention to them, I’d missed one profitable trade opportunity after another due to my theory that the market was completely wrong to price these agency bonds in a way that mirrored the risk pricing of U.S. Government bonds.

Instead, I believed that the bonds of Fannie Mae and Freddie Mac should resemble the way every other U.S. Corporation, such as Ford or General Electric, was priced. Why didn’t the pricing of their bonds reflect that their risk and uncertainty increased over time, like any other corporation? 

In fact, I’d had some experience with their dodgy accounting. At the time, I thought it was just my being a neophyte regarding corporate finance. In 1999 or 2000, after a dramatic rally in mortgage securities, I attempted an amateur’s version of forensic accounting for what Freddie Mac might report for earnings. I was off by more than thirty percent, a factor so large that I felt like an idiot. These weren’t seemingly complex portfolios to value.

Only later did the SEC prosecute Freddie for understating their earnings beginning with that period by something like seven billion dollars. Freddie admitted to managing their earnings from 2000 through 2002 in a way that parked profits for later periods in an attempt to smooth out their earnings and make the company look more consistently and predictably profitable. 

However, my trade was going to be all about bond math, not earnings statement calculations. The agency bond curve had gotten to the point that I could once again do one of those trades I’d been passing on for years, costing my firm money every time, due to my seemingly misguided scepticism. The difference was this time that the math was compelling enough that even if the Agency bonds began to mirror other corporate yield premiums, in eight months the day-by-day positive carry on the trade would eventually bail me out. It would be a rough ride, but time would eventually be on my side.

End of TL;DR Section

In 2001, it didn’t cost much to attend a BRK meeting. I flew Southwest roundtrip out of Chicago’s Midway airport for next-to-nothing. Add in airport parking, cabs in Omaha, a cheap boxed lunch—all-in I spent just under a hundred dollars. 

Two days later, I came to work and immediately told my broker that I was abandoning the trade idea once and for all. It turned out to be the right move. Definitely the best $98 I’d ever spent on research.

Buffett’s comments were definitely a canary in the coal mine. Over the last two decades I’ve found that to be more than occasionally true. Due to his policy of criticizing by practice and praising by name, most chroniclers of the meeting completely miss the behavior or company he might be targeting with a remark or description. It flies right over their heads. 

What Else Did They Say in 2001?

Thinking back on this, I wondered whether the rest of their comments aged that well. I decided to round out a top five:

"In 1993, the pharmaceutical sector had a future that was easier to predict. In aggregate, the pharmaceutical industry has a much better record of returns on large sums of capital and a higher percentage of profitable companies than does technology."

This first one referenced Buffett’s post-mortem on missing buying the pharma industry across the board during the Hillary-Care scare of 1993. Buffett mentioned that the drug companies were one of the few industries whereby the profits didn’t all accrue to the top one or two industry leaders. Instead, the seventh and eighth largest companies were still compellingly profitable. He bemoaned his sucking his thumb instead of just buying the whole basket. 

I think this comment aged well if you look to the processes rather than the specifics. Clearly, making sweeping statements about industry attributes has led lazy investors to avoid entire swaths of the market due to sweeping pronouncements that categorize types of business as too difficult to analyze. While people zeroed in on Buffett’s specific preference for one industry over another, what they really should have taken away is that the way to approach investing is to understand what the economics of the top ten businesses in a field actually look like. 

"The mistakes in Berkshire Hathaway’s history that have been the most extreme have been errors of omission. Lots of blown opportunities. We only regard errors as errors when they are in our circle of competence. The ones that are particularly galling are when we were too small in an opportunity we understood."

Buffett and Munger have repeated this mantra for decades. As Charlie would say “Nothing to add.”

Two decades ago, I knew a ton about derivatives and very little about how to value a business or a stock. I looked everywhere for good insights and the pickings were admittedly slim. The following year, when I attended the meeting, a chance encounter led me to a path of collaborations and partnerships that changed my investing life. That’s a story for another time.

It is, however, integral to what we want to build next. As is this next set of quotes: 

What you want to learn is how to value a business, and then compare that to the price.

Investment and finance teaching in this country is generally pathetic.

The way my notes read, I suspect that Warren made the first statement and Charlie contributed the additional commentary. If you reread it with that sequence of voices in your life, it comes properly alive:

Warren: What you want to learn is how to value a business, and then compare that to the price.

Charlie: Investment and finance teaching in this country is generally pathetic.

I keep coming back to that day. Beginning with that combination of $98 and my willingness to spend a day listening and learning, I changed the course of my financial life.  

I never take anything anyone says as gospel, including and maybe at times especially Warren and Charlie. However, I always make room to bring in anyone’s views and put them in competition with whatever else might be floating around in my head. Then I sort it out for myself.

Of course, when you are really engaged in a problem, even the briefest mention or perspective can really help to complete the picture. In that meeting, Buffett had previously brought up earnings management outside the Freddie and Fannie comments:

"Very few large companies can compound their growth over 20 years of 15% from current record earnings. The implications involved in some valuations is astonishing, particularly if you are demanding 15% returns." 

In twenty-one years, some things never change. 

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