The Berkshire Hathaway annual meeting this past weekend had a few notable differences this year. Missing from the meeting were Charlie Munger’s witty quips, a packed stadium, and the often-repeated meaning-of-life questions.
Instead, it took on a more serious tone. For Buffett, the focus is on the survival of Berkshire. The single message: risk management. The lesson is making sure money is available when you need it most.
These are the notes:
On Risk Management
When I look at worst case possibilities, I would say that there are things that I think are quite improbable. And I hope they don’t happen, but that doesn’t mean they won’t happen. I mean, for example, in our insurance business, we could have the world’s, or the country’s, number one hurricane that it’s ever had, but that doesn’t preclude the fact that could have the biggest earthquake a month later. So we don’t prepare ourselves for a single problem. We prepare ourselves for problems that sometimes create their own momentum… There are things to trip other things, and we take a very much a worst case scenario into mind that probably is a considerably worse case than most people do….
I’m not recommending that people buy stocks today or tomorrow or next week or next month. I think it all depends on your circumstances, but you shouldn’t buy stocks unless you expect, in my view, you expect to hold them for a very extended period and you are prepared financially and psychologically to hold them…
Buffett has spent over five decades building Berkshire into one of the biggest companies in the world. Throughout that time, it’s been a story about growth, just not at the expense of survival. It’s risk management 101 and the foundation of Buffett’s philosophy.
His number one goal is surviving this period and protecting the long term success of the business. He’s keeping more cash on hand, just like someone would add to an emergency fund if the future seems uncertain. So he’s understandably cautious.
Of course, that does not mean he’s not willing to invest. It’s safe to say Buffett is optimistic about stocks in the long run, less so in the short run.
For Buffett, investing is a function of opportunity. If opportunities don’t exist (with a willing partner) that meet his requirements, he’s forced to sit and wait (he said a $30-50 billion deal is possible if he could find one — he can’t).
But for everyone not named Warren Buffett, stocks bought, with a long term focus in mind, will be a good investment over the next few decades. The caveat: stocks may not be great over the next few years.
Unpleasant surprises and low probability outcomes can always sneak up on investors in the short term. Proper risk management helps you survive those events.
On Range of Outcomes
But in any event, the range of probabilities on health narrowed down somewhat, I would say the range, the probabilities, or possibilities, and on the economic side are still extraordinarily wide. We do not know exactly what happens when you voluntarily shut down a substantial portion of your society… This is quite an experiment and we may know the answer to most of the questions reasonably soon, but we may not know the answers to some very important questions for many years. So it still has this enormous range of possibilities.
Range of outcomes and probability were terms repeated more often in this meeting than any meeting I’ve seen in the past. Both help assess risk and reward. It’s a matter of figuring out what’s possible versus what’s likely to happen.
Ben Graham’s earliest writings in the Magazine of Wall Street are a good example of how it’s used. He wrote up individual stocks back in the early 1920s. In each case, he worked through the best, worst, and most likely outcome for each stock.
Sometimes the range and probabilities are easy to figure out. Sometimes it’s difficult to impossible. Like today.
Nobody knew the virus existed five months ago. And nobody knows what things will look like five months from now. To think that we’ve magically figured everything out is silly.
So it’s no surprise that Buffett thinks the range of outcomes is wide. Huge unknowns exist — unknowns around the virus, the chance of a second wave, the impact on different businesses, the impact across the economy, and the impact on consumer behavior. None of it is easily measured. But the range of outcomes will change — hopefully shrink — as new information comes in.
The point is to think more like Graham and Buffett when assessing risk. Can you figure out the best, worst, and most likely outcome for an investment and a rough probability of each? Does the expected return on the likely outcome make it a good investment at the current price?
On Being Careful How You Bet
I don’t know, and perhaps with a bias, I don’t believe anybody knows what the market is going to do tomorrow, next week, next month, next year. I know America is going to move forward over time, but I don’t know for sure, and we learned this on September 10th, 2001, and we learned it a few months ago in terms of the virus. Anything can happen in terms of markets, and you can bet on America, but you got to have to be careful about how you bet, simply because markets can do anything.
The trouble with probabilities is that just because something should happen doesn’t mean it will. Buffett uses airlines as a perfect example of this. What looked like a decent investment turned out to be a dud because the most unlikely event actually happened.
Buffett humbly calls it a mistake. An argument could be made that his decision to buy and sell were both good. He was just unlucky in buying.
Investing is nothing more than a series of decisions. Hopefully, it’s good decisions that end in a profit. But probability allows for that to not always the case. Good decisions can end in a loss. Of course, bad decisions can end in a profit too. It’s a matter of luck — good or bad — because unlikely outcomes happen all the time.
Unfortunately, the outcome typically gets all the press, but it’s the decisions that matter. Good decisions specifically. If you have a good process, and make good decisions, you’ll make money over time — just not on every decision.
When we sell something, very often it’s going to be our entire stake. I mean we don’t trim positions. That’s just not the way we approach it any more than if we buy a hundred percent of a business, we’re going to sell it down to 90% or 80%.
There’s an art to selling that I doubt anyone has figured out entirely. I doubt there’s only one right way either. Just a lot of wrong ways.
Selling is also not something Buffett talks about much. But what he describes aligns with how he did it going all the way back to his partnership days. Once he decides to sell, he’s out entirely.
- “This is a very good time to borrow money, which means it may not be such a great time to lend money.”
- “The market system works wonders, and it’s also brutal if left entirely to itself.”
- “I’ve known some really smart people. Smartness does not necessarily equate to wisdom either.”
- “If I owed any money at 18% the first thing I do with any money I had would be to pay it off. It’s going to be way better than any investment idea I’ve got.”