WARREN BUFFETT ON BUSINESS - Principles From the Sage of Omaha
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WARREN BUFFETT
ON BUSINESS
Principles From the
Sage of Omaha
RICHARD J. CONNORS
RICHARD CONNORS is a registered investment advisor. He is also the owner of Connors Investment
Management Company. Since 2006, Mr. Connors has presented a class at the Washington University’s
Lifelong Learning Institute in St. Louis, Missouri on Warren Buffett’s investment and business strategies. Mr.
Connors is a graduate of Notre Dame University and the St. Louis University.
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are available on a monthly or yearly basis. Further information is available at www.summaries.com.Warren Buffett on Business - Page 1
MAIN IDEA
If you want to invest like Warren Buffett, buy shares in Berkshire Hathaway and be done with it. However, taking into account Warren
Buffett has been investing in public and private companies for more than 50 years now, he has some very good ideas about how
companies can and should be managed. These nuggets of wisdom have mainly been included in the annual Berkshire Hathaway
shareholders letters. When you get right down to brass tacks, to run a business the Warren Buffet way, you should:
• Communicate with and treat both your employees and your stockholders fairly and consistently.
• Practice responsible and ethical corporate governance.
• Be patient and persevere as you work to build value in your enterprise.
• Have a passion for your work and have fun but always be willing to readily admit mistakes.
“The Buffett/Berkshire Hathaway model of managing a business, large or small, should be required reading for all business
executives, entrepreneurs, and business school students. When you strip it all away, effective business management – the Warren
Buffett Way – is remarkably obvious and simple. He describes his business principles as ‘simple, old and few.’”
– Richard Connors
Always treat your shareholders as owner-partners and yourself as managing
1 Shareholders . . . . . . . . . . . Page 2
partner. Embrace stewardship as a way of life in your business practices.
Run your company so it will become the “buyer of choice” when owners want to
2 Culture . . . . . . . . . . . Page 2
sell their business masterpieces in the future. Think long-term, act accordingly.
Have robust corporate governance structures. Make certain all checks and
3 Governance . . . . . . . . . . . Page 3
balances are working by having a strong board to keep the CEO accountable.
When you buy a business, you’re also buying the manager which comes with it.
4 Managers . . . . . . . . . . . Page 3
Make it a point to work with people you like and admire and everything will be fine.
Always be open and transparent about what’s happening in your business.
5 Communication . . . . . . . . . . . Page 4
Disclose fully all the facts – good, bad or indifferent. Give people the information.
When making acquisitions, look at the people involved first and the dynamics of
6 Acquisitions . . . . . . . . . . . Page 4
the business second. Find people you are prepared to back and then do that.
Risk is always present in business. Don’t try and avoid it – that’s impossible. Just
7 Risk . . . . . . . . . . . Page 5
make very certain you are adequately compensated for the risks you take.
By all means be prepared to pay for performance but always establish a direct
8 Compensation . . . . . . . . . . . Page 5
line of sight between what managers do and what they are paid. Keep it simple.
Build time to reflect and think into your schedule. Don’t feel like you have to be
9 Time . . . . . . . . . . . Page 6
doing something all the time. Slow down and focus on what’s important.
If you ever find yourself in the middle of a crisis, face up immediately to the bad
10 Crises . . . . . . . . . . . Page 6
news. Take responsibility. Then get to work doing what needs to be done.
Focus on what your earnings rate is on equity capital employed rather than
11 Principles . . . . . . . . . . . Page 7
earnings per share. This distinguishes the stellar performers from the also-rans.
Always act like you own the company you work for outright and you’ll do fine.
12 Behavior . . . . . . . . . . . Page 7
Good managers are stewards of their enterprises, not plunderers.
Everyone makes mistakes. Expect that to happen. The key is to learn and move
13 Mistakes . . . . . . . . . . . Page 8
forward rather than getting discouraged. Hold regular post mortems and learn.
Intelligent investing is not hard. All you have to do is to correctly evaluate
14 Investing . . . . . . . . . . . Page 8
businesses within your circle of competence which will grow in value in the future.Warren Buffett on Business - Page 2
Buffett on Business 1 Shareholders Buffett on Business 2 Culture
Always treat your shareholders as owner-partners and Run your company so it will become the “buyer of choice”
yourself as managing partner. Embrace stewardship as when owners want to sell their business masterpieces
a way of life in your business practices. in the future. Think long-term and act accordingly.
The best way to do business is to always take a long-term view. Berkshire Hathaway has a strong corporate culture which has
As a stockholder, don’t just view your investment as a piece of some very distinctive features:
paper you hold on to until it is worth more and then it gets onsold. n Berkshire never has an “exit strategy” in mind whenever it
Rather, visualize yourself as being a part owner of a business acquires a business. Rather, it buys well run companies and
that you intend to stay involved with indefinitely. Measure your then expects to hold them forever.
success by the long-term progress of the company rather than by
n When a company is acquired by Berkshire, the managers are
the daily movement of the stock price.
expected to keep running it with minimum interference from
If you are the manager of a business, it’s smart to treat your Warren Buffett, Charlie Munger or anyone else.
shareholders as co-venturers. Imagine your stockholders have
n Berkshire encourages its stockholders to think long-term and
committed their funds to you for the long haul and therefore you
therefore never worries about quarterly earnings at all. They
should treat them like you would your own family members. To
are what they are. The company expects the majority of its
help you retain that perspective, it’s ideal if your own financial
shares to be held by investors who eventually die while still
fortune moves in lockstep with that of your enterprise. The best
holding them. CEOs of subsidiary companies are therefore
alignment occurs when you have a substantial portion of your
asked to manage to maximize long-term value rather than
own wealth invested in the company you are managing. That
worry about next quarter’s earnings.
way you make money when your stockholder partners do and in
exactly the same proportion as them. n Berkshire has no operating or capital allocation policies the
CEOs of its operational businesses are expected to adopt.
This has been the case with Berkshire Hathaway since its
They are free to choose whatever policies best suit their own
inception. The company’s managers, Warren Buffett and Charlie
needs.
Munger, have their personal fortunes overwhelmingly
concentrated in Berkshire shares. They do not ask their n Berkshire will not engage in a hostile takeover under any
stockholders to invest with them but then put their own money circumstances whatsoever. The company generally buys
elsewhere. Nor do they try and extract large salaries or options to operating businesses for cash but will consider issuing stock
purchase shares at below market prices. Their entire attitude is: on rare occasions.
“If you suffer, we will suffer; if we prosper, so will you. And we will n Berkshire is very conservative. The company does not hire
not break this bond by introducing compensation arrangements consultants, does not try and keep up with the latest trends
that give us a greater participation in the upside than the and insists on doing things in an old-fashioned open and
downside.” transparent way.
“Although our form is corporate, our attitude is partnership. “Our long-avowed goal is to be the ‘buyer of choice’ for
Charlie Munger and I think of our shareholders as businesses – particularly those built and owned by families. The
owner-partners, and ourselves as managing partners. We do not way to achieve this goal is to deserve it. That means we must
view the company itself as the owner of our business assets but keep our promises; avoid leveraging up acquired businesses;
instead view the company as a conduit through which our grant unusual autonomy to our managers; and hold the
shareholders own the assets. CEOs must embrace stewardship purchased companies through thick and thin (though we prefer
as a way of life and treat their owners as partners, not patsies. It’s thick and thicker). Our record matches our rhetoric. Most buyers
time for CEOs to walk the walk,” competing against us, however, follow a different path. For them,
– Warren Buffett acquisitions are ‘merchandise.’ Before the ink dries on their
purchase contracts, these operators are contemplating ‘exit
“The priority is that all of us continue to zealously guard
strategies.’ We have a decided advantage, therefore, when we
Berkshire’s reputation. We can’t be perfect but we can try to be.
encounter sellers who truly care about the future of their
We can afford to lose money – even a lot of money. But we can’t
businesses.”
afford to lose reputation – even a shred of reputation. We must
– Warren Buffett
continue to measure every act against not only what is legal but
also what we would be happy to have written on the front page of “Why don’t more companies and investors copy Berkshire
a national newspaper in an article written by an unfriendly but Hathaway? It’s a good question. Our approach has worked for
intelligent reporter.” us. Look at the fun we, our managers and our shareholders are
– Warren Buffett having. More people should copy us. It’s not difficult, but it looks
difficult because it’s unconventional – it isn’t the way things are
“For many of our shareholders, our stock is all they own, and
normally done. We have low overhead, we don’t have quarterly
we’re acutely aware of that. Our culture of conversatism runs
goals and budgets or a standard personnel system, and our
pretty deep. This is an amazingly sound place. We are more
investing is much more concentrated than is the average. It’s
disaster-resistant than most other places. We haven’t pushed it
simple and common sense.”
as hard as other people would have pushed it.”
– Charlie Munger
– Warren BuffettWarren Buffett on Business - Page 3
Buffett on Business 3 Governance Buffett on Business 4 Managers
Have robust corporate governance structures. Make certain all When you buy a business, you’re also buying the manager
the checks and balances are working by having a strong board which comes with it. Make it a point to work only with people
who will keep the CEO accountable for what happens. you like and admire and everything will work out fine.
The worst thing you can have in a corporation is a board of When Berkshire acquires a company, it does so in the
directors who merely rubber stamp what the CEO wants to do. expectation the people who are already running the company
The whole idea of directors is to have a group who will keep the want to stay there and will do so. Warren Buffett describes this as
CEO accountable for what he or she does on behalf of the hiring people who want to “paint their own painting” rather than
stockholders. Fill your board with people who will do that and have someone from the head office come in and tell them what
whose personal interests are aligned with those of rank-and-file color to use. Similarly, if you make acquisitions, look for well run
shareholders. businesses which have solid management in place and plan on
Good directors will have four qualities: keeping those people engaged and happy well into the future.
1. They will be genuinely independent – meaning the fees they When you have good managers in place, treat them well:
receive for acting as directors will form only a small part of n Give them the applause and appreciation they deserve – go
their overall annual income. If this is not the case, there will out of your way to tell them they are doing a good job. Be a
always be a vested interest for them to go along with knowledgeable observer and give credit where credit is due.
whatever the CEO wants in order to keep the money flowing. n Treat them fairly – don’t try and take advantage of them in any
2. They must be interested in the company – so they will dig into way, shape or form. “Our basic goal as an owner is to behave
all of the issues which face the enterprise themselves rather with our managers as we like our owners to behave with us,”
than rely solely on management supplied analysis. Good says Warren Buffett.
directors should be out kicking the tires and digging into n Give them freedom to act – let them set their own agendas,
what’s happening on their own initiative all the time. create and pursue their own market opportunities and do what
3. They need to have a shareholder orientation – which is makes sense to them. Don’t try and second guess them.
generally best accomplished if the directors have a personal
shareholding in the company of $1 million or more which they “So when I buy a business, I am usually buying the manager with
have purchased with their own money. That way, the it, because I don’t know how to run the business. So when
directors will act more like owners (which is helpful) and less someone comes along that wants to sell their business, I have to
like mere hired guns (which is less desirable). look at them in the eye and I have to decide whether they love the
money or love the business. It’s okay to love the money, but they
4. They must have business smarts and savvy – so they can have to love the business.”
pick up on the vibes when something fishy is going on. – Warren Buffett
Directors need to be able to evaluate when foolish
acquisitions are being proposed, when manifestly excessive “Our managers have produced extraordinary results by doing
compensation packages are under discussion and when rather ordinary things – but doing them exceptionally well. Our
foolhardy initiatives are being suggested without anyone managers protect their franchises, they control costs, they
else’s help. search for new products and markets that build on their existing
In a healthy company, the independent directors should be able strengths and they don’t get diverted. They work exceptionally
to meet together and discuss the company’s progress without hard at the details of their businesses, and it shows.”
the CEO being present and part of the discussion. Berkshire – Warren Buffett
encourages this to happen regularly. The board also discusses “If each of us hires people who are smaller than we are, we shall
who would be called on to serve as acting CEO in the event the become a party of dwarfs. But, if each of us hires people who are
current CEO becomes unable to function for any reason which bigger than we are, we shall become a company of giants.”
may arise. This contingency plan is updated regularly and is – David Ogilvy, founder, Ogilvy & Mather
ready to be put into action at short notice.
“I believe in going to work for businesses you admire and people
“If able but greedy managers overreach and try to dip too deeply you admire. Anytime you are around somebody that you’re
into the shareholders’ pockets, directors must slap their hands.” getting something out of and you feel good about your
– Warren Buffett organization, you just have to have a good result. I advise you
“Over time, the skill with which a company’s managers allocate never to do anything because you think it’s miserable now but it’s
capital has an enormous impact on the enterprise’s value. going to be great 10 years from now, or because you think you’ve
Almost by definition, a really good business generates far more got x dollars now, but I’ll have 10x. If you are not enjoying it today,
money (at least after its early years) than it can use internally. you’re probably not going to enjoy it 10 years from now.”
The company could, of course, distribute the money to – Warren Buffett
shareholders by way of dividends or share repurchases. But “Our managers focus on moat-widening – and are brilliant at it.
often the CEO asks a strategic planning staff, consultants, or Quite simply, they are passionate about their businesses.
investment bankers whether an acquisition or two might make Usually, they were running these long before we came along; our
sense. That’s like asking your interior decorator whether you only function has been to stay out of the way.”
need a $50,000 rug.” – Warren Buffett
– Warren BuffettWarren Buffett on Business - Page 4
Buffett on Business 5 Communication Buffett on Business 6 Acquisitions
Always be open and transparent about what’s happening in When making acquisitions, look at the people involved first
your business. Disclose fully all the facts – good, bad or and the dynamics of the business second. Find people you
indifferent. Give people the information they crave. are prepared to back and then do that to the hilt.
The gold standard for business disclosure is to give your Berkshire Hathaway is well known as a successful investment
stakeholders the information you’d like to receive if positions company. It grows by buying shares in other companies rather
were reversed. If you are a business manager, it’s much more than in making or selling anything itself. A few of the key
important to give shareholders a frank and candid assessment of purchases Berkshire has made which have fueled the
the long-term economic prospects for your enterprise than it is to company’s growth include:
fill your annual report with pictures of customers, personnel, n Purchasing the Nebraska Furniture Market for $60 million in
plants or products. Dispense with all the puffery provided by the 1983. This was a company founded by Rose Blumkin, a
public relations department or consultant. Just tell it like it is using Russian immigrant who arrived in the United States at age 23
your own words and people will respond. being unable to speak English. She took 16 years to save
“It’s called an annual report. It’s not called the annual sales $500 so she could start this company in Omaha, Nebraska, a
document. It’s not called the annual, you know, tribute to city of 700,000 people. Through sheer hard work and
management’s aspirations or anything. It’s called the annual determination, Mrs. Blumkin built Nebraska Furniture Market
report.” to the point at which it was generating $100 million in annual
– Warren Buffett sales out of one store, 200,000 square-feet in size. Mrs.
Blumkin turned 100 on December 3, 1993 and still continued
If you speak with candor, your shareholders will love you for it. to work at the store seven days a week from opening to
People are sick and tired of annual reports where the closing.
management laud what went right but bury what went wrong in a n In 1976, Berkshire purchased half of Government Employees
veritable flood of “proforma” earnings statements, discussions Insurance Company for $40 million. In 1995, Berkshire
about meaningless EBITDA (earnings before interest, taxes, purchase the other half of the company for $2.3 billion.
depreciation and amortization) or a wad of unintelligible GEICO pioneered the concept of selling insurance through
footnotes. Have the attitude anytime you trumpet future earnings direct marketing rather than through agents, the entrenched
projections, what you’re really asking is that shareholders ignore sales method for every other insurance company. GEICO has
your lousy current operating results. continued to grow strongly since Berkshire’s acquisition of the
“Charlie and I not only don’t know today what our businesses will company and is today a very solid performer in Berkshire’s
earn next year – we don’t even know what they will earn next investment portfolio.
quarter. We are suspicious of those CEOs who regularly claim n In 1998, Berkshire agreed to merge with General Re, a
they do know the future – and we become downright incredulous reinsurance company which provides insurance to other
if they consistently reach their declared targets. Managers that insurance companies. Unbeknown to Berkshire, General Re
always promise to ‘make the numbers’ will at some point be Securities was deeply involved in buying and selling financial
tempted to make up the numbers.” derivatives. Derivative contracts are financial instruments
– Warren Buffett which call for money to change hands at some future date,
with the amount involved dependent on one or more
Berkshire is legendary for the way its uses its annual meeting to reference items such as interest rates, stock prices or
let its shareholders have access to the company’s senior currency values. Derivatives require the other party to have
management team of Warren Buffett and Charlie Munger. It’s the money available to pay should they be called on to do so
not unusual for the question-and-answer session to go for five and therefore their ultimate future value is almost impossible
hours or more. This is the gold standard in terms of to calculate using conservative techniques. For this reason,
manager-to-owner communications. It’s also a very democratic Warren Buffet has described financial derivatives as “time
way to disseminate information since everyone hears what’s bombs, both for the parties that deal in them and the
being said at the same time. The company does not hold economic system”. Berkshire moved to sell General Re’s
separate analyst’s briefings or anything of that nature. derivatives operation but ultimately had to end up terminating
it by unwinding its more than 23,000 outstanding derivatives
“We will be candid in our reporting to you, emphasizing the
in early 2002. This resulted in pre-tax losses for Berkshire of
pluses and minuses important in appraising business value. The
$173 million in 2002 and $99 million in 2003 alone. Ultimately,
guideline is to tell you the business facts that we would want to
pre-tax losses for Berkshire would top $409 million.
know if your positions were reversed. We give you no less.
Moreover, as a company with a major communications “In our view, derivatives are financial weapons of mass
business, it would be inexcusable for us to apply lesser destruction, carrying dangers that, while now latent, are
standards of accuracy, balance and incisiveness when reporting potentially lethal. The derivatives genie is now well out of the
on others. We also believe candor benefits us as managers. The bottle, and these instruments will almost certainly multiply in
CEO who misleads others in public may eventually mislead variety and number until some event makes their toxicity clear.
himself in private.” Central banks and governments have so far found no effective
– Warren Buffett way to control, or even monitor, the risks posed by these
contracts.”
– Warren BuffettWarren Buffett on Business - Page 5
Buffett on Business 7 Risk Buffett on Business 8 Compensation
Risk is always present in business. Don’t try and avoid By all means be prepared to pay for performance but
it – that’s impossible. Just make very certain you are always establish a direct line of sight between what managers
adequately compensated for the risks you take. do and what they are paid. Keep it simple and fair.
Berkshire is in the reinsurance business. In layman’s terms, the Irrational and excessive executive compensation arrangements
company sells insurance to other insurance companies who have become much too common today. It’s time for reform. By all
want to reduce their financial risks should some kind of means, offer people large carrots for what they do right but these
catastrophic event happen. This is a good business to be in compensation arrangements have to take into account the
because most of the time, reinsurance will show a large profit. economic potential and capital intensity of the business as well to
Sooner or later, however, the company will have to make a major be equitable. Merely paying CEOs to turn up for work is
payout. The only real question is when that time will come ludicrous.
because it inevitably will.
“It has become fashionable at public companies to describe
To succeed at underwriting in general and reinsurance in almost every compensation plan as aligning the interests of
particular, three key principles must come into play: management with those of shareholders. In our book, alignment
1. You have to stay within your circle of competence – and means being a partner in both directions, not just on the upside.
accept only those risks which you understand and can Many ‘alignment plans’ flunk this basic test, being artful forms of
quantify accurately. Make certain you have evaluated all ‘heads I win, tails you lose.’ A common form of misalignment
relevant factors in making your assessment of risk. occurs in the typical stock option arrangement, which does not
2. You have to decline any risks which threaten the future periodically increase the option price to compensate for the fact
solvency of your business – even if from an aggregation of a that retained earnings are building up the wealth of the company.
number of unrelated risks. Make certain you don’t threaten Indeed, the combination of a ten-year option, a low dividend
the future health of your business by accepting multiple risks payout, and compound interest can provide lush gains to a
which may seem unrelated but in reality are. manager who has done no more than tread water in his job. A
cynic might even note that when payments to owners are held
3. You have to avoid moral risk just as thoroughly – or put
down, the profit to the option-holding manager increases. I have
another way don’t try and do good business with bad people.
yet to see this vital point spelled out in a proxy statement asking
Attempting to do business with unethical people is usually
shareholders to approve an option plan.”
expensive and on some occasions prohibitively so.
– Warren Buffett
As long as you have the discipline to stick with these three
principles, then you won’t take on excessive risks knowingly. Berkshire has in place compensation arrangements where some
Again, there’s no problem with taking on risk as long as you make managers can receive incentive bonuses of up to five times their
certain you have the liquidity to meet your commitments should base salary. Warren Buffett and Charlie Munger genuinely hope
the worst case scenario eventuate and you have been paid their managers earn these bonuses because if they do, it will
appropriately for assuming that risk. mean their business units have turned in exceptional
performances. Berkshire is, however, careful to define what
“Charlie and I detest taking even small risks unless we feel we constitutes exceptional performance very concisely. Managers
are being adequately compensated for doing so. About as far as who achieve against stiff headwinds can and should expect to be
we will go down that path is occasionally eat cottage cheese a rewarded well whereas those who enjoy the benefit of tailwinds
day after the expiration on the carton.” not of their own making will not be rewarded to the same degree.
– Warren Buffett
Berkshire is also wary of compensation agreements where one
“We remain prepared to lose $6 billion in a single event, if we company tries to match the excesses of other companies in the
have been paid appropriately for assuming that risk. We are not name of parity. That argument doesn’t hold water with Warren
willing, though, to take on even very small exposures at prices Buffett. Berkshire doesn’t contract the services of compensation
that don’t reflect our evaluation of loss probabilities. Appropriate consultants and cannot conceive of any circumstances under
prices don’t guarantee profits in any given year, but which they would be required. All the company’s executive
inappropriate prices almost certainly guarantee eventual losses. compensation agreements are easy to understand and in sync
Rates have recently fallen because a flood of capital has entered with what Berkshire wants the respective executives to
the super-cat field. We have therefore sharply reduced our wind accomplish.
exposure. Our behavior here parallels that which we employ in
“Most managers talk the talk but don’t walk the walk, choosing
financial markets: Be fearful when others are greedy, and be
instead to employ compensation systems that are long on
greedy when others are fearful.”
carrots but short on sticks (and that almost invariably treat equity
– Warren Buffett
capital as if it were cost-free). There’s nothing wrong with paying
“At Berkshire, we believe in Charlie’s dictum – ‘Just tell me the well for truly exceptional performance. But, for anything short of
bad news; the good news will take care of itself’ – and that is the that, it’s time for directors to shout ‘less!’ It would be a travesty if
behavior we expect of our managers when they are reporting to the bloated pay of recent years becomes a baseline for future
us. The most important thing to do when you find yourself in a compensation. Compensation committees should go back to the
hole is to stop digging.” drawing boards.”
– Warren Buffett – Warren BuffettWarren Buffett on Business - Page 6
Buffett on Business 9 Time Buffett on Business 10 Crises
Build time to reflect and think into your schedule. If you ever find yourself in the middle of a crisis,
Don’t feel like you have to be doing something all the time. face up immediately to the bad news. Take responsibility.
Slow down and focus on what’s important. Then get to work doing what needs to be done.
“We both insist on a lot of time being available each day to just sit In 1987, Berkshire purchased $700 million of redeemable
and think. That is very uncommon in American business. We preferred stock in Salomon Brothers making Berkshire the
read and think. So Warren and I do more reading and thinking largest shareholder in Salomon. When a 34-year-old bond trader
and less doing than most people in business. We do that made secret and unauthorized trades in U.S. Treasury securities
because we like that kind of life.” in December 1990 and February 1991, a huge furore erupted.
– Charlie Munger Salomon’s chairman, president and in-house counsel were fired
or resigned and on August 18, 1991, Warren Buffett was
Despite the fact Warren Buffett is head of the world’s largest appointed to the unpaid position of chairman of Salomon
investment company and one of the richest people in the world, Brothers.
his schedule is remarkably free. He doesn’t schedule meetings That same day, August 18, 1991, the U.S. Treasury announced
with people from when he starts work each day to when he Salomon would be banned from bidding in U.S. Government
finishes at night. Nor does he insist on long-winded briefings. securities auctions. Four hours later, after some intensive
Mostly, he sits in his office and reads. lobbying by Warren Buffett, the ban was rescinded. He achieved
In the average day, Warren Buffett will read about five this by first making full disclosure of the facts in the matter and
newspapers and a large number of annual reports, 10K and 10Q then by offering new controls which would ensure problems
statements. By his reckoning, he will spend 75% to 80% of each would never arise again in the future.
day reading and the rest of the day on the phone buying or selling
stock, trading in foreign currencies and so forth. “I would like to start by apologizing for the acts that have brought
us here. The Nation has a right to expect its rules and laws will be
“A shareholder once asked Buffett how he spent his days. obeyed. At Salomon, certain of these were broken. I want
Warren said he mostly read and talked on the phone. ‘That’s employees to ask themselves whether they are willing to have
what I do, Charlie, what do you do?’ ‘That question reminds me any contemplated act appear on the front page of their local
very much of a friend of mine in World War II in a group that had paper the next day, to be read by their spouses, children and
nothing to do,’ replied Munger. ‘A general once went up to my friends. If they follow this test, they need not fear my other
friend’s boss, we’ll call him Captain Glotz. He said ‘Captain Glotz, message to them: Lose money for the firm, and I will be
what do you do?’ His boss replied, ‘Not a damn thing.’ The understanding; lose a shred of reputation for the firm, and I will be
general got madder and madder and turned to my friend and ruthless.”
said, ‘What do you do?’ My friend said, ‘I help Captain Glotz.’ – Warren Buffett
That’s the best way to describe what I do at Berkshire.”
– Richard Connors Buffett served as interim chairman of Salomon Brothers for ten
months. During that time, Buffett:
“I have learned an incredible amount from Warren, some of them n Installed rules and procedures which would prevent any
are things you can express, like really looking at the time on your reoccurrence of the rogue trading.
calendar, valuing as much free time as possible. I love it when
n Set up a compliance committee of the board of directors to
Warren gets out his calendar.”
monitor performance, with Warren Buffett acting as the self
– Bill Gates
appointed chief compliance officer for the firm.
“At the Harvard Business School last year, a student asked me n Set up a reserve fund of $200 million to meet settlements,
when I planned to retire and I replied, ‘About five to ten years fines, penalties and so forth.
after I die.’ Berkshire is my first love and one that will never fade.”
n Revamped the firm’s incentive compensation plan to place
– Warren Buffett
more emphasis on pay-for-performance.
“I will tell you a secret: Deal making beats working. Deal making n Appointed a new CEO, legal counsel and ultimately chairman.
is exciting and fun, and working is grubby. Running anything is By the time Buffett stepped down as interim chairman, Salomon
primarily an enormous amount of grubby detail work. Deal Brothers was well on the way towards regaining its position as a
making is romantic, sexy. That’s why you have deals that make successful investment banking firm. Buffett’s actions were a
no sense.” good guide to how high profile business crises can and should be
– Peter Drucker handled.
“At our sessions, I tell the newcomers the story of the Tennessee “In 1989 when I – a happy consumer of five cans of Cherry Coke
group and its spotting of Clayton Homes. I do this in the spirit of daily – announced our purchase of $1 billion worth of Coca-Cola
the farmer who enters his hen house with an Ostrich egg and stock, I described the move as a rather extreme example of
admonishes the flock: ‘I don’t like to complain, girls, but this is just putting our money where my mouth was. On August 18 of last
a small sampling of what the competition is doing.’ To date, our year, when I was elected interim chairman of Salomon, Inc., It
new scouts have not brought us deals. But their mission in life was a different story: I put my mouth where our money was.”
has been made clear to them.” – Warren Buffett
– Warren BuffettWarren Buffett on Business - Page 7
Buffett on Business 11 Principles Buffett on Business 12 Behavior
Focus on what your earnings rate is on equity capital Always act like you own the company you work for outright
employed rather than earnings per share. This distinguishes and you’ll do fine. Good managers are stewards of their
the stellar performers from the also-rans. enterprises, not plunderers trying to maximize their pay.
The real acid test of managerial excellence is what they earn on It’s common for corporate leaders to criticize government for
equity capital invested. It’s no great feat for a manager to earn spending taxpayer’s money differently from the way they would
more by putting up more money. Great managers will do things if the money were coming out of their own pocket. All
consistently find new and better ways to earn a superior return on too often, however, the management of firms fall into the same
capital for their enterprises. trap. Berkshire has managed to avoid this problem because
Berkshire looks at four criteria when deciding whether or not to Warren Buffett and Charlie Munger own around 47% of
acquire a company: Berkshire’s stock between them and therefore they receive their
1. It must be a business that’s understandable. rewards as owners, not managers.
2. Favorable long-term economics must be available. It’s actually easier for an inadequate CEO to keep his or her job
3. The company must have able and trustworthy management. than it is for an incompetent subordinate. If, for example, an
4. It must be available for a sensible price tag. entry-level typist claims to be able to type 80 words a minute but
in fact can type only 50 words a minute, he or she will be found
“A truly great business must have an enduring ‘moat’ that out in no time whatsoever and will be fired. An inadequate CEO,
protects excellent returns on invested capital. The dynamics of by contrast, can keep his or her job for an extended period
capitalism guarantee that competitors will repeatedly assault because there is no definitive criteria by which job performance
any business ‘castle’ that is earning high returns. Therefore a can be measured. Boards of directors are notoriously inefficient
formidable barrier such as the company’s being the low-cost at weeding out poor performing CEOs because of the congenial
producer (GEICO, CostCo) or possessing a powerful world-wide atmosphere which tends to be present in most boards. For the
brand (Coca-Cola, Gillette, American Express) is essential for board to criticize the CEO is considered to be impolite and
sustained success. Business history is filled with ‘Roman therefore the company suffers.
Candles,’ companies whose moats proved illusory and were
soon crossed.” Many public company CEOs have also become quite adept at
– Warren Buffett manipulating revenues to keep their share prices artificially high.
This is often done in the mistaken belief the job of the CEO is to
Warren Buffett often states he and Charlie Munger work towards encourage the highest possible stock price at all times.
achieving four goals for Berkshire: Therefore, restructuring charges are crammed into one quarter
1. To maintain Berkshire’s financial position by maintaining instead of the more logical approach of attributing them to a
huge cash reserves, modest near-term obligations and number of years. By dumping all the bad news in one quarter,
dozens of sources of earnings and cash. then the results for future quarters will be artificially higher.
2. To widen the “moats” around all of Berkshire’s operating It’s also easy for CEOs to get sidetracked and neglect their core
businesses by helping expand their competitive advantages. businesses while evaluating potential acquisitions. Loss of focus
can mean a company will ignore obvious ways to organically
3. To acquire and develop new and varied streams of earnings. grow its own business in the quest for the large injections of new
4. To expand and deepen the cadre of outstanding operating cash which can potentially come from acquisitions. All too often
managers Berkshire has in place. these new acquisitions end up in disaster while important issues
relating to the company’s core business are neglected.
“Every day, in countless ways, the competitive position of each
of our businesses grows either weaker or stronger. If we are It’s deceptive and/or dangerous for CEOs to predict growth rates
delighting customers, eliminating unnecessary costs and for their companies in the future. These public statements of
improving our products and services, we gain strength. On a intention can lead to trouble. It’s fine to have internally discussed
daily basis the effects of our actions are imperceptible; goals to work towards but when a CEO commits the company to
cumulatively, though, their consequences are enormous.” achieve some growth rate, all kinds of problems can arise. At the
– Warren Buffett very least, CEOs can engage in uneconomic operational
maneuvers in order to make their number. Or they might shift
“Berkshire’s ownership may make even the best of managers revenue from one quarter to another to give the desired results.
more effective. First, we eliminate all of the ritualistic and non There is a very fine line between fudging the books and outright
productive activities that normally go with the job of CEO. Our fraud and too many CEOs have been caught out doing these
managers are totally in charge of their personal schedules. kinds of manipulations.
Second, we give each a simple mission: Just run your business
as if: 1) you own 100% of it; 2) it is the only asset that you and “The job of CEOs is now to regain America’s trust – and for the
your family have or will have; and 3) you can’t sell or merge it for country’s sake it’s important that they do so. They will not
at least a century.” succeed in this endeavor, however, by way of fatuous ads,
– Warren Buffett meaningless policy statements, structural changes of boards
and committees. Instead, CEOs must embrace stewardship as a
“We regard product quality as sacred.” way of life and treat owners as partners, not patsies. It’s time for
– Warren Buffett CEOs to walk the walk.”
– Warren BuffettWarren Buffett on Business - Page 8
Buffett on Business 13 Mistakes Buffett on Business 14 Investing
Everyone makes mistakes. Expect that to happen. The key Intelligent investing is not hard. All you have to do is to
is to learn and move forward rather than getting discouraged. correctly evaluate businesses within your circle of competence
Hold regular, systematic post mortems and learn. which will grow in value in the future. That’s it.
“It’s far better to buy a wonderful company at a fair price than a “Our equity-investing strategy remains little changed from what it
fair company at a wonderful price.” was fifteen years ago, when we said in the 1977 annual report:
– Warren Buffett We select our marketable equity securities in much the way we
would evaluate a business for acquisition in its entirety. We want
Early in his investment career, Warren Buffett spent lots of time the business to be one (a) that we understand; (b) with favorable
looking for bargains. More than a few times, he found what look long-term prospects; (c) operated by competent and honest
like a great deal ended up being a poor performer. After around people; and (d) available at a very attractive price.”
25 years of investment activities, Berkshire now looks to avoid – Warren Buffett
problem situations. Warren Buffett and Charlie Munger have
learned by experience it’s better not to get into businesses which More than likely most investors will find the best way to own
have difficult problems to solve. They now describe their common stocks is through purchasing an index fund. If you do
approach as looking for companies which have one-foot hurdles decide to construct your own portfolio, be realistic about what
which can be stepped over rather than those which are facing your personal circle of competence is. The size of that circle is
formidable seven-footers. likely to be small and that’s just fine. As long as you know its
The other principle Berkshire adheres to religiously is the boundaries and stay within them, everything will work out.
company only goes into business with people who are known, “To invest successfully, you need not understand beta, efficient
liked and trusted. Berkshire has learned good jockeys will always markets, modern portfolio theory, option pricing or emerging
do well on good horses but not on broken-down nags. markets. You may, in fact, be better off knowing nothing of these.
“I’ve said many times that when a management with a reputation That, of course, is not the prevailing view at most business
for brilliance tackles a business with a reputation for bad schools, whose finance curriculum tends to be dominated by
economics, it is the reputation of the business that remains such subjects. In our view, though, investment students need
intact. I just wish I hadn’t been so energetic in creating examples. only two well-taught courses – How to Value a Business, and
My behavior has matched that admitted by Mae West: ‘I was How to Think About Market Prices.”
Snow White, but I drifted.’” – Warren Buffett
– Warren Buffett Most investors are elated when stock prices rise and depressed
Very few companies are good at learning from mistakes which is when they fall. This is a very unusual behavior when you stop and
unfortunate. Bad mistakes tend to be covered up and swept think about it. If you are a net saver and plan on buying more
under the carpet or left to die of natural causes. Everyone loves stock in the future, then you should be elated when prices fall. It
to trumpet their triumphs. Smart companies run systematic and means you will make even greater gains on your investments in
objective post mortems where decisions are objectively the future. It is only the sellers of equities in the near future which
reviewed, especially mistakes or dumb decisions. This is a should be concerned about falling stock prices. If you plan on
practice which should be more widely picked up on. being a long-term investor, falling stock prices is a great event
rather than something to fear.
Warren Buffett and Charlie Munger are very up-front about the
investing mistakes they have made on behalf of Berkshire. Many “We gained enormously from the low prices placed on many
of these involve using Berkshire stock to fund acquisitions where equities and businesses in the 1970s and 1980s. Markets were
the deals have not added value to the company. By being so then hostile to investment transients were friendly to those taking
disarmingly candid, stockholders in Berkshire actually feel more up permanent residence. In recent years, the actions we took in
confident in their management performance rather than less so. those decades have been validated, but we have found few new
This may be a good lesson for other companies. Candor counts opportunities.”
and nobody expects a manager to get a home run every time he – Warren Buffett
or she is at bat.
“We’ve long felt the only value of stock forecasters is to make
“Agonizing over errors is a mistake. But acknowledging them fortune tellers look good. Even now, Charlie and I continue to
and analyzing them can be useful, although that practice is rare believe that short-term market forecasts are poison and should
in corporate boardrooms. Dumb decisions either get no be kept locked up in a safe place, away from children and also
follow-up or are rationalized.” from grown-ups who behave in the market like children. We have
– Warren Buffett no idea – and never have had – whether the market is going to go
up, down or sideways in the near- or intermediate-term future.
“When Richard Branson was asked how to become a millionaire, We simply attempt to be fearful when others are greedy and to be
he had a quick answer: ‘There’s really nothing to it. Start as a greedy when others are fearful.”
billionaire and then buy an airline.” – Warren Buffett
– Richard Connors
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