It is interesting to review the couple of questions and answers pasted below from the Ruane, Cunniff & Goldfarb Investor Day earlier this year, considering that Mr. Buffett has recently bought Berkshire Hathaway a railroad and significantly increased its stake in Wal-Mart. If anyone happens to have the annual letters for the Sequoia Fund from the 1970’s and 1980’s, I would be very grateful if you could email them to me: firstname.lastname@example.org
Ruane, Cunniff & Goldfarb Investor Day, May 15, 2009 – Excerpt from Transcript:
Do you think the companies in your portfolio have the pricing power to protect their earnings from inflation? Or should you put on hedges to cover you from that inevitability?
I would say that pricing power varies. I think probably the strongest in terms of pricing power would be the rock companies, the quarry companies, namely Martin Marietta and Vulcan, which have continued to raise prices despite very significant declines in demand. You don’t see that combination very often — maybe cigarettes or railroads.
But I’d also add that if you go back to Warren Buffett’s article in Fortune about inflation and common stocks, I think he put more emphasis on the cash generating nature of the businesses than on their pricing power. That’s not to dismiss pricing power, but as he pointed out, in an inflationary period what you want to avoid are capital intensive businesses that are forced to reinvest a fair amount of the cash that they throw off back into the business just because of increased inflation in working capital as well as plant and equipment. On that score of cash generation, we’ve had a strong emphasis for a long period of time and that should serve us well in a period of accelerating inflation.
I would add one thing, which I think most people know. The problem with inflation is not just the direct problem of inflation. Bond investors are not stupid; fixed income investors are not stupid — if the inflation rate goes from two percent to six percent, they’re not going to keep accepting two percent on their Treasury bonds and on their bank deposits. So interest rates will go up. And if interest rates were in the higher single digits, that would be bad for the economy and bad for stocks.
So that would be a secondary effect. It would make the economy weaker. I saw a pretty good comment in Jeremy Grantham’s latest missive to the effect that he is worrying that the large deficits spawned by the — referring back to Bob’s initial point in his prepared comments — that the large deficits spawned by the quote “stimulus plan” may have the effect of making the recession less severe at the expense of lengthening it. So I thought that was pretty well said, as it usually is.
A professor at Columbia University’s value investing program has suggested that a large part of Wal-Mart’s success has been due to the local competitive advantages it created by expanding geographically in tightly concentric circles. He suggests that Wal-Mart benefited mightily from economies of scale especially with regard to distribution by dominating local and regional markets as it grew. I’m wondering if you agree with that and also if you feel that Target and perhaps Fastenal are taking a similar strategy with regard to their growth.
I agree with that. Wal-Mart’s competitive advantage, the reason Wal-Mart has the lowest cost, is in large part because it has a substantial advantage in distribution versus almost anyone. Target has not expanded in the same kind of tightly concentric circles because Target requires a little bit higher demographic neighborhood for the store to work and be successful. So it’s not as simple an issue for them to just build them out two miles at a time across the country.
So Target’s strategy is a little bit different. Target’s got low cost but they will never be as low as Wal-Mart’s. They will never have as many stores as Wal-Mart because Target has a narrower customer base. On the other hand, however, I would say Target has a pretty desirable store base because they opened a lot of stores in large metro markets that will be difficult for Wal-Mart to penetrate. I think they’ll both be successful, but Wal-Mart certainly is and will continue to be the low cost provider. Bob talked about companies that are well-positioned for inflation — I can’t think of too many companies that are better positioned for hyperinflation than Wal-Mart.
Related previous post: Warren Buffett's Comments on Inflation