Monday, September 1, 2014

Ruane, Cunniff & Goldfarb Investor Day Transcript (May 2014)

Link to: Ruane, Cunniff & Goldfarb Investor Day Transcript (or in PDF)

At last year's meeting, I asked you if Google was priced to perfection and you correctly said it was not. So I am curious; at this point what do you feel its growth prospects are? Could you also comment on the recent split, particularly with the non-voting shares?

Chase Sheridan:

I will comment on the split first; I think that is the easier question. For us it is a non-event. Sergey Brin, Larry Page, and Eric Schmidt already have voting control of the company; so it does not really affect our voting power in the company, which was zero to start with, effectively. Since we are very happy with the management of Google, it is not something we spend a lot of time on. Larry Page has shown himself to be a visionary and has done a better job with the company than we could have hoped.

As for the growth prospects of Google, it is a relevant question for any company that has a $360 billion market cap. It is always an issue. We asked ourselves that when we bought the company and it had an enterprise value of $118 billion. We thought with a company of that size, can you really invest in it if it does not have the potential to be the most valuable company in the world? Our conclusion was that it had that potential. We are not making any predictions. It is looking more and more likely over time, but we will see what happens.

I have no insight into the company’s growth prospects beyond what is already out there and published. I look at what eMarketer puts out — growth in US desktop clicks and revenue is not very strong. So there are mature businesses within Google. But growth in mobile is still going like gangbusters, and Google has a greater share of mobile search than it has of desktop search. It is still penetrating some of the less-developed markets throughout the world. But eventually you have to wonder what the potential of the un-penetrated market, the remaining white space, is because Google’s penetration is rather high.

There are so many projects that Google is investing in, some of which may bear fruit. But there are two areas that I think it has yet to monetize really well. One would be the video market. Through YouTube Google has access to some of the ad dollars that go into television spending, and it is hard to see where that is going at the present moment. But there is a huge, huge pool of advertising money out there for an aggressive and innovative company to tap, and Google is in as good a position as any to try to access that. Google still has a lot of work left to do to monetize local advertising through Google Maps or Google Now. The company is putting a lot of effort into doing that. So we will see. But relative to the growth that we can see, the valuation really is not terribly demanding.



You have such a small holding in Costco, and it is wonderful. The share price has doubled in the last few years. I wonder why you gave the girl the engagement ring but did not get married … add more stock.

David Poppe:

I think we get back to that answer of we are not very smart. We went out to see Costco in 1999 or 2000 and met with Jim Sinegal, the CEO. The stock was $27. It was probably 20 times earnings at the time — I do not remember what the earnings were back then. We came back and thought, “Wow, great company.” I have to say I do not have a lot of heroes, but he is probably one of my favorite CEOs I have ever met. He is everything you have ever read about him. We had a toehold position in it. Fifteen years later, it is $111. We still own about a 0.1% position. So we just missed it; it happens. A lot of times they do not get into Sequoia so you do not know about them. But the only thing I would say there is you can look at a lot of pitches and take strikes, and not strike out in this game so long as you hit the ones you do swing at. Costco is one that, unfortunately, we just took a strike right down the middle.



About fifteen years ago, I asked Charlie Munger at a Wesco meeting what he thought of investing in natural resource stocks as a hedge against inflation. He said in very strong terms that he thought it was one of the dumber ideas he had ever heard. He proceeded to lecture about the advantages of investing in companies “awash with cash,” are the words he used. Lots of free cash flow that does not have to be pumped back into plant and equipment at inflationary prices. At this past meeting, according to the Morningstar blog, he said, “It is a blessing to have capital intensive businesses like BNSF and Berkshire Hathaway Energy, which give us an opportunity to reinvest large sums of capital at attractive rates of return.” Then he went on to indicate that future acquisitions are likely to be in capital intensive businesses. Why the complete change in investment philosophy?

Jon Brandt:



That is what I figured.

Jon Brandt:

He has to find a way to put the money to work, and he has to accept less of a return than he did in the past. Charlie would say something like it is too damn bad that we cannot invest like we did in the past. But you are just going to have to suffer through it.

I still think Berkshire can get to a double-digit growth in intrinsic value per year, even with these horrible capital intensive businesses. But ideally you want to be investing in a company that can grow and does not need to put the money to work in capital expenditures. Then you can buy more companies and you have a compound interest wealth-creating machine. Berkshire is going to be a wealth-creating machine that goes just a little slower in the future. Warren said about utilities — it is not a way to get rich, but it is a way to stay rich. I think that would be true of the railroad also.

If you look at the return on equity of the railroad — everyone talks about return on capital because that is how railroads are quasi regulated — but the return on equity at the railroad is quite adequate. That is partly due to the fact that the railroad’s leverage ratio has increased somewhat since Berkshire bought it. Also, at the utility, MidAmerican is intelligently using an increased amount of leverage in its acquisitions resulting in satisfactory returns on equity employed. The railroad has paid dividends to Berkshire equal to reported net income since Warren acquired it. Railroads are capital intensive, but in part through some borrowings, in part through the benefits of accelerated depreciation or what they call bonus depreciation, the railroad has been quote/unquote “a capital intensive company” but even with all it spent on capital, I am pretty sure it has dividended out as much free cash flow as it reported in earnings. So it is not quite as bad as it sounds. There could be some reversal of that bonus depreciation, but I still think free cash flow should be a decent percentage of the reported earnings. Same thing with the utility.

[H/T ValueWalk]