Monday, June 29, 2009

Examiner Interview with Janet Tavakoli about Warren Buffett

Tavakoli should know a thing or two about the value of lunch with Buffett. She dined with the Berkshire chief in 2005 and wrote a book, "Dear Mr. Buffett," partly about the experience. Tavakoli, who still communicates with Buffett periodically and was in Omaha, Neb., for this year's annual meeting, is founder and president of Chicago-based Tavakoli Structured Finance, a financial consulting firm.

Examiner: What did you two talk about during the lunch?

JT: We covered dozens of topics. Warren is a highly intelligent polymath, and he has a fabulous memory. His wide base of general knowledge and life experience enable him to add interesting color to almost any topic. He switches topics quickly, and he picked up speed as the afternoon progressed. It is mental work to keep up with Warren. He will go as fast as you can handle.

Warren is proud of the fact that he has created wealth for his shareholders, his long-term partners. By the time Donald Othmer, a chemical engineer, died in 1995, his investment in Berkshire Hathaway was worth around $750 million. He has a keen sense of the enormous responsibility of managing the hard earned money shareholder entrusted to him. The idea of building value is not only wholesome, it is life-affirming. During our meeting, I got the sense of what a totally decent person Warren is. The blow-up in the global financial markets that was just starting to occur, and it was partly due to malicious mischief. Contrasting Warren Buffett's philosophy with the shenanigans of phony assets combined with inexcusable leverage and cover-ups was all the more poignant as the crisis unfolded.

I mention some of the many topics we discussed in my book, but my personal take-aways have to do with Warren's sane approach to the markets. We hear a lot of black swan quackery making claims that Warren Buffett's investment style is dead. Yet, the "black swan" funds have poor track records, albeit that has not been widely reported, and in fact, it has been inaccurately reported. It is nothing more than a PR stunt. If one wants to buy insurance, i.e., put options, one does not have to pay 2% in fees and 20% of the upside to a mediocre manager with no exit strategy. The funds may have one good year followed by years of consistently losing money. The loss of that money is permanent value destruction. More than that, what kind of person wants to spend their entire life curled up in a corner with their fists balled up in front of their faces in a defensive posture? It's a ridiculous way to spend your life, and you create nothing of value in the economy other than buying insurance. No wonder they have not held onto their insurance payouts and have poor track records.

When one invests in value, there is no permanent destruction of value. Stock prices may go up or down, but the underlying companies have value, and they make products that people want and need. These companies keepgenerating earnings and value and when the economy recovers, they are positioned to soar. Warren doesn't distinguish between "value" and "growth" companies because they are one in the same to a value investor. He wants to buy companies at a fair price-better yet, at a cheap price-and he wants to buy companies that have a potential to grow.

While it is true that Berkshire Hathaway may not achieve the high returns of its past due to its enormous size, it will continue to achieve future satisfactory returns. Investors focus more on book value and other metrics rather than the fickle market price. People said value investing was dead in the 1970's when Berkshire Hathaway's share price was down two years in a row (more than 15% for the fiscal year then ending March 1974, and down more than 35% for March 1975). The share price was $51 on March 31, 1975, down from $93 on March 31, 1973. Even if you had "bad timing," and had bought the stock at $93, you would be a happy investor today (BRKA closed yesterday at $86,705). Long-term value investing works if you know the principles of finance and know how to value a company.

The philosophy of value investing seems very healthy to me. One generates value by investing in society and creating permanent value in the economy.

Another thing that struck me about Warren is that he does not dwell on past mistakes. He is not a brooder. He freely admits that mistakes will be made, and that you may never figure out what complicated mix of psychology led you to make them. The key is to avoid making big ones. This is where the idea of building a margin of safety comes in. He skews the probability of success in his favor by limiting the probability of disaster and increasing the probability of a high future gain. He doesn't rely on random luck, he is using conditional probabilities. Given that he knows the principles of creating value, he has stacked the odds in his favor of a satisfactory outcome. No one can guarantee you a successful outcome, unexpected events will occur, and mistakes will be made. Knowing all of that, one can still improve one's odds, and Warren Buffett excels at stacking the deck in favor of his investors.

Examiner: What are some things that you have observed about WEB during the lunch or subsequent interactions that the public doesn't know about him?

JT: Warren does not talk down to people, and he doesn't try to impress people with his intelligence. As a result, many people underestimate him. For example, one reporter wasted an interview with Warren by repeating a myth that he doesn't carry a cell phone. Warren whipped out his cell phone and joked that Alexander Graham Bell had given it to him. He would never belittle someone for wasting his time (and theirs), but he also won't tell the reporter what to ask. He can like a Wimbledon winner playing tennis with a child. He won't slam the ball at the feet of an inexperienced player. But when he meets a skilled player, he increases his level of play to match the other player.

Warren's command of derivatives and financial principles is deep, but his explanations are so elegantly simplified that experts sometimes deceive themselves into thinking he is not as smart as they are. I call it the "I am a genius, and you're not" syndrome. Warren doesn't suffer from that. When Warren appears on television, he makes things sound simple. When he hesitates, it is as if he is translating complex material to simple language for public consumption. A less secure man might try to impress the audience with jargon or with details. He is not competing with anyone else, and he respects his audience. I would like to be more like him when I grow up.


Book: Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street