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Manager Interview: Whitney George on Berkshire Hathaway's 2018 AGM

From Sprottmedia.com

The annual shareholder meeting for Berkshire Hathaway took place in Omaha, Nebraska. The “Woodstock of Capitalism” attracted tens of thousands of Warren Buffett devotees from around the globe. The 87-year-old Oracle of Omaha answered many questions at the three-day event. Buffett and Charlie Munger dedicated several hours talking about business strategy, the economy, trade policy, and the big elephant in the room.

The 2018 Annual Meeting comes at a time of high volatility for elevated equity markets and ahead of expected interest rate hikes from the Federal Reserve. Sprott Media’s Albert Lu spoke with Sprott USA’s Chairman, Whitney George, about Buffett’s responses to some of the tough questions and the inevitable fundamental shifts on the horizon.

Buffett's Comments on Gold Were Misleading

Albert Lu: Berkshire Hathaway just concluded its annual shareholder’s meeting in Omaha, Nebraska, on Saturday, May 5. What were your initial thoughts on the meeting?

Whitney George: I have known about Warren Buffett for 40 years, have followed his discipline for more than 30 years, and have owned shares in Berkshire Hathaway for 20.  It was really interesting to hear the wisdom of arguably one of the most successful investors of modern times. I have never traveled to Omaha for the meeting, much to many people’s surprise, because I’m already such a convert that I reasoned that joining the cult on site, in person, would wreck my ability to remain objective. Watching it on my own on Saturday morning was fun.

Albert Lu: One thing that struck me is that Warren Buffett started out by talking about gold. Did you find that strange at all?

Whitney George: No, not really. I think the main point he was trying to make with that copy of a 1942 newspaper in front of him was that equities are a productive place to invest, and America is a wonderful place to invest in. He is a great marketer of this message, and his comments were primarily meant to be upbeat on the growth of the American economy since he bought his first stock in 1942. Gold investors, wrongly I believe, get associated with doom and gloom, and low points in the market. But unlike Buffett, I believe you can be optimistic and have a strong outlook on the economy while still owning some gold. But what I found interesting about Buffett’s comments is that investors were not even allowed to own gold in 1942. The U.S. federal government made it illegal for investors to own gold from 1933 until Jan. 1, 1975.

I found the relevance of Buffett’s comments on gold a little bit misleading. And it made me think about all the reasons why he should own some gold in Berkshire Hathaway, particularly now given that he has piled up more than $100 billion in cash. He shared that he is waiting for better prices to deploy this cash, while at the same time he is encouraging people to invest in S&P 500 indexes as opposed to allocating capital to active management.

Follow What Buffett Does, Not What He Says

There were many crosscurrents in Buffett’s comments. And having observed Buffett for a very long time, you want to do what Warren does, not necessarily what he says, because sometimes they are not the same thing. He is not recommending that investors go out and buy Berkshire or Apple or hold a significant amount of cash, but that is in fact what he is doing right now. I think you have to pay attention to what’s actually going on as opposed to what Buffett’s marketing pitch is. A recent interesting example is that he allowed his name to be associated with a tax on millionaires under the Obama administration and here now we have a new tax law where arguably Berkshire may be the largest corporate beneficiary of lower taxes. He is perfectly happy to play both sides of the street.

Albert Lu: What about his comparison between $10,000 of gold and $10,000 of equities? Buffett is obviously good at math and works out this flawless argument about how equities have outperformed gold in the long run, but it may not be appropriate for most people?

Whitney George: His example may not have been practical for most investors. There are not many of us who can start investing at age 11 and still be going strong at 87 years old. We all have to live in the real world where we are likely to become productive and make investments some time in our 20s or 30s, if we are lucky, and, presumably, retire sometime in our 60s or 70s. As much as we like to talk about long-term time horizons, I think it’s important for people to be a little bit more realistic about what actually happens. For most investors, a time horizon of 25-35 years is more reasonable than the 60-70 plus years he used in his example.

Also, the time period of Buffett’s comparison begins at a low point in the stock market (1942, when we were in the middle of a war) and ends now in 2018, immediately following a nine-year bull market. I think this is a bit disingenuous. The fact is that during the 75-year span he discusses there have been periods as long as 15 years when the stock market did nothing. For example, if you had bought shares at the wrong time, back in 1968 and then held them until 1982 you would be breaking even and, on an inflation-adjusted basis, your true breakeven point would not happen until sometime in the mid-1990s. His example does not translate to the real world for most investors, and you don’t want to find yourself trying to retire when you happen to be in one of those bad extended decades of no stock market returns.

I was even more interested in his comments about cryptocurrencies, when he said, “Nonproductive assets remain that way.” He then pointed out that gold at the time of Christ to now would have only given you a compound annual rate of about two-tenths of a percent return. This amused me because I thought, “OK, compared to what?” If you were an immortal investor and you had invested in Roman infrastructure or Spanish Conquistador exploration or the British Empire’s colonial farming project, you would have nothing to show for any of those. Yet, all the gold is still here.

Gold Plays an Important Role in Protecting Wealth

Gold does have an important investment purpose. It is a store of value. Gold is used in portfolios to protect the wealth that has been created, and not something that people use in their portfolios to get wealthy. This should not be lost on the audience that was assembled there at Berkshire Hathaway’s annual meeting.

Albert Lu: I think it’s just an apples to oranges comparison to pit gold against an active asset such as the stock market equities.

Whitney George: Gold is an asset, but I think Buffett makes the distinction between productive and non-productive assets, and he throws gold into the latter category. But I find that gold is no less productive than the insurance policies he sells through Geico. Those policies do have a utility even though they are not generating a positive return or have an annual cost. The cost of owning gold has come down significantly. Buffett often refers to the cost of storing and insuring gold. But there are modern investment products that allow you to own gold and pay less than 40 basis points a year for everything to be taken care of for you. These investments were not available even two decades ago.

Times have changed. You can’t expect an 87-year-old and a 94-year-old to change that much more although they have been pretty nimble over the years. And so, it wouldn’t shock me if Buffett ended up discovering some gold. Given that Buffett is an expert in insurance and consumer products, and has a positive view of the global economy, it’s not hard to imagine that if the Chinese economy does very well and they happen to culturally enjoy owning gold that the demand for gold will go up and therefore the price as well. The same is true with India. In fact, the same is true for just about every place in the world other than America where we have a competing currency which is the reserve currency. We have a politically vested interest in promoting what it is that we have and can control as opposed to what the rest of the world might find more appealing, like gold.

As Gold Ownership Gets Modernized, It Could Become an Alternative Currency

The other part about the crypto discussion that was particularly humorous was when Charlie Munger made the analogy that buying cryptocurrencies is like buying “turds” just because your neighbors are trading them. I don’t disagree that it might be in a speculative bubble with cryptocurrencies, but if you examine the underlying reasons behind why those neighbors are buying cryptos, you need to appreciate that they have an appetite for something that is an alternative. The fact that crypto valuations went crazy and people continued buying just because prices were going up happens all the time. It happened when the Internet was developed during the dot-com period. People overdid it, but we still have an online bookseller called Amazon that has survived.

You have to look at the utility of some of these great new ideas. They sometimes get overdone, but that doesn’t mean that they are a one-and-done kind of situation. I think as the ownership of gold gets modernized, it, in fact, could be the alternative currency that people globally seem to be seeking out as we go through this tumultuous period with destabilizers like Trump and Brexit.

Apple's Brand has Cachet, and Buffett is on Board

Albert Lu: Buffett and Munger do deserve a lot of credit. One area you can point to is his purchase of Apple? There was a time when he would not have purchased Apple, and he was quite vocally against purchasing the stock. He has changed his mind obviously and is taking a very big position in Apple. What do you think about that?

Whitney George: I’m very excited as I’ve owned Apple since 2011. Being a contrarian, when the stock got depressed because Steve Jobs had passed away, I used the opportunity to buy some Apple and have been a huge fan ever since. In fact, after Berkshire Hathaway, it is my largest personal holding and it is the largest holding in the funds that I run and has been for quite some time. Buffett gets it. He gets capital allocation. He gets consumers. And I’m happy that he is buying both as an owner of Apple and as an owner of Berkshire Hathaway.

Albert Lu: How do you assess the risk to Apple of the end of the smartphone super cycle and the fact that it’s going to have to find some new ground?

Whitney George: Great companies always find ways to evolve. Certainly, Apple has been a very innovative company since day one. I’m not particularly concerned about how it’s going to delight us next. I think what people are starting to understand better is the growing ecosystem that is evolving rapidly in services beneath Apple’s hardware products. Yes, Apple has to deal with seasonality. For example, it gets a big bump in advance of Christmas, and then things fall off. It also has product cycles, as people hold off on buying new phones to see what the next one looks like. You can’t just get rid of these cyclical elements that bother investors and have a nice, smooth growth trajectory. But Apple’s service business is very constant and smooth, has a higher margin, and is growing rapidly. In fact, I believe someone asserted that it might have more revenue than all but five or six S&P 500 companies on its own.

Apple’s customers are becoming stickier all the time. How often does Apple have to renew its hardware? This is becoming less of an issue. Apple makes money in the hardware business, unlike others, because it has a strong brand. People keep arguing for Apple to cut iPhone prices in order to sell more. But I think you maintain a brand like Apples by having price integrity. Its brand has the cachet that people are willing to pay more for because it represents something.

Buffett understands brands as a way of protecting against the ultimate inflation. With Apple, I don’t think it was hard for him to come to the conclusion and understand that Apple’s business, as it grows and matures, is likely to become a higher margin and more stable business, and not a riskier one.

Tech has Become Overdone; I'm Looking for "Picks and Shovels"

Albert Lu: What are you looking at for the next year or two in terms of tech? Do you think it’s over?

Whitney George: I think there are some challenges because the sector has become so big and profitable and that makes them targets. Certainly, there has been a sudden awakening of people’s awareness of how their personal data is being distributed, and I think this may produce a headwind. If nothing else, it’s going to increase the cost for companies like Facebook and Google that are essentially selling people’s data to advertisers as their primary business model. I think that whenever you’re facing regulation, or whenever you’re facing higher costs for compliance and monitoring people, momentum will pause.

Tech has become a bit overdone. Warren Buffett doesn’t own Microsoft because he is good friends with Bill Gates. I had owned Microsoft. I, unfortunately, sold it a year too soon but it was one of my favorite picks in 2009. Most of the hardware opportunities I am seeing are in technologies and in hardware; it’s what makes the cloud services at data centers work. Whether it’s a hard drive, computer data storage company like Western Digital or an equipment manufacturer like Lam Research, these stocks are trading at single-digit multiples when you net out their balance sheets and are critical for all of the things that the popular FAANG [Facebook, Apple, Amazon, Netflix and Google] stocks want to make happen. I’m in the “buying the picks and shovels” mode right now.

Albert Lu: One of Berkshire’s secrets is that when there is nothing to do, Warren is very good at doing nothing. When the markets are the way they are, the value investor has to be patient. Are you still in that patient mode? And if so, when do you see us coming out of this phase?

A Patient Long-Term Approach

Whitney George: I’m definitely in the patient mode right now. The markets have become thinner, and there are fewer stocks trading less well with more computers involved. Doing transactions actually has become more expensive and therefore counterproductive. I’ve always been patient, and evaluate opportunities through the lens of a three-to-five-year time horizon. The market may be, in aggregate, viewed as expensive but it is all over the place in terms of valuations. Even now, 9 years into a bull market, I’m still finding companies that I think are attractive to buy.

There are opportunities that have worked out for me, and others that have not. Overall, I think a patient long-term approach suits all investors well. This approach helps to mitigate costs, and it is tax efficient, and it has worked very well for the best investor known to man, Buffett.

Albert Lu: Corporate balance sheets are levered up. Do you think this is a problem? If it is, how will this problem manifest itself?

Whitney George: It’s a growing issue. Buffett might have said this or maybe it was Jim Grant, “Balance sheets don’t matter until the day they do and then it’s all that matters.” And that’s what the financial crisis was about. I can point to some individual scary situations. Tesla, burning through a billion dollars a quarter in cash with $2.8 billion in cash on its balance sheet and debt coming due this year, and 30% of those cash deposits are from people waiting for their cars. It’s a pretty dire situation at this stage.

I don’t think people are paying attention to Netflix’s balance sheet, and the obligations it has or has committed to for programming, as well as how it is financing its growth. Again, it’s going to go on until it doesn’t. I haven’t looked at the market in aggregate, but rather individual companies. The situation does get skewed by some of these very large cash-rich companies like Apple.

Albert Lu: We will leave it there, Whitney. I have many other questions that I would like to post here, but we’ll have to save that for another time. Thank you for joining me.

Whitney George: Thank you, Albert. It’s always a pleasure.

For a more in-depth look at Sprott’s response to Buffett’s recent comments on gold, read trey Reik's Gold Shows Up at the Berkshire Hathaway Meeting.

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Whitney George
Whitney George
Senior Managing Director, Chairman, Sprott USA, Portfolio Manager of Sprott Focus Trust
Sprott Asset Management USA, Inc.
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