Daniel Pecaut Daniel Pecaut.

The best investing opportunities often occur in the midst of a convulsion: The key is to buy when others are paralyzed. That’s what legendary value investor Warren Buffett told attendees at Berkshire Hathaway’s 2006 annual shareholders meeting, at which he cautioned — two years before the financial meltdown — against the housing bubble, derivatives and the weaker dollar.

Indeed, there’s no reason that Buffett’s enduring stock-buying advice shouldn’t hold true nowadays, says Daniel Pecaut, chair and CIO of Pecaut & Co. The RIA has attended more than three decades of Berkshire meetings and turned his copious notes into a book, “University of Berkshire Hathaway: 30 Years of Lessons Learned From Warren Buffett & Charlie Munger at the Annual Shareholders Meeting,” written with Corey Wrenn, president and CEO of Pecaut.

The fly-on-the-wall tome is voyeuristic, but in a good way.

(Related: Warren Buffett’s 10 Nuggets of Investing Wisdom: Berkshire Letter 2018)

Buffet is famed for acquiring all or part of a business at bargain prices and typically helping its value to soar.

Berkshire has been Pecaut’s biggest client holding for nearly 25 years. The RIA manages about $200 million in client assets.

The book covers a chapter for each Berkshire meeting from 1986 through 2015. About 500 people showed up for the first one, Pecaut reports. In 2015, 40,000 were in attendance.

In the interview, he discusses the investing wisdom Buffett and longtime partner, witty curmudgeon Charlie Munger, Berkshire vice chair, dispensed at the meetings and how it can be applied today.

The RIA also pointed to a big clue about Buffett’s investing strategy embedded in Berkshire’s quarterly reports. Hint: An enlightening, revealing appendix of his book shows Berkshire’s cash/bond/stock ratios from 1979 through 2014.

In the interview, Pecaut talks, too, about Buffett’s stance concerning Wells Fargo; his 2013 forecast for investor behavior when interest rates would rise again; what he pays attention to most in sizing up companies; and the concerted action he has taken amid the health care crisis.

Berkshire started as a textile company in 1839. Fifty-plus years ago, Buffett took over. The conglomerate — with star subsidiaries including Geico and See’s Candies — represents half-a-trillion dollars in assets.

Pecaut, 61, is a Harvard-grad grandson of Russell Pecaut, who founded Pecaut & Co. as a brokerage in 1960. Corey Wrenn, 59, formerly with Berkshire for about nine years, joined Pecaut as a partner in 1992; and his notes are the basis of certain “University…” chapters.

ThinkAdvisor recently interviewed Daniel Pecaut, on the phone from the firm’s Sioux City, Iowa, headquarters.

Here are highlights of our conversation:

THINKADVISOR: How did attending the Berkshire Hathaway meetings help you the most?

DANIEL PECAUT: To think rationally about business, to have clarity of mind — because there are so many factors that pull the brain way from rational thinking.

How would you characterize the meetings?

For those early meetings: “electric.” You could feel in your body that [Buffett] was an exceptional talent.

What specific piece of wisdom that you picked up do you value most?

When you buy a stock, you buy a business. So be a business analyst. That has guided every day of my career. The “life” piece would be: Your best investment is yourself.

In 2013, Buffett predicted that when the Federal Reserve stops buying securities, investors would re-evaluate their investments, especially those made based on low interest rates. Is that what’s happening in the market now?

That is exactly what’s happening. The Fed has raised rates, which inhibits liquidity. But the other factor is that QE — quantitative easing — has stopped, and it’s become QT — quantitative tightening.

So how was that forecast of his six years ago reflected in Buffett’s own investing?

Over time, he’ll let the cash portion grow late in a bull market. So, in 1999-2000, and then in 2006-2007, he had a much higher-than-average cash position. In 2017-2018, he had over $100 billion in cash. Keep watching these figures, which are in the Berkshire Hathaway quarterly reports. They give you a clue that he’s saying — without saying it — that things are high, and they could get cheaper. He’s happy to sit on the cash and earn nothing for the opportunity to buy something at a big discount in the future.

At the 2006 meeting, Buffet said that the best opportunities occur in the middle of some “convulsion” and that the key is to buy when others are “paralyzed,” according to Corey Wrenn’s note-taking. Does that apply to right now?

It’s not as bad as that yet. But certain industries are there, and other industries will get there.

What were the most prescient of Buffett’s forecasts?

He has the ability to see around corners and warn of things going badly. In 1987 he and Munger began to predict the S&L [Savings and Loan] crisis. No one else was saying this, that I know of. In 1989-’90, sure enough, it happened. It was the biggest financial crisis in post-War history, up to that point.

What other forecast stands out?

In 1994, Buffett said [he wouldn’t be surprised if the failure in derivatives caused a financial catastrophe in the next decade] — and in 1998 we had the Long-Term Capital Management debacle. He sees problem areas forming and then goes public about where they’re getting out of control.

At the 2008 shareholders’ meeting — during the financial crisis — Buffett said: “Buying securities made of tranches of other instruments was madness.” Had he warned of that earlier?

Yes, well before. In fact, he owned a lot of Freddie Mac and made a lot of money on it. But he sold the entire position. He was very upset about what was happening in the mortgage world and the way that Freddie Mac itself was operating. One way to manage client money is to avoid [a crisis], and that’s something Buffett does exceptionally well. It’s really important to his long-term track record.

What’s Buffett’s attitude about Wells Fargo in view of the bank’s scandals? He reportedly began investing in Wells in 1989.

Wells is one of his largest holdings and has been for a long time. He believes the current problems are fixable, and are getting fixed, and that it will therefore be a better company going into the future. But he thinks the episode of the last few years was pretty boneheaded.

He said that?

“Boneheaded” is my word. But he’d use a similar word.

Does he still love banks, in general, as much as did?

Yes. In fact, he bought $10 billion in bank stocks in the third quarter of [2018], added about $6 billion to his Bank of America position and added $4 billion to his position in JPMorgan.

Is he still adding to Wells Fargo?

No. he maxed out. I think he probably would buy more, but he has to stay under 10% because at 9% you’re just an investor [vs. an owner]. After 10%, the regulations change.

What’s the biggest investing mistake that Buffett and Charlie Munger have made? Was it Dexter Shoe Co.? In his 2008 letter to shareholders, Buffett said so.

That’s a big one! I think the quickest mistake was World Book. [Almost as soon as they bought it], Encarta [Microsoft’s digital encyclopedia] came out. [Encyclopedias] went to digital form — a whole new way of getting information — within about a year of his purchasing World Book, and it just destroyed the business.

But didn’t Buffett foresee how the internet would change industries?

Clearly, no [not then]. These things happen. It’s a dynamic world. Once in a while, there’s a big shift, and suddenly you have a business that’s obsolete.

What happened with World Book?

They still own it. And there’s a digital version. They tried to adapt to the new [online] model, but it’s nowhere near the brand it was.

By 1999, Buffett was saying that the internet would change retail, as well as retail real estate. Having gained that insight, what did he do regarding his investing?

The No. 1 thing was to avoid companies that would get run over by technology.

You report Buffett’s saying, at the 1991 meeting, that out of all their businesses, the insurance business had the greatest potential. Why?

One big piece of Berkshire that’s often underestimated and not really understood is that insurance companies create “float.” That is, when policyholders send in premium payments, in return, the company gives them a promise to pay if some unfortunate situation occurs. In the interim, the company can keep that premium in a reserve, called a float. We estimate that for every dollar of capital Berkshire has, about another 50 cents is float — and has been for the last 40 years.

Was Geico insurance the best investment Buffett ever made? He owns the whole company.

Geico would be way up there.

Does he OK all the advertising campaigns? Geico certainly advertises extensively.

Yes. This is the key to Geico. Buffett goes way back with Geico. Then, in 1996, he bought up the shares of Geico that he didn’t already own, and he immediately doubled the advertising budget. So now Geico was advertising a lot and creating a brand. But what Buffett saw was unlimited because he still wanted to pay dividends and show earnings growth over time.

So what did he do?

He thought: Forget about making money today — just take the market. None of the old, staid insurance companies would do this. And a year later, Geico’s advertising budget was bigger than the rest of the entire insurance industry combined. Buffett blew them out of the water. And Geico [has gained] momentum and new market share every year since.

What are some of Buffett’s principles of investing?

When you buy a stock, you buy a business — be focused on that. This immediately sets up a flow of questions: What does the competition look like? Who are the managers? What does the company’s margins look like? [etc.] It’s not about interest rates or what Congress is going to do or what will happen next with the trade talks. Those aren’t as important as the fundamentals of the business and the psychological attitude about the market. The other key is to have a margin of safety: Buy a dollar of value for 50 cents. Give yourself a wide margin because the unexpected will happen.

Why doesn’t Buffett focus on macro events?

He’s aware of those issues. But the key is to have a long-term view. So, worrying about whether or not the Fed is going to increase rates this month is the wrong attitude. But if you think interest rates will rise over the next five years, that’s significantly important and something to factor into your business valuations.

At a few meetings, at least, Buffett said he doesn’t use the same criteria for evaluating every company he considers; instead, he looks at the individual firm.

Right. Each industry will have a couple of key variables, and that’s what he’s really good at — knowing those well.

Buffett and Munger say they don’t believe in Modern Portfolio Theory, including asset allocation and diversification. You quoted Munger as saying that MPT is “asinine.” Please explain.

They [don’t believe in] diversifying assets mindlessly. It doesn’t make sense to them. They feel that if you really want to earn high returns over time, have a very concentrated portfolio and really know what you own.

It’s my understanding that Buffett didn’t want to invest in technology. What was his mindset?

In the 1990s, he saw that most technology companies were kind of getting eaten alive by the rest of the industry. There are a few that have made it and made it huge — like Facebook and Apple. But as a whole, the industry [has been rough].

So he felt it was hard to predict what would happen if he invested in a tech company?

Right. If you’re buying a business, you want to be pretty sure where it might be in 10 or 20 years. With technology, it’s next to impossible to predict that.

But he did buy some tech later on.

Yes. The big shocker is that he’s bought $50 billion worth of Apple stock, starting a couple of years ago. He said that Apple is a technology company, but it’s also a consumer products company and a global brand.

Judging by their comments at meetings, Buffett and Munger seem to be down on lawyers, accountants, investment managers, and economic and financial gurus. What’s that all about?

They’re definitely about intellectual honesty. If you’re straight up and own your mistakes and tell it like it is, you’re all right with them. But there are certainly a lot of snake-oil salesmen in the world; and when they smell that — not being intellectually honest — they call it out. For instance, in the 1990s, the National Accounting Board changed the way stock options were accounted for; and Buffett and Munger were really upset. They said it was basically malpractice. Well, that accounting change led to a lot of folly, particularly an Internet bubble.

At the 2006 meeting, Buffett said that “media — newspapers, TV and cable — will be less active than in the past.” But he still seemed to see value in newspapers.

He loved newspapers. But the Internet changed [that business] — and unbelievably quickly. The hometown newspaper [only] four years ago was a money machine.

However, Berkshire still owns The Buffalo News.

Yes. Buffett went on a little spending spree buying up some small local newspapers. I think he thought of it as Buffett’s Folly, like a hobby. But he thought local papers offered unique things that local people wanted, like obituaries and local-events reporting. So there’s still value there.

At the 2013 meeting, Buffett said that health care costs were the biggest threat to American competitiveness. Please elaborate.

The last time I looked, major companies’ health care [costs] were running at about 17% of GDP. We spend massive amounts more on health care than [other countries]. So last year Berkshire formed a coalition with Jeff Bezos of Amazon and Jamie Dimon of JPMorgan to make health care more efficient and more effective for their employees. What they discover might help reform the whole system.

Berkshire managers don’t submit budgets, Buffett noted in 2005. What about now?

I don’t think they do. Buffett wants the managers to be focused on building a moat [around the company]. Every day, he makes the business more compelling to customers, more impregnable to competitors, the products or services the company is selling more convenient and better priced.

But what’s the advantage to managers not keeping budgets?

Let’s go back to Geico. If the managers had an advertising budget and Buffett said, “We’re doubling it,” it would blow up that budget, right? If you [focus on] budgets, you limit your focus. Buffett says: Focus on what matters most, and then focus your resources in that direction.

Has this big question been answered: Who will succeed Warren Buffett?

Part of the answer is that there will never be another Buffett. But the company has terrific managers. Ted Weschler and Todd Combs, both on the investment team, have been excellent. So to manage the portfolios, those two are keepers. On the operating business side, they promoted [to board vice chairs] Greg Abel [chair-CEO of Berkshire Hathaway Energy Co.], and Ajit Jain, who runs the insurance division. Buffett will tell you, “They’re the guys who will lead us forward when I’m not here.”

He said that, or he indicated so in other ways?

Kind of in between. The fact that they added them to the board tells you that these are the two most talented executives going forward.

Why are Buffett and Munger such a good team?

They deeply respect each other and have mutual admiration. They have intellectual honesty — if they make a mistake, they own it. And they have a great sense of humor.

Have you ever met with Buffett?

Never privately. I just shake his hand at the meetings and that sort of thing.

Never had a conversation with him?

Not directly. I did email about having “University of Berkshire Hathaway” in the bookstore at the shareholder meetings. Buffett chooses which books go into the Berkshire bookstore.

What did he say?

No thanks.

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