Tap Dancing to Work: Warren Buffett on Practically Everything, 1966-2013

by Carol J. Loomis

It’s tough to square PetroChina with the “buy what you know” mantra that has helped make Buffett the world’s second-richest man. This is a guy who for decades has mainly stuck to businesses in his own backyard. Investors hoping for an explanation at Berkshire Hathaway’s annual meeting in May didn’t find one. “We think we understand the oil business in China reasonably well,” Buffett said. “We don’t make any great judgments about China.” Countless investors have been burned over the years betting against Buffett. Still, some China analysts question the move. “There must be some other reason for it,” speculates CSFB’s Peter Best. Viewed from a computer screen on the other side of the earth, PetroChina, which produces two-thirds of China’s oil and natural gas, may look like a winner. China guzzles more than five million barrels of oil a day, and that thirst will surely grow. Car sales surged nearly 60% last year. And PetroChina, which trades at about seven times earnings, looks like a steal compared with Exxon Mobil’s P/E of 15.

Berkshire sold its PetroChina stock in 2007, and here is what Buffett said in that year’s annual report about the holding: “In 2002 and 2003 Berkshire bought 1.3% of PetroChina for $488 million, a price that valued the entire business at about $37 billion. Charlie and I felt that the company was worth about $100 billion. By 2007, two factors had materially increased its value: The price of oil had climbed significantly, and PetroChina’s management had done a great job in building oil and gas reserves. In the second half of last year, the market value of the company rose to $275 billion, about what we thought it was worth compared to other giant oil companies. So we sold our holdings for $4 billion.”

U.S.? Simply put, after World War II and up until the early 1970s we operated in the industrious Thriftville style, regularly selling more abroad than we purchased. We concurrently invested our surplus abroad, with the result that our net investment—that is, our holdings of foreign assets less foreign holdings of U.S. assets—increased (under methodology, since revised, that the government was then using) from $37 billion in 1950 to $68 billion in 1970. In those days, to sum up, our country’s “net worth,” viewed in totality, consisted of all the wealth within our borders plus a modest portion of the wealth in the rest of the world. Additionally, because the U.S. was in a net ownership position with respect to the rest of the world, we realized net investment income that, piled on top of our trade surplus, became a second source of investable funds. Our fiscal situation was thus similar to that of an individual who was both saving some of his salary and reinvesting the dividends from his existing nest egg. In the late 1970s the trade situation reversed, producing deficits that initially ran about 1% of GDP. That was hardly serious, particularly because net investment income remained positive. Indeed, with the power of compound interest working for us, our net ownership balance hit its high in 1980 at $360 billion. Since then, however, it’s been all downhill, with the pace of decline rapidly accelerating in the past five years. Our annual trade deficit now exceeds 4% of GDP. ...

More important, however, is that foreign ownership of our assets will grow at about $500 billion per year at the present trade-deficit level, which means that the deficit will be adding about one percentage point annually to foreigners’ net ownership of our national wealth. As that ownership grows, so will the annual net investment income flowing out of this country. That will leave us paying ever-increasing dividends and interest to the world rather than being a net receiver of them, as in the past. We have entered the world of negative compounding—goodbye pleasure, hello pain.

We were taught in Economics 101 that countries could not for long sustain large, ever-growing trade deficits. At a point, so it was claimed, the spree of the consumption-happy nation would be braked by currency-rate adjustments and by the unwillingness of creditor countries to accept an endless flow of IOUs from the big spenders. And that’s the way it has indeed worked for the rest of the world, as we can see by the abrupt shutoffs of credit that many profligate nations have suffered in recent decades. The U.S., however, enjoys special status. In effect, we can behave today as we wish because our past financial behavior was so exemplary—and because we are so rich. Neither our capacity nor our intention to pay is questioned, and we continue to hav...

In evaluating business options at Berkshire, my partner, Charles Munger, suggests that we pay close attention to his jocular wish: “All I want to know is where I’m going to die, so I’ll never go there.” Framers of our trade policy should heed this caution—and steer clear of Squanderville.

too. He said, ‘You’re neither right nor wrong because others agree with you. You’re right because your facts and reasoning are right.’

FORTUNE: Back to the lightning round: Make a call on the market. Seven years from now, will the S&P 500 have returned over or under 10% annually? BUFFETT: More likely to be under than over. You’re not going to have the GDP in nominal terms grow 5% a year and everybody make 10% a year. GATES: I’d say under, most likely. The notion that returns will continue to be superhigh—there are some clouds out there.

It’s too bad that economics isn’t taught or a hobby for lots of people, because you do run into those who seem to say, “There’s only a certain number of jobs.” That’s not the case. Let’s say tomorrow we could decide that everyone in India is as rich as we are. Would the world be a better place? Certainly. Would the U.S. thrive more because of the great products and work that would be done over there? Absolutely. The world getting richer is a great thing. It has been a great thing. It will continue to be.

It’s interesting that the same people who talk about the terrible cycle of dependency that welfare brings will then hand their kids when they emerge from the womb a lifetime supply of food stamps. But some poor woman who’s had two pregnancies by the time she’s 17, they say, Oh, this is terrible to give her anything.

If you talk about equality of opportunity in this country and really having everybody with talent having a fair shot at getting the brass ring, the idea that you hand over huge positions in society simply because someone came from the right womb, I just think it’s almost un-American.

The explanation of how this is happening begins with a fundamental truth: With unimportant exceptions, such as bankruptcies in which some of a company’s losses are borne by creditors, the most that owners in aggregate can earn between now and Judgment Day is what their businesses in aggregate earn. True, by buying and selling that is clever or lucky, investor A may take more than his share of the pie at the expense of investor B. And, yes, all investors feel richer when stocks soar. But an owner can exit only by having someone take his place. If one investor sells high, another must buy high. For owners as a whole, there is simply no magic—no shower of money from outer space—that will enable them to extract wealth from their companies beyond that created by the companies themselves.

Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the fourth law of motion: For investors as a whole, returns decrease as motion increases.

“We chose our style of operation to fit our natures, which demanded that plenty of time be spent thinking and learning, while engaging in lifelong self-criticism, light contrition for every error, and much humor. Naturally this caused extreme delegation, which is what we would have wanted as recipients of trust. We knew our methods would create good financial results for us and those who relied on us. But we did not anticipate that we would draw so much more admiration than we deserved and that this would help us to be happy as we in effect became teachers who to some extent copied Warren’s mentor, Ben Graham.”

The book’s title and conceit is, of course, a nod to Benjamin Franklin, a man whom Munger greatly admires. “There is the sheer amount of Franklin’s wisdom,” says Munger who just for a second flashes a cherubic grin. “And the talent. Franklin played four instruments. He was the nation’s leading scientist and inventor, plus a leading author, statesman, and philanthropist. There has never been anyone like him.”

“We have a high moral responsibility to be rational,” he says. Think about that for a minute. Have you ever heard any business leader describe their charge thusly? There’s a reason that there’s just one Berkshire Hathaway and one Warren Buffett. And one Charlie Munger too.

In any case, Susie didn’t get very excited when I told her we were going to get rich. She either didn’t care or didn’t believe me—probably both, in fact. But to the extent we did amass wealth, we were totally in sync about what to do with it—and that was to give it back to society. In that, we agreed with Andrew Carnegie, who said that huge fortunes that flow in large part from society should in large part be returned to society. In my case, the ability to allocate capital would have had little utility unless I lived in a rich, populous country in which enormous quantities of marketable securities were traded and were sometimes ridiculously mispriced. And fortunately for me, that describes the U.S. in the second half of the last century.

The vast majority of large foundations operate with the intent of lasting forever and therefore rarely exceed the minimum spending ratio of 5% (calculated on an organization’s asset value of the previous year) which they need to retain tax-exempt status. According to data compiled by Buffett’s staff, 28 of the 30 largest foundations paid out less than 5% of assets in grants in 2005. (They reached the 5% threshold by counting operating costs).

“I once spent days interviewing a businessman almost as smart as Buffett, and this guy never exhibited the slightest curiosity about my background or how I got to Fortune. But before that car ride with Buffett was over, he had asked me one question after another about myself. You don’t see that often among the people we interview.”

Before we start in on questions, I would like to tell you about one thing going on recently. It may have some meaning to you if you’re still being taught efficient-market theory, which was standard procedure 25 years ago. But we’ve had a recent illustration of why the theory is misguided. In the past seven or eight or nine weeks, Berkshire has built up a position in auction-rate securities [bonds whose interest rates are periodically reset at auction] of about $4 billion. And what we have seen there is really quite phenomenal. Every day we get bid lists. The fascinating thing is that on these bid lists, frequently the same credit will appear more than once. Here’s one from yesterday. We bid on this particular issue—this happens to be Citizens Insurance, which is a creature of the state of Florida. It was set up to take care of hurricane insurance, and it’s backed by premium taxes, and if they have a big hurricane and the fund becomes inadequate, they raise the premium taxes. There’s nothing wrong with the credit. So we bid on three different Citizens securities that day. We got one bid at an 11.33% interest rate. One that we didn’t buy went for 9.87%, and one went for 6.0%. It’s the same bond, the same time, the same dealer. And a big issue. This is not some little anomaly, as they like to say in academic circles every time they find something that disagrees with their theory. So wild things happen in the markets. And the markets have not gotten more rational over the year...

How do you get your ideas? I just read. I read all day. I mean, we put $500 million in PetroChina. All I did was read the annual report. [Editor’s note: Berkshire purchased the shares five years ago and sold them in 2007 for $4 billion.]

The stock market kept going down and down in the first days of 2009, and we decided at Fortune that it just might be time to update Buffett’s market metric—the relationship of the total value of U.S. stocks to GNP. We had run a chart of that metric in late 2001, in “Warren Buffett on the Stock Market” (see page 191). The message then was a clarion “Don’t buy!” But, this time, when my coauthor on this piece, Doris Burke, ran the numbers, they showed that the market was definitely in Buffett’s buying range. So we published this article and chart in an issue that reached subscribers around February 1. Okay, this buy signal wasn’t perfect: From February 1, the S&P 500 viciously went down another 18 percent before bottoming on March 9. Even so, if you’d bought an S&P 500 total return ETF on that February 1 and held until midyear 2012, you would have earned a 78 percent total return—and been very happy that Buffett shared this metric.

Is it time to buy stocks? According to both this 85-year chart and famed investor Warren Buffett, it just might be. The point of the chart is that there should be a rational relationship between the total market value of U.S. stocks and the output of the U.S. economy—its GNP.

Fortune first ran a version of this chart in late 2001. Stocks had by that time retreated sharply from the manic levels of the Internet bubble. But they were still very high, with stock values at 133% of GNP. That level certainly did not suggest to Buffett that it was time to buy stocks. But he visualized a moment when purchases might make sense, saying, “If the percenta...

Today BYD employs 130,000 people in 11 factories, eight in China and one each in India, Hungary, and Romania. Its U.S. operations are small—about 20 people work in a sales and marketing outpost in Elk Grove Village, Ill., near Motorola, and another 20 or so work in San Francisco, not far from Apple. BYD makes about 80% of Motorola’s RAZR handsets, as well as batteries for iPods and iPhones and low-cost computers, including the model distributed by Nicholas Negroponte’s One Laptop per Child nonprofit based in Cambridge, Mass. Revenues, which have grown by about 45% annually during the past five years, reached $4 billion in 2008.

This pledge will leave my lifestyle untouched and that of my children as well. They have already received significant sums for their personal use and will receive more in the future. They live comfortable and productive lives. And I will continue to live in a manner that gives me everything that I could possibly want in life. Some material things make my life more enjoyable; many, however, would not. I like having an expensive private plane, but owning a half-dozen homes would be a burden. Too often, a vast collection of possessions ends up possessing its owner. The asset I most value, aside from health, is interesting, diverse, and long-standing friends.

My wealth has come from a combination of living in America, some lucky genes, and compound interest. Both my children and I won what I call the ovarian lottery. (For starters, the odds against my 1930 birth taking place in the U.S. were at least 30 to 1. My being male and white also removed huge obstacles that a majority of Americans then faced.) My luck was accentuated by my living in a market system that sometimes produces distorted results, though overall it serves our country well. I’ve worked in an economy that rewards someone who saves the lives of others on a battlefield with a medal, rewards a great teacher with thank-you notes from parents, but rewards those who can detect the mispricing of securities with sums reaching into the billions. In short, fate’s distribution of long straws is wildly capricious.

The reaction of my family and me to our extraordinary good fortune is not guilt, but rather gratitude. Were we to use more than 1% of my claim checks on ourselves, neither our happiness nor our well-being would be enhanced. In contrast, that remaini...

“My father knew early on what he loved to do, and he did it, and he’s doing it to this day,” he says. “So I tell audiences [in China] that my father and I do, in fact, do the same thing for a living. We both do what we love.”

Today, a wry comment that Wall Streeter Shelby Cullom Davis made long ago seems apt: “Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.”

Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce—gold’s price as I write this—its value would be about $9.6 trillion. Call this cube pile A. Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops—and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

My own preference—and you knew this was coming—is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola, IBM, and our own See’s Candy meet that double-barreled test. Certain other companies—think of our regulated utilities, for example—fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets.

So, my fellow males, what’s in this for us? Why should we care whether the remaining barriers facing women are dismantled and the fun-house mirrors junked? Never mind that I believe the ethical case in itself is compelling. Let’s look instead to your self-interest. No manager operates his or her plants at 80% efficiency when steps could be taken that would increase output. And no CEO wants male employees to be underutilized when improved training or working conditions would boost productivity. So take it one step further: If obvious benefits flow from helping the male component of the workforce achieve its potential, why in the world wouldn’t you want to include its counterpart? Fellow males, get onboard. The closer that America comes to fully employing the talents of all its citizens, the greater its output of goods and services will be. We’ve seen what can be accomplished when we use 50% of our human capacity. If you visualize what 100% can do, you’ll join me as an unbridled optimist about America’s future.