Question: I’m still quite young, I don’t have a house yet and I’m thinking about buying a house someday soon. And in order to do that I’m going to have to put a down payment, which means I might have to sell my shares. And I was wondering if you can provide some insight on when is the best time to buy a house, and how much down payment you should be putting down, in relation to interest rates and also in relation to available cash and the stock market.
Buffett: Well, Charlie’s going to give you an answer to that in a second. I’ll just relay one story, which was when I got married we did have about $10,000 starting off, and I told Susie, I said, “Now, you know, there’s two choices, it’s up to you. We can either buy a house, which will use up all my capital and clean me out, and it’ll be like a carpenter who’s had his tools taken away for him. “Or you can let me work on this and someday, who knows, maybe I’ll even buy a little bit larger house than would otherwise be the case.”
So she was very understanding on that point. And we waited until 1956. We got married in 1952.
And I decided to buy a house when the down payment was about 10% or so of my net worth, because I really felt I wanted to use the capital for other purposes.
But that was a way different environment in terms of what was available to buy. In effect, if you have the house you want to buy, you know, I definitely believe in just going out and probably getting the job done. But in effect, you’re probably making something in the area of a 7 or 8% [annual return] investment, implicitly, when you do it. So you know, you’ll have to figure out your own equation from that.
Charlie probably has better advice on that. He’s a big homeowner in both senses of the word.
Munger: I think the time to buy a house is when you need one.
Buffett: And when do you need one?
Munger: Well, I have very old-fashioned ideas on that, too. The single people, I don’t care if they ever get a house.
Buffett: When do you need one if you’re married, Charlie? You need one when your wife wants one?!
Munger: Yeah, yes. I think you’ve got that exactly right.
Question: You’ve said that great companies are those that have an economic moat, and I understand that phrase to mean a sustainable competitive advantage. Do businesses begin their lives with sustainable competitive advantages, or must that be developed over a very long time? And then, what are the fundamental bases upon which you’ve seen companies successfully develop sustainable competitive advantages? Of those, which do you think is the most enduring and which is the least?
Buffett: Well, sometimes they can develop it very quickly. I would say that Microsoft, in terms of the operating system, that was a relatively quick development. But that was an industry that was exploding, and things were changing very fast.
On the other hand, if you go back to See’s Candies, which started in 1921, there was no way you could build a sustainable competitive advantage, at least that would be recognizable, in times measured shorter than decades. I mean, you opened up one shop at a time, and nobody’d heard of you originally, and then a few people did. And boxed chocolates were something that people may have bought once or twice a year for a holiday occasion or whatever. So, you weren’t going to embed yourself in the minds of Californians in one or two or five years just because you were turning out outstanding box of chocolates.
So it depends on the way the industry itself is developing.
Walmart has done an incredible job in quite a short period of time. But even they [took some time] — they took it in the small towns, and they progressed along, and refined their techniques as they went.
But I would say that there could be things in new industries.
I would say with NetJets, we have a sustainable competitive advantage. And that’s an industry that was only originated in 1986 when Rich Santulli got the idea, and it was in its total infancy for a good many years after that. But what he has built, and is building and fortifying, is that sustainable competitive advantage. But it depends very much on the industry you’re in.
And I mean, Coca-Cola. 1886, Jacobs Pharmacy, Atlanta, Georgia, you know. John Pemberton came up with a product. And did he have a sustainable competitive advantage that day? If he did, he blew it because he sold the place for 2,000 bucks to Asa Candler.
It took decades, thousands of competitors over that time. They were painting one barn at a time, and designing one Saturday Evening Post ad at a time, and all of that, and pebbles — you know. Around the world in World War II, General Eisenhower went to Mr. Woodruff and he said, “I want a Coke within the arm’s length of every American serviceman.” He said, “I want something to remind them of home.” And so he built a lot of bottling plants for Coke around the world. And that was a huge impetus.
But that was, what? 60 years or so after the product was invented.
So it takes a long time in certain kinds of products, but I could see certain areas of the world where a huge competitive advantage is built in a very short period of time.
I would say that probably, in terms of animated feature-length films, for example, Walt Disney did that. And after Snow White and a few more, it took him a while until he could cash in on it, but it became Disney and nobody else in that field for quite a while, and fairly quickly.
Munger: Yeah, there are a lot of different models that create a sustainable competitive advantage.
And there are also some models where you can lose it very fast. Just ask Arthur Andersen. That was a very good name in America not very long ago.
And I think it would be harder to lose the good name of Wrigley’s gum than the good name of Arthur Andersen.
I think there’s some perfectly remarkable competitive advantages that people have gotten over time. And the great trouble with the investment process is that they’re so damned obvious that the stocks sell at very high prices.
Buffett: Snickers has been the number one candy bar for probably 30 or 40 years now. How do you really knock it off?
I mean, we make candy, we would love to displace Snickers, but it’s hard to think of ways to knock them from the number one spot.
My guess is that they’ll be number one in 10 years from now in candy bars, and the list doesn’t change much in that field because —
If you think about the nature of how you make that choice as to what candy bar [you are going to buy and eat] —
If you were chewing Spearmint chewing gum five years ago, and you buy a pack of some chewing gum today, it’s likely to be Spearmint. I mean, there’s just things that you experiment a lot with, and there’re things that you don’t fool around with once you’re happy. You can understand that if you observe your own habits and people’s habits around you.
[And then] there’s other [aspect to it] — usually if something can gain competitive advantage very quickly, you have to worry about them losing it quickly, too. I mean, when an industry is in flux, there are a lot of people that think they’re the survivors, or the ones that are going to prosper, where it turns out otherwise.
If things are changing very fast in an industry, it could be possible to develop an economic moat relatively quickly. Examples: Microsoft (with Windows), Walt Disney (in animated feature-length films), Walmart, NetJets
But, beware: what comes quickly, may go just as quickly. And even if the moat was built over decades, it could be destroyed very quickly. Example: Arthur Andersen
If a product needs to spread out and embed itself into the mind of millions of consumers, it may take several decades. Both the frequency of consumption and the product “stickiness” impact the “spreading out” outcome. Examples: See’s Candies, Coca-Cola, Snickers
Question: Hello, Mr. Buffett and Mr. Munger. I am 12 years old. […] My question is not about money. It’s about friendship. How do you remain friends and business partners for so long? And what advice do you have for young people like me in selecting true friends and future business partners? Thank you.
Buffett: Well, when Charlie and I met in 1959 we were introduced by the Davis family, and they predicted that within 30 minutes we would either not be able to stand each other or we would get along terrifically.
And that was a fairly insightful analysis, actually, by the Davises, because you had two personalities that both had some tendencies toward dominance in certain situations.
But we hit it off. We have disagreed, but we have never had an argument that I can remember at all in 43 years.
And yet we both have strong opinions and they aren’t the same strong opinions at times.
But the truth is we’ve had an enormous amount of fun together, we continue to have an enormous amount of fun, and nothing will change that, basically.
It may have worked better because he’s in California and I’m in Omaha, I don’t know.
I’ll let Charlie comment on it.
Munger: Well, that’s a wonderful question you’ve asked, because Warren and I both know some very successful businessmen who have not one true friend on earth. And rightly so.
Buffett: That’s true.
Munger: And that is no way to live a life. And if by asking that question, you’re asking: how do I get the right friends? You are really onto the right question.
And when you get with the right friends, if you’ve worked hard at becoming the right sort of fellow, I think you’ll recognize what you have and then all you have to do is hang on.
Buffett: The real question is: what do you like in other people? I mean, what do you want from a friend?
And if you’ll think about it, there are certain qualities that you admire in other people, that you find likeable, and that cause you to want to be around certain people.
And then look at those qualities and say to yourself, “Which of these is it physically or mentally impossible for me to have?” And the answer will be none.
I mean, it’s only reasonable that if certain things that attract you to other people that, if you possess those, they will attract other people to you.
And secondarily, if you find certain things repulsive in other people — whether they brag or they’re dishonest or whatever it may be — if that turns you off, it’s going to turn other people off if you possess those qualities.
And those are choices. You know, very few of those things are in your DNA. They are choices.
And they are also habits. I mean, if you have habits that attract people early on, you’ll have them later on. And if you have habits that repel people, you’re not going to cure it when you’re 60 or 70.
Buffett: It’s not a complicated equation. And, as I remember, Benjamin Franklin did something like that one time. Didn’t he list the qualities he admired, and then just set out to acquire them?
Munger: Absolutely. He went at it the way you’ve gone after acquiring money.
Buffett: They’re not mutually exclusive.
Munger: No [they are not].
Their advice in a nutshell:
They also threw in the conversation some other interesting observations about themselves, and human nature in general:
John Collison talks about the challenges of quantifying OpEx vs CapEx, and intangible capital and R&D vs tangible capital of a software company:
Accounting standards are invented by us humans to give us a view of a business and they’re up to us to choose. They’re generally in kind of long boring committees, but we humans choose how we look at businesses. I have absolutely no patience for the crowd that’s all this winging about non-GAAP metrics. [In fact, the GAAP standards are just] relatively arbitrarily chosen and constantly tweaked set of standards for looking at a business. If they’re constantly tweaked, presumably you would expect that they can be improved upon.
One of the areas in which I think the standard way we look at businesses is just completely wrong, is in reasoning about R&D and intangible capital.
Capital has really moved over the past 100 years away from heavy machines to intellectual capital and intangible capital. Traditionally, if you read a balance sheet and a company has a bunch of stuff, then it has a bunch of assets on its balance sheet. If you’re a cafe, maybe your assets are the coffee machine, maybe a really expensive coffee machine. These days with technology businesses, what are the capital within the business? One of the assets that the business have, it’s probably software that has been developed in house by the business. At Google, for instance, it is the search engine that’s it. Now for 20 years, Google engineers have laboriously worked on to make it good.
Capital used to be about something really tangible, like an espresso machine. Something you can reason about its value really easily. Its value doesn’t change that much over time, and there’s a clear market for it. You could go out and sell this espresso machine for some amount of money. So, one of the accounting principles is that you just carry things at cost, before depreciation. But it’s really hard to reason about the value of intangible capital, like Stripe Radar, how does the value of that system that we built?
The reason this gets interesting is because you and I might very reasonably want to think about: What is the profitability of a business after you strip out all the investment in future growth? Because as you look at the technology sector, one of the things that kind of unifies technology companies is that they don’t tend to produce kind of huge amounts of cash flows until later in their maturity. Companies that are in their growth phase, either pre-public companies or recently public companies tend to be mostly reinvesting in growth.
As we look at how accounting works for this, it’s really basic. All you have is companies that are spending lots of money on operations, engineering salaries, operation salaries, lawyer salaries, kind of the general OpEx, and no real intelligent view on what is the capital that we’re developing. What is the multi-year value that we’re getting from this system that we’re building versus what is the actual ongoing cost of operating the system?
And so that’s something that we spent a lot of time at Stripe getting good internal management views into is as a system-by-system, line-by-line level. How much are we investing in kind of the future potential of this system vs. What is the existing profitability of the system? What is really the core question for a technology business which is: How much are you paying to operate this business, versus how much are you investing in a long lived technology advantage?
Patrick: Everyone will pay a lot of lip service to the concept of free cashflow, but I think for all the reasons you’ve pointed out, it’s a very hard metric to get to. And then there’s also just silly concepts. What is the useful life of a piece of software? Like how do you even reason about something like that? And therefore, think about something like depreciation. A lot of what is registered as operating expenses in a business is kind of like what we used to call capital expenses, because it’s going to be useful for a long time. And I think this is an important, it’s a really important topic for public investors with more of these businesses due to become public.
The most interesting thing about that definition for me was splitting out the two forms of CapEx. CapEx spend that has a multiyear horizon or a multiyear payoff is split out into:
- CapEx into what is just needed to tread water, investment required for the company to keep same competitive position and keep its unit volume
- CapEx required to expand
We haven’t fully chased it through [in Stripe], but I think that’s a really interesting distinction.
Buffett obviously always talks about the example of the textile mill that Berkshire Hathaway got its start with. It was such an incredibly terrible business because you were spending all this CapEx just to tread water, just to stay in place.
I think it’s important for companies to be honest with, I mean, not only external investors, but companies be honest with themselves on this. Is this spend just the cost of doing business, the cost of operating our business, and we are maintaining our competitive position or are we expanding in some way? Are we growing our share of market? Are we expanding to a new country? Are we developing a new product that will monetize separately?