2000: Does Buffett have a firm limit on the multiple he will pay for a company?

AUDIENCE MEMBER: My name is Jin Xi Wan (PH) from San Diego, California.

First, I would thank both of you. My question is also about growth and value.

If you look at the business in this country, most of them, if not all of them, are cyclical to various degrees. Certain businesses are, of course, more cyclical than other businesses.

So when you buy a business or make a investment in a new stock, do you ever cut off — like if a business lose money in a downturn, we are not going to buy.

If its earning begin to decline or downturn, we’re not going to buy. But if the earning growth slows down, then we can look at a business and make an investment. So do you have a cutoff, in terms of this cyclical factor?

And also, when you buy a business — in terms of the current P/E ratio, also do you have a cutoff? Let’s say, if it’s P/E ratio is more than 15, 16, we are not going to buy the business, no matter how much the earning will grow in the future. So basically, it’s about the growth and the value.

WARREN BUFFETT: Yeah, we have — to answer your question directly — we have no cutoff, whatsoever.

We don’t think in terms of absolutes that way because, again, we are trying to think of how many birds are in the bush. And sometimes the number that are currently being shown could be negative.

One of the best buys we ever made was in 1976 when we bought a significant percentage — what became through repurchases — 50 percent of GEICO at a time when the company was losing a lot of money and was destined to lose a lot of money in the immediate future.

And, you know, the fact they were losing money was not lost on us, but we thought we saw a future there that was significantly different than the current situation.

So it would not bother us in the least to buy into a business that currently was losing money for some reason that we understood, and where we thought that the future was going to be significantly different.

Similarly, if a business is making some money — there’s no P/E ratio that we have in mind as being a cutoff point at all. There are businesses — I mean, you could have some business making a sliver of money on which you would pay a very, very high P/E ratio. But it’s basically —

We look at all of these as businesses. We’re, for example, in — at Executive Jet — NetJets — we’re losing money in Europe. Well, we expect to lose money in Europe getting established.

So does that mean it’s a bad thing to buy a hundred percent of, if you own the whole company, or three percent of, if Executive Jet was a public company and you were buying into? No. I mean, it —

There are all kinds of decisions that involve the future looking different, in some important way, than the present. Most of our decisions relate to things where we expect the future not to change much.

But you get this — well, American Express was a good example. And when we bought it in 1964, a fellow named Tino DeAngelis had caused them incredible trouble. You know, it was one of those decisions that looked, for a time, as if it could break the company.

So, we knew — if you’d been charging for what Tino had stolen from the company against the income account that year, or the legal costs that were going to be attached to it, you were looking at a significant loss.

But the question was, what was American Express going to look like 10 or 20 years later? And we felt very good about that.

So there are no arbitrary cutoff points. But there is that focus on, how much cash will this business deliver, you know, between now and kingdom come? Now as a practical matter, if you estimate it for 20 years or so, the terminal values get less important.

So — but you do want to have, in your mind, a stream of cash that will be thrown off over, say, a 20-year period, that makes sense discounted at a proper interest rate, compared to what you’re paying today. And that’s what investment’s all about.

Charlie?

CHARLIE MUNGER: Yeah, the answer is almost the exact reverse of what you were pointing toward. A business with something glorious underneath, disguised by terrible numbers that cause cutoff points in other people’s minds, is ideal for us, if we can figure it out.

WARREN BUFFETT: And we’ve had a couple of those in our history that have made us a lot of money. I mean, we don’t want to wish anybody ill, but —

CHARLIE MUNGER: Oh, I wouldn’t go that far —

WARREN BUFFETT: OK, well Charlie — (Laughter)

I think he’s speaking for both of us. (Laughter)