2000: How does Buffett think about risk?

AUDIENCE MEMBER: My name is Greg Blevins (PH) from Bargetown, Kentucky.

I have a question about intrinsic value. It comes from comments that you made in your annual report this year. In there, you describe the extraordinary skills of [Berkshire reinsurance chief] Ajit Jain in judging risk.

When I think about Berkshire and its ability to increase intrinsic value, it seems to me that judging risk has been at least as important as an ability to calculate a net present value.

So my question to each of you is, would you give us some comments on how you think about risk?

WARREN BUFFETT: Well, we think of business risk in terms of what can happen — say five, 10, 15 years from now — that will destroy, or modify, or reduce the economic strengths that we perceive currently exist in a business.

In some businesses that’s very — it’s impossible — to figure — at least it’s impossible for us to figure — and then we just — we don’t even think about it then.

We are enormously risk averse. We are not risk adverse, in terms of losing a billion dollars if there were an earthquake in California today. And we’re thinking of writing a policy, for example, in the next week or so, on a primary insurance risk of over a billion dollars.

That doesn’t bother us as long as the math is in our favor. But in terms of doing a group of transactions like that, we are very risk averse. In other words, we want to think that we’ve got a mathematical edge in every transaction.

And we think that we’ll do enough transactions over a lifetime so that, no matter what the result of any single one, that the group expectancy would — gets almost to certainty.

When we look at businesses, we try to think of what can go wrong with them. We try to look [for] businesses that are good businesses now, and we think about what can go wrong with them.

If we can think of very much that can go wrong with them, we just forget it. We are not in the business of assuming a lot of risk in businesses.

That doesn’t mean we don’t do it inadvertently and make mistakes, because we do. But we don’t intentionally, or willingly, voluntarily, go into situations where we perceive really significant risk that the business is going to change in a major way.

And that gets down to what you probably heard me talk about before, is, what kind of a moat is around the business?

Every business that we look at we think of as an economic castle. And castles are subject to marauders. And in capitalism, any castle you have, whether it’s razor blades, or soft drinks, or whatever, you have to expect the —

And you want the capitalistic system to work in a way that millions of people are out there with capital thinking about ways to take your castle away from you, and appropriate it for their own use. And then the question is, what kind of a moat do you have around that castle that protects it?

See’s Candy has a wonderful moat around its castle. And Chuck Huggins has taken that moat, which he took charge of in 1972, and he has widened that moat every year. He throws crocodiles, and sharks, and piranhas in the moat, and it gets harder and harder for people to swim across and attack the castle. So they don’t do it.

If you look, since 1972, Forrest Mars tried with Ethel M — I don’t know, 20 years ago. And I hate to think of how much money it cost him to try that. And he was a very experienced businessman.

So we think of the — we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business.

And to our managers, we say we want the moat widened every year. You know, that does not necessarily mean that the profit is more this year than last year, because it won’t be sometimes. But if the moat is widened every year, the business will do very well.

When we don’t have a — when we see a moat that’s tenuous in any way — getting back to your question — it’s just too risky. We don’t know how to valuate that, and therefore we leave it alone.

We think all of our businesses — virtually all of our businesses — have pretty darn good moats, and we think the managers are widening them.

Charlie?

CHARLIE MUNGER: How could you say it better? (Laughter)

WARREN BUFFETT: Here, have a — have some peanut brittle on that one. (Laughter)