2006: How would Buffett value a newspaper company today?

AUDIENCE MEMBER: Hi. My name is Jeremy from San Diego. And, first of all, I want to thank you all for the tremendous impact that you’ve had on my career as a professional investor.

My question is also about the newspaper industry that the gentleman earlier touched on.

And for some of those same points that you brought up, some of the largest newspaper stocks seem to earn incredible return on invested capital as compared to a lot of the businesses in the S&P 500.

My question is more specifically related to valuation. If either of you were looking at a newspaper stock today and watching them fall, as some people may categorize falling knives, what would you use to determine — or how would you determine a very comfortable margin of safety to protect yourself against the deteriorating aspects of the newspaper industry?

WARREN BUFFETT: Yeah. Well, the question is what multiple you — what multiple should you pay for a business that’s earning $100 million a year — call it pretax — whose earnings are going to go down 5 percent a year compared to what you should pay for a business with a — that’s earning $100 million a year whose earnings are going to go up 5 percent a year.

And I would say that — I’m not saying that those are percentages I predict on newspaper companies — but certainly newspaper companies face the prospect of their newspaper earnings eroding.

And we’ve seen some of it already. We see every trend pointing in that direction. We own a newspaper ourselves.

And, you know, I do not think the circulation of our paper will be larger in five years, and I don’t think the advertising pages will be greater.

And I think that’s true even of newspapers that operate in more prosperous — or, actually, more growing, I should say — areas of the country than we do.

So — but I don’t think — I don’t think most owners of papers still have quite gotten to the point where they start projecting out declining earnings.

Certainly multiples on newspaper stocks are unattractively high if you would see some decline, like 5 or 6 percent a year on earnings, occurring to this point. They just — they’re not cheap enough to compensate for that sort of erosion in earning power.

And then you face the added risk that they may have, sort of, a perception lag and that they may continue to use some of that money to buy other newspapers at prices which, again, don’t make much sense.

It’s pretty hard in a declining business to buy things cheap enough to compensate for the decline.

People in the business always tend to think that they’re seeing the first robin, you know, or something, and that it’s going to get better. And I would say in the newspaper business, the decline, if anything, is accelerated somewhat. I —

You know, when they take — when they take people out to the cemetery, they’re taking newspaper readers, and when people graduate from school, they’re not gaining newspaper readers.

And that may not change things overnight, but it goes in the wrong direction. And the less the readers, the less the readership, the less compelling argument to have to advertisers.

So that virtuous circle where everybody read a paper because every ad was in it, and every ad was in it because everybody read a paper, that virtuous cycle is going in the other direction now. And I don’t think present prices for papers compensate for that.

And you are now hearing from a couple of guys that just love newspapers.

We think newspapers are indispensable, but we don’t have a lot of — we have less company in that view. We love — I read five newspapers every day. Charlie probably does about the same.

CHARLIE MUNGER: Four.

WARREN BUFFETT: Yeah, he’s — well, it shows too. The — (Laughter)

The — we couldn’t live without them. But a lot of people can, and more people can every day. And though we started out — we love the idea of buying newspapers. We traveled to Cincinnati, cheap hotels, all kinds of things, to buy newspapers.

But — and we thought, incidentally, we loved them as products, and we thought they were the greatest of businesses, the ultimate bulletproof franchise. But it became apparent we were wrong.

You know, we still love them as news — as products, but we were wrong about the bulletproof franchise. And, you know, we’ve got to believe our eyes, in terms of what we’re seeing in that world.

Charlie?

CHARLIE MUNGER: Yeah. I have an even greater sin to admit to. I once thought General Motors was a bulletproof franchise. And — but we have a wonderful way of coping with a lot of these things. We have this “too hard” pile.

I don’t know if Warren is buying General Motors or not, but I have a good guess.

And it’s just too hard. If something is too hard to do, we look for something that isn’t too hard to do. (Laughter)

What could be more obvious than that? (Laughter)

WARREN BUFFETT: It may mean that we don’t do very much. (Laughter)

CHARLIE MUNGER: Yeah. Yeah.

WARREN BUFFETT: We won’t get into specifics. The news — it’s — I don’t think anybody has watched the newspaper business much more carefully than Charlie and I have for, really, 50 years.

We used to — we always talked about every paper in the country, and the potential for buying it and, all that sort of thing.

And it was a — it was easily understood. I mean, it was about as easy an economic — a business economics problem — as you could imagine. And we slowly woke up to the change on it.

Actually, I wrote in the 1991 annual report, the newspaper — the very — the preprints of the world, you know, started turning the newspaper into a wrapper. It contained a whole bunch of things that could have been contained in some other package.

Now, your newspaper wasn’t reproducible in some other package, but this thing was carrying around a bunch of preprints. Now, the question is there a bunch — is there — are there easier ways to carry around those preprints?

But there was nothing magical about the paper except it got inside the house and brought the preprints inside the house. And as the newspaper lost penetration, it became a somewhat less efficient way of getting things into the house and other ways became more efficient at getting things into the house.

So these things — it’s not a hard business to understand. And it has been interesting to me to watch both owners — direct owners — and investors in the business sort of resist seeing what’s right in front of them, you know?

It just — it went so long the other way that you couldn’t make a mistake buying a monopoly newspaper. Nobody ever made a mistake buying one, you know, until, what, 1975 or ’80 or something like that.

CHARLIE MUNGER: Yeah. If the technology had not changed, they’d still be impregnable franchises. But the technology did change. Fortunately, carbide cutting tools appear to have no good substitute. (Laughter)

WARREN BUFFETT: It’s a lot better business over time, if you have the right management. Now, it takes very good management. Nice thing about the newspaper business 30 or 40 years ago, it took no management at all.

I mean, if you had an idiot nephew, you know, you — that would be a perfect — or a network television station. I mean, they were going to make money no matter what happened.

They were going to make more money if they were under good management. I mean, if Tom Murphy was running your television stations, you were going to do much better than if you had your nephew doing it, but the nephew would have done all right. (Laughs)