2007: How has Buffett's thoughts on Berkshire's intrinsic value evolved over time?

AUDIENCE MEMBER: This is Phil McCall (PH) from Connecticut.

I wondered if you could comment on a subject I don’t think you like to talk about very much, which is intrinsic value, and the evolution over the past 10 or 12 years of going to — off and on — but giving us investments and then giving us the operating income and suggesting that might be a good guide to us.

I find it extremely helpful. I’m not sure other people do when looking out the 20 years you’re talking about, looking ahead on both those two parts. Any comments you might have, I’d surely appreciate.

WARREN BUFFETT: Yeah. Well, the intrinsic value of Berkshire, like any other businesses, is based on the future amount of cash that can be expected to be delivered by the business between now and judgment day, discounted back at the proper rate.

Now, that’s pretty nebulous. Another way of looking at it is to try and figure out the value of the businesses we own presently, and we try to give you the information that will enable you to make a reasonably close estimate at that.

We own lots of marketable securities. It’s probably safe to say that they’re worth more or less what they are carried for. And then we own a number of operating businesses, and we try to give you the figures on those businesses that are the figures that we use in making our own judgments about the value of those businesses.

Now, that tells you what we have today and more or less what it’s worth. But since Berkshire retains all of its earnings, it becomes very important to evaluate what will be done with those earnings over time.

I mean, it is not only a question what the present businesses are worth. It’s a judgment on the efficiency or the effectiveness with which retained earnings will be used.

If you had looked at the intrinsic value of Berkshire in 1965, we had a textile business that was probably worth about $12 a share. But that was not the only part of the equation, because we intended to use any cash generated to try and buy into better businesses than we had, and we were fortunate to be able to buy in the insurance business in 1967 and build on that.

So it was not only a combination of the business we had, but the skill with which retained earnings would be used, that determined what the present value actually should have been at Berkshire going back that far.

It’s the same situation today. We will put to work billions and billions of dollars this year and next year and the year after. If we put that to work effectively, each dollar has a greater present value than a dollar has simply in cash or distributed. If we do ineffectively, it has a value of something less.

The businesses today, you know, we have whatever the figure is in the annual report — roughly $80,000 in marketable securities.

If our insurance business breaks even, that $80,000 is free to us, in terms of using it. And we have a group of operating businesses and we show their earnings in the report and we’re going to try to add to those and they’ll try to add to their earnings.

But if Charlie and I were each right now to write down on a piece of paper what we think the intrinsic value of Berkshire is, our figures would not be the same. They’d be reasonably close.

And I think with that, I’ll turn it over to Charlie.

CHARLIE MUNGER: Yeah. What’s hard to judge at Berkshire is the likelihood that you’ll have anything like the past to look forward to in the future.

Berkshire has gotten very extreme, in terms of investment results. In fact, it’s gotten so extreme that it’s hard to think of another similar precedent in the history of the world.

And the balance sheet is gross, considering the small beginnings of the place. Now, what on earth has caused this extreme record to go on for such a very long time?

I would argue that the young man who was reading everything he could read when he was 10-years-old became a learning machine, and he got a lot of power early, and then he got a very long run when he kept learning.

If Warren had not been learning all the while, I’m telling you having watched the process closely, the record would be a pale shadow of what it is. And Warren has improved since he passed the retirement age of man.

In other words, in this field, at least, you can improve when you’re old.

Now, most people don’t even try and create that kind of a record. They pass power from one 65-year-old to one 59-year-old and then do it over and over again. But you get an enormous advantage from practice in this field.

And so what happened accidentally in the case of Warren has helped you shareholders greatly because you had this long run with power extremely concentrated, and with the man holding the power being a ferocious learner.

Our system ought to be more copied than it is. (Applause)

This idea of passing the power from one old codger to another, in a settled way, is not necessarily the right system at all.

WARREN BUFFETT: We have a very strong culture now of rationality, of being owner-oriented, that will go on long after I’m not around. And we have a talent on the operating side in place to do a lot of wonderful things over time.

We will need, in capital allocation, to keep doing intelligent things. We won’t get to do brilliant things because you don’t get to do brilliant things with the kind of sums we’re talking about. Maybe once in a blue moon or something, you know, you’ll get a chance.

But we will need somebody that never does — basically doesn’t do any dumb things, and occasionally does something that’s reasonably good. That can be done.

And we have — we’re on that road already. It does not — fitting into this organization as an investment officer or a capital allocator, you’re getting in the right vehicle. It has the right standards. It will reject ideas that really are irrational.

I’ve been on a lot of boards. Charlie’s been on a lot of boards. You would be amazed at the number of things that are responding to “animal spirits” rather than to rationality that take place. And we have our animal spirits but we devote them to other areas.