2010: Why has Berkshire shifted to investing in capital-intensive industries?

AUDIENCE MEMBER: Hi, I’m Steve Fulton (PH) from Louisville, Kentucky. Once again, I gave up a box seat to the Kentucky Derby to come ask you a question. (Laughter)

And I appreciate that opportunity.

My question’s focused on the shift, if you will, to investing in the capital-intensive businesses and the related impact on intrinsic value.

You again stated in the annual report that best businesses for owners are those that have high returns on capital and require little incremental capital.

I realize this decision is somewhat driven by the substantial amounts of cash that the current operating companies are spinning off, but I would like you to contrast the requirement for this capital against the definition of intrinsic value, which is the discounted value of the cash that’s being taken out.

And just for all of us to be aware, you’ve mentioned the fact that you think these businesses will require tens of billions of dollars over the few decades, and just the time value of that, I’d like to understand a little bit more of your insight into that.

WARREN BUFFETT: OK. Although it’s clear you understand the situation quite well, and it’s — as important a question as you could ask, virtually, I would say, at Berkshire.

We are putting money into good — big money — into good businesses from an economic standpoint. But they are not as good as some we could buy when we were dealing with smaller amounts of money.

If you take See’s Candy, it has 40 million or so of required capital in the business, and, you know, it earns something well above that.

Now, if we could double the capital, if we could put another 40 million in at anything like the returns we receive on the first 40 million, I mean, we’d be down there this afternoon with the money.

Unfortunately, the wonderful businesses don’t soak up capital. That’s one of the reasons they’re wonderful.

At the size we are, we earn operating earnings, $2.2 billion, or whatever it was in the first quarter, and we don’t pay it out, and our job is to put that out as intelligently as we can.

And we can’t find the See’s Candies that will sop up that kind of money. When we find them, we’ll buy them, but they will not sop up the kind of money we’ll generate.

And then the question is, can we put it to work intelligently, if not brilliantly? And so far, we think the answer to that is yes.

We think it makes sense to go into the capital-intensive businesses that we have. And incidentally, so far, it has made sense. I mean, it’s worked quite well. But it can’t work brilliantly.

The world is not set up so that you can reinvest tens of billions of dollars, and many, many tens over time, and get huge returns. It just doesn’t happen.

And we try to spell that out as carefully as we can so that the shareholders will understand our limitations.

Now, you could say, “Well, then aren’t you better off paying it out?”

We’re not better off paying it out as long as we can translate, as you mentioned, the discounted value of future cash generation. If we can translate it into a little something more than a dollar of present value, we’ll keep looking for ways to do that.

In our judgment, we did that with BNSF, but the scorecard will be written on that in 10 or 20 years.

We did it with MidAmerican Energy. We went into a business, very capital intensive, and so far, we’ve done very well, in terms of compounding equity.

But it can’t be a Coca-Cola, in terms of a basic business where you really don’t need very much capital, if any, hardly. And you can keep growing the business if you’re lucky, if you’ve got a growing business.

See’s is not a growing business. It’s a wonderful business, but it doesn’t translate itself around the world like something like Coca-Cola would.

So I would say you’ve got your finger right on the right point. I think you understand it as well as we do. I hope we don’t disappoint you, in terms of putting money out to work at decent returns, good returns.

But if anybody expects brilliant returns from this base in Berkshire, you know, we don’t know how to do it.

Charlie?

CHARLIE MUNGER: Well, I’m just as good at not knowing as you are. (Laughter)