Warren Buffet on Book Value vs Intrinsic Value, from Berkshire Hathaway
1994 Letter to Shareholders:


     We regularly report our per-share book value, an easily 
calculable number, though one of limited use.  Just as regularly, 
we tell you that what counts is intrinsic value, a number that is 
impossible to pinpoint but essential to estimate.

     For example, in 1964, we could state with certitude that 
Berkshire's per-share book value was $19.46.  However, that 
figure considerably overstated the stock's intrinsic value since 
all of the company's resources were tied up in a sub-profitable 
textile business.  Our textile assets had neither going-concern 
nor liquidation values equal to their carrying values.  In 1964, 
then, anyone inquiring into the soundness of Berkshire's balance 
sheet might well have deserved the answer once offered up by a 
Hollywood mogul of dubious reputation:  "Don't worry, the 
liabilities are solid."

     Today, Berkshire's situation has reversed:  Many of the 
businesses we control are worth far more than their carrying 
value.  (Those we don't control, such as Coca-Cola or Gillette, 
are carried at current market values.)  We continue to give you 
book value figures, however, because they serve as a rough, 
albeit significantly understated, tracking measure for Berkshire's 
intrinsic value.  Last year, in fact, the two measures moved in 
concert:  Book value gained 13.9%, and that was the approximate 
gain in intrinsic value also.

     We define intrinsic value as the discounted value of the 
cash that can be taken out of a business during its remaining 
life.  Anyone calculating intrinsic value necessarily comes up 
with a highly subjective figure that will change both as 
estimates of future cash flows are revised and as interest rates 
move.  Despite its fuzziness, however, intrinsic value is all-
important and is the only logical way to evaluate the relative 
attractiveness of investments and businesses.

     To see how historical input (book value) and future output 
(intrinsic value) can diverge, let's look at another form of 
investment, a college education.  Think of the education's cost 
as its "book value."  If it is to be accurate, the cost should 
include the earnings that were foregone by the student because he 
chose college rather than a job.

     For this exercise, we will ignore the important non-economic 
benefits of an education and focus strictly on its economic 
value.  First, we must estimate the earnings that the graduate 
will receive over his lifetime and subtract from that figure an 
estimate of what he would have earned had he lacked his 
education.  That gives us an excess earnings figure, which must 
then be discounted, at an appropriate interest rate, back to 
graduation day.  The dollar result equals the intrinsic economic 
value of the education.

     Some graduates will find that the book value of their 
education exceeds its intrinsic value, which means that whoever 
paid for the education didn't get his money's worth.  In other 
cases, the intrinsic value of an education will far exceed its 
book value, a result that proves capital was wisely deployed.  In 
all cases, what is clear is that book value is meaningless as an 
indicator of intrinsic value.

     Now let's get less academic and look at Scott Fetzer, an 
example from Berkshire's own experience.  This account will not 
only illustrate how the relationship of book value and intrinsic 
value can change but also will provide an accounting lesson that 
I know you have been breathlessly awaiting.  Naturally, I've 
chosen here to talk about an acquisition that has turned out to 
be a huge winner.

     Berkshire purchased Scott Fetzer at the beginning of 1986.  
At the time, the company was a collection of 22 businesses, and 
today we have exactly the same line-up - no additions and no 
disposals.  Scott Fetzer's main operations are World Book, Kirby, 
and Campbell Hausfeld, but many other units are important 
contributors to earnings as well.

     We paid $315.2 million for Scott Fetzer, which at the time 
had $172.6 million of book value.  The $142.6 million premium we 
handed over indicated our belief that the company's intrinsic 
value was close to double its book value.

     In the table below we trace the book value of Scott Fetzer, 
as well as its earnings and dividends, since our purchase.
  
                       (1)                                 (4)
                    Beginning      (2)         (3)        Ending
Year                Book Value   Earnings   Dividends   Book Value
----                ----------   --------   ---------   ----------
                                   (In $ Millions)      (1)+(2)-(3)

1986 ...............  $172.6      $ 40.3     $125.0       $ 87.9
1987 ...............    87.9        48.6       41.0         95.5
1988 ...............    95.5        58.0       35.0        118.6
1989 ...............   118.6        58.5       71.5        105.5
1990 ...............   105.5        61.3       33.5        133.3
1991 ...............   133.3        61.4       74.0        120.7
1992 ...............   120.7        70.5       80.0        111.2
1993 ...............   111.2        77.5       98.0         90.7
1994 ...............    90.7        79.3       76.0         94.0


     Because it had excess cash when our deal was made, Scott 
Fetzer was able to pay Berkshire dividends of $125 million in 
1986, though it earned only $40.3 million.  I should mention that 
we have not introduced leverage into Scott Fetzer's balance 
sheet.  In fact, the company has gone from very modest debt when 
we purchased it to virtually no debt at all (except for debt used 
by its finance subsidiary).  Similarly, we have not sold plants 
and leased them back, nor sold receivables, nor the like.  
Throughout our years of ownership, Scott Fetzer has operated as a 
conservatively-financed and liquid enterprise.

     As you can see, Scott Fetzer's earnings have increased 
steadily since we bought it, but book value has not grown 
commensurately.  Consequently, return on equity, which was 
exceptional at the time of our purchase, has now become truly 
extraordinary.  Just how extraordinary is illustrated by 
comparing Scott Fetzer's performance to that of the Fortune 500, 
a group it would qualify for if it were a stand-alone company.

     Had Scott Fetzer been on the 1993 500 list - the latest 
available for inspection - the company's return on equity would 
have ranked 4th.  But that is far from the whole story.  The top 
three companies in return on equity were Insilco, LTV and Gaylord 
Container, each of which emerged from bankruptcy in 1993 and none 
of which achieved meaningful earnings that year except for those 
they realized when they were accorded debt forgiveness in 
bankruptcy proceedings.  Leaving aside such non-operating 
windfalls, Scott Fetzer's return on equity would have ranked it 
first on the Fortune 500, well ahead of number two.  Indeed, 
Scott Fetzer's return on equity was double that of the company 
ranking tenth.

     You might expect that Scott Fetzer's success could only be 
explained by a cyclical peak in earnings, a monopolistic 
position, or leverage.  But no such circumstances apply.  Rather, 
the company's success comes from the managerial expertise of CEO 
Ralph Schey, of whom I'll tell you more later.

     First, however, the promised accounting lesson:  When we 
paid a $142.6 million premium over book value for Scott Fetzer, 
that figure had to be recorded on Berkshire's balance sheet.  
I'll spare you the details of how this worked (these were laid 
out in an appendix to our 1986 Annual Report) and get to the 
bottom line:  After a premium is initially recorded, it must in 
almost all cases be written off over time through annual charges 
that are shown as costs in the acquiring company's earnings 
statement.

     The following table shows, first, the annual charges 
Berkshire has made to gradually extinguish the Scott Fetzer 
acquisition premium and, second, the premium that remains on our 
books.  These charges have no effect on cash or the taxes we pay, 
and are not, in our view, an economic cost (though many 
accountants would disagree with us).  They are merely a way for 
us to reduce the carrying value of Scott Fetzer on our books so 
that the figure will eventually match the net worth that Scott 
Fetzer actually employs in its business.

                      Beginning     Purchase-Premium      Ending
                       Purchase         Charge to        Purchase
Year                   Premium     Berkshire Earnings    Premium
----                  ---------    ------------------    --------
                                     (In $ Millions)

1986 ................  $142.6            $ 11.6           $131.0
1987 ................   131.0               7.1            123.9
1988 ................   123.9               7.9            115.9
1989 ................   115.9               7.0            108.9
1990 ................   108.9               7.1            101.9
1991 ................   101.9               6.9             95.0
1992 ................    95.0               7.7             87.2
1993 ................    87.2              28.1             59.1
1994 ................    59.1               4.9             54.2

     Note that by the end of 1994 the premium was reduced to 
$54.2 million.  When this figure is added to Scott Fetzer's year-
end book value of $94 million, the total is $148.2 million, which 
is the current carrying value of Scott Fetzer on Berkshire's 
books.  That amount is less than half of our carrying value for 
the company when it was acquired.  Yet Scott Fetzer is now 
earning about twice what it then did.  Clearly, the intrinsic 
value of the business has consistently grown, even though we have 
just as consistently marked down its carrying value through 
purchase-premium charges that reduced Berkshire's earnings and 
net worth.

     The difference between Scott Fetzer's intrinsic value and 
its carrying value on Berkshire's books is now huge.  As I 
mentioned earlier - but am delighted to mention again - credit 
for this agreeable mismatch goes to Ralph Schey, a focused, smart 
and high-grade manager.

     The reasons for Ralph's success are not complicated.  Ben 
Graham taught me 45 years ago that in investing it is not 
necessary to do extraordinary things to get extraordinary 
results.  In later life, I have been surprised to find that this 
statement holds true in business management as well.  What a 
manager must do is handle the basics well and not get diverted.  
That's precisely Ralph's formula.  He establishes the right goals 
and never forgets what he set out to do.  On the personal side, 
Ralph is a joy to work with.  He's forthright about problems and 
is self-confident without being self-important.

     He is also experienced.  Though I don't know Ralph's age, I 
do know that, like many of our managers, he is over 65.  At 
Berkshire, we look to performance, not to the calendar.  Charlie 
and I, at 71 and 64 respectively, now keep George Foreman's 
picture on our desks.  You can make book that our scorn for a 
mandatory retirement age will grow stronger every year.


Intrinsic Value and Capital Allocation

     Understanding intrinsic value is as important for managers 
as it is for investors.  When managers are making capital 
allocation decisions - including decisions to repurchase shares - 
it's vital that they act in ways that increase per-share 
intrinsic value and avoid moves that decrease it.  This principle 
may seem obvious but we constantly see it violated.  And, when 
misallocations occur, shareholders are hurt.

     For example, in contemplating business mergers and 
acquisitions, many managers tend to focus on whether the 
transaction is immediately dilutive or anti-dilutive to earnings 
per share (or, at financial institutions, to per-share book 
value).  An emphasis of this sort carries great dangers.  Going 
back to our college-education example, imagine that a 25-year-old 
first-year MBA student is considering merging his future economic 
interests with those of a 25-year-old day laborer.  The MBA 
student, a non-earner, would find that a "share-for-share" merger 
of his equity interest in himself with that of the day laborer 
would enhance his near-term earnings (in a big way!).  But what 
could be sillier for the student than a deal of this kind?

     In corporate transactions, it's equally silly for the would-
be purchaser to focus on current earnings when the prospective 
acquiree has either different prospects, different amounts of 
non-operating assets, or a different capital structure.  At 
Berkshire, we have rejected many merger and purchase 
opportunities that would have boosted current and near-term 
earnings but that would have reduced per-share intrinsic value.  
Our approach, rather, has been to follow Wayne Gretzky's advice: 
"Go to where the puck is going to be, not to where it is."  As a 
result, our shareholders are now many billions of dollars richer 
than they would have been if we had used the standard catechism.

     The sad fact is that most major acquisitions display an 
egregious imbalance:  They are a bonanza for the shareholders of 
the acquiree; they increase the income and status of the 
acquirer's management; and they are a honey pot for the 
investment bankers and other professionals on both sides.  But, 
alas, they usually reduce the wealth of the acquirer's shareholders, 
often to a substantial extent.  That happens because the acquirer 
typically gives up more intrinsic value than it receives.  Do that 
enough, says John Medlin, the retired head of Wachovia Corp., and 
"you are running a chain letter in reverse."

     Over time, the skill with which a company's managers 
allocate capital has an enormous impact on the enterprise's 
value.  Almost by definition, a really good business generates 
far more money (at least after its early years) than it can use 
internally.  The company could, of course, distribute the money 
to shareholders by way of dividends or share repurchases.  But 
often the CEO asks a strategic planning staff, consultants or 
investment bankers whether an acquisition or two might make 
sense.  That's like asking your interior decorator whether you 
need a $50,000 rug.

     The acquisition problem is often compounded by a biological 
bias:  Many CEO's attain their positions in part because they 
possess an abundance of animal spirits and ego.  If an executive 
is heavily endowed with these qualities - which, it should be 
acknowledged, sometimes have their advantages - they won't 
disappear when he reaches the top.  When such a CEO is encouraged 
by his advisors to make deals, he responds much as would a 
teenage boy who is encouraged by his father to have a normal sex 
life.  It's not a push he needs.

     Some years back, a CEO friend of mine - in jest, it must be 
said - unintentionally described the pathology of many big deals. 
This friend, who ran a property-casualty insurer, was explaining 
to his directors why he wanted to acquire a certain life 
insurance company.  After droning rather unpersuasively through 
the economics and strategic rationale for the acquisition, he 
abruptly abandoned the script.  With an impish look, he simply 
said:  "Aw, fellas, all the other kids have one."

     At Berkshire, our managers will continue to earn 
extraordinary returns from what appear to be ordinary businesses. 
As a first step, these managers will look for ways to deploy 
their earnings advantageously in their businesses.  What's left, 
they will send to Charlie and me.  We then will try to use those 
funds in ways that build per-share intrinsic value.  Our goal 
will be to acquire either part or all of businesses that we 
believe we understand, that have good, sustainable underlying 
economics, and that are run by managers whom we like, admire and 
trust.

If you were today 20-something years old would you primarily be searching for: a) Situations reminiscent of 1957 –– akin to Daehan Flour Mills, or b) Situations reminiscent of 1987 –– akin to Moody’’s Corporation?

Either is fine. a) is better for small sums. b) is better for large sums

[Mr. Buffett, on June 23, 1999 you shared with Business Week:

If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.]

[At a talk to Columbia students in 1993 you shared:

When I got out of Columbia the first place I went to work was a five-person brokerage firm with operations in Omaha. It subscribed to Moody’s industrial manual, banks and finance manual and public utilities manual. I went through all those page by page.

I found a little company called Genesee Valley Gas near Rochester . It had 22,000 shares out. It was a public utility that was earning about $5 per share, and the nice thing about it was you could buy it at $5 per share.

I found Western Insurance in Fort Scott, Kansas. The price range in Moody’s financial manual…was $12-$20. Earnings were $16 a share. I ran an ad in the Fort Scott paper to buy that stock.

I found the Union Street Railway, in New Bedford, a bus company. At that time it was selling at about $45 and, as I remember, had $120 a share in cash and no liabilities.]

[Along similar lines, in late 2005 I understand you explained to a group of Harvard students the following:

Citicorp sent a manual on Korean stocks. Within 5 or 6 hours, twenty stocks selling at 2 or 3x earnings with strong balance sheets were identified. Korea rebuilt itself in a big way post 1998. Companies overbuilt their balance sheets –– including Daehan Flour Mill with 15,000 won/year earning power and selling at ““2 and change”” times earnings. The strategy was to buy the securities of twenty companies thereby spreading the risk that some of the companies will be run by crooks. $100 million was quickly put to work.]

[The ““1987”” Fisher Approach -The following excerpts from an article written by Carol Loomis published on April 11, 1988 in Fortune provide interesting clarity on the modus-operandi of Berkshire circa 1987:

Unusual Profitability (High ROE with Low Debt; i.e. high ROIC) – ……But in his 1987 annual report, Buffett the businessman comes out of the closet to point out just how good these enterprises and their managers are. Had the Sainted Seven operated as a single business in 1987, he says, they would have employed $175 million in equity capital, paid only a net $2 million in interest, and earned, after taxes, $100 million. That’s a return on equity of 57%, and it is exceptional. As Buffett says, ”You’ll seldom see such a percentage anywhere, let alone at large, diversified companies with nominal leverage.”

Unusual Growth (Opportunities for Reinvestment of Retained Earnings) – ……Some folks of the right sort, by the name of Heldman, read that ad and brought him their uniform business, Fechheimer, in 1986. The business had only about $6 million in profits, which is an operation smaller than Buffett thinks ideal. ……A few hundred miles away at Fechheimer (……1987 sales: $75 million)

Paying for Quality – ……By 1972, Blue Chip Stamps, a Berkshire affiliate that has since been merged into the parent, was paying three times book value to buy See’s Candies, and the good-business era was launched. ”I have been shaped tremendously by Charlie,” says Buffett. ”Boy, if I had listened only to Ben, would I ever be a lot poorer.]

What’s your opinion of cigar butts vs quality businesses?

[CM: If See’s Candy had asked $100,000 more [in the purchase price; Buffett chimed in, “$10,000 more”], Warren and I would have walked — that’s how dumb we were.]

[Ira Marshall said you guys are crazy — there are some things you should pay up for, like quality businesses and people. You are underestimating quality. We listened to the criticism and changed our mind. This is a good lesson for anyone: the ability to take criticism constructively and learn from it. If you take the indirect lessons we learned from See’s, you could say Berkshire was built on constructive criticism. Now we don’t want any more today. [Laughter]]

The qualitative [evaluating management, competitive advantage, etc.] is harder to teach and understand, so why not just focus on the quantitative [e.g., cigar butt investing]? Charlie emphasized quality [of a business] much more than I did initially. He had a different background.

It makes more sense to buy a wonderful business at a fair price. We’ve changed over the years in this direction. It’s not hard to watch businesses over 50 years and learn where the big money can be made.

Even when you get a new important idea, the old ideas are still there. There wasn’t a strong line of demarcation when we moved from cigar butts to wonderful businesses. But over time, we moved.

If you were starting out today, what would you do the same or differently?

We started out this snowball at the top of a very long hill. My advice is either start very early or live very long. I guess I’’d do it the same way: maybe I’’d start with small companies and buy good businesses. Or little pieces of ‘‘em called stocks.

[CM: The first $100,000 is probably the hardest part. Staying rational and significantly underspending your income helps, too.]

—————————————————

If we were to do it over again, we’d do it pretty much the same way. The world hasn’t changed that much. We’d read everything in sight about businesses and industries we think we’d understand. And, working with far less capital, our investment universe would be far broader than it is currently.

There’s nothing different, in my view, about analyzing securities today vs. 50 years ago.

—————————————————

We formed our first partnership 50 years and two days ago, on May 4, 1956, with $105,000. If we were starting again, Charlie would say we shouldn’t be doing this, but if we were, we’d be investing in securities around the world. Charlie would say we couldn’t find 20, but we don’t need 20 – we only need a few that can pay off very big. We’d also be buying [stocks in] smaller companies.

If we were planning to buy [entire] businesses, we’d have a tough time. We’d have no reputation and only $1 million.

Charlie started out in real-estate development because with only a little capital, brain power and energy, you could magnify the returns in real estate unlike in other sectors.

I’d just do it one foot in front of the other over time. But the basic principles wouldn’t be different. If I’d been running a little partnership three years ago, I’d have started out 100% in Korea.

Munger: You should find something to invest in and then compare everything else against that. That’s your opportunity cost. That’s what you learn in freshman economics, even if it hasn’t made it into modern portfolio theory. That’s why modern portfolio theory is so asinine.

Buffett: It really is.

Munger: When Warren said he’d put 100% of his fund in Korea, maybe he wouldn’t quite do that, but pretty much. Most people won’t find a lot of great things [to invest in]. Instead, you’ll want to find a few things that are much better than anything else. Act on these.

—————————————————-

[RE: How Buffett Would Invest with a Small Amount of Money]

If I were working with a very small sum – you all should hope this doesn’t happen – I’d be doing almost entirely different things than I do. Your universe expands – there are thousands of times as many options if you’re investing $10,000 rather than $100 billion, other than buying entire businesses. You can earn very high returns with very small amounts of money. Everyone can’t do it, but if you know what you’re doing, you can do it. We cannot earn phenomenal returns putting $3, $4 or $5 billion in a stock. It won’t work – it’s not even close.

If Charlie and I had $500,000 or $2 million to invest, we’d find little things we could do, not all of it in stocks.

Munger: But there’s no point in our thinking about that now.

—————————————————-

You have to find your passion in life. I would choose the same job. I enjoy it. It is a terrible mistake to sleepwalk through your life. Unless Shirley MacLaine is right, you won’t have another one. My dad had a business with [investment] books on his shelves, and they turned me on. This was before Playboy. If he was a minister, I’m not sure I would have been as enthused. If you have obligations, you have to deal with realities. I tell students to go work for an organization you admire or an individual you admire, which usually means that most MBAs I meet become self-employed. [laughter] I went to work for Ben Graham. I never asked my salary. Get the right spouse. Charlie talks about the man who spent twenty years looking for the perfect woman and found her. Unfortunately, she was looking for the perfect man. If you are lucky, you will be happy and as a result, you will behave better. It makes it easier.

CM: You’ll do better if you have passion for something in which you have aptitude. If Warren had gone into ballet, no one would have heard of him.

WB: Or would have heard of me very differently. [laughter]

—————————————————-

[Q – With small sums of money, what strategies would you pursue?]

WB: If I were working with small sums of money, it would open up thousands of possibilities. We have found very mispriced bonds. We found them in Korea a few years ago. You could make big returns but had to be of small size. I wouldn’t be in currencies with a small amount of money. I had a friend who used to buy tax liens. I’d look in small stocks or specialized bonds. Wouldn’t you say that, Charlie?

CM: Sure.

—————————————————-

[Q – If you were starting a $26 million fund, what would you do differently with a smaller asset base? How many positions would you hold, and what kind of turnover would you have? What would you do if some investments lost 50% and some gained?]

Buffett: We would hold the half-dozen stocks we liked best. We would do the same thing if they lost 50%. Cost has nothing to do with it. We look at price and think about what something is worth. Keep it in the few you know.

Munger: He [Buffett] has tactfully suggested you adopt a different way of thinking. [laughter]

[Comment: As Buffett stated, cost basis has nothing to do with investment judgment (apart from tax considerations). Nevertheless, many investors (like the questioner) pay way too much attention to what they’ve paid, rather than its value.]

According to a business week report published in 1999, you were quoted as saying “it’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.” First, would you say the same thing today? Second, since that statement infers that you would invest in smaller companies, other than investing in small-caps, what else would you do differently?

Yes, I would still say the same thing today. In fact, we are still earning those types of returns on some of our smaller investments. The best decade was the 1950s; I was earning 50% plus returns with small amounts of capital. I could do the same thing today with smaller amounts. It would perhaps even be easier to make that much money in today’s environment because information is easier to access.

You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map – way off the map. You may find local companies that have nothing wrong with them at all. A company that I found, Western Insurance Securities, was trading for $3/share when it was earning $20/share!! I tried to buy up as much of it as possible. No one will tell you about these businesses. You have to find them.

Other examples: Genesee Valley Gas, public utility trading at a P/E of 2, GEICO, Union Street Railway of New Bedford selling at $30 when $100/share is sitting in cash, high yield position in 2002. No one will tell you about these ideas, you have to find them.

The answer is still yes today that you can still earn extraordinary returns on smaller amounts of capital. For example, I wouldn’t have had to buy issue after issue of different high yield bonds. Having a lot of money to invest forced Berkshire to buy those that were less attractive. With less capital, I could have put all my money into the most attractive issues and really creamed it.

I know more about business and investing today, but my returns have continued to decline since the 50′s. Money gets to be an anchor on performance. At Berkshire’s size, there would be no more than 200 common stocks in the world that we could invest in if we were running a mutual fund or some other kind of investment business.

Do you believe that we’ll have significant mispricings again? And if you were 26 today how would you generate the 50% returns that you said you might do with smaller amounts of capital?

Attractive opportunities come from observing human behavior. In 1998, people behaved like frightened cavemen (referring to the Long Term Capital Management meltdown). People make their own opportunities. They will be frozen by fear, excited by greed and it doesn’t matter what their IQ, degrees etc is. Growth of 50% per year is with small capitalization, not large cap. The point is I got rich looking for stock with strong earnings.

The last 50 years weren’t unique. It’s just capitalizing on human behavior. It’s people that make opportunities when others are frozen by fear or excited by greed. Human behavior allows for success if you are able to detach yourself emotionally.

In 1951, I got out of school at 20 years old. At the time there were two publishers of stock information, Moody’s and Standards and Poor’s. I used Moody’s and went through every manual. I recently bought a copy of the 1951 Moody off of Amazon. On page 1433, there’s a stock you could have made some money on. The EPS was $29 and the Price Range was from $3-$21/share. On another page, there is a company that had an EPS of $29.5 and the price range was $27-28, 1x earnings. You can get rich finding things like this, things that aren’t written about.

A couple of years ago I got this investment guide on Korean stocks. I began looking through it. It felt like 1974 all over again. Look here at this company…Dae Han, I don’t know how you pronounce it, it’s a flour company. It earned 12,879 won previously. It currently had a book value of 200,000 won and was earning 18,000 won. It had traded as high as 43,000 and as low as 35,000 won. At the time, the current price was 40,000 or 2 times earnings. In 4 hours I had found 20 companies like this.

The point is nobody is going to tell you about these companies. There are no broker reports on Dae Han Flour Company. When you invest like this, you will make money. Sure 1 or 2 companies may turn out to be poor choices, but the others will more than make up for any losses. Not all of them will be good, but some will and those will make you rich. And this didn’t happen in 1932, this was in 2004! These opportunities will be there in the next 30 years. You’ll have streaks where you’ll find some bad companies and a few times where you’ll make money with everything that you do.

The Wall Street analysts are brilliant people; they are better at math, but we know more about human nature.

In your investing life you will have several opportunities and one or two that can’t go wrong. For example, in 1998 the NY fed offered a 30-year treasury bonds yielding less then the 29-½ year treasury bonds by 30 basis points. What happened was LTCM put a trade on at 10 basis points and it was a crowded trade, they were 100% certain to make money but they could not afford any hiccups. I know more about human nature; these were MIT grads, really smart guys, and they almost toppled the system with their highly leveraged trading.

This was definitely a good time to act.

You have often spoken of the difficulties of compounding large sums of money. But in an article I read, you were quoted as saying that you think you could compound 50% returns on small sums of money, say $1 million. Where could you find those kind of investments in today’’s market?

I was misquoted in that article. I get together with about 60 people every couple years and get their expectations of returns. Of those investors, I think there’s a half dozen who could get those kinds of returns – but they’re only going to find those returns in small places.

I stumble onto those things occasionally but I’m not looking for them. I’m looking for things that Berkshire Hathaway can do.