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good afternoon i'm patrick wolf from arlington virginia charlie i can't resist telling you that i'm actually the fellow who plays the chess games blindfolded so i look forward to not seeing you there tomorrow right i actually have a two-part question i'd like to ask you to elaborate a bit how you think about opportunity cost and i'm i think i'm going to be elaborating very much on the very last question that was asked first of all in the annual report you say explicitly that you look for 10 pre-tax return on equity in looking at common stocks and i think you talked earlier about how you built up from that for five to six percent um after tax return and then you layer on inflation and then layer on taxes my first question would be how do you adjust that required rate of return across periods of time so for example when interest rates are higher and do you look for a different equity premium return over different periods of time my second i just said that you actually would apply the same discount rate across the stocks and i'm sure you know that modern finance actually suggests that you should not do that that you should be thinking about the timing of cash flows and in particular the covariance with the general market now you've made a point of emphasizing that when you think of risk you think of risk primarily in terms of will you get the cash flows that you predict you will get over time sort of numerator risk if you think in terms of discounted cash flow which i think everyone here will have to acknowledge your results speak for themselves has probably been a very effective way of thinking about risk but there is a true economic cost to think about the timing of cash flows as well and it may be a much smaller cost but it is still a real cost i might for example suggest you think about somebody deciding between two jobs the jobs are completely identical and the person expects to make the same amount of money from each job but there's one difference and the difference is one job will pay him more when the economy is in the tank and the other job will pay him more when the economy is going gangbusters now if he asked you which job was actually worth more my guess is you would tell him that the one that would pay him more when the economy's in the tank and the reason is if he wanted to make more money by moonlighting or doing something else it'd be much easier when the economy's doing better that's the essential logic behind the idea that you look at the co-variance of when cash flows come in with the overall market it's a real cost even though it is difficult to measure and even if it is a smaller risk the numerator risk the risk of getting the actual cash flows since it's a real cost i imagine you must think about it and so my second question to you would be how do you think about it and if you decide not to why now first of all i would like to say patrick we appreciate you coming out because patrick now i don't know how many years it's been but it's been a number has volunteered on sunday to play now i think he's playing six people or so blindfolded simultaneously and after hearing that question you can understand how he does it uh but patrick as well as bob hammond and and then this year peter morris and and and and bill roberti all all come out and on sunday they have we've got these extraordinary talents out there and for people who like the various games they play they they devote an afternoon for it and ask nothing in return so i we really appreciate it patrick and and uh i'll look forward to seeing if you're peaking out of your blindfold tomorrow uh the the question on on opportunity costs and the 10 we mentioned you know basically that's that's the figure we quit on and we quit on buying we don't want to buy equities where our real expectancy is below ten percent now that's true whether short rates are six percent or whether short rates are one percent we just feel that that it would get very sloppy to start dipping below that and we would add we feel also obviously that we will get opportunities that are at least at that level and perhaps substantially above so there's just a point at which we drop out of the game and it's arbitrary there's no no scientific studies or anything but i will bet you that a lot of years in the future we we or you will be able to find equities that uh that you understand or we understand and that have a probability uh the probability of returns uh 10 or greater now once you find a group of equities in that range now and leaving aside the problem of huge sums of money which we have uh then we just buy the most attractive that usually means the ones we feel the surest about i mean is a practical matter there's just some businesses that possess economic characteristics that make their future prospects far out for far more predictable than others there's all kinds of businesses that you just can't you can't remotely predict uh what they'll learn and you just have to forget about them but when we get so we we have over time gotten very partial to the businesses where we think the predictability is high but we still want a threshold return of 10 which is not that great after tax anyway charlie do you want to comment on that portion of the that question first yeah the i think in the last analysis everything we do comes back to opportunity cost but it to some extent in fact to some considerable extent we are guessing at our future opportunity cost warren is basically saying that he's guessing that he's in due course to to put out money at pretty attractive rates of return and therefore he's not gonna waste a lot of firepower now at lower returns but that's an opportunity cost calculation and if interest rates were to more or less permanently settle at one percent or something like that and warren were to reappraise his notions of future opportunity cost he would change the numbers like kane said what do you do when you change your view of the facts or you change your conduct but so far at least we have hurdles in our mind which are basically well they they involve implicitly future opportunity cost right now with our 16 billion that's getting one and a quarter percent pre-tax that's 200 million dollars a year we could very easily buy governments uh doing in 20 years and get roughly 5 percent so we could change that 200 million a year to 800 million a year of income and we're making a decision as charlie says that it's better to take 200 million for a while on the theory that we'll find something that gives us 10 percent or better than to commit to the 800 million a year uh and then find that in a year thereabouts when the better opportunities came along that what we had committed to had a big principle loss in it but that's you know that that's not uh it's not it's not terribly scientific uh but it all i can tell you is in practice it's it it seems to work pretty well years ago when warren ran a partnership and to some extent the partnership that i ran was operated in the same way we implicitly did what you're suggesting and that part of the partnership funds were in so-called event arbitrage investments and those tended to generate returns occasionally when the market generally was in the tank and alternative investments would more mimic the general market so we were doing what this academic theory prescribes you know 40 years ago and but we didn't use the modern lingo yeah we've got some preferences for having a lot of money coming in all the time but we do go into into insurance transactions with huge volatility uh which could mean that a get a big chunk of money could go out at one time or in a very short period of time and we won't give up a lot in expectable return for smoothness but if you give us a choice of having money come in every week and the pre and the same present value of money coming in in very lumpy ways that we wouldn't know about we would choose the smooth but if you give us a choice of a higher present value for the lumpiness we will take the lumpiness and that's usually the choice that's i mean that's usually we get offered that choice and other people value smoothness so highly that we do get a spread in our view for lumpy returns we are writing and then we're going to close this up but you will read a lot or you may hear a lot maybe you've heard it already pepsi cola is having a contest they're going to have a drawing in september the contest goes through a lot of little phases but in the end there's going to be one person who's going to have one chance and a thousand of winning a billion dollars that billion dollars will have a present value of maybe 250 million if whoever gets to that position hits the number we will pay it and we don't mind paying out 250 million dollars as long as we got paid appropriately for us and that would create bad cash flow that particular week uh we're willing to maybe even for two weeks we're willing we're willing to assume that for a a payment and very very few people in the world are even those that can afford it we would even assume it for two and a half billion present value we'd want more proportionally to assume it for that but charlie and i i think would agree that we would take that on if we got paid well enough for it we wouldn't do it for 25 million but we would we will we will do things and therefore you know we get the calls on that sort of thing and that is more profitable business over time than uh bread and butter business it also can you know it can lead to having an intense interest in watching the television show when the drawing takes place making sure who draws the number two charlie you have anything to add then we'll yeah once you're talking about opportunity cost that's personal to yourself and your own situation you've departed from modern finance totally and that's what we've done we're intelligently making these guesses as best we can based on our own circumstances and our own abilities i think it's crazy to do it based on somebody else's circumstances and somebody else's abilities thanks for coming and we i hope we see you all next year
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