Friendly investment advice from Warren Buffett's buddy

Friendly investment advice from Warren Buffett's buddy

Friday, October 18, 1996

San Francisco Business Times - by Mark Calvey

IT PAYS TO BUY QUALITY: Charlie Munger, Warren Buffett's sidekick at Berkshire Hathaway Inc., shared his thoughts on investing during a recent visit to San Francisco. He tossed in a little personal advice for good measure.

His speech at the Oct. 10 Mein Indicator Lunch focused on the peculiar characteristics of Omaha-based Berkshire, of which he's vice chairman.

Munger is widely credited for expanding Buffett's investment horizons to include fully valued companies that have superior franchises, management teams or other characteristics that foster growth year in and year out. Munger persuaded Buffett to embark on the new investment strategy with the 1972 acquisition of South San Francisco's See's Candies for $25 million -- a tiny fraction of what it's worth today.

"See's candy company was the first high-quality business we ever bought," he observed. See's also demonstrated to Berkshire the value of building a "seamless web of trust" between a company and its customers and suppliers, he said in making the point that doing the right thing can pay big dividends both personally and professionally.

Berkshire has a lot of patience in waiting for the right investment opportunities to come along, and similar patience and selectivity can be useful in one's personal life as well, Munger said.

"When you have doubts about a person, you can pass," he said. "There's enough nice people to interface with."

Other observations Munger shared:

• Strategic plans prompt people to do something when sometimes the best course of action is no action.

"Strategic plans cause more dumb decisions than anything else in America."

• Berkshire's mistakes tended to be "great losses of omission.

"If we had invested in McDonald's in its infancy ..." he ruminated. Berkshire recently acquired a significant stake in the nation's largest restaurant chain.

• Know your limits.

"A money manager with an IQ of 160 and thinks it's 180 will kill you," he said. "Going with a money manager with an IQ of 130 who thinks its 125 could serve you well."

• Berkshire buys so many simple things.

"How smart do you have to be to own Coca-Cola?" he asked of the company that has built a worldwide empire on brown sugar water and astute marketing. "Why doesn't Coca-Cola get through to other people?"

LIKE BEES TO HONEY: Where there's wealth, bankers will soon follow.

This is evident in the number of banks and financial firms rushing into California to ride the wave of wealth creation.

Fortunes are being made in high tech, entertainment and trade to name just a few of the sectors contributing to the state's robust economy.

One indication of how much wealth resides in the state can be found on the recently released 1996 Forbes 400 list of the wealthiest.

Almost a fourth of those making the list are Californians. New York is a distant second with 58 residents; Texas, 35; and Florida, 25.

California also far outpaces the rest of the nation in the number of fastest-growing companies, according to the annual list compiled by Inc. magazine.

"We're providing the right environment for risk taking," said C. William Criss Jr., western regional manager for the Chase Manhattan Private Bank in San Francisco.

"This has always been a place with no boundaries," Criss said. "You just need to have a pretty good idea."

INVESTMENT BANK BOOSTS RESEARCH: David Francis has moved to Punk, Ziegel & Knoell's San Francisco office as vice president and analyst covering health care information systems. He had been working in the same area focusing on corporate finance at the specialty investment bank's New York headquarters.

Francis will expand the firm's coverage to include other sectors tied to health care information systems, such as health-care data products and services, managed care systems and other outsourcing and business services.

"Because of the entrepreneurial spirit and concentration of venture capitalists, there's a number of emerging companies in the health care information systems area in the Bay Area," Francis said in explaining his relocation to San Francisco.

Punk Ziegel's San Francisco staff has grown from four bankers and staff to eight in the last six months.

BANK BUILDS CAPITAL PRESENCE: San Francisco-based Pacific Bank has opened a loan production office in Sacramento's financial district.

The bank plans to use the new office to expand its presence in trade financing.

Pacific Bank anticipates it will serve trade clients not only in Northern California, but in the Pacific Northwest, Idaho and Nevada as well.

Veteran Sacramento banker Jerry Avila, 51, has been appointed senior vice president and manager of the Sacramento office.

ACQUISITION EXPANDS SERVICES: The credit scoring company Fair, Isaac & Co. of San Rafael expanded its credit management consulting services with the purchase of Credit & Risk Management Associates Inc. for $3 million.

The six-year-old Baltimore company, which employs 20, counts some of the nation's largest creditors among its clients.

Credit & Risk will operate as an independent subsidiary, advising clients and will continue recommending products and services from Fair Isaac and other vendors.

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The World According to "Poor Charlie"

December 2005

Charlie Munger has been Warren Buffett's partner and alter ego for more than 45 years. The pair has produced one of the best investing records in history. Shares of Berkshire Hathaway, of which Munger is vice chairman, have gained an annualized 24% over the past 40 years. The conglomerate, which the stock market values at $130 billion, owns and operates more than 65 businesses and invests in many others. Buffett's annual reports are studied by money managers. But Munger, 81, has always been media shy. That changed when Peter Kaufman compiled Munger's writing and speeches in a new book, Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger ($49.00, PCA Publications). Here Munger speaks with Kiplinger's Steven Goldberg.

Why has Berkshire done so well?

Just remember that we had a long run and an early start, particularly in Warren's case. It's much easier for me to talk about Warren than myself, so let's talk about Warren. Not only did he have a long run from an early start, but he got very smart very young -- then continuously improved over 50 years.

Buffett was a student of Ben Graham, the father of security analysis. He was buying deep value stocks -- "cigar butts" -- until you got involved.

If I'd never lived, Warren would have morphed into liking the better businesses better and being less interested in deep-value cigar butts. The supply of cigar butts was running out. And the tax code gives you an enormous advantage if you can find some things you can just sit with.

There are a whole lot of reasons, and Warren was a natural for always just getting smarter. The natural drift was going that way without Charlie Munger. But he'd been brainwashed a little by worshiping Ben Graham and making so much money following traditional Graham methods that I may have pushed him along a little faster in the direction that he was already going.

How do you work together?

Well, it's mostly the telephone and as the years have gone on, and I've passed 80 and Warren is 75, there's less contact on the phone. Warren is a lot busier now than he was when he was younger. Warren has an enormous amount of contact with the operating businesses compared to what he had early in his career. And, again, he does almost all of that by phone, although he does fly around some.

What are your work styles like?

We have certain things in common. We both hate to have too many forward commitments in our schedules. We both insist on a lot of time being available almost every day to just sit and think. That is very uncommon in American business. We read and think. So Warren and I do more reading and thinking and less doing than most people in business. We do that because we like that kind of a life. But we've turned that quirk into a positive outcome for ourselves.

How much of your success is from investing and how much from managing businesses?

Understanding how to be a good investor makes you a better business manager and vice versa.

Warren's way of managing businesses does not take a lot of time. I would bet that something like half of our business operations have never had the foot of Warren Buffet in them. It's not a very burdensome type of business management.

The business management record of Warren is pretty damn good, and I think it's frequently underestimated. He is a better business executive for spending no time engaged in micromanagement.

Your book takes a very multi-disciplinary approach. Why?

It's very useful to have a good grasp of all the big ideas in hard and soft science. A, it gives perspective. B, it gives a way for you to organize and file away experience in your head, so to speak.

How important is temperament in investing?

A lot of people with high IQs are terrible investors because they've got terrible temperaments. And that is why we say that having a certain kind of temperament is more important than brains. You need to keep raw irrational emotion under control. You need patience and discipline and an ability to take losses and adversity without going crazy. You need an ability to not be driven crazy by extreme success.

How should most individual investors invest?

Our standard prescription for the know-nothing investor with a long-term time horizon is a no-load index fund. I think that works better than relying on your stock broker. The people who are telling you to do something else are all being paid by commissions or fees. The result is that while index fund investing is becoming more and more popular, by and large it's not the individual investors that are doing it. It's the institutions.

What about people who want to pick stocks? 

You're back to basic Ben Graham, with a few modifications. You really have to know a lot about business. You have to know a lot about competitive advantage. You have to know a lot about the maintainability of competitive advantage. You have to have a mind that quantifies things in terms of value. And you have to be able to compare those values with other values available in the stock market. So you're talking about a pretty complex body of knowledge.

What do you think of the efficient market theory, which holds that at any one time all knowledge by everyone about a stock is reflected in the price?

I think it is roughly right that the market is efficient, which makes it very hard to beat merely by being an intelligent investor. But I don't think it's totally efficient at all. And the difference between being totally efficient and somewhat efficient leaves an enormous opportunity for people like us to get these unusual records. It's efficient enough, so it's hard to have a great investment record. But it's by no means impossible. Nor is it something that only a very few people can do. The top three or four percent of the investment management world will do fine.

What would a good investor's portfolio look like? Would it look like the average mutual fund with 2% positions?

Not if they were doing it Munger style. The Berkshire-style investors tend to be less diversified than other people. The academics have done a terrible disservice to intelligent investors by glorifying the idea of diversification. Because I just think the whole concept is literally almost insane. It emphasizes feeling good about not having your investment results depart very much from average investment results. But why would you get on the bandwagon like that if somebody didn't make you with a whip and a gun?

Is finding bargains difficult in today's market?

We wouldn't have $45 billion lying around if you could always find things to do in any volume you wanted. Being rational in the investment world at a time when other people are losing their minds -- usually all it does is keep you out of something that causes a lot of trouble for other people. If you stayed away from the mania in the high-tech stocks at its peak, you were saved from disaster later, but you didn't make any money.

Should people be investing more abroad, particularly in emerging markets?

Different foreign cultures have very different friendliness to the passive shareholder from abroad. Some would be as reliable as the United States to invest in, and others would be way less reliable. Because it's hard to quantify which ones are reliable and why, most people don't think about it at all. That's crazy. It's a very important subject. Assuming China grows like crazy, how much of the proceeds of that growth are going to flow through to the passive foreign owners of Chinese stock? That is a very intelligent question that practically nobody asks.

What do you think of the U.S. trade and budget deficits -- and their impact on the dollar, which Berkshire is still betting against?

It's not at all clear exactly from some objective bunch of economic data just where the dollar ought to trade compared to the Euro. Who in the hell knows? It's clear that you can't run twin deficits on the scale that the U.S. has forever. As [economist] Herb Stein said, "If something can't go on forever, it will eventually stop." But knowing just when it's going to stop is a very difficult matter.

Is there a bubble in the real estate?

When I see people going to some old flea-bitten old condo and the list price is $1.8 million, and they decide to put it on the market for $2.2 million, and five people start bidding for it, and they sell it for $2.7 million, I say that's a bubble. So there are some bubbly places in the economy. I am amazed at the price of real estate in Manhattan.

So there is some bubble in the game. Is it going to go back to really cheap houses in good neighborhoods in good cities? I don't think so. So I think there will be huge collapses in some places, but, on average, I think that good houses in good places are going to be plenty expensive in future years.

Is there a bubble in energy stocks?

When it gets into these spikes, with shortages and uproar and so forth, people go bananas, but that's capitalism. If the price of automobiles were going up 40% a year, you'd have a boom in auto stocks. But if you stop to think about it, of the companies that you could have bought in, say, 1911, to hold for a long time, one of the very best stocks would have been Rockefeller's Standard Oil Trust. It became almost all of today's integrated oil companies.

How do you feel most corporate citizens behave in the U.S.?

Well, I disapprove of the way most executive compensation is arranged in America. I think it goes to gross excess. And I certainly don't like phony accounting that takes part of the real cost of running the business and doesn't run it through the income account as a charge against the reported earnings. I don't like dishonorable, lying accounting.

Do you think the stock market will return its long-term annualized 10% in the next decade?

A good figure for rational expectation would be no higher than 6%. I think it's unreasonable to assume that the world is going to try to arrange itself so that the inactive, asset-owning class is going to get a much higher share of the GDP than it normally gets. When you start thinking that way, you get into these modest figures. The reason the return has been so good in the past is that the price-earnings ratio went way up.

Ibbotson finds 10% average returns back to 1926, and Jeremy Siegel has found roughly the same back to 1802.

Jeremy Siegel's numbers are total balderdash. When you go back that long ago, you've got a different bunch of companies. You've got a bunch of railroads. It's a different world. I think it's like extrapolating human development by looking at the evolution of life from the worm on up. He's a nut case. There wasn't enough common stock investment for the ordinary person in 1880 to put in your eye.

What do you see for bonds?

The bond market has fewer opportunities now. The short-term rates are the same as the long-term rates, and the premium interest rate you get for taking risk is lower than it ought to be, given the risk. By definition, that's a world in which bond investment is much tougher to do with great advantage.

What do you expect in terms of returns for Berkshire Hathaway?

We have solemnly promised our shareholders that our future returns will be considerably below our previous returns.

But annual reports have been saying that year after year after year.

But lately we've been better at doing what we have long predicted.

What happens to Berkshire after the two of you?

Well, the world will go on and, in my opinion, Berkshire will still be a strong, rich place and with a central culture that will be shrewd and risk-averse. But do I think that we will get another person better than Warren to come in and replace Warren? I think the odds are against it.

http://www.kiplinger.com/features/archives/2005/11/munger.html

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When CEOs Have Warren Buffett in Their Boardroom

What's it like to have America's greatest investor as your shareholder? Buffett's biographer talks to CEOs who know

By Alice Schroeder

Who wouldn't love to pick up the phone and ask Warren Buffett for advice? People have spent more than $1 million just to have lunch with the man. He was voted the most admired corporate director in America by Directorship magazine in 2008. Chief executives of companies he has a stake in laud his patience, foresight, and ability to capture the essence of a complex financial situation in just a few words. They also like the fact that he usually leaves them alone as long as they're getting the job done.

Sometimes Buffett emerges from behind his desk and shows a side of himself that's far less familiar. When he sees something he doesn't like in a company whose shares he owns, the famously passive investor can swing into action to protect his investment—jawboning behind the scenes, scolding, cutting opportunistic deals, even hiring and firing CEOs. For some of those on the receiving end of his activism, it can feel a bit like being attacked by Santa Claus.

Buffett's virtues and philosophy are well known, and at 79, his ability to spread them throughout the business world has never been greater. In mid-February, his holding company, Berkshire Hathaway, (BRK.A) was listed for the first time on the Standard & Poor's 500-stock index, and the stock price and volume jumped as investors rushed in. His annual letter to shareholders, to be released on Feb. 27, is always one of the most parsed memos of the year. Berkshire's purchase of Burlington Northern (BNI) in November 2009—a self-described all-in bet on America—and its $5 billion stake in Goldman Sachs (GS) make Buffett a major stakeholder in the global economic recovery, with tentacles that span from coal to collateralized debt obligations. And his now infamous dressing down of Kraft (KFT) CEO Irene Rosenfeld over Kraft's purchase of Cadbury (CBY) proved that behind that Cherry Coke smile, there's still plenty of bite.

In speaking with CEOS for this story, and in writing the 2008 biography The Snowball with Buffett's cooperation, I learned a great deal about the way he manages the people he counts on to make money for him and his shareholders. He is, in many cases, just as genial and supportive as his persona would lead you to believe. "First my mother and then I have been able to call and ask his advice on matters affecting the company, large and small," says Donald E. Graham, CEO of Washington Post Co (WPO). "His advice has been worth billions to our not-so-large company."

During the credit crunch of March 2008, American Express (AXP) CEO Kenneth I. Chenault had to ask for help from Buffett at a moment when Berkshire's stake in American Express had lost $8 billion because of credit losses and concerns the company could not borrow to fund its operations. One might think Chenault had reason to fear the call. Instead, he knew Buffett, whose company owns 13% of American Express, would be his "confidence booster." Even in the highly charged atmosphere of a financial meltdown, his style is unwavering—"objective, direct, and he knows what he believes," Chenault says. The CEO felt fortunate that Buffett was indifferent to the market pressure on American Express.

At the time, Chenault faced intense pressure to cut the company's payout to investors, as his peers had done. Buffett "understood the reputational reasons why American Express should not cut the dividend," he says, and backed the decision to maintain it. Since the crisis, Berkshire's investment has recovered $4 billion of its value.

When other CEO friends got into trouble during the downturn, Buffett offered them more than advice. William C. Foote, head of wallboard and gypsum product maker USG (USG), first met the investor before Berkshire backstopped a USG stock offering in 2006, buying a 17% stake in the company. Foote tried to impress his new shareholder by reciting housing statistics from the 1960s to the 1980s—and was shocked when Buffett immediately responded with data from the 1940s and 1950s.

Although USG was struggling through bankruptcy, Buffett treated Foote with the benevolent neglect he generally displays toward managers whose companies are cruising. Foote would call occasionally and traveled to Omaha two or three times a year, spending a couple of hours chatting in Buffett's office before eating a steak at one of his favorite restaurants. He "doesn't offer suggestions as much as answer questions and provide perspective," Foote said.

The USG chief found the advice valuable and enjoyed the feeling that Buffett had enough confidence in him not to meddle. Then the housing market imploded and demand for wallboard collapsed. Buffett leaped into the fray in a way that benefited both Berkshire and USG. Berkshire took $300 million of a $400 million issuance of 10% notes convertible until 2018 at Berkshire's discretion into stock at $11.40 per share. (USG was trading at around $5.66 before the deal and is now at about $13.40, meaning the conversion feature is in the money). The equity sweetener effectively raised the cost of the notes, while limiting the impact on USG's income statement to its $30 million annual cash interest tithe to Berkshire, helpful at a time when USG is losing hundreds of millions of dollars a year.

When Buffett is unhappy with a CEO, you can tell mostly from what he doesn't say. "He criticizes by omission and faint praise," says former Wells Fargo (WFC) Chairman Richard M. "Dick" Kovacevich, a longtime friend and world-class manager whom Buffett has compared to Wal-Mart (WMT) founder Sam Walton. "If you are a close observer of him, it's not hard to figure out."

To be publicly criticized by Buffett, even subtly, might send a shiver through any executive who does business with him. It happened to Irene Rosenfeld on Jan. 21, after Kraft agreed to buy the iconic British candy company Cadbury for $13.17 a share. Berkshire is Kraft's biggest shareholder, with a 9.4% stake. Buffett had opposed an earlier version of the deal but said if Kraft put up more cash in a revised deal that didn't "destroy value," he would approve.

Kraft's share price rose because the remarks seemed to indicate that a modestly higher bid could meet his terms as long as it contained less stock. When Rosenfeld carried out a version of the plan, agreeing to pay $7.74 in cash and offer 0.1874 new Kraft shares for each share of Cadbury, investors assumed the two had worked out a deal. On the day it was announced, William Ackman of hedge fund Pershing Square Capital Management appeared on CNBC and predicted the investor would support it.

Instead, minutes later, Buffett turned up on CNBC and called Rosenfeld's agreement with Cadbury a "bad deal" for Kraft shareholders and a "big mistake." His televised griping stunned observers because it was so uncharacteristic. "You would think he would have been happy—she did what he wanted," says a major shareholder who asked not to be named because he values his relationship with both CEOs. "He reversed himself."

Buffett made it clear he thought the revised bid "destroys value." He seemed especially irate that Kraft had sold its profitable frozen pizza business to Nestlé (NSRGY) to raise cash for the Cadbury acquisition (and take its rival out of the bidding for the confectioner). He described the sale price of the pizza business as a cheap nine times earnings (a good deal for a unit that reported significant margin and sales growth during the recession). To avoid a $1 billion tax bill, he argued that Rosenfeld should have spun the unit off tax-free instead. Buffett also seemed to covet the business himself, saying, "I wish I would have bought the pizza business at nine times pretax earnings."

Kraft Senior Vice-President Perry Yeatman says the company respects Buffett and expects him to see the wisdom of the deal someday. Other defenders of Rosenfeld say Buffett's TV appearance was mainly to distance himself from the deal because he didn't get his way. Asked twice by CNBC whether he would sell his Kraft stock, he ducked the question.

Buffett, who did not respond to questions for this article, denied there is a personal rift between him and Rosenfeld; he told CNBC that he likes Rosenfeld, considers her straightforward, and would even have her as a trustee of his will. James M. Kilts, who ran Kraft when it was part of Philip Morris and was CEO of Nabisco before serving as chief of Gillette from 2001 to 2005, is a longtime friend of both. Kilts had no comment on the supposed rift but noted that with Buffett, "It's always business. It's never personal." Buffett's own summation, too, was financial, and he expressed his disappointment in the simplest terms. "I feel poorer," he said.

A FRIEND IN NEED

Buffett's vocal treatment of Kraft is poles apart from his handling of most companies in which Berkshire invests. Usually he is warm, helpful, and waits to be asked for his opinion. Despite receiving $600 million from the Troubled Asset Relief Program, M&T Bank (MTB), another Berkshire investment, remained relatively stable during the credit crisis. Instead of leaning heavily on Buffett, CEO Robert G. Wilmers spent much of his time the past two years sitting in Buffalo and scooping up other distressed banks. Buffett has always had kind things to say about M&T, partly because Wilmers makes sound acquisitions. He mostly talks with Buffett on the phone. "Eighty or 90% of the time it's on my nickel," he says. He thinks of the investor as a "priceless" sounding board who gives superb advice. In one memorable instance, Wilmers turned to him while being pressured by regulators and investment bankers to participate in the first Chrysler bailout in 1979. Buffett's pithy advice: "Those who won't fill your pocket will fill your ears."

This is how Buffett has typically viewed investment bankers: as useless, self-serving windbags, which is why he doesn't waste time befriending them. His one early effort to profit from investing in Wall Street came to tears when he put $700 million of Berkshire's money into Salomon Brothers in 1987. Buffett was a passive board member until he had to personally rescue Salomon after one of its traders defrauded the government in treasury bond auctions and the firm nearly failed. Then he waged a bitter fight over severance with ousted Salomon boss John Gutfreund. Managing an investment bank that was teetering on the brink of bankruptcy for nine months was a miserable experience. Buffett later said an important lesson from Salomon was that he had mistakenly trusted the bank's management.

Given that history, investors were shocked when Buffett poured $5 billion of Berkshire's money into Goldman during the depths of the financial crisis. Goldman is the one firm that Buffett has traded with throughout his career, ever since Goldman banker Byron Trott, who has since left the firm, won his trust around 2002 by finding companies for Berkshire to buy.

As a 10-year-old in 1940, Buffett once told me, he met Goldman senior partner Sidney J. Weinberg during a tour of the New York Stock Exchange (NYX). ("What stock do you like, Warren?" Weinberg asked him.) Until the financial crisis, though, Buffett had never shaken hands with Goldman CEO Lloyd C. Blankfein. Days after the collapse of Lehman Brothers, when it appeared that all major U.S. banks could fail, it was Trott who approached the investor on Goldman's behalf with a deal richer than that offered by any other company. Berkshire paid $5 billion for 10% perpetual preferred shares of Goldman with attached warrants at $115 at a time when the stock was trading at $125 per share, meaning the warrants were already "in the money." If Berkshire had exercised them immediately, it would have netted $10 per share. Buffett's reputation helped Goldman raise another $5 billion of capital, twice as much as it originally sought.

A few days after, Buffett and Blankfein met for the first time and shared a jovial moment at a conference. Buffett later took steps to protect his investment, first by using his personal capital as America's most trusted investor to publicly defend the federal bailout of Wall Street, then—after Goldman fueled public anger by setting aside billions for employee bonuses—by teaming with its management to put up $500 million to assist small businesses.

Buffett, an outspoken critic of CEO greed, pays himself $100,000 a year. He has nearly all the managers of Berkshire's wholly owned businesses set their own pay, and in light of his tiny compensation, they usually err on the low side, too. When it comes to the companies in which Berkshire invests, though, he takes a broader view. Wells Fargo's Kovacevich reaped tens of million from stock options but opposed reporting them as company expenses. Buffett was a vocal advocate of expensing them, but that didn't hurt their relationship in the least.

On the same day that Buffett pummeled Rosenfeld on CNBC, he praised Blankfein to Bloomberg News. "I don't think anybody could have done a better job at Goldman Sachs than Lloyd Blankfein," he said. "I give him enormous credit for how he's run Goldman. You've got to expect vilification of banks." Rosenfeld made Buffett feel poorer. Blankfein is making him noticeably richer.

THE ULTIMATE COMPLIMENT

Buffett is fascinated with executives who display unusual mastery at operating a profitable business. He appreciates the nuances of the craft the way an art patron enjoys watching a sculptor at work. Wells Fargo's Kovacevich is one of his favorite CEO artisans, yet Kovacevich calls Buffett "more hands-off than any investor." He says the two have had, at most, 20 conversations in 10 years, even though the bank is one of Berkshire's most important investments. Kovacevich was CEO of Norwest bank when it acquired Wells Fargo in 1998, and at the time Buffett insisted that Kovacevich not tell him anything that would make him an insider, because that would preclude Berkshire from buying or selling the stock.

When Buffett met Jim Kilts in 2001, he told Fortune that Kilts—who had turned around Nabisco—"made as much sense in terms of talking about business in general as anybody I've ever talked to." Kilts came out of retirement that year to rescue Gillette, doing so partly because he wanted to work with Buffett, since Berkshire owned 9% of the company. The Omaha investor's fondness for him grew rapidly as Gillette's performance rebounded.

At the time, Gillette was suffering from the multibillion-dollar blunder of overpaying for battery maker Duracell. It had also promised investors unrealistic 15% to 20% annual earnings growth, and was channel-stuffing product to its distributors to meet projections. To Buffett's applause, Kilts dropped the practice of issuing earnings guidance entirely. He cut thousands of jobs, closed plants, paid off debt, and shifted resources into new products and advertising.

Even so, Kilts says he tried not to bother Buffett. "It would be so easy to misuse the fact that he was available," Kilts says, "because he would be obligated to talk to me if I picked up the phone." Buffett, he says, was a quiescent board member, but when he did speak "he had such power and weight and clarity that it was memorable." At one board meeting, Kilts proposed increasing directors' pay. Two other directors spoke passionately against the move. Buffett quickly shut down the discussion while saving face for the dissenters by saying, "Well, I'll just take your increase, then."

After the Gillette turnaround, Buffett paid what Kilts considered the ultimate compliment by withdrawing entirely; he resigned from the board. "If you've got the right person running the business," he said at the time, "you don't need me."

WHEN WARREN STANDS BACK

Few companies need Buffett more than Moody's (MCO), the troubled credit-rating agency. Moody's and its peers have been blamed as enablers of the financial crisis because they inflated the credit ratings of dubious mortgage-backed securities. In March 2009, Berkshire owned more than 20% of Moody's. Why, several former ratings analysts ask, didn't the investor light a fire under the board to tighten the company's standards, or speak out? Surely he was as obliged to denounce flawed ratings that endangered the global financial system as he was to offer an opinion of how much Kraft paid for Cadbury.

A former Moody's employee with intimate knowledge of the executive suite there describes Buffett as "not a very engaged investor." (Like most Moody's sources, he asked not to be identified in light of ongoing investigations into the company.) Another insider confirms that senior management of Moody's, including CEO Raymond W. McDaniel Jr., "doesn't have regular conversations with" Buffett nor does it "seek advice from him on corporate governance or business strategy." Moody's declined to comment.

Moody's and Buffett had reason to keep their distance; it's a conflict of interest for the agency to rate a major investor such as Berkshire. Analysts who review a company are supposed to be free of thoughts of what a downgrade might mean to their personal net worth. Moody's discloses the Berkshire conflict in a Securities & Exchange Commission filing.

Even so, one former Moody's analyst describes e-mailing Buffett in 2007 to warn that rating securitized products was a ticking time bomb, and to ask whether he wanted more information. His e-mailed response, says this analyst, said he was a passive investor with a hands-off approach to Moody's. Buffett didn't respond to requests for comment about the e-mail.

It is impossible to quantify the cost of Buffett's disengagement from the rating agency under these unusual circumstances. Moody's stock has since declined more than 50% and investors in asset-backed securities have lost billions. The agency downgraded Berkshire's top AAA rating by one notch in April 2009; Buffett began to sell in July 2009 and has since disposed of about one-third of Berkshire's holdings.

FORCING AN OUSTER

If Moody's is an illustration of what it means to have Buffett's money but not his engagement, Coca-Cola (KO) is a portrait of the investor exploring virtually every kind of relationship with management. For years, Buffett admired Coca-Cola's revered CEO, Roberto Goizueta, and never meddled; Goizueta did not want advice. When the beverage giant began to falter after Goizueta's unexpected death from cancer in 1997, Buffett helped force the early departure in 1998 of Goizueta's successor, M. Douglas Ivester. That year, Coca-Cola stock was at a peak and Berkshire's stake was worth $17 billion. For the next few years, the company meandered further off course, and as it did, Buffett became increasingly involved in trying to set things right. In 2000, Ivester's successor, Douglas N. Daft, proposed buying Quaker Oats for its Gatorade brand. Buffett quashed the idea at a special board meeting, using a trademark one-liner: "We would have given up 2 billion cases a year of Coca-Cola to get something like 400 million cases a year of Gatorade." PepsiCo (PEP) subsequently bought Quaker Oats in a deal that is widely regarded as successful, and the wisdom of Coca-Cola in passing up the opportunity has been debated far and wide. What is not debated is Buffett's influence.

Buffett became deeply disturbed by Coca-Cola's chaotic culture and poor earnings, but few people knew how upset he was because he said little in public. Daft retired in February 2003, citing health reasons. Buffett became directly involved in the CEO search. He tried to charm Kilts into taking the job. When Kilts said no, he tried to recruit former General Electric (GE) CEO Jack Welch. Eventually, Buffett signed off on bringing former Coca-Cola executive E. Neville Isdell out of retirement to stabilize the company. When Isdell retired, he was succeeded by Muhtar Kent, who has offset declines in domestic sales with growth in emerging markets. As Coke's fortunes improved, Buffett's relationship with its CEOs grew more cordial. He withdrew from his activist role, resigning from the board in 2006. Berkshire still owns 200 million shares and 8.6% of Coca-Cola, a stake now worth $11 billion.

BETTING ON A "CHOO-CHOO"

In April 2008, Buffett took a hamburger- and jellybean-fueled trip on a vintage railcar from Kansas City, Mo., to Chicago with Matthew K. Rose, CEO of Burlington Northern Santa Fe (BNI). They used the 430-mile journey to talk over Rose's plans to move the railroad's recent turnaround into high gear. Rose showed his guest Burlington's Chicago intermodal freight yard, which handles containers that move among ships, trains, and trucks without being unloaded. Buffett eventually increased Berkshire's ownership of Burlington to 22%.

In 2009, Rose agreed to sell the rest of the railroad to Berkshire for $26 billion, giving Buffett what he calls his "choo-choo." Buffett described this as an "all-in wager on the economic future of the U.S." He's betting that rail traffic will grow, and imports from Asia will continue to dominate as the economy mends. Burlington is the nation's biggest coal hauler—coal transport represents more than a fifth of its revenues—so he's assuming the world will keep using coal even if the U.S. switches to cleaner energy sources. Lastly, Burlington could be a big winner if railroad rights-of-way become power corridors to conduct energy from wind farms.

Buffett always likes a sweetener, and Burlington gives him one in the form of information. He learns about wallboard demand from USG and consumer-credit trends from American Express, but Rose has called the railroad a kaleidoscope of the economy. Rail traffic patterns are a window on commodity, wholesale, consumer, and international trade flows. Buffett is adding this kaleidoscope to what his other CEOs tell him about the "reset of the consumer" to a lower level of spending. They feed him data from Berkshire's portfolio of companies—sales of building materials, jewelry, furniture, real estate, credit, fractional jets, vacuum cleaners, fabricated steel, newspaper ad lineage, and other products and services. He may now command as much information about the state of the U.S. economy as anyone, including the Federal Reserve—and probably gets his faster.

This should go a long way toward maintaining Rose's relationship with his new boss. What else can he expect now that he works for Buffett? He can call whenever he wants and get the best advice in corporate America, and Buffett will put on events to boost his employees' morale. In return, Rose, who declined comment, needs to make money for Buffett. If he does, he will be celebrated at Berkshire's annual meeting in Omaha—where Buffett sells all of his products to the 35,000 investors who come for the show—and cheered in Berkshire's shareholder letter, Buffett's annual report card on his managers, in which he praises loudly or faintly, or punishes with silence.

There is only one way for a company that's wholly owned by Berkshire to make money for Buffett—by earning it. Berkshire can't offer high-priced deals like USG's and Goldman's to its own businesses when something goes wrong because the proceeds would come straight out of its vault. So Rose's No. 1 job is to keep Burlington out of trouble.

Buffett is betting that Rose can do it. He bought Burlington partly out of confidence in the executive. If all goes right, their dealings will be long, friendly, and mutually profitable. As former Gillette CEO Kilts says, "We had a warm, close, personal relationship, but at the end of the day, I knew it was business."

http://www.businessweek.com/print/magazine/content/10_10/b4169030631058.htm