Why Honesty Matters to Warren Buffett
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
How Berkshire Hathaway Got Bigger by Getting Better (Part Nine)
Moving right along in our study of Warren Buffett, we enter the ninth article in a journey to learn how he strived to become better and grew the company bigger. His “Owner’s Manual” for Berkshire Hathaway (NYSE: BRK-B) shareholders is an exceptional case study in discovering how to view your own portfolio and the companies within it. I’ve been looking at each principle laid out in the owner’s manual from the perspective found in a story inspired by Chick-fil-A founder Truett Cathy. If you haven’t heard the story yet, back in the 1980’s when a Boston Chicken (now Boston Market) had just finished raising capital to expand, the management at Chick-fil-A spent a long time discussing how they too could get bigger in order to fend off this threat. After hearing enough talk about getting bigger, Cathy pounded the table and said, “I am sick and tired of listening to you talk about how we can get bigger. If we get better, our customers will demand we get bigger.” In this ninth part of this series, we’ll ruminate on the concept of honest reporting and why it should matter to investors.
Principle #12:
“We will be candid in our reporting to you, emphasizing the pluses and minuses important in appraising business value. Our guideline is to tell you the business facts that we would want to know if our positions were reversed. We owe you no less. Moreover, as a company with a major communications business, it would be inexcusable for us to apply lesser standards of accuracy, balance and incisiveness when reporting on ourselves than we would expect our news people to apply when reporting on others. We also believe candor benefits us as managers: The CEO who misleads others in public may eventually mislead himself in private.”
It’s human nature to want to paint the truth in the most favorable light. Who wants to admit that a mistake was made or that things are not as good as we want them to be? There is a fine line, however, between making excuses and being misleading. Benjamin Franklin said it well when he said, “one who is good at making excuses is good for little else.” On the other hand, those who mislead end up costing investors and the company a lot of money.
It is not uncommon to hear a company couch an earnings miss with something beyond their control. In retail industries, weather is often blamed for a soft quarter. In management parlance when a company reports lower sales due to the impact of weather they really are saying, “yeah, we missed the quarter but did you see that storm? Everyone was too busy watching the weather channel to buy our products.” While I’m not making light of the fact that the weather does impact sales, sometimes managements use that excuse to mask a deeper issue.
They key, though, is in determining whether weather is truly to blame. While this article about Berkshire holding Costco (NASDAQ: COST) would seem to indicate that management uses weather as an excuse, I’m not so sure. The author points out that in four consecutive reports Costco blamed weather for impacting comparable results by at least a half a basis point. Knowing whether management is just making an excuse or being completely honest isn’t easy. Berkshire owns a 1% stake in Costco, in part due to their respect for management in how well they run the company while focusing on providing better value to their customers. In the case of Costco, I think you can give the company a pass when they use the weather excuse, but how do you know when an excuse is masking something bigger?
Truth is you don’t. Most companies try to deny any painful revelations in hopes that they can fix the problem before they have to report it to shareholders. To a degree, we saw this in Microsoft’s (NASDAQ: MSFT) recent write down of their previously acquired aQuantive business. They acquired the company in 2007, paying an 85% premium to shareholders (thanks Mr. Softy!) for a deal valued at $6.3 billion in an attempt to compete with Google (NASDAQ: GOOG) in online advertising. Five years later they are writing down $5.3 billion of that acquisition and they are finally admitting it wasn’t a great idea, as future growth and profitability are lower than their previous estimates. What I think is obvious to most investors is that the division didn’t lose 85% of its value over night; the company just waited to state the obvious for as long as they could. In the case of Microsoft, this write down wasn’t a real surprise as it has been telegraphed for a long time and disclosed prior to their latest earnings release. It didn’t truly affect the value of the company, as I think most investors realized soon enough that the $6.3 billion spent on the acquisition wasn’t going to help them beat Google at their own game. Still, it is a write down that should have happened a long time ago.
Other times potentially damaging news is hidden within the company, and there is nothing you can do about it. Take the JP Morgan (NYSE: JPM) “London Whale” debacle. When rumors of losses started to surface, we were assured that they’d only be around $2 billion but they’ve recently tripled to $5.8 billion, and that might not be the end of it. We started hearing about the London Whale trade long before it backfired but were told that the trade was a hedge and not a bet. Worse yet, it’s believed that these trades were covered up by traders. That begs the question, who knew and when did they know?
So, the real question, how do you know if your management team is being completely honest? I’ll propose three things to consider which, while not fool proof, do at least make it less likely that you’ll be hit with a shocking revelation.
- Does the company have a good track record? If the company has a track record of under-promising and over-delivering, then it’s a good bet that they are striving to be conservative and less likely to disappoint.
- Do they go into detail in their investor releases? While we all like pictures and graphs, is there any real meat in what the company is reporting? Are their reports written in a way that the average investor can understand them or do they use a lot of jargon? If a company’s reports just glosses over the subject, it should at least raise a yellow flag in your mind.
- Does management have a tone? If you are going to invest your hard earned money in a company, you should listen to at least one conference call each year in order to hear the tone of management. The fourth quarter call is the best because you’ll hear their thoughts about the upcoming year as well as their wrap-up of the previous one.
While you can’t completely prevent a disaster in your portfolio, and by this I mean permanent loss of capital, you can reduce the chances that it does happen by paying greater attention to what managements are saying. You are looking for candor and honesty, the good news and the bad news. We know that bad news is unavoidable; we just want it reported honestly, with steps being taken to rectify the problems. If you want your portfolio to grow bigger, you’ll need to take the time to listen to what management is saying, and sometimes you do have to read between the lines. Strive to invest in better companies with an honest management team and your portfolio will grow bigger as a result.
latimerburned has options positions on Microsoft and Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway, Costco Wholesale, Google, JPMorgan Chase & Co., and Microsoft. Motley Fool newsletter services recommend Berkshire Hathaway, Costco Wholesale, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
