Breakfast in Omaha Meeting 2024 – Session One

In 2022, I started a new tradition, and so this year too I hosted my readers for breakfast in Omaha.

This was a wide-ranging Q&A session. We discussed

• What are your thoughts on supply chain issues in the defense industry?
• How do you manage risk in our portfolio?
• How do you know when to sell?
• What are your thoughts on particular opportunities or risks in investing in Eastern Europe?
• Why don’t you invest in China?
• Did you find anything interesting when finding a potential investment in Japan?
• What are investors’ edges?
• How can regulation from gov’t affect McKesson?
• How do you overcome the pain and suffering of missing out when you sell a stock that has increased in price?
• On Charter Communications
• How do you see Charter going four or five years from now?
• Can you discuss your process of researching a company and buying a company?
• Do you act as an activist towards companies in your portfolio?
• How to deal with oligopolies?
• Analyzing companies with low and high-profit margins
• What’s your primary source for finding management integrity?

Breakfast in Omaha Meeting 2024 transcript

Thank you, everyone, for coming. I’m excited to have all of you here. I don’t have a speech. I’m here to ensure you’re fed, not starving, and answer your questions. So ask away, that’s what I’m here for.

Question 1: What are your thoughts on supply chain issues in the defense industry? 

My thoughts on supply chain issues in the defense industry – it’s a multi-layered question because there are different issues in the United States versus Europe.

In the United States, the biggest issue American suppliers face is a labor shortage. We own Huntington Ingalls, which builds submarines. Their biggest problem is they can’t hire enough people. That’s the biggest constraint for our submarine construction.

In Europe, the issue is different. If you listen to BAE or almost any other big supplier, they talk about how a lot of little suppliers either went out of business or have been very close to going out of business. They ran out of capital and needed a working capital infusion.

These companies are infusing a lot of capital into these little companies because if you build a plane and you’re missing a little bolt, you can’t sell the plane. In Europe, that’s the biggest issue.

I could see a lot of little suppliers struggling, and they’re the bottlenecks for the whole industry. About a quarter of our portfolio is in defense companies. And these companies went up a lot. Usually, as a value investor,  you have to be less smart when you buy something that’s very cheap.

When it goes up in price, your IQ has to go up proportionately. We haven’t sold a single share of any of our defense companies yet. The reason for that is, especially when it comes to European companies, Europe has been collecting peace dividends for so long and underinvested in its defense for so long that it basically has to make up for 30 years of underinvesting.

It’s going to take a while because even if a country decides, like the UK did last week, to spend two and a half percent of GDP on defense by 2030, it means the laws have to be passed, the bills have to be passed, they have to be funded, companies have to build factories. It all takes time. So it’s going to take a while before this future high defense spending shows up in companies’ earnings. We’ve been very patient with those companies. This is not the question you asked, but this is what I do, I answer the questions I want to answer. 

Question 2: How do you manage risk in your portfolio? 

First, let’s define what risk is. If you ever took a finance class, you’ll be told by your modern portfolio theory teacher that risk is volatility. For us, risk is not volatility, but as you guys know, it’s probably loss of capital.

So when we do research and when we buy a company, we do it because we made a whole bunch of assumptions. And then something happens, and these assumptions are tested. We say, well, we made this assumption, and now it’s wrong.

I’ll give you an example. We used to own Tesco in the UK. Tesco used to have 6% to 6.5% operating margins. For any of you who look at grocery stocks, that’s unheard of. The UK market had higher prices and less competition – it’s kind of a big island. And then Aldi and Lidl came in and started pushing the prices down for everybody.

So we had to go back and realize that my assumptions for six to six and a half percent operating margins flew out the window. I think if we get four percent, we are lucky. Now, I promise you this, you don’t have to be a genius to know that at a 6% operating margin, the company is worth more than at 4%.

So we had to go back and change our assumptions. The fair value declined, and we sold the stock. This is basically how we approach it. When new information comes in, we change our assumptions, put this into the models, and see what the new fair value is. Depending on what happens to the stock price and my confidence level, I may buy more stock. It happens quite a bit. Sometimes I just do nothing to make sure I’m right.

Question 3: How do you know when to sell? 

I’ll give you three reasons why people sell, and we’ll look at each one of them.

Reason number one is when you buy a stock, it goes up a lot, so you sell. In this situation, you have to accept the fact that you will sell, and it can go higher. You just have to accept it because it’s not like you have a crystal ball and know, “I’m gonna sell, and the next day it’s gonna decline.” That’s not how it works. We often sell stocks and they go higher. So there’s no science to that because it’s emotions that drive stock prices in the short term anyway.

When things go wrong, that’s another reason why you sell, like what we just discussed. And there, again, there are many different reasons.

I’m not gonna mention the company’s name, but one of the mistakes I made that was painful in the last couple of years was with a company that I’m not gonna name. I completely got the management wrong. I thought the management was great, and it was horrible. Let me tell you a little anecdote that I heard. When I heard this, I should have sold the stock, and I didn’t. And this is how unscientific it is. In hindsight, it’s so obvious that I should have sold the stock.

So this is a company that got sued, and there was a lawsuit filed against the CEO and the company. In the lawsuit, this little detail was disclosed. When I read that, I was shocked by it, but I didn’t do anything about it. And here’s the detail.

The employee says, “I went to the CEO, and while he was talking, his assistant was cutting his steak for him.” And to me, if you think about it, there is so much data in that little detail. Because it tells you everything you need to know about this human being.

Another example would be Jeff Immelt, everybody knows Jeff Immelt of GE.

The famous story is about how they have two planes. But that’s not even the most egregious story. The egregious story was in a great book called “Lessons from the Titans.” There’s a terrific story there about Jeff Immelt. This guy’s asking him, “So when you travel into a new city, do you have like, how do you reserve a hotel room?” He’s like, “Well, I have a forward team going there, making sure everything is set up correctly, and they bring my personal gym to the hotel.” Can you imagine this? This is the CEO. The shareholders of GE are paying for somebody to bring dumbbells to Marriott here or something. That’s, yeah.

So, now, there’s nothing scientific about what I told you, right?

But these little details, like, we own a company, which I’m not gonna mention the name of. I learned that they have a manager outing in one of the most expensive resorts in Florida, and for me that’s a huge yellow flag.

So how do you put all this together? You look for these little clues. There’s nothing scientific about that, right? But all you’re trying to do is piece this puzzle together. Selling is always difficult, and it’s never perfect. You just try to make the best decisions you can and learn from them as much as possible. So, next time I own a company and I learn about the CEO’s food being cut by somebody else, I know what to do. Except it’s never gonna be exactly like that, right? It’s going to be something else, so I have to look for the signs. You have to be aware of them.

Question 4: What are your thoughts on particular opportunities or risks in investing in Eastern Europe?

I have a friend, Steve Gorelik, who is not here, who specializes in investing in Eastern Europe. He has forgotten more about investing in Eastern Europe than I ever knew so let me see if I can fake an answer.

Honestly, I don’t think I have a good answer, but I think… The only thing I can say is that in general, in these markets, it’s always trickier because the rule of law is not as developed by definition. So if we do invest there, we always take smaller positions because we may not know as much as we think we do. That’s kind of my only insight, but my friend Steve invests in Georgia, Estonia, and other places. This is just my very general comment.

Question 5: Why don’t you invest in China? 

That is the easiest question. If all questions were like this, it would be so much easier. So why do I not invest in China? For the same reason, I don’t invest in Russia. For the same reason, I don’t invest in countries where I have this rule. And it’s a very simple test: If I write a negative article about the country’s leader, would I feel comfortable traveling to this country after I wrote this article? If the answer is no, I probably should not invest in that country.

And this is a true story. In 2008, I went to Russia for the only time I’ve been there since I left in 1991. This was after the government stole a company from its shareholders. I was going to write a negative article, and actually, I did write it, but I never published it. The reason I didn’t publish it was because I was thinking, I’m traveling to Russia, and nobody’s going to care what I wrote about in this article, except if I get pulled over for crossing the street. They’re going to find out I’m an American citizen, they’re going to Google me, they’re going to find this article, and then my fate may change.

So, for that reason, I’ve never invested in Russia, and for the same reason, I’ve never invested in China. The Chinese government decided that Jack Ma said something wrong. By the way, this is something I always had an issue with regarding Charlie Munger, because he kind of, I don’t know what it is, he looked at Singapore and Hong Kong, and somehow he fantasized about China. I looked at China and I just saw kind of a bigger version of Russia, but maybe more pragmatic to some degree. This is why we never really invested in China because I don’t want to wake up in the morning and find out that the CEO said something that the government didn’t like and suddenly I don’t know the company anymore. So that’s the answer.

Question 6: Did you come across anything interesting when finding a potential investment in Japan? 

I think Japan is very interesting in general. I’m fascinated by the culture. It’s a different world. Obviously, until maybe two or three years ago, Japan was uninvestable for the most part because companies were run for the benefit of employees and management, but not shareholders.

If you look at those companies, whatever cash they generated never went to shareholders. They never bought back stock, they never paid dividends. Roughly two years ago, the story changed.

The companies realized we’ve been in this bear market for the last 30 years, the stock market hasn’t gone anywhere. And it took the stock exchange pushing them to return capital. Yeah, the stock exchange said, you need to start returning capital to shareholders, you need to start managing these companies for the benefit of shareholders. And that has changed the story. We looked at a lot of companies in Japan and we never bought anything.

We didn’t buy them, and this was happening over the last six months or a year. Every single time it was for different reasons. Sometimes we couldn’t get the management on the phone. Sometimes the financials were not in English. Well, it’s just kind of difficult to do research when it’s, you know, sometimes we did not understand the business.

So I would love to, in other words, I think I would love to own something in Japan. Also, when you invest in Japan, this is tricky. Currency is a real factor. So if you look at the Japanese yen compared to the US dollar, and the purchasing power parity, the Japanese yen is very cheap, but it could also get a lot cheaper too. So that’s a risk. If you buy something in Japan, preferably you want to own an exporter, because they benefit from it. So you have to go through all this kind of stuff. And we went through it. We just couldn’t find something where we said, we want to buy this. But I don’t have the same hesitation I have about China or Russia. I don’t think I have that hesitation about Japan. It’s the beauty of Japan.

And it’s kind of a very different society because it’s a Confucian society where if they decide to change the society, they do. Let me give an example.

Like 20 years ago or something, the government said we don’t want to have high unemployment. So don’t lay off people. And companies didn’t. Okay? And now, like, they just, it’s a very cohesive society from this perspective. So when the country decided that we needed to start treating shareholders better, they started doing that. So there are some advantages to that. Anyway, so in theory, I would love to own something in Japan. We haven’t found anything yet.

Question 7: What are investors’ edges?

I think number one, you need to have a longer time horizon. To be an investor, you need to have a long-term perspective. Having a longer time horizon than everybody else, within reason – I’m not talking about Masayoshi Son from SoftBank, where he has a 300-year time horizon. That’s ridiculous. However, having a longer time horizon than others is a competitive advantage. Being more rational than others is another edge. This rationality comes from several places, including actually doing your research.

Let me tell you a story. I love this story. Everybody here has probably heard a version of it, but there’s a punchline buried deeper than most people know. You guys have heard the story from Charlie Munger about Max Planck and the chauffeur. Max Planck was a physicist who won a Nobel Prize in the late 1940s or 50s. He traveled around American campuses giving the same speech over and over again about physics. He was chauffeured around by the same guy. One day, the chauffeur said, “Listen, I’ve heard your speech so many times that I can give the same speech you do.” Max said, “Sure, do it.”

So the chauffeur goes on stage and delivers a phenomenal speech, even better than Max Planck himself. Then a Q&A happens, and people ask questions. The chauffeur answers flawlessly because he’s heard the answers before. Then somebody asks a question he doesn’t know the answer to, and he says, “You know what, this question is so simple. Let me have my chauffeur answer it.” He points to Max Planck because nobody knows what Planck looks like, and Planck answers it. That was the punchline for most of us, but then I thought a lot about this and realized that’s just the superficial part.

The key part of the story is something else. You have two types of knowledge: chauffeur knowledge and Max Planck knowledge. Chauffeur knowledge is when you’ve read or heard about things and can recite them. You sound articulate and good when you say those things, but the way you acquired that knowledge was not tactile. It’s like doing research by just talking. You read one of my articles, I sounded smart, you bought the stock. That’s chauffeur knowledge. Going through 10-Ks, building your own model, talking to suppliers – that’s doing the research. You develop a different type of knowledge. It’s more tactile. With that type of knowledge, you’re going to be a lot more rational than somebody who just read one of my articles, bought the stock, and then when the stock goes down 20%, starts thinking, “What is Vitaliy thinking?” That’s the difference between chauffeur knowledge and Max Planck knowledge.

Whenever you invest, you want Max Planck knowledge because you want to reach conclusions on your own by going through the research process. That is an edge.

Also, here’s a very important insight: whenever you talk to somebody who sounds intelligent or semi-intelligent, you kind of want to question whether that person arrived at their knowledge like Max Planck or like the chauffeur. It’s important because that person will act very differently. When you interview a money manager, they may sound very smart, but all the knowledge they have might be chauffeur knowledge. So that’s the difference.

Question 8: You said you don’t like to be dependent on government, but it feels to me that if I read through McKesson’s filings, they’re also very dependent on regulations that can change from one day to the next. How do you follow this up? How do you take this risk into account? 

The question is about how government regulations can change McKesson’s business. If you look at healthcare companies in the United States, the drug distributors like McKesson are probably the least sensitive to that. Why? Because they are the railroad for drugs in the United States.

One thing Americans, and probably Europeans too, appreciate is that when you go to the drugstore to buy medicine, you don’t have to worry about whether it’s fake or real. You don’t have to think about it because we trust that it’s going to be real. That happens because of companies like McKesson.

Pfizer is in the business of discovering and manufacturing drugs. They don’t want to deal with 30,000 pharmacies. Therefore, they would rather deal with three or four suppliers. McKesson trucks come, get Pfizer’s drugs, and Pfizer doesn’t have to think about it. McKesson has sales of $250 billion, which sounds like a large number, except their margins are 2%.

So from a regulation perspective, McKesson is the least exposed because Pfizer gets to keep 92% – they keep most of the profitability. Whenever a politician goes after drug pricing, they’re not thinking about McKesson. Could the government change some kind of regulation about distribution? Possibly, but not to the point where it’s going to disrupt the business model.

Out of all the stocks in my portfolio, if I own healthcare companies, that’s the reason we own McKesson. The reason we own it is because I think it’s the least likely to be disrupted, by far. I hope that answers your question. It’s very interesting.

Question 9: How do you overcome the pain and suffering of missing out when you sell a stock that has gone up in price? 

I suffer as much as everybody else. I thought I was the only one. No, no, it’s just you and me. Nobody else. You suffer as much as everybody else, and you try to learn from this. Now, a lot of times, there is absolutely nothing to learn. Let me give you two examples where my suffering was very different.

We used to own Twilio. This never happened to me before. We bought the stock at $25, and it went to $100 in a matter of two years. It just went straight up. Our position got big, and we got out at around $110. After we sold, it went to $450. I did not feel bad about it because when I was selling it at $100, I was thinking it was already overpriced. I should have sold it sooner, but you don’t know. It went higher, but I looked at it and thought, “I don’t know who wants to pay $450 for it.” I did not feel bad because I don’t think I could have predicted that. I would never have let it get to $450 anyway. I probably would have looked at $150 and thought to sell. When it got to $200, I would have felt the same way. There is no way I would have held it to $450. Now, Twilio is a $60 stock. I didn’t feel bad when it was at $450.

Now, there’s a different story. We used to own Electronic Arts. Those who have read my articles for longer than 10 years might remember. In 2011 or 2012, we bought Electronic Arts. This was the early days of smartphones. Electronic Arts looked like a company whose sales were flat-lining because of the transition from boxed games you buy at Best Buy to digital downloads. The boxed sales were declining while digital was going up. Long story short, we bought Electronic Arts. Over the next two years, I saw the stock decline every single day. We bought it at $16, and it bottomed out at $10 – a 40-50% decline. It was very painful. Then the stock doubled and doubled again. I did this wonderful dance, sold the stock, and thought, “Alright, I made money.” Then the stock went up 4-5x in literally two years. That one was extremely painful because I was wrong. Let me tell you why I was wrong. I sold it because I was exhausted from owning it and just wanted closure. It was psychological exhaustion. I just wanted to feel good. But when I look at my original analysis, I was saying earnings would go up a lot.

In the old days, imagine this: you go into the dental office, and while you’re waiting for your daughter to get braces, you’re sitting there playing Game Boy. Can you imagine that? Yeah, that’d be awesome. Never gonna happen, because adults don’t play Game Boy. But can you imagine what happened with smartphones? You put a Game Boy in everybody’s hand. So the market for games expanded. That was my thesis. I said that now adults can play video games in public, which happens all the time, wherever you go. Electronic Arts would benefit from that.

So that was a big part of my thesis, and it was right. Earnings went up a lot. But it was my impatience that made me sell the stock. To me, that was a mistake. With Twilio, I don’t feel bad about it. With Electronic Arts, I do, because that was a flaw in my process.

Follow up question: You can never capture a stock like Berkshire Hathaway that went up 38,000 times, because it will always be expensive. At some point, you will sell. So there’s a new question in this. He’s asking, given the career and business logic, that you would never capture a company like Berkshire Hathaway because it was overvalued based on expenses. 

That’s not what I’m saying. Just to put a pin in this, when I sell a company, I don’t expect to sell at the very top. But when I sell, I want to make sure I’m selling because it’s fully valued. If I sold a company that was fully valued and it went a lot higher, that doesn’t bother me because it just got more overvalued. I can’t predict that. I can’t put it into my process.

Now, how do I deal with the Berkshire Hathaway situation, where you get a company that is a compounder and it’s compounding earnings for a long time, so it’s always going to look expensive? That’s a different question, and we made an adjustment to our process for that. Whenever we look at any company in our portfolio, and we do this for every single company, we always look four or five years out and then discount it back. Uber, for example, is always going to look expensive based on this year’s earnings. But if you look four, five, or six years out, it’s not going to be expensive. On the flip side, a lot of melting ice cube companies are always going to look cheap based on this year’s earnings but very expensive based on earnings five years out. This is our way of dealing with that.

Question 10: On Charter

I’m trying to figure out how much depth I want to go into, because I’ve written so much about it and I don’t want to bore you guys. Let me summarize Charter very quickly. It’s a cable company that really has two businesses. Most people think of cable companies as TV service providers. That is the least important business they have. Even though it’s a high-revenue business, it’s shrinking and has very low profit margins because most of the revenue goes to HBO and ESPN. The margin goes there.

The big, profitable business for them is the internet business – the broadband business. Over the last couple of years, a few things happened. Charter’s subscriber growth has slowed down, actually declining slightly on the broadband side. The question becomes, is Charter becoming a melting ice cube? If it does, that ice cube is not going to melt very fast because they have a lot of debt. This is why the stock is trading at about 5 times free cash flow, by my estimate. I’ll get to that in a second.

Charter is facing two types of competitors: fixed wireless competitors, which I’ll talk about in a second, and fiber. One thing we can probably all agree on in this room is that demand for broadband five years from now is going to be greater than it is today. To me, that’s a given. Now, that means absolutely nothing, because if China can still go out of business, that in itself doesn’t mean anything.

Over the last couple of years, T-Mobile, and to some degree Verizon, have been taking some of Charter’s customers with a fixed wireless product. That threat worries me the least. Why? Physics. First, what is a fixed wireless product? Basically, think about taking a cell phone, turning it into a hotspot like a Wi-Fi hotspot, and that becomes your broadband. The physics works against these companies because spectrum is limited. The average fixed wireless subscriber uses 50 to 70 times more broadband than a regular cell phone subscriber. What’s going to happen is that Verizon and T-Mobile have limited spectrum. Therefore, they have to limit how many subscribers can be in a certain radius using broadband. T-Mobile has already said they want to have about 8 million subscribers because that’s all their network can handle, and they’re already at five million. Verizon is early in this, so they can have a little bit more than that, but there’s just a limit to how many fixed wireless broadband subscribers each company can have on their network. That’s number one.

Number two, it’s a less reliable product. They talk about fixed wireless, but it’s less reliable because these companies have to use medium-spectrum. The way spectrum works is you have low frequency and high frequency. Low frequency can travel very far but carry very little data. High frequency cannot travel as far and cannot penetrate walls and trees as well, but can carry a lot more data. I apologize if this bores you. I’ll stop, because this is why I’m trying to figure out how deep I want to go. Okay, all right, so just for you, because I think nobody else cares. Anyway, I’m going to wind up very quickly.

Long story short, you basically have a product with limited reach. It’s not as good a product because it’s a lot more intermittent than normal broadband. Patek Philippe, the watch company, has probably the best marketing slogan I’ve ever heard: “You never actually own a Patek Philippe. You merely look after it for the next generation.” So let me apply this to the story. My message to T-Mobile and Verizon is that you don’t really own those fixed wireless customers. You’re just taking care of them until they get sick of your service and go back to Charter. That’s exactly what’s going to happen.

Two more things, and I’m going to stop because this could really get long. Charter is going through a huge network upgrade which is going to make their broadband as fast and bidirectional as fiber. They’ll be done in two years. It’s most important for marketing. If you have 500 megabytes of broadband, that’s all you need, but in two years, they’ll have 10 gigabits. That’s number one. When they do this, their free cash flow will go up a lot because right now, capital expenditures are elevated due to the network upgrade.

Finally, they already have eight million wireless customers, and it’s growing 30-40% a year. They are pricing that product 20-30% cheaper than AT&T, Verizon, and T-Mobile. So that product has real legs. It’s going to become a good source of cash flow and increase retention in the future. Sorry, this is very difficult to answer without getting too detailed. Yeah?

Question 11: You talked about looking at where things are going to be four or five years from now. So wouldn’t that be a reason to own Charter if you see that turnaround happening? 

Yeah, we own it, but we don’t own Charter directly. Let me explain. We own a company called Liberty Broadband. Liberty Broadband is the largest shareholder of Charter. It owns 24-25% of Charter, but we are buying Liberty Broadband at a 20% discount to Charter. So it’s a double discount. We own Charter. I don’t look at Liberty Broadband because it’s just a shell that owns Charter.

Question 12: Can you discuss your process of researching a company and buying a company? 

I think the process has a lot of systematized randomness. You’re constantly looking for ideas as you interact with the world. You read a lot. I read a lot. I travel, talk to other value investors, and read companies’ financials.

Let me start over. When people usually think about value investors, we picture Buffett sitting at his desk and reading all the time. You kind of think about this process as being very sterile – the guy sitting in a cubicle, maybe a fancy cubicle, just reading all the time. I would argue there’s a lot of value to that, but I don’t think it’s enough. I think it’s very important to me to be present in this world. Traveling is very important to me. I’ll give you an example. Philip Morris International has a product called IQOS, which is heated tobacco. A lot of Europeans have seen this product. How many of you are from Europe? How many of you know what I’m talking about? IQOS? You don’t know these little heated tobacco sticks? Okay. Well, Europeans know it because you see it everywhere. You walk into the Milan train station, and you see little kiosks that look like they’re selling Apple devices, but they’re selling IQOS products. If I had never been to the Milan train station, long story short, I would not know about that product. So I think traveling, interacting with the world, and talking to other value investors is incredibly important. Your mind has to be constantly on, constantly looking for ideas. I think that’s very, very important. Sitting in my cubicle and reading has value, and I do plenty of that, but to me, it’s not enough.

But let’s say I found an idea. Then I just get obsessed and start researching it. My obsession may go away if I stumble upon a CEO having their steak cut by somebody else. I’m like, “Okay, I’m not interested.” My obsession goes away very quickly. But if it’s not that, I keep going deeper and deeper. A lot of times, I think, “God, I would love to own this company,” but we build a cash flow model and it’s just not at the right price. It happens all the time. We put it on a watch list, and as Jews would say, God willing, the price will come down at some point. It was four years ago, anyway.

So that’s kind of the process. It involves a lot of patience and realizing that just because I spent a lot of time researching a company doesn’t mean I have to buy the stock right now. I want to buy it at the right time, at the right price. And just be patient. Yeah, yes sir.

Question 13: When you see the CEO get his steak cut for him at the restaurant were trying to become an activist? 

Oh God, no. I mean, listen, there are people who, as you can see, I’m a lover, not a fighter kind of person. The way I become an activist is with my feet. I just leave. I’m not going to do proxy fights. I’m not going to do any of this stuff. It takes a huge amount of energy, and I think it takes a certain type of person to do that. It’s a person who likes dealing with a lot of lawyers. You have to hire law firms, et cetera. I don’t like dealing with lawyers. I have a lot of client lawyers and I love them, but I don’t like paying their fees. I don’t like any of that stuff. So no, if I don’t like the management, I just leave.

And by the way, you asked me if I’m not forgiving. If I start questioning management’s integrity, I’m gone. I don’t care about the price. I’m gone. A long time ago, I made this painful mistake. There’s a lot of pain in what I’m about to tell you. We owned this company where the CEO was known to be a crook. But when we bought it, I had the insight that I think he’ll be less of a crook going forward. This is not how crookedness works. It only gets worse. So if I ever question management integrity, first of all, I never buy if I have doubts. But if I change my mind, I always sell the stock.

Question 14: I keep finding companies that are oligopolies, where like 60% are owned by three companies in the entire market. It only works if they act rationally as oligopolies, right? 

You need the humans, the CEOs, to work together. You know what I’m saying? They have to avoid price wars, or the entire thing doesn’t make sense. So I struggle with this. I’m curious about any insights you have. Few players, but they’re very rational in some industries and not in others. Like, two examples: McKesson, the drug distributor, versus wireless companies.

A few years ago, I think AmerisourceBergen, which now has a new name that I refuse to remember, tried to go after McKesson’s customers. McKesson’s reaction was fierce, and AmerisourceBergen backed away. You get that kind of signal. In the drug distribution industry, it has been rational for a long time. None of them have a competitive advantage to take market share away from each other. So it’s been very rational.

With the wireless industry, I think the difference with T-Mobile was that you had this very old American IBM-of-the-60s kind of thinking with AT&T and Verizon. And then you have this guy who ran T-Mobile, who ran the company very differently and was able to take a huge market share from them. I remember when T-Mobile was a joke, and now it’s the best-run wireless company out there.

But then you look at cable companies. It’s kind of interesting. If you look at cable companies versus wireless companies, cable companies have this very collegial, partnership-like mentality, right? Comcast and Charter are best friends. The reason they’re best friends is that their territories never overlap. Verizon, T-Mobile, and AT&T are fierce competitors because they are competing for the same customer. I would rather be in the cable business than in wireless. By the way, I think wireless companies, and I’m wrong a lot, but I think wireless companies are going to be horrible investments for a long, long time. I would not touch that.

Question 15: Analyzing companies with low and high-profit margins.

There is one factor that can equalize this equation, return on capital. The return on capital for McKesson is probably 20-something percent. And if you look at distributors in general, they usually have a very balance sheet heavy business. If you look at your traditional companies that distribute semiconductors or electronic components like Arrow Electronics or other companies, they usually have, I forget, maybe 300 days of inventory or something. A year and a half of inventory, and their return on capital is horrible just because the inventory consumes a lot of this. If you look at McKesson’s balance sheet, I forget the numbers, but I think they have maybe 30 days of inventory. Yeah, so the balance sheet is very light. Therefore, the return on capital is very, very high. The asset base is relatively small, so it’s a very good business.

So in this situation, I think return on capital is more important to me than exactly what the profit margin is. If it’s a low-margin business, I’m generalizing right now tremendously, but usually, it’s less attractive for competition to come in. So you could argue that there are benefits to that. But then when you have a high-margin business and you’re Apple and you have this incredible brand, you probably get to keep those margins as well. So it’s a case-by-case basis, but I would also spend a lot of time looking at the balance sheet structure, return on capital, this kind of stuff.

I think it’s just neither company when you start a war and you can’t win. This is the thing, the beauty of this is that this is a war neither company can win. Therefore, it’s less likely. Again, I could be proven wrong. Just because things haven’t happened in the past doesn’t mean they won’t happen in the future. But every time in the past when a price war started, it always fizzled out because the other companies responded very irrationally. Then you realize, “Okay, do we want to destroy? I’m not sure if it’s worth it.” If they get into a price war with McKesson, they can’t win.

So they don’t start the price war. Everybody in the industry is earning a good return on capital. It’s not really, so it’s been very, very rational. Then the way they compete with each other in the other adjacent businesses and other verticals, even there, they’re somewhat rational, but it’s still very competitive.

So I’m not giving a great answer because it’s on a case-by-case basis. Listen, if I start seeing things changing, I’m like, “Well, maybe I was wrong. Maybe things will be different.” One thing you have to have in this business is a lot of humility. I may end up being wrong. I may end up being wrong on Charter. Like, every, every time I constantly think about how my thesis could be wrong. So far, the stock performance hasn’t been great, but I think my thesis so far is intact. But I may change my mind.

One thing that’s important to understand is I have a portfolio of stocks, and all of them have different characteristics. We have 25, 30 stocks. And I promise you, one thing I know about this, there are a few guarantees I can make to clients. One guarantee I can make is I’ll be wrong on some of those stocks. I don’t know how many. And as long as I’m not wrong all the time, we’ll be fine.

Question 16: What’s your primary source for finding management integrity? 

Let me tell you what we do. A couple of things. First of all, look at what they’ve done in the past. That doesn’t speak about integrity, but it looks at the track record. We use Tegus. And then another service, and they just changed the name several times, another competitive service we use, where we see a lot of expert interviews with company suppliers, ex-management, et cetera. You pick up a lot of things from those interviews, and a lot of times they’re very informative. We talk to management, too.

But the point you’re making is very, very important. To become a company CEO, you have to be a very good salesperson. A very shy guy doesn’t become a CEO, right? Because you need to be, it’s a certain type of personality, right? And these people are usually very polished. So, I have the opposite filter now. When I see a CEO speak my language, you have a couple of CEO speaks, okay? You have one that’s kind of, “We’re going to do things to maximize shareholder value.” When I hear this, that makes me feel uneasy, exactly, because they’re just repeating what everybody else is saying, and I know it’s complete bullshit.

And then you have other people who sound incredibly Buffett-like. And those people scare me as well because I start thinking, “Well, they’re just trying to use my language to appeal to me.” Maybe this is me being a paranoid Russian or a paranoid Jewish Russian. So I’ve always questioned, I’m very alert to this, because they just tell me what I want to hear.

So I think just reading, like talking to them and pushing them on that. When I talk to them, I try not to give them answers. I’m like, “So are you going to buy back stock when it’s cheap?” They’re like, “No, no, I don’t think anyone we’re ever going to say no, we’re never going to buy stock when it’s cheap.” Of course, they’re going to say yes when it’s cheap, right? Well, then the question would become, “Well, how do you determine when it’s cheap?” That’s a more important question. It’s more valuable to go there and understand who you think they are than a firm. Yeah, you have a thesis.

I think this whole business is about having a thesis. We are scientists in this way. We have a thesis and then we try to prove or disprove it. But it’s just a thesis. It’s not a certainty. We just use our curiosity to figure out if our assumptions are right, and if they aren’t, then we change our minds.

Thank you so much for coming. This was a lot of fun. I appreciate it. Thank you guys.