Ruane, Cunniff & Goldfarb Investor Day Transcript

Excerpts:

If you are really worried about inflation risk, there are ways to hedge inflation risk where you still get a reasonable yield. You might look at timber, you might look at oil companies. But one very good way I think to hedge inflation risk is to invest in excellent companies that have pricing power. You get yield from that; so I don’t really see a reason to buy gold when you can invest in a business that leverages the creativity of people and gives you an earnings yield at the same time.

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On energy I’d give the same answer I gave a few years ago. Which is it’s a good business; we spend time on it. At least three or four people here have written internal reports on energy companies within the last six months. There are some wonderful companies. We own a few shares of Canadian National Resources, which is a very smart company run out of Canada by Murray Edwards. But in general we don’t know what the price is going to be of oil and gas. So sort of like with gold, we just don’t know what the price will be, we don’t really know how to forecast it. So there tend to be people who have firmer opinions than we do about what the price of oil and gas will be. Therefore, they end up being willing to pay more for the shares than we are.

There is a good saying in the oil and gas business that the cure for high prices is high prices, and the cure for low prices is low prices. So for example at the moment no one is interested in gas because the price is so low. But the fact is the gas supply goes down 25 percent in one year in the United States if there is no drilling. So if people would just stop drilling, any supply and demand problem that you could think of would be quickly corrected.

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I would say that a number of the changes in the composition of the portfolio have reduced our exposure to the economic cycle. Martin Marietta would be a good example of that. So we’re less exposed. I have to say I think most companies have been stress-tested in the last couple of years in terms of their vulnerability to difficult economic circumstances and declines in demand. So we’ve addressed that in part by reducing our cyclical exposure. The dilemma for us today — and the previous question I think I addressed this — is it’s possible that the next cycle could be more about inflation and less about weak demand.

There are some investors whom I admire out there who have made huge bets on inflation. I suppose if we had a very, very strong conviction about inflation we might have kept some or all of our Martin Marietta, as an example. So I think we’re pretty well protected against the kind of decline in aggregate demand that we’ve seen. Hopefully our protection against inflation, as mentioned earlier, is owning terrific businesses with high cash generation.

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Question:

You talk about potential not imminent inflation and try to find companies with pricing power and that are financially strong. I guess that’s been debated over the years. We haven’t seen inflation in so long. Can you comment on that? Is there really an answer to inflation? Maybe Jon can talk about Buffett’s 1977 article in Fortune where he wrote that inflation was the cruelest tax, and that contrary to popular belief, you can’t win with companies and inflation.

Bob Goldfarb:

I think a clear inference of that piece is that companies that generate a lot of cash and have minimal required reinvestment of that cash in their business and that can grow with minimal cash are terrific inflation hedges. I think that was true in 1977 and I think that’s true today.

Jon Brandt:

The title of the article was a little misleading. It was “How Inflation Swindles the Equity Investor,” and it talked about how capital intensive businesses have to keep putting more money into their inventory and receivables and other sources of capital when dollars inflate. But as Bob points out, he also said elsewhere that if you buy a company that doesn’t have great capital needs, you can avoid most of that inflationary tax.

Bob Goldfarb:

And then he went out and bought a railroad!

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Question:

This question may be a little bit beyond your traditional radar screen. But have you ever been tempted to buy a Chinese company and if not, what would it take to get you interested in that market?

Greg Alexander:

We read about things sometimes — frequently, actually. But there is an inscrutability factor. For example, there is a grocery retailer called WuMart. The fellow who founded it ended up in prison. Then one of our guys found this nice little company which was too small for the fund, but it was just fun to read about, called China Packaging. It was making some $20 million a year. Maybe it had $50-$60 million of cash. It didn’t sell for much over the cash. Then one day we heard the cash that the company said that it had, it didn’t have.

There is really no press — you see what happens with Google — and there is really no English language press — I don’t think the Chinese language business press is that much bigger. So we prefer to look at the companies that do business in China. Danaher, actually, has a pretty thriving business there. Expeditors, which is a long-time holding and which has made the fund a lot of money, is a primary mover of goods from China and Hong Kong by air to the United States. So, so far, we’ve started indirectly.

David Poppe:

If you look at the example of Germany, where the accounting standards are different, the disclosure standards are different, management’s attitude towards transparency is much different — we didn’t do very well there. Not to blame it on accounting standards, but we didn’t do very well there. To be in a developing world stock where the standards are all so different, we would be at an extreme disadvantage. We’re not in those markets, we don’t know those folks.

Greg Alexander:

China in particular.

David Poppe:

And China in particular. The standards are obviously not bad in every country but Germany is a pretty modern economy and we had a tough time there. You have to be humble about how much knowledge you are really going to have compared to the US or even Canada or the UK, where really standards are so similar that you can have a high degree of confidence. It’s not just the language, it’s the attitudes towards disclosure and transparency that really become a problem.