yego.me
💡 Stop wasting time. Read Youtube instead of watch. Download Chrome Extension

Bill Ackman Asks Warren Buffett and Charlie Munger How To Analyze Financial Statements


4m read
·Oct 27, 2024

Thank you Bill Ackman from New York New York for the handful. Triple-A rated companies AIG, Fannie Mae, Freddie Mac, and MBIA are under formal investigation for accounting shenanigans and are in the process of restating their financials. Like Charlie said before, I think of a triple-A rated company as an exemplar—a company that should behave with the highest accounting and ethical standards.

My questions this leads me to are: how can investors comfortably invest in any financial service company when even a decent percentage of the triple-A rated companies have false or misleading financials? And I guess the follow-up question is: why don't the rating agencies do some independent due diligence from an accounting standpoint so that they can help serve as a watch on this issue?

Well, financial companies are more difficult to analyze than many companies. I mean, it is more—if you take the insurance business, you know the biggest single element that is very difficult to evaluate, even if you own the company, is the loss and loss adjustment expense reserve. That has a huge impact on reported earnings of any given period. The shorter the period, the more the impact can be from just small changes in assumptions.

You know we carry, we'll say, forty-five billion of lost reserves, but you know, if I had to bet my life on whether forty-five billion turned out to be a little over or a little under, I mean, it said be it. I think a long time, and you could just as easily have a figure of forty-five and a half billion or forty-four and a half billion. And if you were concerned about reporting given earnings in a given period, that would be an easy game to play.

In a bank, you know, what basically is what, whether the loans are any good, and I've been on the boards of banks and that's—you know, I've gotten surprises. It's tough to tell. It's the national companies—if you're analyzing something like WD-40, you know, our See's Candy, our brick business, whatever— they may have good or bad prospects, but you're not likely to be fooling yourself much about what's going on currently.

But with financial institutions, it's much tougher. Then you get add throwing derivatives on top of it, and you know, it's— no one probably knows, you know, perfectly what some of it, or even within a reasonable range, the exact condition of some of the biggest, you know, banks in the world.

And, but that brings you back to the due diligence question of the agencies. You had very high-grade, very smart, financially smart people on the boards of both Freddie and Fannie, and yet, you know, one was five billion and one was apparently nine billion. Those are big numbers, and I don't think those people were negligent.

It's just—it’s very, very tough to know precisely what's going on in a financial institution. Charlie and I were directors of Salomon, and Charlie was on the Audit Committee. I forget the size of a few of those things that you found, but you know, what wasn't found— and that doesn't mean that people below or crooks or anything like that. It just means that it's very tough with thousands and thousands and thousands of complicated transactions, sometimes involving the computations involving multiple variables.

It can be very hard to figure out where things stand at any given moment. And, of course, when the numbers get huge on both sides and you get small changes in these huge numbers, they have this incredible effect on quarterly or yearly figures because it all comes lumped in. Those adjustments come lumped in a short period of time.

So, I just think you have to accept the fact that insurance, banking, finance companies—we've seen all kinds of finance company, both frauds and just big, big mistakes over time, just one after another over the year. And it's just a more dangerous field to analyze. It doesn't mean you can't make money, and we've made a lot of money on it, but it's difficult.

Now, obviously, a Geico, where you're insuring pretty much the same thing— auto drivers— and your statistics are much more valid in something like that than they will be if you're taking something like asbestosis liability. You're subject to far greater errors in estimation. It doesn't mean that people aren't operating in good faith, but, you know, I would take just take the asbestos estimates of the twenty largest insurance companies. I will bet you they're way off, but I don't know in which direction.

And that's sort of the nature of financial companies. I wouldn't fault the rating agencies in terms of not being able to dig into the financials and find things that—you know, all of the companies that you've talked about have had big-name auditors, and our auditors at Berkshire—how many hours did they spend last year? You know, I don't know whether it would be probably sixty, seventy thousand hours.

And I'm sure another—you know, if you take major banks, they're spending more than that. But, you know, can they be certain of the numbers? I doubt it.

Charlie?

Yeah, Warren is obviously correct that where you've got complexity—which by its very nature provides better opportunities to be mistaken and not have it come to notice or to be fraudulent and have it not be found out—you’re gonna get more fraud or mistakes than you are if you're selling a business where you shovel sand out of the river and sell it by the truckload.

And just as a business that sells natural gas is going to have more explosions than a business that sells sand, a business like these major financial institutions by its nature is going to have way more problems, and that will always be true. It's true when financial institutions are owned by governments— in fact, some of the worst financial reporting in the world is done by governments and government institutions like government banks in China, etc.

So, if you don't like the lack of perfect accounting and financial institutions, you're in the wrong world.

More Articles

View All
Homeroom with Sal & Randi Weingarten - Tuesday, August 4
Uh hi everyone, welcome to our homeroom live stream. Sal Khan here from Khan Academy. I’m very excited about the very relevant guest we have today, Randy Weingarten, president of the American Federation of Teachers. Before we jump into that conversation, …
How To Become The World's First Trillionaire
Everyone is looking to make a quick buck. Whether it be a group of kids running a lemonade stand or a multi-billion dollar company making new cutting-edge technology, everyone wants to be rich. To be among the ranks of Bill Gates, Warren Buffett, Mark Zuc…
Relation of null space to linear independence of columns
So I have the matrix A over here, and A has M rows and N columns. So we could call this an M by N matrix. What I want to do in this video is relate the linear independence or linear dependence of the column vectors of A to the null space of A. First of a…
Our Greatest Delusion
I’m not sure what I expected to find when I went to Chernobyl. I mean, it’s been so long since the nuclear reactor there melted down and spewed radioactive atoms across the land. So for almost thirty years, this place has been virtually abandoned. These d…
How to Navigate the Different Life Phases
But also you say, for example, the second phase, the part that I’ve been in tends to be one of the unhappier times of life. You think about how much you’re worrying about your kids and whether they’ll be okay, and all the struggles balancing work and fami…
BlackRock - The company that owns the world?
Narrator: There’s a good chance you’ve never heard of BlackRock. Founded in only 1988 in less than 30 years this American financial firm would grow to become “the company that owns the world” managing assets worth 6,3 trillion dollars. These are assets t…