Warren Buffett and Charlie Munger on How to Calculate Future Earnings

I have a question. When you're valuing the companies and you discount back the future earnings, you talked about how many years out you generally go. If you don't go out a general number of years, how do you arrive at that time period?

Well, that's a very good question. It's the heart of investing, or buying businesses, which we regard as the same thing. It is the framework in which we operate. I mean, we are trying to look at businesses in terms of what kind of cash can they produce if we're buying all of them, or will they produce if we're buying part of them, and there's a difference.

Then, at what discount rate do we bring it back? I think your question was how far out do we look and all that. Despite the fact that we can define that in a very kind of simple and direct equation, you know, we haven't actually sat down and written out a set of numbers to relate that equation. We do it in our heads in a way, obviously. I mean, that's what it's all about. But there's no piece of paper, and we never had a piece of paper that shows what our calculation on Helzberg's or See's Candy or the Buffalo News was in that respect.

So, it would be attaching a little more scientific quality to our analysis than there really is if I gave you some gobbledygook about while we do it for 18 years and stick a terminal value on and do all of this. We are sitting in the office thinking about that question with each business or each investment. We have discount rates in a general way in mind, but we really like the decision to be obvious enough to us that it doesn't require making a detailed calculation.

It's the framework, but it's not applied in the sense that we actually fill in all the variables. Is that a fair way of saying it?

Yeah. Berkshire is being run the way Thomas Hunt Morgan, the great Nobel Laureate, ran the biology department at Caltech. He banned the freedom calculator, which was the computer of that era. People said, "How can you do this? Everywhere else in Caltech we have freedom calculators going." He said, "Well, we're picking up these great nuggets of gold just by organized common sense. Resources are short, and we're not going to resort to any damn placer mining as long as we could pick up these major aggregations of gold." That's the way Berkshire works, and I hope the placer mining era will never come.

Somebody once subpoenaed our staffing papers on some acquisition, and of course, not only did we not have any staffing papers, we didn't have any staff.