Buffett & Munger Expose Investment Lies: Real Returns vs. Pure Fiction

Speaker:
We don't formally have discount rates. I mean, every time I start talking about all this stuff, Charlie reminds me that I've never prepared a spreadsheet, but I do. You know, in in effect, in my mind, I do. But uh we are going to want to get a significantly higher return obviously in terms of cash produced relative to the amount we're outlaying now for a business than we are from a government bond. I mean we you know we are going to we that that has to be the yard stick at a base. Then how much more do we want?

Well, if government bond rates were 2%, we're not going to buy a business to earn three or 3 1/2% expectancy over the years. We just don't want to commit our money that way. We'd rather sit around and wait a little while. Uh if they're four and 3/4%, you know, what do we hope to get over time? Well, we want to get a fair amount more than that.

But I can't I can't tell you that we sit down every morning and and I call Charlie in Los Angeles and say, "What's our hurdle rate today?" I mean we have never used the term uh you know it's a little bit of the the we want enough so that we feel very comfortable if they close on the stock market for a couple of years if interest rates go up another 100 basis points or 200 basis points we're still happy with what we bought and above that I really you know I know it sounds kind of fuzzy but it is fuzzy Charlie yeah the concept of a hurdle rate makes nothing but sense and yet a A lot of terrible errors are made by people who are talking about hurdle rates.

Uh just because you can measure something and guess it doesn't mean that it's the controlling variable and what you're dealing with in a messy world. And uh I don't think there's any substitute [Music] for thinking a whole about a whole lot of investment options and thinking about why one is better than another and what the likely returns are from each etc etc. And the trouble with a hurdle rate concept, not that we don't have one in a sense, uh is that it doesn't work as well as as a system of comparing things.

In other words, if I have something available that I think will give me 8% for sure and I can buy all I want of it and you've got a perfectly good investment that I think will earn seven, I don't have to waste five minutes with you. You're like the mail order service offering the bride through the mail and she's got AIDS. you know, I can go on to some different subject and and it's and so this the concept of opportunity cost is it's so little taught in investment. They teach it in the freshman course in economics in all the major universities, but when you get to the corporate finance departments and so forth, it doesn't lend itself to the kind of mathematics they want to use. So, they ignore it.

that in the real world your opportunity costs are what you want to make your decisions based on. Yeah. And even if you were if you had something that you were really familiar with and were very sure on the 8% 8 and a half wouldn't tempt you if somebody came along. That's a practical matter. It it I've been on as I mentioned I've been on 19 corporate boards.

I would say that of the presentations I've seen and I've seen a lot of them and every one of them had a calculation of internal rate of return. You know, if they'd burned them all, the boards would have been better off. I mean, it it is there is so much nonsense presented because the presenters essentially know what the listeners are desires of hearing and what is needed in order to get through something that the CEO wants to do anyway that you just it's just you just get nonsense figures.

And uh you know, we may get nonsense figures, too, but they're ours. Yeah, and we let me give you an example of that. I have a young friend who sells private partnership interests to investors and he's in a really tough field where it's hard to get decent returns. And I said, "What return do you tell them you're aiming for?" And he said, "20%." And he said, "How did you pick that number?" He said, "If I chose any lower number, they wouldn't give me the money. And there's no one in the world we think can earn 20% with big money. I mean it just so anybody making a promise like that basically we we're going to write off immediately.

Uh uh it's amazing to me what you know in a sense how gullible big investors are, pension funds and so on and that they they have people come around and uh promise them the holy grail and they want it so badly, you know, that they're willing to believe things that just have to be nonsense.