WARREN BUFFETT: 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, in effect, in my mind I do.
But 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 — that
has to be the yardstick at a base. And how much more do we want?
Well, if government bond rates were 2%, we’re not going to buy a business to earn 3% or 3.5%
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. If they’re 4.75%, 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 tell you that we sit down every morning and I call Charlie in Los Angeles and say,
“What’s our hurdle rate today?” I mean, we’ve never used the term.
You know, it’s a little bit of the — we want enough so that we feel very comfortable
if they closed down on the stock market for a couple of years, if interest rates go up another
hundred basis points or 200 basis points, we’re still happy with what we’ve bought.
And above that, I really — I know it sounds kind of fuzzy, but it is fuzzy.
Charlie? CHARLIE MUNGER: Yeah. The concept of a hurdle rate
makes nothing but sense, and yet a lot of terrible errors are made by people who are talking
about hurdle rates.
Just because you can measure something and guess it, doesn’t mean that it’s the
controlling variable in what you’re dealing with in a messy world.
And I don’t think there’s any substitute for thinking about a whole lot of investment
options and thinking about why one is better than another and what the likely returns are
from each, et cetera, et cetera. And the trouble with the hurdle rate concept — not
that we don’t have one, in a sense — is it doesn’t work as well 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 7%, I don’t have to waste 5 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 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 with the kind of mathematics they want to use, so they ignore it.
But in the real world, your opportunity costs are what you want to make your decisions based on.
WARREN BUFFETT: Yeah. And even if you had something you were really familiar with and
were very sure on the 8%, 8.5% wouldn’t tempt you if somebody came along, as a practical matter.
CHARLIE MUNGER: Sure. WARREN BUFFETT: 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, if they’d burned them
all, the boards would have been better off. I mean, there’s so much nonsense presented,
because the presenters, essentially, know what the listeners are desirous of hearing,
and what is needed in order to get through something the CEO wants to do
anyway — you just get nonsense figures. And, you know, we may get nonsense figures,
too, but they’re ours, and we — CHARLIE MUNGER:
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 I said, “How did you pick that number?” And he said, “If I chose any lower number,
they wouldn’t give me the money.” WARREN BUFFETT: 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’re going to write off immediately. It’s amazing to me what — you know, in a sense,
how gullible big investors are, pension funds and so on, in that they have people come around
and 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.