TCS Daily

Warren 1 (hundred billion), Kessler 0

By Stephen W. Stanton - May 14, 2003 12:00 AM

A short while ago, I came across Andy Kessler's article titled "Warren Buffet Hates Your Guts". I have always been very proud of my guts, and I had no idea why Buffet could hate them. So, I read the column.

I am still not convinced. The piece relied mainly on conjecture and flawed logic, begging for a Fisking. Like any lazy online journalist, I immediately went after the low hanging fruit.

First, Kessler argues that Buffet intentionally locks small investors out of his company, Berkshire Hathaway, by refusing to split the stock, keeping its share price out of reach. (By that logic, Enron cared more about regular folks.) Of course, Kessler ignores the upside of high-priced stock. Since each share represents a significant amount of wealth, shareholders take their votes seriously. (Many Enron investors, in contrast, never voted their shares, abdicating that responsibility to incumbent management.) With fewer shares, Berkshire Hathaway enjoys a smaller, more easily managed shareholder base. Most importantly, the company currently has no trouble raising capital, so there is no reason for the company to incur higher administrative costs to service one thousand times as many shareholders.

Kessler's argument has an almost Marxist ring to it: Buffet hates the proletariat because a high stock price keeps the means of production in the hands of the bourgeois. Inexplicably, Kessler then does a 180 and attacks Buffet for the exact opposite reason: Buffet wants to preserve inheritance and estate taxes. Of course, death taxes take the accumulated wealth of the bourgeois and redistribute it among the proletariat. Kessler argues that this is proof that Buffet hates everybody, not just the poor. Let me get this straight: Buffet makes the rich richer in life, and then enriches the poor in death. With enemies like that, I can only imagine the benevolence of Kessler's friends.

It does not end there. Buffet also allegedly hates CEOs since he limits the pay of the ones that work for him. That, of course, is hogwash. Every employer has a vested interest in paying employees as little as possible. Buffet did not shoot himself in the foot by underpaying his executives. The individual companies in Berkshire's portfolio have performed spectacularly. Berkshire Hathaway has returned several hundred percent more than the major equity indexes over the past 12 years. The stock even went up over the past two years as the markets tanked. The company gained an average of 12% more than the S&P 500, including dividends, each year since 1965. Who could reasonably believe that fatter paychecks would have made the executives work any harder or make the stock go up any higher?

Kessler stretches his argument ever thinner, maintaining that Buffet advocates expensing stock options because he hates his managers. Here is the (flawed) logic: Putting option grants on the income statement would drive down net income figures, inflate P/E ratios, and potentially hurt stock prices of companies that generously distribute options. This would force companies to curtail the wanton granting of options.

Of course, Kessler implies that investors willing to spend $74,000 for a single share of stock do not look at the notes to financial statements. (Note that in Buffet's Owner's Manual, he declared "Accounting consequences do not influence our operating or capital-allocation decisions.") Regardless of any income statement treatment, the notes to the financials clearly indicate the impact of stock options on current shareholders. Expensing just provides another estimate of that impact, and this accounting treatment is a useful metric recommended by everyone at the department of redundancy department. Besides, you do not have to hate your employees to expect them to earn their paychecks. Investors have every right to squawk at excessive stock options. Hiding these grants in the footnotes is not a friendly thing to do. It isn't "generous" to give away investors' money.

Moreover, option holders have a dramatically different risk profile than stockholders. Option prices are driven by volatility. Stock prices are driven by predictable cash flows. Options expire worthless if the stock price does not move. Therefore, option holders have nothing to lose from a risky strategy and everything to gain. Each stock, on the other hand, is worth something. Shareholders have a lot to lose. Option holders swing for the fences. Stock holders just want to keep the team at bat. Curbing option grants is not anti-employee, its pro-investor.

Kessler goes on to assert that "all insurance companies are a drain on the U.S. economy". (Buffet evidently drains the economy out of spite.) This, too, is hogwash. Every action in business and in life carries both risks and rewards. Many participants in the economy are unable to bear some of the risks to which they are exposed. Without insurance, millions of entrepreneurs would shut their doors. Picture a successful Mom & Pop store, one that reliably generates a good income for a family. Each year, the store may face a one-in-a-hundred chance that a freak accident will cause a million dollars worth of damage, destroying Mom & Pop's entire life savings. After ten years, ten percent of these owners would be utterly destitute. Without insurance, family businesses that plan to operate for decades have two choices: Either build up enough cash to deal with the worst case scenario when it happens (hopefully decades from now), or accept that a random occurrence will make bankruptcy inevitable someday.

Insurance pools these risks and keeps viable entrepreneurs in business. The average expected annual loss in this hypothetical scenario is ten thousand dollars. Every store could easily kick in that amount each year (or even a bit more to make it worthwhile for the insurance company). Thanks to insurance, entrepreneurs will not avoid the industry for fear of losing a million bucks.

Kessler faults Buffet for investing in "unproductive companies", including McDonald's, furniture companies, and underwear makers. (I would ask Kessler to check inside his pants for underwear and under them for a chair.) Kessler calls this "a problem for the U.S.", because the concept of productivity is vital to the economy, though anathema to Buffet. More hogwash. (Are there any dirty pigs left?).

First of all, every solvent company is worth something. When Buffet buys a company at a discount and drives the value up through operational improvements, improved marketing, and better strategic plans, he creates billions in wealth. (The proof is in his track record.) McDonald's is the epitome of productivity, training unskilled labor to make fresh, hot meals affordable to the masses. Prior to Mickey D's, food service was slow, inefficient, and relatively expensive. The company's supply chain, marketing, and production innovations now crank out meals so cheaply that even at minimum wage, it takes less time to earn the cost of a meal than it does to eat it.

Moreover, there is a lot of room for innovation left in the "old economy". I guess Kessler missed Buffet's disintermediation of the auto insurance industry at Geico. Intellectual property does not begin with computers and end with pharmacies. Intellectual property also drives productivity in the manufacture of tangible products. Buffet's management team creates shorter supply chains, leaner production, more efficient distribution, and more appropriate and dynamic strategies for each unit.

Kessler asserts that Buffet supports double taxation of dividends and, by extension, hates retirees. Kessler's only support of this argument is Berkshire's dividend history: The company has never paid dividends. (We're way past our hogwash quota.) That is like saying I must hate parking on my block because I never did. Never mind that I would have incurred a $110 fine each time. Never mind that Buffet would have paid a 40% penalty (aka "tax") on dividends. If I could park there without a ticket, I would. If Buffet could pay tax-free dividends, he might. In fact, he already has.

Berkshire Hathaway already pays what amount to tax-free dividends. The company takes advantage of the corporate tax deduction for charitable gifts. Shareholders may designate a recipient for their share of the company's contributions. In effect, individuals skirt both the corporate and individual level of taxation to contribute to the charity of their choosing. If the individuals made the same gift using dividends paid out of taxable corporate profits, they would have 35% less money to give, even with a full deduction at the individual level. According to the 2002 letter to shareholders, "About 97.3% of all eligible shares participated in Berkshire's 2002 shareholder-designated contributions program". Clearly, Buffet's aversion to dividends has more to do with tax avoidance than spite.

Buffet claims that if dividend tax cuts are enacted, his effective tax rate would exceed his secretary's. Of course, he forgets that Social Security creates an entitlement for his secretary, while he gets nothing for his tax dollars. A better solution would be privatized accounts, granting each employee ownership of his or her contributions. His tax rate would far exceed hers, and Buffet just might be satisfied with that.

Kessler goes on to mention that Buffet backs population control. The point is moot. Espousing a widely held, if dubious, theory of planetary overcrowding does not in any way demonstrate that Buffet hates our guts. More likely, his good intentions have been hijacked and exploited by junk science. Buffet's claim to fame is finance, not biology, physics, anthropology, or agriculture. Where Kessler sees contempt, I see misguided benevolence.

Buffet might hate my guts. More likely, he doesn't know who I am, and he wouldn't hate me if he did. Everybody has a hard time figuring out what goes on inside Buffet's head. We have no chance of knowing what is going on inside his heart.

If anyone is a "mean spirited dude" around here, it's Kessler. Why else would he make bold and unsupported assertions about Buffet's motives? Maybe as a hedge fund manager, Kessler resented Buffet for controlling a stock that offered little profitable opportunities for arbitrage or short selling. Perhaps as a writer, he dislikes Buffet's reluctance to interview. He might be jealous of Buffet's wealth or superior stock picking performance. Kessler might just find Buffet morally reprehensible for his staunch support of abortion. Any combination of these factors could have motivated Kessler to write what he did.

These are all possibilities, but I do not believe any of them. I am not going to put my money on any of these wild theories. I have never spoken with Kessler. He is probably a really nice guy. I have no idea what motivates him. Based on his latest column, I doubt Kessler knows much more about Buffet. I would like to see the details. Prove me wrong.

TCS Daily Archives