Hi, Philip King (PH) from San Francisco. I’ve got another question about valuation — more specifically, the relation of P/Es to interest rates. I understand that you don’t want to lay down a rigid formula for valuation, but I also know that you don’t want people to think that a multiple of 20 times earnings is cheap, or a multiple of five times earnings is expensive. So, Benjamin Graham, he devised a central value theory that valued the average stock at an earnings yield that’s about a third above bond yields. In other words, that would work out to maybe 11 times earnings, currently. And I know that you’ve compared the average business to a 13 percent bond that’s worth roughly book at 13 percent interest rates, and worth perhaps roughly twice book at 6 percent interest rates. So, given current interest rates of 7 to 8 percent, as they are now, that would tend to imply that stocks are worth perhaps 12 to 13 times earnings. And yet, the acquisitions that I’ve seen in the private market have gone out at more like 17 to 20 times earnings. And I’d like to know, what do you think is the rough range of multiples that make sense? WARREN BUFFETT
Yeah. Well, it isn’t a multiple of today’s earnings that is primarily determinate of things. We bought our Coca-Cola, for example, in 1988 and ’89, on this stock, at a price of $11 a share. Which — as low as 9, as high as 13, but it averaged about $11. And it’ll earn, we’ll say, most estimates are between 230 and 240 this year. So, that’s under five times this year’s earnings, but it was a pretty good size multiple back when we bought it. It’s the future that counts. It’s like what I wrote there, what Wayne Gretzky says, to go where the puck is going to be, not where it is. So, the current multiple interacts with the reinvestment of capital and the rate at which that capital’s invested, to determine the attractiveness of something now. And we are affected in that valuation process to a considerable degree by interest rates, but not by whether they’re 7.3, or 7.0, or 7.5. But I mean, we’ll be thinking much differently if they’re — long-term rates are 11 percent or 5 percent. And — but we don’t have any magic multiples in mind. We’re thinking — we want to be in the business that 10 years from now is earning a whole lot more money than it is now, and that we will still feel good about the prospects of the business at that time. That’s the kind of business we’re trying to buy all of, and that’s the kind of business that we try and buy part of. And then sometimes we buy others, too. (Laughs) Charlie? CHARLIE MUNGER
We don’t do any of that rigid formulaic stuff. WARREN BUFFETT
There’s a general framework, that you can call a formula, in our mind. But we also don’t kid ourselves that we know so much about the specifics that we would actually make a calculation, in terms of the equation. When we bought Coke in ’88 and ’89 we had this idea about what we thought the business would do over time, but we never reduced it to making a calculation. Maybe we should, but I mean, it just — we don’t think there’s that kind of precision to it. We think it’s the right way to think in a general way. And we think, if you try to — if you think that you can do it to pinpoint it, you’re kidding yourself. And therefore, we think that when we make a decision, there ought to be such a margin of safety that it ought to be so attractive that you don’t have to carry it out to three decimal places. We’ll take a couple more and then we’ll have to leave. We’ve got a directors — we have one directors meeting a year and we don’t want to disappoint them.
Zone 4? (Laughs)
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"I skate to where the puck is going to be, not where it has been." ~Wayne Gretzky
In the present, focus on the future and not the past.