A Grilled Buffett
In 2009, the US government was in full panic mode after experiencing one of the worst economic bubbles in history. The government established the Financial Crisis Inquiry Commission, a ten-member commission that was assigned the task of investigating the causes of the 2007-2008 financial crisis. The Commission had the power to subpoena documents and witnesses (businessmen and women, academicians, government officials, etc.) for testimony.
One person the Commission questioned was Warren Buffett.
The interview covered Buffett’s investment in Moody’s, his thoughts on the causes of the financial crisis, his views on financial policies and regulations, and many other topics.
Although the interview took place in 2010 and the Commission reported its findings in 2011, the transcript was not released until much later.
You can read all 103 pages of the interview right here (it’s fascinating).
But in just the first few pages of the transcript, Warren Buffett gives a unique behind-the-scenes look into his investment process.
Buffett invested in Dun & Bradstreet in 1999 and 2000. Founded in 1841, Dun & Bradstreet provides commercial data (e.g. business credit reports, sales & marketing lists, business research reports through its Hoover’s subsidiary) and was one of the first companies to be publicly traded on the New York Stock Exchange.
In 2000, Dun & Bradstreet spun off Moody’s (one of the major credit rating agencies, which D&B bought in 1962) as a separately traded public company – which gave Buffett shares in both Dun & Bradstreet and Moody’s.
The major credit rating agencies (Moody’s, Standard & Poor’s, and Fitch) were heavily criticized during the 2007-2008 financial crisis for giving perfect credit ratings (e.g. AAA) to bad subprime mortgage-backed CDOs – which ended up being a big contributing factor to the financial crisis.
So, the interviewer from the Financial Crisis Inquiry Commission begins his interview with Buffett by asking how he decided to invest in Moody’s and what his involvement with the company has been.
The transcript has been slightly shortened and edited to make it more readable. Enjoy!
BONDI: I understand, sir, that in 1999 and in February 2000, you invested in Dun and Bradstreet.
BUFFETT: That’s correct. I don’t have the dates, but that sounds right. Yes, sir.
BONDI: And am I correct, sir, in saying you made no purchases after Moody’s spun off from Dun and Bradstreet?
BUFFETT: I believe that’s correct.
BONDI: Okay. What kind of due diligence did you and your staff do when you first purchased Dun and Bradstreet in 1999 and then again in 2000?
BUFFETT: Yes. There is no staff. I make all the investment decisions, and I do all my own analysis. And basically it was an evaluation of both Dun and Bradstreet and Moody’s, but of the economics of their business. And I never met with anybody.
Dun and Bradstreet had a very good business, and Moody’s had an even better business. And basically, the single-most important decision in evaluating a business is pricing power.
If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by a tenth of a cent, then you’ve got a terrible business. I’ve been in both, and I know the difference.
BONDI: In 2006, Moody’s began to repurchase its shares, buying back its shares that were outstanding, and they did so from 2006 to 2008, according to our records.
Why didn’t you sell back your shares to Moody’s at that time? I know subsequent in 2009 you sold some shares, but from ‘06 to ‘09, during the buyback, did you consider selling your shares back, and if so, why didn’t you?
BUFFETT: No, I thought they had an extraordinary business, and – you know, they still have an extraordinary business. It’s now subject to a different threat, which we’ll get into later, I’m sure.
But I made a mistake in that it got to very lofty heights and we didn’t sell – it didn’t make any difference if we were selling to them or selling in the market. But there are very few businesses that had the competitive position that Moody’s and Standard and Poor’s had. They both have the same position, essentially. There are very few businesses like that in the world. It’s a natural duopoly to some extent.
Now, that may get changed, but it has historically been a natural duopoly where anybody coming in and offering to cut their price in half had no chance of success. And there’s not many businesses where someone can come in and offer to cut the price in half and somebody doesn’t think about shifting. But that’s the nature of the ratings business. And it’s a naturally obtained one.
It’s assisted by the fact that the two of them became a standard for regulators and all of that, so it’s been assisted by the governmental actions over time. But it’s a natural duopoly.
BUFFETT: The rating agencies, they have models, and we all have models in our mind, you know, when we’re investing. But they’ve got them all worked out, with a lot of checklists and all of that sort of thing. I don’t believe in those, myself.
All I can say is, I’ve got a model in my mind. Everybody has a model in their mind when they’re making investments. But reliance on models, you know, work 98 percent of the time, but they never work 100 percent of the time. And everybody ought to realize that, that’s using them.
So what conclusions can we draw from this behind-the-scenes look?
First, Buffett’s investment process is incredible. Every other investment firm in the world has research analysts, market strategists, complex financial models, fully staffed deal teams, and intense investment committees.
Buffett, on the other hand, does all of his own analysis and uses the model in his own head. Amazing.
Second, Buffett tells us that “the single-most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business.”
Moody’s Pricing Power
Moody’s has pricing power because it has a duopoly of the credit ratings market with Standard & Poor’s (and to a lesser extent Fitch). If you want a credit rating, you basically have to go to Moody’s or S&P, because they are the industry standard and often are the only credit ratings that are accepted by investors, regulators, and others.
In fact, Moody’s, S&P, and Fitch are the only nationally recognized statistical rating organizations (NRSRO) designated by the SEC. So someone new could come in and set up a ratings agency and charge 50% what Moody’s and S&P charge, but they just wouldn’t get any business.
As a kid, Buffett used to sit on the porch of his friend’s house and watch the cars and the street trolley pass on the street in front of the house during rush hour. One day he said to his friend’s mom, “All that traffic. What a shame you aren’t making money from the people going by. What a shame, Mrs. Russell.” Even little 9-year-old Warren was thinking about businesses, and he wanted his friend’s mom to set up a toll booth. And that’s how he’s always thought about businesses and investing.
Buffett’s always sought businesses with large economic moats – businesses that have a large, unique, and sustainable competitive advantage that ultimate results in pricing power and high returns on invested capital.
If you’d like to read the rest of the interview, then click here or read on below. Thanks for your continued support of Vintage Value and be sure to share this article with a friend or on social media!