Warren Buffett: Why You Must Never Own Chip Stocks

Key Concepts

• Circle of Competence: The domain of knowledge and expertise within which an individual or entity can make sound judgments and decisions.
• "Too Hard" Pile: A category for business opportunities or problems that are too complex or unpredictable to evaluate effectively, and are therefore avoided.
• Owner Mentality: Thinking and acting like an owner of a business, prioritizing long-term value and responsible decision-making.
• Corporate Governance: The system of rules, practices, and processes by which a company is directed and controlled.
• Dual Voting: A share structure where different classes of shares have different voting rights.

The Birth of Intel and the Challenge of Prediction

The speaker recounts being present at the "birth of Intel" through an investment in Grenell, where Bob was the chairman. They invested $300,000 in Grenell's original debentures. Despite knowing Bob and considering him smart, the speaker admits they had no idea how to evaluate Intel's future then, and still don't now. They acknowledge that even Intel itself might have been surprised by recent developments with AMD and their business trajectory. The speaker emphasizes that predicting the future of some businesses, even for those in the industry, is extremely difficult, and they have no idea what Intel will look like in five years.

The Edge of Competency and Avoiding the "Too Hard" Pile

A foreign correspondent once remarked that the speaker and Charlie "don't seem smart enough to do so much better than other people as you're doing." Their explanation is that they "know the edge of our competency better than most people do." The speaker stresses the importance of knowing the limits of one's own knowledge, stating, "It's a very useful thing to know the edge of your competency. And I always say it's not a competency if you don't know the edge of it."

Charlie and the speaker have defined "circles of competence" for evaluating businesses. They acknowledge that there are many businesses they cannot evaluate, and some that they believe very few people can. These are typically businesses where the future is highly likely to differ significantly from the present. They are best at evaluating businesses where they can reasonably expect the fundamentals to remain similar in five or ten years, even if the company grows and undertakes new ventures. For example, they believe a car company will likely be a bigger company in five years, but its core fundamentals will remain the same.

In contrast, they cite the telecom business as an example of a sector that has changed dramatically over the last 15-20 years, making it difficult to predict who would succeed even with hindsight. Charlie describes their approach as having "three boxes at the company: in, out, and too hard. And a lot of things end up in the too hard pile. And it doesn't bother us." They don't feel the need to be good at everything, likening it to an Olympic athlete who excels in one event without needing to master all others. This philosophy is echoed by Tom Watson Sr.'s quote: "I'm no genius, but I'm smart in spots and I stay around those spots."

Empowering Managers and Respecting Expertise

The speaker notes that they have found many managers who, while not claiming to solve every problem, run their businesses "extraordinarily well." They use the example of Pete Legal and Forest River, stating that one should not try to compete with him in his business as he would "kill you." However, Pete Legal doesn't attempt to advise on running the insurance business because it's "not his game." This illustrates their preference for working with people who are highly skilled in their areas of understanding, without any inferiority complex.

Boardroom Dynamics and Owner Mentality

The discussion shifts to boardroom dynamics, highlighting that it's a mix of business and social situations. The crucial question in a boardroom is the extent to which participants "think like owners" and possess sufficient business knowledge for their decisions to be sound. The speaker has observed enormous differences in the "business savvy" and "owner thinking" of individuals in boardrooms over the years. They have not seen a significant difference in behavior based on dual voting structures, suggesting that the quality of thinking is more important than the voting mechanism.

The Role of the Board and the Importance of the Right CEO

The primary responsibilities of a board, according to the speaker, are:

1. Getting the right CEO: This is paramount.
2. Preventing the CEO from overreaching: Even capable CEOs can be tempted to take too much for themselves. However, the speaker emphasizes that a low salary is not the sole criterion; the CEO must be the "right" person and not overreach.
3. Exercising independent judgment on important acquisitions: CEOs, even smart ones, can be motivated by non-rational reasons when making acquisitions.

The speaker expresses disappointment with the performance of American directors in recent years, regardless of dual voting systems.

The Power of Large Shareholders in Corporate Governance

The speaker believes the only effective cure for better corporate governance is for "very large shareholders" to "start really zeroing in on whether those questions I just mentioned are being addressed properly." They argue that focusing on peripheral issues, while potentially entertaining and newsworthy, does not improve American business. However, if the "eight or 10 largest shareholder groups," the "really large institutional investors," take a firm stance, such as refusing to vote for directors due to unreasonable compensation plans, change will occur.

Unfortunately, these large shareholders have been "unwilling to do that." The speaker is amazed to discover that some very large institutional investors have "farmed out their voting" to others, indicating they "don't want to think like owners." This lack of owner mentality from major shareholders has consequences for everyone.

Ethics and Reforms in Corporate Boardrooms

Charlie adds that he doesn't believe reforms will have any effect on "ethics in the corporate boardroom." He notes that there are "fashions in the government's subject" and that the troubles in American corporations won't be fixed by such measures. He cautions that all reforms must consider the "kind of people that are likely to be activist in using new powers," describing that crowd as "a mixed crowd to put it gently."

Conclusion

The core message revolves around the critical importance of understanding one's "circle of competence" and avoiding areas that are too complex or unpredictable. The speakers advocate for a disciplined approach to business evaluation, focusing on businesses with stable fundamentals. They also highlight the significance of owner mentality in boardrooms and the crucial role of large shareholders in driving meaningful corporate governance reforms, rather than relying on superficial changes or the actions of smaller shareholder groups. The effectiveness of corporate governance is ultimately tied to the quality of leadership and the responsible decision-making of those in positions of power, particularly the CEO and the board.