Buffett: Financial companies are more difficult to analyze than other companies. They can report whatever earnings they want – it’s an easy game to play. For banks, earnings depend on loans and the reserves set aside. It’s easy to change and manipulate the reserves.
With a company like WD-40 or a brick company, the financials are easy to analyze. But with financial [companies] it’s tough, especially when you throw in derivatives.
There were very high grade, financially sophisticated people who were on the boards of the GSEs [Government-Sponsored Enterprises, such as Fannie Mae and Freddie Mac] and they were not negligent, but it’s very tough [to detect the shenanigans that went on].
Charlie and I were on the board of Salomon and Charlie was on the audit committee, and [it’s just impossible to evaluate thousands of transactions]. You’ll just have to accept that with insurance companies, banks and other financial companies – it’s just a more dangerous field to analyze.
With GEICO it’s easier because the statistics are quite accurate – it’s short-tailed insurance. It’s not like asbestos.
I wouldn’t fault the ratings agencies. Even the big-name auditors didn’t catch it.
[Charlie Munger: Where you have complexity, by nature you can have fraud and mistakes. You’ll have more of that than in a company that shovels sand from a river and sells it. This will always be true of financial companies, including ones run by governments. If you want accurate numbers from financial companies, you’re in the wrong world.]
Source: 2005 Berkshire Hathaway Annual Shareholders Meeting
Question: You’ve recently invested in Goldman Sachs and GE. Is the financial sector a good buy right now?
Buffett: No sector is a good buy unless you understand the business. However, I do believe that there is good value and great opportunity now in the financial sector because it is extremely unpopular.
Sector’s themselves don’t make good buys, companies that are undervalued make good buys.
You know how to value a business, you project the future cash flows discounted to present and buy with a margin of safety. The earnings prospects need to be greater than the current value. Anything that is unpopular is always great to look at. If I was getting out of school right now, I would take a look.
Source: Q&A with 6 Business Schools, 2009