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Wednesday, May 5, 2021
Any business proposition is worthwhile for the right price
In one of the more light-hearted moments of Berkshire Hathaway’s annual shareholders meeting on Saturday, Ajit Jain, vice chairman of Insurance Operations, was asked if he’d be willing to underwrite the insurance to cover Elon Musk’s SpaceX mission to Mars, assuming Musk asked.
“This is an easy one,” Jain said. “No, thank you. I’ll pass.”
However, billionaire investor and Berkshire Chairman Warren Buffett took a different perspective.
“Well, I would say it would depend on the premium,” he said.
This is a good example of how value investors think. Before deciding on a business proposition, they consider the price of the offer relative to what they estimate is the intrinsic value of the business, regardless of how unappealing that business may seem.
In his 1989 letter to Berkshire Hathaway shareholders, Buffett offered an illustration of how this thinking might be applied: “If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the ‘cigar butt’ approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the ‘bargain purchase’ will make that puff all profit.”
In insurance, the question is if the premium paid would make it worthwhile to take the risk of having to cover potential losses. And so, Buffett is essentially saying that Berkshire should see how high a price Musk and SpaceX would be willing to pay for the coverage. Maybe they’d be willing to overpay.
“I would say that I would probably have a somewhat different rate if Elon was on board or not on board,” he said. “I mean, you know, it makes a difference.”
The comment drew laughter, maybe because people think Musk can be reckless. And therefore, any insurance underwriter may be exposed to a greater degree of risk.
On the flip side — as Bloomberg Opinion columnist Matt Levine articulated — maybe “SpaceX will be more careful if its chief executive officer is on board, so it should be cheaper to insure.”
“It makes a difference,” Buffett said. “I mean… that’s called getting skin in the game.”
We’re not going to attempt to model out what this insurance policy should look like.
But the point of this discussion is that any good investor should consider the price before dismissing what might be a great value proposition.
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