At the 2007 Berkshire Hathaway Annual Meeting, Buffett addressed a topic that confounds many investors: discount rates and hurdle rates. Unlike Wall Street analysts who obsess over these metrics, Buffett made it clear that he and Charlie Munger don’t operate that way.
“We don’t formally have discount rates,” he said. “Every time I start talking about all this stuff, Charlie reminds me that I’ve never prepared a spreadsheet.”
That’s a striking statement. The chairman of Berkshire Hathaway, one of the most successful investors in history, doesn’t rely on spreadsheets to make decisions.
Instead, he evaluates businesses based on their ability to produce cash relative to the price paid, always comparing them to the simplest alternative: government bonds.
“We are going to want to get a significantly higher return—obviously, in terms of cash produced relative to the amount we’re outlaying now for a business—than we are from a government bond,” Buffett explained.
That’s the core of his investment philosophy: if a business can’t generate meaningfully better returns than a risk-free government bond, why bother?
This principle helps Buffett and Munger avoid mediocre opportunities. He put it bluntly: “If government bond rates were 2 percent, we’re not going to buy a business to earn 3 or 3 ½ percent expectancy over the years. We just don’t want to commit our money that way.”
Instead, they’re willing to wait for better opportunities.
Many investors spend hours calculating hurdle rates—setting rigid targets for the minimum acceptable return on an investment. But Buffett doesn’t believe in that kind of precision.
“I can’t tell you that we sit down every morning and I call Charlie in Los Angeles and say, ‘What’s our hurdle rate today?’ I mean, we’ve never used the term.”
Buffett and Munger focus on one simple question: Will we be happy owning this business for years, even if the stock market shuts down? If interest rates rise or the market tanks, will the business still generate enough cash to make it a worthwhile investment? If the answer is yes, then it’s a good purchase. If not, they pass.
Buffett admitted, “I know it sounds kind of fuzzy, but it is fuzzy.” And yet, this “fuzzy” approach has built one of the most successful investment records in history.
You can watch the entire meeting here:
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