Morning Session

1. Buffett is losing his voice

WARREN BUFFETT: Good morning. I’m Warren Buffett, the chairman of Berkshire Hathaway, as you probably have gathered by now. (Laughs) I had a real problem last night. I was losing my voice almost entirely. I don’t want you to think I lost it cheering for myself this morning here. I think I’ll do all right, but we’ve always got Charlie here to — he’s always done the talking. I just move my lips, you know. (Laughter) So I’d like to tell you a little bit about how we’re going to conduct things. And then we’ll go through a script that was written by the speechwriter for Saddam Hussein. It has all the warmth and charm and participatory elements you’d expect. And we’ll get through the business of the meeting as promptly as we can, which is usually about five or six minutes. And then Charlie and I will answer questions, your questions until noon, when we’ll have a break for about a half an hour. There’s food outside all the time.

And then at 12:30 we’ll reconvene, and we’ll go till 3:30 or thereabouts. And I hope my voice lasts. We’ve got various non-Coca-Cola products here designed to keep it going. We’ll have a zone system where we have 12 microphones placed around, and — I believe it’s 12 — and we’ll just go around in order. And if you’ll go to the microphone nearest you, there will be someone there who will try to arrange the people — get to ask questions in the order in which they arrived. And we’ll make sure that everybody gets a chance to ask their questions before people go on to second questions. Particularly in the afternoon, we’ll make a special effort to answer the questions from people that have come from outside North America. We really got quite an attendance today. All 50 states — at least in terms of tickets — all 50 states are represented. We had — I had it here somewhere.

Yeah, we had ticket requests, at least, and I met a number of people from South Africa, Australia, Brazil, England, France, Germany, Greece, Hong Kong, Ireland, Iceland, Israel, Saipan, New Zealand, Saudi Arabia, Singapore, Sweden, Switzerland. So when people have come from that sort of distance, we want to make sure that they — obviously we want to make sure that they particularly get their questions answered. Interestingly enough, we have an increased percentage from last year who come from Nebraska this year. And you have to be a little careful in interpreting that, because some people say they’re from Nebraska and really aren’t, because for status reasons they, you know, like that. (Laughter and applause) So make them produce their driver’s license if they tell you they came from Nebraska.

2. Formal business meeting begins

WARREN BUFFETT: I think that’s most of the preliminaries, so I’m going to get into this. We’ll get the meeting over with here promptly with your cooperation. And I will go through this little script that’s been prepared for me, and it says, the meeting will now come to order. I’m Warren Buffett, chairman of the board of directors of the company. I welcome you to this 1997 annual meeting of shareholders. I will first introduce the Berkshire Hathaway directors that are present in addition to myself. I’ve introduced you to Charlie already. And the other directors, I believe, are in the front row here. If they’d stand when I mention their names, you can withhold any applause until finished, and then it’s optional. (Laughter) Howard Buffett, Howie you want to stand up? Susan Buffett. Walter Scott. And Malcolm Chace III, “Kim” Chace. And that is our extensive directorate. (Applause) Give them a lot of applause because they don’t get much else for it. It’s a rather low-paying board.

(Applause) Also with us today are partners in the firm of Deloitte and Touche, our auditors. They are available to respond to appropriate questions you might have concerning their firm’s audit of the accounts of Berkshire. Mr. Forrest Krutter is secretary of Berkshire. He will make a written record of the proceedings. Miss Becki Amick has been appointed inspector of elections at this meeting. She will certify to the count of votes cast in the election for directors. The named proxy holders for this meeting are Walter Scott Jr. and Marc B. Hamburg. Proxy cards have been returned through last Friday representing 1,012,050 Class A Berkshire shares and 645,940 Class B Berkshire shares, to be voted by the proxy holders as indicated on the cards. That number of shares represents a quorum, and we will therefore directly proceed with the meeting. We will conduct the business of the meeting and then adjourn the formal meeting. After that we will entertain questions that you might have. First order of business will be reading of the minutes of the last meeting of shareholders, and I recognize Mr. Walter Scott Jr. who will place the motion before the meeting.

WALTER SCOTT JR.: I move the reading of the minutes of the last meeting of shareholders will be dispensed with.

WARREN BUFFETT: Do I hear a second?

VOICES: (Inaudible)

WARREN BUFFETT: We got a second. The motion has been moved and seconded. Are there any comments or questions? We will vote on this motion by voice vote. Those in favor say “aye.”

VOICES: Aye.

WARREN BUFFETT: Opposed? Say, “I’m leaving.” (Laughter) The motion is carried. Does the secretary have a report of the number of Berkshire shares outstanding, entitled to vote, and represented at the meeting?

FORREST KRUTTER: Yes, I do. As indicated, a proxy statement that accompanied the notice of this meeting that was sent by first-class mail to all shareholders of record on March 7, 1997, being the record date of this meeting, there were 1,205,078 shares of Class A Berkshire Hathaway common stock outstanding, with each share entitled to one vote on motions considered at the meeting, and 815,015 shares of Class B Berkshire Hathaway common stock outstanding with each share entitled to 1/200th of a vote on motions considered at the meeting. Of that number, 1,012,050 Class A shares and 645,940 Class B shares are represented at this meeting by proxies returned through last Friday.

WARREN BUFFETT: Thank you. If a shareholder is present who wishes to withdraw a proxy previously sent in and vote in person on the election of directors, he or she may do so. Also, if any shareholder that is present has not turned in a proxy and desires a ballot in order to vote in person, you may do so. If you wish to do this, please identify yourself to meeting officials in the aisles who will furnish a ballot to you. Will those persons desiring ballots please identify themselves so that we may distribute them?

3. Berkshire board elected

WARREN BUFFETT: OK, the one item of business for this meeting is to elect directors. I now recognize Mr. Walter Scott Jr. to place a motion before the meeting with respect to election of directors. WALTER SCOTT JR.: I move that Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace III, Charles T. Munger, and Walter Scott Jr. be elected as directors.

WARREN BUFFETT: It sounds good to me. Is there a second? (Laughter) It has been moved and seconded that Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace III, Charles T. Munger, and Walter Scott Jr. be elected as directors. Are there any other nominations? Is there any discussion? My kind of group. The nominations are ready to be acted upon. If there are any shareholders voting and present, they should now mark their ballots on the election of directors and allow the ballots to be delivered to the inspector of elections. Think we had one or two to collect there. Would the proxy holders please also submit to the inspector of elections a ballot on the election of directors, voting the proxies in accordance with the instructions they have received? Miss Amick, when you are ready you may give your report.

BECKI AMICK: My report is ready. The ballot of the proxy holders in response to proxies that were received through last Friday cast not less than 1,015,697 and 2,300 votes for each nominee. That number far exceeds the majority of the number of the total votes related to all Class A and Class B shares outstanding. The certification required by Delaware law of the precise count of the votes, including the additional votes to be cast by the proxy holders in response to proxies delivered at this meeting, as well as those cast in person at this meeting, if any, will be given to the secretary to be placed with the minutes of this meeting.

WARREN BUFFETT: Thank you, Miss Amick. Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace III, and Charles T. Munger, and Walter Scott Jr. have been elected as directors. After adjournment of the business meeting I will respond to questions that you may have that relate to the business of Berkshire but do not call for any action at this meeting. Does anyone have any further business to come before this meeting before we adjourn? If not, I recognize Mr. Walter Scott Jr. to place a motion before the meeting. WALTER SCOTT JR.: I move this meeting be adjourned.

WARREN BUFFETT: Second?

VOICES: (Inaudible)

WARREN BUFFETT: Motion to adjourn has been made and seconded. We will vote by voice. Is there any discussion? If not, all in favor say “aye.”

VOICES: Aye.

WARREN BUFFETT: Opposed, say “no.” The meeting is adjourned. (Laughter and applause) You’re a very good group. You know, in that movie they said something about $350,000 an hour, and I see you’re conserving your money here by moving this thing right along. (Laughter)

4. Q&A session begins

WARREN BUFFETT: Now we’re going to answer questions. And if you’ll just go to the nearest microphone, and let’s see where we start here. I’m just orienting myself to a map here. And we have area 1 is right here. I might describe this ahead of time. We have six areas on the main floor and we have six areas throughout the balcony. And they sort of work their way back one through six, and then seven starts over here, and then it works its way around to 12. And we look forward to having questions, the tougher the better. And if you always would just identify yourself and where you’re from, and that you’re a shareholder.

5. McDonald’s isn’t as “inevitable” as Coca-Cola and Gillette

AUDIENCE MEMBER: Yes, sir. My name is Tom Conrad (PH) and I’m from McLean, Virginia. And I’m a shareholder. And I asked a question last year, Mr. Buffett, to you. I was struck with what you said, that it takes only three quality companies to be — to invest in to be set for a lifetime. And I asked you the question last year, “Should I wait until the market goes down, or should I get in now?” And you advised to get in now, and the three companies that I chose were Coca-Cola, Gillette and Disney. And because of that advice I was able to afford the ticket to come back this year — (laughter) — to ask you a second question. (Buffett laughs) And my question is this. I’m thinking of —

WARREN BUFFETT: You ought to quit while you’re ahead, but go ahead. (Laughter)

AUDIENCE MEMBER: I’m thinking of expanding to a fourth company. The fourth company that I’m thinking of is McDonald’s. And —

WARREN BUFFETT: I see.

AUDIENCE MEMBER: — I just wanted to ask you if you feel that McDonald’s has the same ability to dominate the way Coca-Cola and Gillette has. And secondly, do you feel that if the answer is yes, that I should wait until the price comes down a bit, or get in now? And that’s my question.

WARREN BUFFETT: Would you it to the eighth of a point, or shall we round off? (Laughter) In the annual report, we talked about Coca-Cola and Gillette in terms of their base business being what I call “The Inevitables.” But that related, obviously, to the soft drink business in the case of Coca-Cola and the shaving products with Gillette. It doesn’t extend to necessarily everything they do. But fortunately in both those companies those are very important products. I would say that in the food business, you would never get the total certainty of dominance that you would get in products like Coca-Cola and Gillette. People move around in the food business, from where they eat, from — they may favor McDonald’s but they will go to different places at different times. And somebody starts shaving with a Gillette Sensor Plus is very unlikely to go elsewhere, in my view. So they do not — you just — you never would get in the food business, in my judgment, quite the inevitability that you would get in the soft drink business with a Coca-Cola. You’ll never get it again in the soft drink business.

I mean, it took a hundred — I guess it’d be 1886, so it’d be about 111 years to get to the point where they are. And the infrastructure’s incredible, and — so I wouldn’t put it quite in the same class, in terms of inevitability. That doesn’t mean — it can be a better stock investment, depending on the price. But you’re not going to get the price from me, and knowing Charlie I doubt if you’ll get the price from him. But we’ll give him a chance. (Laughs) (Laughter) He’s breathing, folks. He’s breathing. (Laughter and applause)

CHARLIE MUNGER: We’ve got this down to a routine. (Laughter) No, I have nothing to add, Warren.

WARREN BUFFETT: OK. (Laughter) I didn’t have anything to say, either. I just took longer. (Laughter)

6. You can pay too much even if a business is “wonderful”

WARREN BUFFETT: How about area 2?

AUDIENCE MEMBER: Mr. Buffett, my name is Pete Banner (PH) and I’m from Boulder, Colorado, and I’m a shareholder. Recently [Federal Reserve Chairman] Mr. [Alan] Greenspan made his comments about exuberance. And it wasn’t long thereafter that you came out in the annual report and made your comments that you felt the market was fully valued or something of that nature. Did you have, or have you had, any communication with Mr. Greenspan regarding the valuation of the stock market?

WARREN BUFFETT: No, the answer to that is no. The last time I — well, I can’t remember precisely when the last time I saw Alan Greenspan was. It was a long time ago. We had one conversation the day of the Salomon crisis, and he was formerly on the board of Cap Cities before he took his job with the Fed — Cap Cities/ABC — so I knew him then, but — You know, it’s very hard to understand what Alan says sometimes, so there’s not much sense talking to him, I mean — (Laughter) He’s very careful about what he says. But I should — I’m glad you brought up the subject of the annual report. Because what I was doing in the annual report is I had talked about Coke and Gillette as being “The Inevitables,” and what wonderful businesses they were. And I thought it appropriate, particularly — the report goes to a lot of people — that they would not take that as an unqualified buy recommendation about the companies, because they’re absolutely wonderful companies run by outstanding managers.

But you can pay too much, at least in the short run, for businesses like that. So I thought it was only appropriate to point out that no matter how wonderful a business it is, that there always is a risk that you will pay a price where it will take a few years for the business to catch up with the stock. That the stock can get ahead of the business. And I don’t know where that point is with those companies or any other companies, but I did say that I thought that the risks were fairly high that that situation existed with most securities in the market, including companies such as “The Inevitables.” But it was designed to be sure that people did not take the remarks that I made about those companies, and just take that as an unqualified buy recommendation regardless of price. We have no intention of selling those two stocks. We wouldn’t sell them if they were selling at prices considerably higher than they are now. But I didn’t want — particularly — relatively unsophisticated people to see those names there and then think, “This guy is touting these as a wonderful buy.”

Generally speaking, I think if you’re sure enough about a business being wonderful, it’s more important to be certain about the business being a wonderful business than it is to be certain that the price is not 10 percent too high or 5 percent too high or something of the sort. And that’s a philosophy that I came slowly to. I originally was incredibly price conscious. We used to have prayer meetings before we would raise our bid an eighth, you know, around the office. (Laughter) But that was a mistake. And in some cases, a huge mistake. I mean, we’ve missed things because of that. And so what I said in the report was not a market prediction in any sense. We never try to predict the stock market. We do try to price securities. We try to price businesses, is what we try to do. And we find it hard to find wonderful, good, average, substandard businesses that look to us like they’re cheap now. But, you know, you don’t always get a chance to buy things cheap. Charlie?

CHARLIE MUNGER: Well, I certainly agree with that. (Laughter) The one thing we can confidently guarantee is that real inflation-adjusted returns from investing in a standard collection of stocks will be lower in the long-term future than they’ve been in the last 15 years or so. This has been an unprecedented period, and there will be some regression toward the mean in average returns from investing in the stock market.

WARREN BUFFETT: American business has done extraordinarily well in the last decade-plus. And that’s a huge plus for securities, because they just represent pieces of those businesses. Interest rates over the last 15 years have fallen. That’s a big plus for stocks. Anytime interest rates go down, the value of every financial asset goes up, in rational calculation. Both of those factors have combined in recent years to produce conditions that enhance the true value of American business. But those are pretty widely recognized now, and after a while — Ben Graham always used to say you can get in more trouble in investment with a good premise than with a bad premise, because the bad premise will shout out to you immediately as being fallacious, whereas with a good premise it’ll work for awhile. You know, businesses are worth more money if interest rates fall and stocks rise. But then eventually the market action of the securities themselves creates its own rationale for a whole — for a large crop of buyers, and people forget about the reasons and the mathematical limitations that were implied in what they — in what got them excited in the first place.

And after a while, rising prices themselves alone will keep people excited and cause more people to enter the game. And therefore the good premise, after a while, is forgotten except for the fact that it produced these rising prices. And the prices themselves take over. He wrote about that and the connection with the 1920s when Edgar Lawrence Smith in 1924 wrote a fine book on why stocks were better than bonds. And that was sort of the Bible of the bull market of the ’20s, and it made sense, if you paid attention to a couple of the caveats which were in Edgar Lawrence Smith’s little book, which related to price. But people tend to forget about the importance of the price they pay as the experience of a bull market just sort of dulls the senses generally.

7. Berkshire discourages “street name” registrations of its stock

WARREN BUFFETT: Zone 3?

AUDIENCE MEMBER: Mr. Buffett, my name is Lola Wells (PH) and I come from Florida. I’m a very minimum stockholder. And I’m curious why stockholders whose stock is held in street name aren’t eligible to make recommendations for your donations.

WARREN BUFFETT: The distinction really isn’t whether their stock is held in street — well, that’s one distinction. The Class B shareholders, as was pointed out in the prospectus originally for the B shares, do not participate in the program. The A shares that are held by the beneficial owner do participate. We obtained a tax ruling — 1981 or thereabouts — that made sure that the — there would be no taxation as a constructive dividend of the amount that shareholders could designate. There always was that possibility that the IRS would take a position that by allowing shareholders to designate a contribution to a charity, that we were giving them something which first would be taxed as a dividend, and then they would later give away. So we have a tax ruling, and that tax ruling applies to shares held by beneficial owners, or by record holders themselves. And we followed that ruling subsequently. I might say it would be sort of a nightmare too, frankly, if we got into street name holders. We’re at the point now where we probably have 30 or 35,000 street name holders of the A, and with the B it’s probably 60,000 or some number like that.

And it would be quite a nightmare to do. And anyone, you know, unless they have margin debt against their stock, they can put it in their own name and we encourage people to do it. One reason we encourage people to do it is that they’ll get their shareholder communications more promptly, too. We find that it’s quite erratic — that the distribution of reports is quite erratic — when handled through brokerage houses to street name holders. So we really do encourage you to have your stock registered in your own name. You’ll get the communications promptly, and if you get the A shares you’ll be able to participate in the contributions program. And don’t minimize your holdings, incidentally. Between the two of us we control the company, so I’m glad to have you here. (Laughter) Charlie?

CHARLIE MUNGER: There’s no ideological bias against the small shareholder. It’s just not technically feasible to do it as a matter of administration.

WARREN BUFFETT: I should point out that the entire shareholder-designated contributions program, really, all of the work in relation to this meeting, I mean, and Ak-Sar-Ben has been terrific. They’ve helped out enormously. But in terms of sending out 11,000-plus tickets to the meeting, the baseball tickets, the planning that goes into it and everything, it’s all done by the people at Berkshire, basically. They pitch in to do all kinds of work. So when you look at that 3,000-plus square foot office — we get help from an internal auditor who works — does not work — in the office. But very few people just do all of their regular jobs, and then they do this on top of it. And they never thought they were getting into this. (Applause) Thank you. We could have a department of 50 people, you know, assigned to something like this. But, the same way — you know, we get thousands and thousands of requests for annual reports, and they all come in, and we’ve got just a few people, and they handle it with courtesy and cheerfulness and I really tip my hat to them.

8. Why Buffett hasn’t written a book

WARREN BUFFETT: Now, let’s go to Zone Four please.

AUDIENCE MEMBER: Good morning. I’m Marshall Patton (PH) from Bandera, Texas. And first I’d like to thank you very much for not only giving us a good investment vehicle, but giving us a good education along the way. And thanks a lot for the two-volume set of the letters to stockholders over the years. It’s required reading around our place. And if you can contain your hostility, I’d like to thank Charlie Munger for — (Buffett laughs) — the copy of his speech to the University of Southern California Business School students back in 1994. It’s also required reading. And I want to ask you, when are you going to write your book?

WARREN BUFFETT: (Laughs) Well, first of all I’d like to comment on Charlie’s talk here. I think every investor in the world ought to read that talk before they invest. I think that’s a classic. And we have copies available for — we mailed it out a year or so ago to the shareholders at that time. But anybody’d like a copy of that talk I’d be glad to supply it. There doesn’t seem to be any need for me to write a book. Everybody else is doing it. (Laughter) We’ve got Janet Lowe here who just wrote the most recent one. You know, at one time or another I said everything I know and a good bit more. So I’ve never felt compelled to do it. I really feel that the annual reports are sort of a book on the installment system. Plus I think very few people write two books, and I have this kind of unwarranted optimism, I guess, that the best is always yet to come and there are a lot more interesting things that are going to happen, and I would hate to preclude commenting on those.

So I think it’s going to be a few years. But I may get around to it at some point. But I think maybe it’d be a bad sign if it happened, because it might be that I really thought that what I was writing about was more important than what was going to happen next. Charlie, are you going to write a book?

CHARLIE MUNGER: No, but your comment about why you are unable to write a book reminds me of the Middle Western fellow who left an unfinished manuscript. And he apologized for not finishing his book, which was entitled Famous Middle Western Sons Of Bitches. (Laughter) And he said he was always meeting a new one — (laughter) — and therefore he could never finish the book. (Laughter and applause)

WARREN BUFFETT: As a courtesy, Charlie and I are leaving each other out of the book that we write. (Laughter) Charlie was — Charlie grew up in Nebraska, and he’s authentic. He has the credentials to prove it. We worked in the same grocery store at different times many years ago.

9. “Realistic” expectations

WARREN BUFFETT: Area 5, please.

AUDIENCE MEMBER: Mr. Buffett, my name is J.P. from Singapore. I flew 24 hours to get here. Mr. Buffett, throughout your life you have repeatedly under promised and over delivered. For many recent years, for example, you’ve targeted Berkshire Hathaway’s long-term book value growth at 15 percent. Yet you have come through at about 24 percent. That is a big gap of 9 percent between your modesty and the outcome. Perhaps the biggest dose of modesty in corporate history. May I ask, why is there such a big gap between your modesty and the outcome? (Laughter)

WARREN BUFFETT: I don’t think it was modesty. I think it was — For one thing, we’ve had a terrific market that has reappraised all businesses in the last ten or 15 years. So when we really started worrying about future performance, the key factor was having larger amounts of capital. And there’s no question that the larger the amount of capital you work with, the more difficult the job is. Now, we were fortunate that that ascension in capital happened to coincide with things that just lifted all the boats substantially. And so we’ve had better luck than I would have guessed we would have had ten years ago, or five years ago. But it’s been aided by a huge tailwind. And absent that tailwind we would not have done as well. I think maybe we would have done relatively as well, but we would not have done as well in absolute terms. And we won’t have that tailwind in the future, I can assure you of that. But we will have a larger amount of capital, which is the anchor that works on it.

So, if Charlie and I could make a deal to increase the intrinsic value of Berkshire at 15 percent a year over the next ten years, we would sign up now. And I don’t want you to even tempt us with lower numbers, because those numbers get astounding. If we paid no dividend at all over a ten-year period, you can figure out where a 15 percent rate would take us. And we hope to get there, but we think that is absolutely the tops. And I think it’s very likely for a period when the market starts underperforming businesses, that the rate could be very substantially lower than that. Charlie, do you want to expand on that?

CHARLIE MUNGER: Well, the questioner came from Singapore, which has perhaps the best economic record in the history of developing an economy. And therefore he referred to 15 percent per annum as modest. It’s not modest, it’s arrogant. (Laughter) Only somebody from Singapore would call it modest. (Laughter)

WARREN BUFFETT: Yeah. Yeah. Be careful, Charlie, or they’ll have a voice vote that we should move to Singapore, I mean — This is the group that wants performance. Large quantities of money are not going to compound at super rates — at super compound rates. Small sums probably aren’t either, but large sums aren’t. And if anybody that manages large sums of money that promises or implies that they can achieve really outstanding returns, you know, I’d stay away from them. The numbers just get too big. And you know, you’ve seen some of that with certain money management organizations in recent years. And you know, 15 percent on an intrinsic value which is substantially greater than our book value gets to be a very, very big number. And we need huge ideas. We don’t need thousands of ideas. I mean, we might need them, but we could never come up with them. So what we look for is the very large idea. But we’re not finding them now. And we’ll keep looking, and every now and then we will find something.

But really, if you think we’re going to have any chance of doing better than 15 percent, and believe me, that is no number that I’d want to sign my name to, but you really shouldn’t — you’re going to be disappointed in Berkshire. And we don’t want to disappoint you, so that’s the reason we try to be realistic about expectations.

10. Pre-Buffett Berkshire shareholders

WARREN BUFFETT: Zone 6?

AUDIENCE MEMBER: My name is Darrell Patrick (PH) from Dayton, Ohio. How many shareholders do you have that have owned Berkshire longer than you and Charlie? And have you ever gotten together with them?

WARREN BUFFETT: How many shareholders have had it longer than we have? Well, we started buying in 1962. And it was seven and — I think the first ticket was at 7 5/8ths or thereabouts. It was 2,000 shares. I’ve got the trading card on the wall, and I paid a dime commission. I can’t believe I was paying a dime commission in those days. We pay a nickel now, on much higherpriced stocks. (Laughter) It’s a good thing I didn’t have a fistfight with a broker about whether to pay it or not. I might have not had those 2,000 shares. We have as a director, Kim Chace, and his family’s holdings in Berkshire go back to, what? Kim, where are you down here? There we are. What year would you —?

MALCOLM CHACE: The ’20s.

WARREN BUFFETT: The ’20s, yeah. The Chace family has been in Berkshire since the ’20s. But I would say — we bought about 70 percent of the — Buffett Partnership, which was a partnership I ran in the ’60s — bought about 70 percent of the company. So that means they were 300,000 shares roughly that were not owned by us. Aside from the Chace family, I’m sure there are people that — I’m sure we’ve got, you know, 50 or 100 shareholders maybe from that earlier dates that are still around, and I’m glad they are. Charlie?

CHARLIE MUNGER: Nothing to add.

11. Buffett’s jet: “Indefensible” to “Indispensable”

WARREN BUFFETT: Area 7, up in the balcony over here.

AUDIENCE MEMBER: Maurus Spence from Omaha, Nebraska. In light of recent stock market volatility, could you give us your definition of stock market risk, and how does your definition differ from the standard definition? Finally, due to Charlie’s recent counter-revelation about jets, are you going to rename “The Indefensible?”

WARREN BUFFETT: Charlie would like to make an announcement on that second point. (Laughs)

CHARLIE MUNGER: Prompted by Al Ueltschi, we are changing the name of the company plane from “The Indefensible” to “The Indispensable.” (Laughter and applause)

WARREN BUFFETT: Yeah, it was Chateaubriand, who, incidentally, was a writer and philosopher in addition to being the father of a piece of meat — Chateaubriand wrote one time, I believe I’m correct on my attribution here, that events make more traitors than ideas. And if you think about that in terms of Charlie’s remark, that the purchase of FlightSafety caused Charlie to have this counter-revelation. It’s an experience that is duplicated many times in life where people flip over very quickly to a new view based on their new circumstances. Now, what was that first question again? (Laughter)

CHARLIE MUNGER: I might add that I have a friend who’s a United Airlines pilot, and he has recently been promoted into the 747-400. Before he started carrying people like you around for hire, he had to train intensively for five weeks. One-hundred percent of his training was in a simulator. They’re that good. So —

WARREN BUFFETT: They better be that good. They cost us about 19 million. I mean, but they’re fabulous. I mean, if you think about — I think it’s 85 percent of the problems that you can encounter in a plane, if you attempted to teach people by actually being in a plane, they wouldn’t be here anymore, so there’s — You want to develop the instincts and responses that can react to 85 percent of the problems, the only place to learn them is in a simulator, and probably the other 15 percent the best place is.

12. “Volatility is a huge plus to the real investor”

WARREN BUFFETT: Now, let’s go back to your first question. Give it to me again.

AUDIENCE MEMBER: The first part was, would you define — give us your definition of stock market risk and how it differs from the standard definition.

WARREN BUFFETT: Yeah. We don’t think in terms of — well, we think first in terms of business risk, you know. We — the key to [Benjamin] Graham’s approach to investing is not thinking of stocks as stocks or part of a stock market. Stocks are part of a business. People in this room own a piece of a business. If the business does well, they’re going to do all right as long as they don’t pay way too much to join into that business. So we look at — we’re thinking about business risk. Now, business risk can arise in various ways. It can arise from the capital structure when somebody sticks a ton of debt into some business, and so that if there’s a hiccup in the business that the lenders foreclose. It can come about just by the nature of the — certain businesses are just very risky. Back in — when there were more commercial aircraft manufacturers, Charlie and I would think of making a commercial airplane, a big airliner, sort of as a bet-your-company risk because you would shove hundreds and hundreds of millions of dollars out into the pot before you really had customers.

And then if you had a problem with the plane, you know, that company could go. There’s certain businesses that inherently — because of long lead times, because of heavy capital investment — that basically have a lot of risk. And commodity businesses have risk unless you’re the low-cost producer, because the low-cost producer can put you out of business. Our textile business was not the low-cost producer. And we had a fine management, and everybody worked hard. We had cooperative unions, all kinds of things. But we weren’t the low-cost producer, so it was a risky business. The guy who could sell it cheaper than we could made it risky for us. So there’s a lot of ways businesses can be risky. We tend to go into businesses that inherently are low-risk, and are capitalized in a way that that low risk of the business is transformed into a low risk to the enterprise. The risk beyond that is that even though you buy — identify — such businesses, that you pay too much for them. That risk is usually a risk of time rather than loss of principal, unless you get into a really extravagant situation. But then the risk becomes the risk of you yourself.

I mean, whether you can retain your belief in the real fundamentals of the business and not get too concerned about the stock market. The stock market is there to serve you, and not to instruct you. And that’s a key to owning a good business, and getting rid of the risk that would otherwise exist in the market. You mentioned volatility. It doesn’t make any difference to us whether the volatility of the stock market, you know, is — averages a half a percent a day or a quarter percent a day or 5 percent a day. In fact, we’d make a lot more money if volatility was higher, because it would create more mistakes in the market. So volatility is a huge plus to the real investor. Ben Graham used the example of “Mr. Market,” which is the — and we’ve used it. I’ve copied it in the report. I copy from all the good writers.

And Ben said, “You know, just imagine that when you buy a stock, that you — in effect, you’ve bought into a business where you have this obliging partner who comes around every day and offers you a price at which you’ll either buy or sell. And the price is identical.” And no one ever gets that in a private business, where daily you get a buy-sell offer by a party. But in the stock market you get it. That’s a huge advantage. And it’s a bigger advantage if this partner of yours is a heavy-drinking manic depressive. (Laughter) The crazier he is, the more money you’re going to make. So you, as an investor, you love volatility. Not if you’re on margin, but if you’re an investor you aren’t on margin. And if you’re an investor, you love the idea of wild swings because it means more things are going to get mispriced. Actually, volatility in recent years has dampened from what it used to be.

It looks bigger because people think in terms of Dow points and so they see these big numbers about plus 50 or minus 50 or something. But volatility was much higher many years ago than it is now. And you had — the amplitude of the swings was really wild. And that gave you more opportunity. Charlie?

CHARLIE MUNGER: Well, it got to be the occasion in corporate finance departments of universities where they developed the notion of risk-adjusted returns. And my best advice to all of you would be to totally ignore this development. Risk had a very good colloquial meaning, meaning a substantial chance that something would go horribly wrong. And the finance professors sort of got volatility mixed up with a lot of foolish mathematics. To me, it’s less rational than what we do, and I don’t think we’re going to change. (Buffett laughs)

WARREN BUFFETT: Finance departments teach that volatility equals risk. Now, they want to measure risk, and they don’t know any other way. They don’t know how to do it, basically. And so they say that volatility measures risk. And, you know, I’ve often used the example that the Washington Post stock when we first bought it had gone — in 1973 — had gone down almost 50 percent from a valuation of the whole company of close to, say, 180 or 175 million, down to maybe 80 million or 90 million. And because it happened very fast, the beta of the stock had actually increased and a professor would have told you that the stock — company — was more risky if you bought it for 80 million than if you bought it for 170 million. Which is something that I’ve thought about ever since they told me that 25 years ago, and I still haven’t figured it out. (Laughter)

13. University of Florida will teach Graham-style investing

WARREN BUFFETT: Incidentally, I should make an announcement on that, because I think that I’ve made a certain amount of fun of financial departments over the years. A fellow named Mason Hawkins who runs Southeastern Asset Management just gave a million dollar gift to the University of Florida, and the state of Florida is matching that with 750,000. So this million-seven-fifty is going to be used to have several courses in what essentially is the Graham approach to investing, I think, starting very soon. So that there will be at least — and there are more than this — but there will be a finance department in this case specifically devoted to teaching the Graham approach. And I think they’re even going to pick up on my suggestion that I stuck in the annual report about having a course on how to value a business and what your attitude toward the stock market should be. So thanks to Mason, who’s done very well managing money, I should add. And there will be at least one university course that tackles what I think are the important questions in investing.

14. Compulsory reinvestment and “owner earnings”

WARREN BUFFETT: Zone 8, please.

AUDIENCE MEMBER: Gentlemen, my name is Richard Sercer from Tucson, Arizona.

WARREN BUFFETT: Let’s give him a hand. This is the gentleman that led to the FlightSafety purchase. (Applause)

AUDIENCE MEMBER: My question relates to owner earnings. What guidance can you give us as to the calculation of item (c), which is maintenance capital spending and working capital requirements?

WARREN BUFFETT: Item (c)? Richard, I was going to ask you a question. How about another company? (Laughter) Richard and his wife Alma have attended, what, maybe eight or so meetings, and what he did is covered in the annual report. But if it had not been for Richard we would not have merged with FlightSafety. And for that we owe him a lot of thanks. Now, the item (c), I don’t remember item (c).

CHARLIE MUNGER: He’s talking about maintenance expenditures and working capital —

WARREN BUFFETT: Yeah, I know.

CHARLIE MUNGER: — and so forth. The compulsory reinvestment.

WARREN BUFFETT: Oh, oh, back on the — goes back some years on that description. Yeah. In the case of the businesses that we’re in, both wholly owned and major investee companies, we regard the reported earnings — with the exception of the — some major purchase accounting adjustment, which will usually be an amortization of intangibles item — we regard the reported earnings — actually the reported earnings plus — plus or minus, but usually plus — purchase accounting adjustments, to be a pretty good representation of the real earnings of the business. Now you can make the argument that when Coca-Cola’s spending a ton of money each year in marketing and advertising that they’re expensing, that really a portion of that’s creating an asset just as if they were building a factory, because it is creating more value for the company in the future, in addition to doing something for them in the present. And I wouldn’t argue with that. But of course, that was true in the past, too. And if you’d capitalized those expenditures in those earlier years, you’d be amortizing the cost of them at the present time.

I think with a relatively low inflation situation, with the kind of businesses we own, I think that reported earnings plus amortization of any — well, it’s really amortization of intangibles. Other purchase accounting adjustments usually aren’t that important. I would say that they give a good representation to us of owner earnings. Can you think of any exceptions in our businesses particularly, Charlie?

CHARLIE MUNGER: No. We have — after some unpleasant early experience, we have tried to avoid places where there was a lot of compulsory reinvestment just in order to stand still. But there are businesses out there that are still like that. It’s just that we don’t have any.

WARREN BUFFETT: Yeah. I would say that in the case of GEICO, for example, the earnings — the gain in intrinsic value — will be substantially greater than represented by the annual earnings. Whether you want to call that extra amount owner earnings or not is another question. But as we build float from that business, as long as it’s represented by the same kind of policyholders that we’ve had in the past, there is an added element to the gain in intrinsic value that goes well beyond the reported earnings for the year. But whether you want to really think of that as earnings, or whether you just want to think of that as an increment to intrinsic value, you know, I sort of leave to you. But I would say that there’s no question that in our insurance business, where our float was $20 million or so when we went into it in 1967, and where it is now, that there have been earnings, in effect, through the buildup of the float that have been above and beyond the reported earnings that we’ve given to you. I think our look-through earnings are — they’re very rough.

And we don’t try to — we don’t believe in carrying things out to four decimal places where, you know, we really don’t know what the first digit is very well. So, I don’t want — I never want you to think of them as too precise, but I think they give a good rough indication of the actual earnings that are taking place, attributable to our situation every year. And I think the pace at which they move gives you a good idea as to the progress, or the lack of progress, that we’ve made. The only big adjustment I would make in those is in the super-cat insurance business, we’re going to have a really bad year occasionally. And you probably should take something off all of the good years, and you probably should not regard — when the bad year comes — you should not regard that as something to be projected into the future. Charlie?

CHARLIE MUNGER: No more.

WARREN BUFFETT: No more.

15. Ratings after Walt Disney’s purchase of ABC

WARREN BUFFETT: Zone 9, please.

AUDIENCE MEMBER: Mr. Buffett, I’m Rick Fulton from Omaha. Really. Recently I was in Washington, D.C. on — with my wife on a business trip, and I wanted to tell Mrs. Graham, I know she’s here, what a pleasure it is to get up in the morning to a good newspaper like the Washington Post. Also, I have a question about CapCities and now Disney. And is Mr. Murphy keeping busy now that ABC’s owned by Disney? (Buffett laughs) Also, every week you read in the paper the Nielsen ratings. And does it matter that ABC now, it seems that less people recently are watching? Does it matter to Disney’s bottom line? Thank you.

WARREN BUFFETT: Well, the first question about Mr. Murphy is that if we could hire Mr. Murphy we would. I mean, there is no one in this world that is a better manager than Tom Murphy, or a better human being as far as that’s concerned, so — He — I think he’s keeping pretty busy. He has been responsible for NYU Hospital. He wouldn’t say that, but he’s been the chairman of it for some years, and that’s a $800 million a year or thereabouts organization. Charlie runs a hospital, so he knows how busy it can keep you. And he — but I would say this, that I would love to find a business that I could entice Murph to come back and run. Because they don’t get any better than he is. And Charlie, you want to add anything on Murph, or?

CHARLIE MUNGER: Well, I’d like to because you’re absolutely right. (Laughter)

WARREN BUFFETT: And what was the other part of the question?

AUDIENCE MEMBER: Sir, does recent — the decline in ABC’s Nielsen ratings —

WARREN BUFFETT: Yeah.

AUDIENCE MEMBER: — have anything to do with the bottom line?

WARREN BUFFETT: Are we talking (inaudible) —

AUDIENCE MEMBER: — (inaudible) Forrest Gump last night? (Laughter)

WARREN BUFFETT: Yeah, it makes a difference, sure. Ratings translate in many cases into, not — depends on daypart, depends on a whole bunch of things. But overall, you make more money if your ratings are good in news, if they’re good in early morning, if they’re good in daytime, if they’re good at late evening, whatever. I mean, ratings translate into money. They may not translate immediately, particularly if they have some big hit show you may have sold it out too cheap. But over time the prices you receive for your product relate to ratings. And over time, but over a longer period of time, the price that you pay for the product also relates to the ratings. But there’s a difference in the time cycle. So that it makes a difference to any network’s bottom line what their ratings level is. Disney is conscious of that, and they are very able operators, and I predict you’ll see in a couple of years. But you can’t it immediately.

The schedule fixes don’t work on a, you know, week to week basis because people have habits, and there’s a time lag involved in any change. And you’ve seen — over the last 20 years — you’ve seen various networks on top or on the bottom from time to time. So it moves around. It moves around a fair amount. Charlie?

CHARLIE MUNGER: Yeah, I think the TV network business is intrinsically a pretty tough business. And Disney did way better on ESPN than they might have forecast, and they probably did a little worse on the network. These things happen.

WARREN BUFFETT: That was, incidentally, the situation when CapCities bought ABC. In 1985, we made the deal, I think, and it closed — I think it closed the first day or two of ’86. I may be wrong on that. But the network diminished — the ratings — diminished significantly, and particularly in daytime. We’d always thought daytime was almost a certainty to produce big earnings, and it had. Primetime is what people pay the most attention to, but daytime slipped significantly after we bought it. It has no relationship to those movies — I mean, to a movie you saw earlier — when I started appearing on it. Don’t want anybody to make that connection, but it did happen to be at the same time. The kicker we got, again, was ESPN. ESPN was losing money when CapCities made the deal to buy ABC, and we never really regarded it as being that — having that big a potential. And you know, it has been huge. It was enormously better for us than we ever anticipated. Leonard Goldenson, who ran ABC, told us it was going to be that good.

But, of course, we were too smart to pay any attention to him. And I think Disney has been pleasantly surprised by how well ESPN has done, too. It’s a powerhouse.

16. Creation of Class B shares similar to a stock split

WARREN BUFFETT: Zone 10, please.

AUDIENCE MEMBER: My name is Bill Turan (PH). I’m from Des Moines, Iowa, and I’m a stockholder. It would appear that there’s going to be a capital gains tax cut. If it does materialize, would you consider a stock split? (Buffett laughs) Secondly, is there an extra copy of your annual report available on the premises?

WARREN BUFFETT: My guess is we’ll get you an annual report. In fact, if someone could take it up to zone 10, we’ll be glad to get it to you. I don’t think — well, I’ll put it this way. If they cut the capital gains tax to zero, we’ll maybe — (Laughter) I don’t think I’d get Charlie’s vote though, anyway. No, we will not be splitting Berkshire stock. (Applause) Incidentally, we do not consider splitting the stock a pro-shareholder move. If we did, we’d do it. We think that net, to take the entire experience, it’s worked out well for shareholders, and we think we have a more investor-oriented — or investment-oriented — audience in this room today than we would have had if we’d split many times. It is a way of enticing certain types of investors, and perhaps discouraging others. And so it’s worked well. But I will say this, too. We got pushed into, in effect, issuing the Class B shares last year.

Wasn’t our — wouldn’t have been something we would have done, except for the possible formation of the unit trust. And I would say that’s worked out very well from our standpoint. So we’re happy that it happened, and we’re happy that the Class B shareholders have joined us. And we now have something that’s denominated, you know, at a much lower level. And there have been no bad effects whatsoever from having the Class B out there. So anybody owns the A stock and wants to split, you can split 30-for-1 this afternoon. I mean, how many other companies give you that chance? Charlie?

CHARLIE MUNGER: I think what he’s trying to tell you is that you’ve had your stock split. (Laughter)

17. We don’t know how to value Intel and Microsoft

WARREN BUFFETT: Zone 11, please.

AUDIENCE MEMBER: Yes, Mr. Buffett, I would like to thank you again for issuing the Class B shares.

WARREN BUFFETT: (Laughs) Well, I’m glad we did, and I hope you own them.

AUDIENCE MEMBER: I am a class B shareholder. I need your comment on some analysis that we did. If someone uses your investment philosophy of building a highly concentrated portfolio of six to eight stocks, and adopts your buy-and-holding principle so that the max of compounding and no tax works for you, but however, with one major modification: invest in high-octane companies like Intel and Microsoft that are growing at 30 percent, instead of typical 15 percent growth company in your portfolio. My question is, will this investment philosophy will translate into twice the shareholder return as you have historically provided to your shareholders?

WARREN BUFFETT: Yeah. Well, it will certainly work out to twice the return if Intel and Microsoft do twice as well as Coke and Gillette. I mean, it’s a question of being able to identify businesses that you understand and feel very certain about. And if you understand those businesses, and many people do, but Charlie and I don’t, you have the opportunity to evaluate them. And if you decide they’re fairly priced and they have marvelous prospects, you’re going to do very well. But there’s a whole group of companies, a very large group of companies, that Charlie and I just don’t know how to value. And that doesn’t bother us. I mean, you know, we don’t know what — we don’t know how to figure out what cocoa beans are going to do, or the Russian ruble, or I mean, there’s all kinds of financial instruments that we just don’t feel we have the knowledge to evaluate. And really, you know, it might be a little too much to expect that somebody would understand every business in the world.

And we find some that are much harder for us to understand. And when I say understand, my idea of understanding a business is that you’ve got a pretty good idea where it’s going to be in ten years. And I just can’t get that conviction with a lot of businesses, whereas I can get it with relatively few. But I only need a few. As you’ve pointed out, you only need a few, six or eight or something like that. It would be better for you — it certainly would have been better for you — if we had the insights about what we regard as the somewhat more complicated businesses you describe, because there was and may still be a chance to make a whole lot more money if those growth rates that you describe are maintained. But I don’t think they’re — I don’t think you’ll find better managers than Andy Grove at Intel and Bill Gates at Microsoft. And they certainly seem to have fantastic positions in the businesses they’re in. But I don’t know enough about those businesses to be as sure that those positions are fantastic as I am about being sure that Gillette and Coca-Cola’s businesses are fantastic.

You may understand those businesses better than you understand Coke and Gillette because of your background or just the way your mind is wired. But I don’t, and therefore I have to stick with what I really think I can understand. And if there’s more money to be made elsewhere, I think the people that make it are entitled to it. Charlie?

CHARLIE MUNGER: Well, if you take a business like Intel, there are limitations under the laws of physics which eventually stop your putting more transistors on a single chip. And the 30 percent per annum, or something like that, you — I don’t think — those limitations are still a good distance away, but they’re not any infinite distance away. That means that Intel has to leverage its current leadership into new activities, just as IBM leveraged the Hollerith machine into the computer. Predicting whether somebody’s going to be able to do that in advance is just — it’s too tough for us.

WARREN BUFFETT: Bob Noyce —

CHARLIE MUNGER: We could (inaudible) to you.

WARREN BUFFETT: Bob Noyce, one of the two founders of — two primary founders — of Intel, grew up in Grinnell, Iowa. I think he’s the son of a minister in Grinnell, and went through Grinnell College and was chairman of the board of trustees of Grinnell when I went on the board of Grinnell back in the late ’60s. And when he left Fairchild to form Intel with Gordon Moore, Grinnell bought 10 percent of the private placement that funded — was the initial funding for Intel. And Bob was a terrific guy. He was very easy to talk to, just as Bill Gates is. I mean, these fellows explained the businesses to me, and they’re great teachers but I’m a lousy student. And they — I mean, they really do. They’re very good at explaining their businesses. Bob was a very down to earth Iowa boy who could tell you the risks and tell you the upside, and enormously likeable, a hundred percent honest, every way. So we did buy 10 percent of the original issue.

The genius that ran the investment committee and managed to sell those a few years later, I won’t give you his name. (Laughter) And there’s no prize for anybody that calculates the value of those shares now. Incidentally, one of the things Bob was very keen on originally, in fact he was probably the keenest on it, was he had some watch that Intel was making. And it was a fabulous watch, according to Bob. It just had one problem. We sent a guy out from Grinnell who was going out to the West Coast to where Intel was. And Bob gave him one of these watches. And when he got back to Grinnell he wrote up a report about this little investment we had, and he said, “These watches are marvelous.” He said, “Without touching anything, they managed to adapt to the time zones as they change as we went along.” In other words, they were running very fast, as it turned out. (Laughter) And they worked with that watch for about five or six years, and they fell on their face.

And as you know, you know, they had a total transformation in the mid-’80s when the product on which they relied also ran out of gas. So, it’s not — And Andy Grove has written a terrific book, incidentally, “Only the Paranoid Survive,” which describes strategic inflection points. I recommend that every one of you read that book, because it is a terrific book. But they had an Andy Grove there who made that transformation, along with some other people. But that doesn’t happen every time. Companies get left behind. We don’t want to be in businesses where companies — where we feel companies can be left behind. And that means that, you know — and Intel could have, and almost did, go off the tracks. IBM owned a big piece of Intel, as you know, and they sold it in the mid-’80s. So, you know, here are a bunch of people that should know a lot about that business but they couldn’t see the future either. I think it’s very tough to make money that way, but I think some people can make a lot of money understanding those kinds of businesses.

I mean, there are people with the insights. Walter Scott, one of our directors, has done terrifically with a business that started, you know, just a gleam in the eye maybe ten or 12 years ago here in Omaha, and it turned into a huge business. And you know, Walter explained that to me on the way down to football games, but bad student again, so — (Laughs) Walter — if Walter could have connected, and you know, I’d cheer from the stands. But that doesn’t bother me at all. I mean, what would bother me is if I think I understand a business and I don’t. That would bother me. Charlie?

CHARLIE MUNGER: Well, having flunked when we were young and strong at understanding some complex businesses, we’re not looking to master what we earlier failed at — (laughs) — in our latter years. (Laughter)

WARREN BUFFETT: Zone 12? This may turn out like a revival meeting where we all confess our sins and come forward (inaudible). (Laughter)

18. Confident about Salomon but not rest of Wall St.

AUDIENCE MEMBER: Good morning, gentlemen. My name is Cary Blecker (PH) from Wellington, Florida. I know in 1987 when you purchased — or invested — in the Salomon Brothers convertible preferred stock, you had the eight-year time frame to convert it into common or take the cash out. I know in ’95 you took cash out, which was not a vote of confidence for Salomon Brothers. Any feelings on that in the future?

WARREN BUFFETT: Yeah. We — as the gentleman mentioned, we bought it in 1987, and starting in 1995 we have a — we have, every year for five years, we either have to take cash or convert to common, 20 percent of the original issue of 700 million. We don’t have to make those decisions ahead of time. So we, in 1995, we elected to take cash. In 1996 we elected to take stock. And you know, we see no reason ever to swing at the ball while it’s still in the pitcher’s glove. We’d just as soon wait till it gets to the plate to make the decision. So the ball will get to the plate on October 31st of 1997, I believe, for the next 20 percent. And we’ll decide whether to swing at that point. But we don’t need to make that decision today. I would say that, you know, the odds are overwhelming that we’ll convert, but we’ll wait until that time to make the final decision. We have terrific confidence in the people that run Salomon.

They helped us through some incredibly dark days in the past, and showed the stuff of which they were made. And so we feel very good about that. We don’t have the same degree of conviction about the profitability of the investment banking or brokerage business as a whole. It’s not the sort of — you don’t develop that kind of conviction about that business versus a Coca-Cola or something. They’re different. They have different economic characteristics. So we will see how the businesses — the industry — evolves. But we feel very good about the management, and the odds are extremely high that we will convert. But we will swing at the ball when it gets to the plate. Charlie?

CHARLIE MUNGER: No more.

WARREN BUFFETT: OK.

19. Can’t exchange stocks without paying taxes

WARREN BUFFETT: Let’s see. We did 12. We’re back at 1 again.

AUDIENCE MEMBER: My name is Ted Vokali (PH) from Corpus Christi, Texas. And I would like to ask a question to you. Companies are purchased from time to time, and the purchasing company will give shares instead of cash, and their shareholder will receive new shares. Can an individual investor transfer non-Berkshire to Berkshire with or without going through a broker? And if not, how does Berkshire do this with another company? And if possible, I would like to also receive a copy of the annual report.

WARREN BUFFETT: OK, we’ll get you a copy of the annual report. The only way I know of — and maybe Charlie knows some other way — the only way you can switch your shares in one company for — into shares of another company is to have a tax-free merger. And the Internal Revenue Code has specifications about that. You can have a transaction, as we had with FlightSafety where a portion is — of the shareholders — can take cash, and a portion can take stock, and it’s still tax-free for the people who elect stock. You can’t have too many people take cash and have that happen. There are a lot of technical rules about what’s tax-free. But there’s no way that you can own General Motors and transfer it into General Electric stock without a tax and a broker. Well, you don’t have to have a broker. If your neighbor happens to own it you could make a deal privately. But the easiest way usually is through a broker. But there’s no way you can do it without tax, unless General Motors and General Electric decide to merge at some point.

So the opportunities to switch from one security to another without tax are really limited to merger. And in terms of brokerage costs, it just happens to be that it’s — that the most economical way of finding the person in the world that wants to both buy the stock you want to sell and sell you the stock you want to buy is through an intermediary — a broker. And the costs of that actually can be relatively low. Charlie?

CHARLIE MUNGER: Well, I think there’s one way still permitted by the tax laws. You can still form a partnership. If you own General Electric and I own General Motors and we each feel too concentrated, well, you could form a partnership and each put in your stock. And in essence you would each thereafter be invested half and half with some diversification. I will predict that Wall Street will eventually get around to promoting such partnerships.

WARREN BUFFETT: Yeah, well, they did through swap funds, you know, since 25 years ago. And then — that was where you put in your highly — your stock that had an enormous amount of unrealized appreciation in it, and a whole bunch of other people did, and then you owned a fund which itself had a lot of unrealized appreciation in it. And you had —

CHARLIE MUNGER: Plus a new layer of costs.

WARREN BUFFETT: Yeah, plus a new layer of costs, always. And you owned a piece of this larger fund, and you owned a piece of everything else — everything that the other people wanted to get rid of, and they owned a piece of what you wanted to get rid of, and superimposed with some costs. But that vehicle was sort of stopped in its tracks, I think, in the mid-’70s by an amendment to the Internal Revenue Code. But as Charlie said, you could replicate the effect of a swap fund by doing it with a partnership. It’d be kind of awkward, but it can be done.

20. Strong businesses, but no “master plan”

WARREN BUFFETT: Zone 2?

AUDIENCE MEMBER: Gentlemen, I’m Marc Rabinov from Australia. I am a shareholder. I had a question really related to our own businesses, and how they’re going, and where you’re looking to be in ten years’ time. Perhaps I could start with the insurance float. It’s grown at 20 percent. Do you think that 20 percent growth rate will continue for the next ten years? Do you think our stable businesses, which have been growing at, say, 5 or 7 percent will maintain that rate? And do you think FlightSafety, which from the SEC filings has been growing at about 5 percent, do you think that’ll continue at that rate?

WARREN BUFFETT: Well, we’re glad to have you from Australia. I think we’ve got about 15 people here from Australia, so it — got a good representation. I don’t think the insurance float can grow at 20 percent a year. That’s been helped by some acquisitions and things. I mean, it’s done way better, obviously, than we ever thought it would 30, almost 30 years ago when we made the deal with Jack Ringwalt. I would say, though, that I think GEICO is going to do even better than we expected when we bought it. And we thought it was going to do awfully well then. In Tony Nicely, you know, we have an absolutely outstanding manager of that business. And he is focused on it. He knows it. I think he went to work there when he was 18. And he’s been there 35 years or thereabouts. They don’t come any better. And he is absolutely zeroed in on the things that he should be zeroed in on, and he’s — the implementation gets better all the time.

I mentioned in the annual report that the unit growth of GEICO’s voluntary auto business — and we talk about voluntary because you get assigned risk-type things that lose you money, but the real business is the voluntary auto business — grew at 10 percent last year, which was the best growth rate in over two decades. First four months of this year, it’s growing at about 16 percent. And 16 percent unit growth translates into about 20 percent a year premium growth. So GEICO at present would give you some encouragement for at least that segment of the insurance float growing at a rate that’s sort of comparable to the past. Insurance is going to be a very big business for us. And the float will grow, in my view, at a good rate. But I wouldn’t want to predict that good a rate. Most of our other businesses, very good businesses. They don’t have 20 percent a year growth possibilities in them. They throw off lots of cash, which we can use to buy other things, which may turn out to be a better strategy than even having a single high-growth business.

FlightSafety, about six weeks ago or thereabouts, announced a major hookup in a joint venture with Boeing, as you may have noticed. And they’re a terrific partner, and it’ll be a great partnership. That’s just for our — the training for our — for larger planes, primarily, I think, hundred-seat and up planes, although I think there may be a few Fokkers in there that are slightly smaller planes. But it’s basically the big commercial planes. And the combination of FlightSafety and Boeing worldwide in training over the coming decades, I think, will be a very powerful combination. So we’ve got some very good businesses. And I don’t see that movie that’s presented before — I sit out here like you and watch it. But I like the ending of it. And the people we have out there, they’ve run businesses extremely well in the past. They get better results out of those businesses, frankly, than other people would, or that other people in the industry generally do. So I think they have good futures. But they will throw off lots of cash in aggregate.

And the tough job — we like to tell people it’s the tough job anyway — is that Charlie and I have to figure out where to put that cash to maintain higher — reasonable — growth rate.

AUDIENCE MEMBER: (Inaudible)

WARREN BUFFETT: Could you — I’m not sure that’s — could you turn that on, please, so that —

MARK RAVENHILL: I’m sorry to pin you down, but —

WARREN BUFFETT: That’s OK. You can pin me down.

AUDIENCE MEMBER: — would you guess that FlightSafety, then, is more likely to be in that 10 to 15 percent ballpark?

WARREN BUFFETT: Well, it’s hard to tell on numbers. I mean, certainly there’s going to be growth in pilot training around the world. But FlightSafety already has a significant portion of the corporate market, for example. So it would be hard to grow a lot faster in the corporate market, although I can hear Al grinding his teeth, you know, when I say that, because he plans to grow a lot faster than the market. But the corporate market, we’ve got a significant percentage. Commercial market, there could be a lot of potential in. You know, it won’t come tomorrow or the next day. But, you know, ideally we would like to see people when they buy a 777 or 747 or something, buy a lifetime pilot training contract at that time. So I wouldn’t want to stick a number on it, but I’ve got high hopes. And FlightSafety also announced recently a very major contract with the government through Raytheon. So it’s a company that’s got its sights set a lot higher than where it is now.

AUDIENCE MEMBER: And insurance, 15 percent? (Inaudible)

WARREN BUFFETT: Will you — you want tenths of a percent or will you — (Laughter) We just don’t know. I mean, we didn’t know 25 — we didn’t — 30 years ago we didn’t know we would be in the insurance business. I mean, Berkshire, we have no master plan. And Charlie and I did not sit down in 1960 — early ’65 — and say, “We’re going to do this and that,” and all that. We’re going to do — we’re going to try and do sensible things as we go along. The more money we have, the harder it is to find sensible things. But that’s the criteria. Insurance is certainly a major area of opportunity for us. It’s been a major opportunity. We have — in certain fields we have a terrific advantage for the three reasons I laid out in the annual report. But I mean, we have capital strength, and a willingness to take on risk, and a speed of action, and a certainty of payment, that in aggregate no one matches.

Now, how much demand there is for that depends on circumstances in the business and how much supply there is at lower prices that we think don’t make sense is another question. But I think we’ll do OK in insurance over time.

21. Most money managers have “gotten a lot for nothing”

WARREN BUFFETT: Zone 3?

AUDIENCE MEMBER: Mr. Buffett, Mr. Munger, I’m Tim Medley from Jackson, Mississippi.

WARREN BUFFETT: We’re glad to have you back, Jim — Tim. How many years have you come?

AUDIENCE MEMBER: This is my 11th.

WARREN BUFFETT: Good.

AUDIENCE MEMBER: They’ve been 11 great years. Thank you very much. At this meeting four or five years ago, you commented that money managers in the aggregate have not done better than various market indices. And you attributed this, in part, to the frictional cost inherent in an actively-managed portfolio. I wonder if today you would update your thoughts on this. And do you think that this underperformance compared to index funds will continue? And then a related question, if the two of you were giving advice to a classroom of equity mutual fund managers, are there two or three things in particular that you would want to suggest to them?

WARREN BUFFETT: Yeah. Well, I would say this. Money managers, in the last few years since I made that statement, have not disappointed me. (Laughter) In aggregate, they have underperformed index funds. And it’s the nature of the game. They simply cannot overperform, in aggregate. There are too many of them managing too big a portion of the pool. And for the same reason that the crowd could not come out here to Ak-Sar-Ben in the past years and make money, in aggregate, because there was a bite being taken out of every dollar that was invested in the parimutuel machines, that people that invest their dollars elsewhere through money managers in aggregate cannot do as well as they could do by themselves creating their own index fund, or it would be easier to have — just to buy into an index fund. It’s — you know, they say in this world you can’t get something for nothing. But the truth is money managers, in aggregate, have gotten something for nothing. I mean, they’ve gotten a lot for nothing.

And — (applause) And people — investors have paid — and the corollary is investors have paid something for nothing. And that doesn’t mean that people are evil. It doesn’t mean that they’re charlatans or anything. It’s the nature, if you got a 6 or $7 trillion, or whatever it may be, equity market, and you have a very significant percentage of it managed by professionals, and they charge you significant fees to invest with them, and they have costs when they change around. They cannot do as well as unmanaged money, in aggregate. And it’s the only field in the world that I, you know, that I can think of — Charlie’ll think of some others — but where the amateur, as long as he recognizes he’s an amateur, will do better than the professional does for the people whose money he’s handling. And therefore if I were in a — teaching this class or speaking to that class, I would probably tell them that for their own psychological well-being they should probably leave the room. (Laughter) Charlie?

CHARLIE MUNGER: Well, I pretty well said what I had to say on this subject in that talk I gave at USC. And anybody that wants to read that, why, can read it. I will say that one of the things I like about the annual meeting is I get to interface with a whole lot of people that have even lower annual investment management expenses than Berkshire Hathaway the company does. I mean, if you stop to think about it, we’ve got our costs almost to zero, and many of you have gotten it to zero.

WARREN BUFFETT: Yeah, we — Charlie and I would be glad to take any money management organization in the world that manages — oh, just been handed a note that says, “Unfortunately, we don’t have extra annual reports on site. Those shareholders desiring one should call us or write.” So. And we’re also on the internet. You can run it off there, too. So I apologize for not having them on the — here. But they’re easy to get. Just dial 346-1400 and there’s an annual report line, and you’ll have one sent to you. We would be willing to take any money management organization in the world managing 10 billion or more, and in the case of brokerage houses who have their brokers in aggregate handling 10 billion or more, and we would be willing to bet that their aggregate investment experience over the next five years or ten years for the group that they advise will be less — will be poorer — than that achieved by a no-load, very low-cost index fund. And we’d put up a lot of money to make that wager with anybody that would care to step forward.

Gambling may be illegal, but now you can do it through something called derivatives, you see? (Laughter) We could create an instrument that would allow that, even though it might be against the laws of the state of Nebraska. Charlie, would you join me on that or —?

CHARLIE MUNGER: Well, I certainly agree with you. I always say that the — exactly one-fifth have to be in the bottom 20 percent, and — (Laughter) There are certain fundamental forces at work here that — But it is a very peculiar profession where you have to be in a state of psychological denial to shave in the morning if you do the work. I don’t think that’s true for a handful —

WARREN BUFFETT: Well, it isn’t.

CHARLIE MUNGER: — of investment managers. I think we know investment managers who add value. But it’s a comparatively rare and small percentage.

WARREN BUFFETT: Yeah. There — we have identified, in the past even — I mean, on a prospective basis, not retrospective — managers who have added value. And there’s couple of them in this room.

CHARLIE MUNGER: Well, and there’s Lou Simpson of GEICO.

WARREN BUFFETT: Well, he’s the one I had in mind. (Laughter) You can do it. You can’t do it with unlimited amounts of money, and a good record tends to attract money. Even a mediocre record presented by a good salesperson tends to attract money. But there are people working with smaller amounts of money that — (coughs) — where the probabilities are that they will do better than — excuse me. (Clears throat) Where the probabilities are that they will — (clears throat) — do better than average. But they’re very rare. Incidentally, I apologize on this voice. I had to leave Gorat’s early last night, and there were a number of you I was hoping to see. But I just — it was gone entirely last night, and then I — I’d like to tell you I did it by Cherry Coke, but I’ve managed to nurse it back to where it’s working again in reasonable shape.

22. USAir CEO Stephen Wolf has done “terrific” job

WARREN BUFFETT: Zone 4?

AUDIENCE MEMBER: Martha Copeland (PH) from San Francisco. My question involves the headwinds which face USAir. Are you considering redeploying assets? Or how will your management plan to improve this company?

WARREN BUFFETT: Well, we’re just an investor in US — they call it now US Airways — but we’re just an investor. We’ve owned a preferred stock for almost eight years. The company had some very rough going. Charlie and I would not have thought its chances for survival were very good, even some years back. But it’s done quite well lately. Stephen Wolf has done a terrific job of running it. So as of the middle of April, all of our dividends are — were caught up, current. We’ve received, I don’t know, 260 or ’70 million in dividends in the last eight years. But we have nothing to do with managing the company. Matter of fact, there are some people that might have noted that when Charlie and I left as directors, that was when the fortunes of the company turned abruptly upward. (Laughter) But — and we feel very good about what Stephen Wolf has done. I mean, he — there’s no tougher job than running an airline. That is not a job I would wish on anyone. And he’s improved the operating performance dramatically, and the financial performance has improved.

And better yet, the preferred dividends have been paid. So we thank him for that, but we have nothing to do with it. By the terms of our preferred, in just a little over two years, we are due to be paid back our principal amount. It was really a loan in equity form, with a kick — possible kicker on the upside because of the conversion privilege on the preferred. We would have sold the conversion privilege for nothing a few years ago, but it actually is not so far away now. The stock’s in the low 30s, and our conversion is in the high 30s. So we actually have some chance of even having conversion value on that. It’s been a very pleasant surprise. You know, I made a mistake in getting into it, but Mr. Wolf is — seems to be capable of nullifying my mistake. Charlie?

CHARLIE MUNGER: Pass. (Laughter)

WARREN BUFFETT: We’ll give him this (inaudible). (Laughter)

23. Put all your money into Berkshire stock?

WARREN BUFFETT: Zone 5, please.

AUDIENCE MEMBER: I’m Eric Butler (PH) from Menlo Park, California. A couple of questions, one serious, one not quite. Considering Berkshire Hathaway is well run at low cost, and is diversified, why should anyone do anything but put all their money into Berkshire Hathaway instead of maintaining a diversified portfolio? And in some of these hagiographic kind of biographies, it’s apparent that you have other investments yourself beyond Berkshire Hathaway. The second question I had, is there any significance to the fact that the Omaha World-Herald does not include Berkshire Hathaway in its stock tables on any day? Is this a sign that they do not honor profits?

WARREN BUFFETT: (Laughs) No, they — actually, they have a separate little table called Midlands — I think it’s entitled Midlands Investment. But they pick out about 50 stocks that are of particular interest to people in this area, and they lift those from the regular table and put it in this separate table, which is usually on a second page right following the main stock table. So they give us our just due on that, but you do have to — you should look in a different table for that. Second question about putting all your money in, I’ve got 99 percent of my money in Berkshire. But it was bought at a different price. (Laughter) And Charlie’s was bought a little cheaper, too, I think. So you know, we like the idea of having it all in there, but we don’t recommend that people do that because it’s — you will get very lowcost management. What we hope — well we hope is that from this point forward, that that cost does not reflect its value. But the price at which you enter is very important. You do get a great group of businesses. You get a lot of great operating managers.

You get very reasonable costs. But that is fairly widely recognized now compared to the past, and people pay more for it than they used to. I’m still very comfortable with it, and I think Charlie’s comfortable with it, too. But everyone has to make up their own mind about price. Charlie?

CHARLIE MUNGER: Yeah. Eventually, if the success continues and we have more of this hagiography, the stock will get to such a high price that it’s no longer sensible at all to buy. We hope we dampen that process as we go along. And of course, there’s always the very substantial chance that we’ll just fail to meet expectations due to the vicissitudes of life.

WARREN BUFFETT: Falling on our face is what we call it. (Laughter)

24. Won’t buy a tobacco company, but could buy tobacco stocks

WARREN BUFFETT: Zone 6.

AUDIENCE MEMBER: My name is Michael Hooper. I’m from Grand Island, Nebraska. I applaud Berkshire for starting the Class B shares. My question deals with tobacco stocks, which have been beaten down lately. Does Berkshire own any tobacco stocks, and are some of these stocks attractive now that prices are down on some of them? And in particular, a company called UST. Thank you.

WARREN BUFFETT: Yeah. We have owned — we won’t comment on what we own now — but we have owned tobacco stocks in the past. We’ve never owned a lot of them, although we may have made a mistake by not owning a lot of them. But we’ve owned tobacco stocks in the past, and I’ve had people write me about whether we should do it or not. We own a newspaper in Buffalo. It carries tobacco advertising. We don’t — well, actually, Charlie’s a director of a sensational warehouse chain called Costco, which used to be called PriceCostco. You know, they sell cigarettes. So we are part of the distribution chain in — with a hundred percent-owned subsidiary in the Buffalo News. And so we have felt that if we felt they were attractive as an investment, we would invest in tobacco stocks. We made a decision some years ago that we didn’t want to be in the manufacture of chewing tobacco.

We were offered the chance to buy a company that has done sensationally well subsequently, and we sat in a hotel in Memphis in the lobby and talked about it, and finally decided we didn’t want to do it. Can I give you some —?

CHARLIE MUNGER: But it wasn’t because we thought it wouldn’t do well. We knew it was going to do well.

WARREN BUFFETT: We knew it was going to do well. But now, why would we take the ads for those companies, or why would we own a supermarket, for example, that sells them, or a 7-Eleven, you know, or a convenience store that sells them or something of the sort, and not want to manufacture them? I really can’t give you the answer to that precisely. But I just know that one bothers me and the other doesn’t bother me. And I’m sure other people would draw the line in a different way. So the fact that we’ve not been significant holders of tobacco stocks has not been because they’ve been on a boycotted list with us. It just means that overall we were uncomfortable enough about their prospects over time that we did not feel like making a big commitment in them. Charlie?

CHARLIE MUNGER: Yeah. I think each company, each individual, has to draw its own ethical and moral lines, and personally, I like the messy complexity of having to do that. It makes life interesting.

WARREN BUFFETT: I hadn’t heard that before. (Laughter) We’ll make him in charge of this decision.

CHARLIE MUNGER: Yeah, no, no. But I don’t think we can justify our call, particularly. We just — we have to draw the line somewhere between what we’re willing to do and what we’re not, and we draw it by our own lights.

WARREN BUFFETT: We owned a lot of bonds at one time of RJR Nabisco, for example, some years back. And should we own the bonds and not own the stocks? Should we own, you know — should be willing to own the stock but not be willing to own the business? Those are tough calls. Probably the biggest distributor of — the biggest seller — of cigarettes in the United States is probably Walmart, but — just because they’re the biggest seller of everything. They’re the biggest seller of Gillette products, and they’re huge. And you know, do I find that morally reprehensible? I don’t. If I owned — we owned all of Walmart, we’d be selling cigarettes at Walmart. But other people might call it differently, and I wouldn’t disagree with them.

25. Buffett on anti-abortion protesters

WARREN BUFFETT: Zone 7?

AUDIENCE MEMBER: Gentlemen, I’m John Tarsney (PH), a shareholder from Omaha, Nebraska. People have already asked any sophisticated question that I might have, so I’m reduced to my simple ones. I first became a shareholder through FlightSafety, and at that time I wasn’t sure that I wanted to be bought out. However, I decided that any man who could agree with me on FlightSafety might be a good man to go along with.

CHARLIE MUNGER: (Laughs) Well, that’s one way of doing it. (Laughter) Maybe you’d fit in well at headquarters. (Laughter)

AUDIENCE MEMBER: I have a couple — well, I don’t use Gillette products, either, as those of you who are close to me can see. (Laughter) My questions, my simple ones then, are, a couple of years ago, or within the recent times, you had said you would not necessarily buy Berkshire Hathaway. And I’d like to know whether you still feel the same way. Secondly, since I came to you through FlightSafety I’m wondering if there’s any other positions I should be looking at in that same — (laughter) — same light. And thirdly, there was a very distressing sign to me — sign that I saw when I drove in. And I don’t know what the meaning of it is, or if you do. And it said something about abortion. And I just don’t have a clue. If you do — now, you can use yes or no answers to these and save your voice. (Buffett laughs) Or suit yourself and elaborate.

WARREN BUFFETT: Yeah, we’ll work backwards. I think the signs probably relate to the contributions to Planned Parenthood. (Applause) Thank you. We follow a policy, as you know, at Berkshire of corporate contributions being designated by shareholders. We have some made by our operating companies to their local communities, and the local managers do what they think appropriate within their communities and with their own businesses. So Tony Nicely at GEICO — I have no idea what GEICO contributes to, but they make those decisions at GEICO. But in terms of the parent company, we let the shareholders designate the contributions. We have a number of shareholders who designate Planned Parenthood. We have other shareholders who designate organizations that are — would be opposed to the ideas of Planned Parenthood. We make no judgment about those. (Mild applause) And in terms of — I designate the Buffett Foundation every year, and then the Buffett Foundation, in turn, gives money to other things, including Planned Parenthood. And so, in the sense that those funds come indirectly from Berkshire, they come in direct proportion to ownership the same way as everybody else gets a chance to do with their shares. And we’ve had people write us about it.

You know, I — there’s no way in the world we would — you know, in fact there’s some that would say that we should be boycotted because I do this. And we would not dream of questioning, you know, the people that we buy our almonds from, or walnuts from, or chocolate from, as to what their beliefs were, you know, before we bought that, or whether we would hire somebody that they’d have to agree with our beliefs, so — It seems to me perfectly appropriate for people to express their views on it, and they probably don’t like — clearly they don’t like — what I do on that. But it’s where my reasoning and, you know, my own judgment leads me. But they’re out there, the few people out there expressing their views on it, and they’re entitled to do that. And I don’t have any problem with that.

I think when they start saying, you know, “We don’t want to hire you because you have a different view than we do,” or “We don’t want to buy your products,” I think that’s a little different position to take. I wouldn’t do that. But again, it’s their right to do that.

26. Berkshire stock is now “more appropriately valued”

WARREN BUFFETT: Going back to whether we would buy the stock, I would say this a year ago — well, it was about March 1st because that’s when I wrote the annual report in 1996 — the stock was 36,000 and I said it was not undervalued at that point. And since we were more or less forced to have an offering by the unit trust, which I’m very glad in retrospect we did, but it was not our idea, we felt that it was only appropriate in connection with that offering to point out that we had said it was not undervalued, and since Charlie and I like to buy undervalued securities, that we would not buy it ourselves at that price or recommend that others do. And in the ensuing year, the intrinsic value of Berkshire changed quite dramatically. And the price didn’t change. In other words, the stock, after years of overperforming the business somewhat, underperformed the business. Which, of course, it’s bound to do. And we’re glad that they got back more in tandem. So we said this year that we regarded the stock as being much more appropriately valued than it was a year earlier, which is obvious.

And I would say that the caution I made about securities generally would apply. I would not except Berkshire from that caution, but I would rather own or purchase Berkshire myself than I would most other securities. I can tell you that. Charlie? (Applause) Charlie gives to Planned Parenthood, too, so he has to — (laughs). They didn’t put his names on those signs, but I’ll take care of that. (Laughter)

CHARLIE MUNGER: I’m perfectly willing to have that limelight passed, as well as the opportunity to say more on the subject.

WARREN BUFFETT: Did I miss one question up there? I think there were three of them, and I addressed two of them.

AUDIENCE MEMBER: About any other area I should be looking at.

WARREN BUFFETT: That’s the reason I skipped it. (Laughter) Yeah, we don’t direct people to any specific investments.

27. World Book encyclopedia vs Microsoft’s Encarta

WARREN BUFFETT: Zone 8, please.

AUDIENCE MEMBER: Good morning, Mr. Buffett and Mr. Munger. This is Nancy Jacobs (PH) from Omaha, a shareholder for about four years now. Before I leave today, I’m planning to purchase the World Book on CD-ROM for my ten-year-old daughter. And I’d like a few words from either one of you, or both of you, about why I’m making the right choice. And second, does purchasing World Book over a competitor give her a somewhat improved chance of becoming a brilliant billionaire investor?

WARREN BUFFETT: Practically guarantees it, but go ahead. (Laughter)

AUDIENCE MEMBER: OK. I’m buying, then.

WARREN BUFFETT: Charlie, you want to — you love to talk about World Book.

CHARLIE MUNGER: Well, I think World Book is clearly the class of the field. They have every word in the English language graded for reading comprehensibility, and the articles are cleverly written so the difficulty of comprehension rises slightly as you go through it. And it’s very user-friendly to young people. And since it’s something you want to encourage, making it user-friendly is wonderful. I also find that with whatever intellect I have, it’s more user-friendly to me. And so I think it’s a hell of a product, either for the young people or the old. And for a quick reference system, I don’t think there is anything better. Personally, I like the reading version, being an old-fashioned fellow. And I can hardly imagine a world where the wise people don’t do a lot of reading. Now, maybe we’re going to have wise people in the future who spend all their time in front of screens in the course of getting that wisdom. But I doubt it. That’s all. (Laughter) I think you may have bought a wonderful product, but I would have the other one, too.

(Laughter)

WARREN BUFFETT: The product you see there was the joint development, and was launched in January of this year in conjunction with IBM. IBM has been our partner in that product. I believe it’s being bundled into all the IBM PCs now being sold. So they’ve worked very well with us. Frankly, there’s a book, even, that deals with this. Bill Gates did a very good job of developing a product that was bundled with millions and millions and millions of PCs. It’s called Encarta. It’s actually Funk and Wagnalls. He hates it when that comes out, but they changed the name to Encarta, which was smart of him. (Laughter) And there are a few people in this room who were witness to a demonstration four or five years ago in Bermuda, where in connection with Encarta, they showed the moon and the earth. And the moon bumped into the earth in this. And I just, I don’t know why it sticks in my mind. I thought I would mention it today, that the — (Laughter) But his is doing very well.

So apparently there are a number of people that don’t care about the fact the moon and the earth collide, but in the World Book the moon and the earth never bump into each other. (Laughter) He’s done extremely well with Encarta, incidentally. I mean, it was a masterpiece of moving into an area and pushing hard. And you know, I tip my hat to him, but now we’re going to —

CHARLIE MUNGER: Yeah, we copied him.

WARREN BUFFETT: Yeah, we copied him. Right. (Laughter) OK, Nancy, be sure to buy the print version, too, so Charlie will respect you. (Laughter)

28. Tax fairness, economic prosperity, and the “ovarian lottery”

WARREN BUFFETT: Zone 9.

AUDIENCE MEMBER: Good morning, gentlemen. My name is Patrick Byrne. I’m here today from Hanover, New Hampshire. I’ve searched for a couple questions upon which I might get the two of you to disagree. First, what level of taxation — and I direct these as much to Mr. Munger, therefore, as to you Mr. Buffett — first, what level of taxation on capital gains is most conducive to the long-term economic health of a society, and is that also the fair or just rate? In other words, is the just rate of taxation on capital gains precisely that rate that creates the most economic stuff? Or is there some other goal a state might pursue? And as a not-so-subtly related question, I work in a New Hampshire factory that makes industrial torches.

WARREN BUFFETT: As CEO, I might add, Patrick. (Laughter)

AUDIENCE MEMBER: Say again?

WARREN BUFFETT: As CEO of — that “working” made it sound like you were down there on the floor. I just wanted people to — (Laughter). Patrick writes me letters from chairman to chairman, so I think we’ve got to get him back at it.

AUDIENCE MEMBER: Continuing. (Laughter) Well, it’s a small company. I do work as CEO, but it’s not much of a hierarchy. We make torches used in heavy manufacturing, and the fortunes of our factory echo those of industrial America. Do you agree with the conventional wisdom that maintains that the age of classical industrial America has passed, and that we will — that America cannot be competitive in the long term with low-wage countries? So the first question is on taxation of capital gains, and then the second is on the future for industrial America.

WARREN BUFFETT: I have a sensational answer on the tip of my tongue, but I think I’ll let Charlie go first — (laughs) — while I refine it a bit.

CHARLIE MUNGER: Well, I think there’s an easy answer to your capital gain issue. And one is what makes an economy work best in some abstract mathematical sense. And the other is the consideration that you allude to, which gets into issues of fairness. Aristotle felt that systems work better when they were generally perceived as fair. The civilization worked better if people saw the differences in rewards as having been fairly — reasonably fair, anyway. And I think that if you had a civilization where if you work 90 hours a week driving a taxicab with no money, no medical insurance and so forth, and somebody else does nothing but own Berkshire Hathaway shares and sit on the country club porch and peel off a few every year to pay the bills, that would be regarded as so unfair that even if it had some theoretical economic efficiency it would be counterproductive for our particular civilization to have that kind of a tax code. So I’m all for having some taxation of capital gains. Once you reach that conclusion, you get into the question of what should — what is the fair rate? I think the fair rate might well be a little lower than it is now, but not much lower.

WARREN BUFFETT: Sounds to me like he’s a seller — of Berkshire. (Laughs) Patrick is a former heavyweight boxer, and just got his Ph.D. fairly recently from Stanford with a 700-page dissertation, which has in it some commentary that actually bears on this. And I thank Patrick, actually, for introducing me to kind of a system of construct — mental construct — to attack questions like this. Patrick gave me the example one time — and I think this may go back to John Rawls at Harvard — but he said, just imagine that you were going to be born 24 hours from now. And you’d been granted this extraordinary power. You were given the right to determine the rules — the economic rules — of the society that you were going to enter. And those rules were going to prevail for your lifetime, and your children’s lifetime, and your grandchildren’s lifetime. Now, you’ve got this ability in this 24-hour period to make this decision as to the structure, but there — as in most of these genie-type questions there’s one hooker.

You don’t know whether you’re going to be born black or white. You don’t know whether you’re going to be born male or female. You don’t know whether you’re going to be born bright or retarded. You don’t know whether you’re going to be born infirm or able-bodied. You don’t know whether you’re going to be born in the United States or Afghanistan. In other words, you’re going to participate in 24 hours in what I call the ovarian lottery. (Laughter) It’s the most important event in which you’ll ever participate. It’s going to determine way more than what school you go to, how hard you work, all kinds of things. You’re going to get one ball drawn out of a barrel that probably contains 5.7 billion balls now, and that’s you. Now, what kind of a society are you going to construct with that in prospect? Well, I suspect you would focus on two issues that Patrick mentioned in his question.

You would try to figure out a system that is going to produce an abundant amount of goods, and where that abundance is going to increase at a rapid rate during your lifetime, and your children and your grandchildren, so they can live better than you do, in aggregate, and their grandchildren can live better. So you’d want some system that turned out what people wanted and needed, and you’d want something that turned them out in increasing quantities for as far as the eye can see. But you would also want a system that, while it did that, treated the people that did not win the ovarian lottery in a way that you would want to be treated if you were in their position. Because a lot of people don’t win the lottery. I mean, Charlie — when we were born the odds were over 30-to-1 against being born in the United States, you know? Just winning that portion of the lottery, enormous plus. We wouldn’t be worth a damn in Afghanistan. We’d be giving talks, nobody’d be listening. Terrible. (Laughter) That’s the worst of all worlds. So we won it that way.

We won it partially in the era in which we were born by being born male, you know — When I was growing up, you know, women had — they could be teachers or secretaries or nurses, and that was about it. And 50 percent of the talent in the country was excluded from, in very large part, virtually all occupations. We won it by being white. You know, no tribute to us, it just happened that way. And we won it in another way by being wired in a certain way, which we had nothing to do with, that happens to enable us to be good at valuing businesses. And you know, is that the greatest talent in the world? No. It just happens to be something that pays off like crazy in this system. (Laughter) Now, when you get through with that, you still want to have a system where the people that are born —like Bill Gates or Andy Grove or something — get to turn those talents to work in a way that really maximizes those talents. I mean, it would be a crime to have Bill or Andy or people like that, or Tom Murphy, working in some pedestrian occupation just because you had this great egalitarian instinct.

The trick, it seems to me, is to have some balance that causes the people who have the talents that can produce goods that people want in a market society, to turn them out in great quantity, and to keep wanting to do it all their lives, and at the same time takes the people that lost the lottery and makes sure that just because they, you know, on that one moment in time they got the wrong ticket, don’t live a life that’s dramatically worse than the people that were luckier. And when I get all through that long speech, I probably come out with the idea that the capital gains tax as it exists today is probably about right, so — I see very few people — and I’ve been around a lot of people with money and talent over time — they don’t always go together — but I’ve been around both classes — (laughs) — and the — I see very few of them that are turned off from using their talents by a 28 percent capital gains tax. It just doesn’t happen. I mean, they do what they like to do. And part of the reason they’re good at what they do is they like to do it.

And I’ve just never seen it happen. And I’ve seen a lot of people that pay taxes that are higher than 28 percent that are contributing more to society, by some judgment other than a pure market system. (BREAK IN TAPE)

29. “American economy encourages adaptation”

WARREN BUFFETT: The other question about the low-cost industrial — you know, how does the industrial society evolve, I — you know, the world evolves in a way, in a market society, so people do what they’re best at. And this country’s done very well in recent years — something like, you know, software that — where a Microsoft has been leading or an Intel or something. I mean, we have done very well. Ten years ago the American public was sort of down on itself, or 15 years ago, in terms of what the economy could do. But here we are with our unemployment rate — in Nebraska it’s under 3 percent. And you know, you look at the countries of Europe that were supposedly going to beat us into the ground, or you look at Japan. I think the American economy encourages adaptation. I mean, Singapore may be better, but in terms of major large economies, I think the American economy does awfully well in encouraging adaptation to what people want, and delivering it to them in ever-increasing amounts. And you know, I view that as all to the good. So I don’t regard any industry as sacred.

I regard innovation and freeing up the able people to — able, in terms of production of goods in a market economy — to spend 12 hours a day all the time — I don’t see Andy or Bill letting up at all, in terms of where Intel and Microsoft are now. I don’t see Roberto Goizueta at Coca-Cola, or Michael Eisner at Disney, or any of those people. They don’t work 40-hour weeks, they work 70 or 80-hour weeks. And I think that system works very well in this country, and I don’t worry particularly about the specific products that are turned out. Charlie?

30. Munger critical of Harvard philosopher John Rawls

CHARLIE MUNGER: I would not like the conclusion that both Warren and I have reached, that issues of fairness are properly to be considered in the tax laws, to cause anyone here to believe that I have a great respect for Harvard University’s philosopher John Rawls. He is perhaps the world’s best-known living philosopher. And personally, I think he’s had a pernicious influence on human thought. He doesn’t know enough science. He doesn’t know enough economics. He doesn’t know enough about how systems work to be really good at figuring out what’s fair in systems. And he studied too much philosophy and too little of everything else. (Laughter) If anybody thinks we love John Rawls, well, you can count me out. (Laughter)

WARREN BUFFETT: No — I wasn’t endorsing his conclusions, I was endorsing his thought — his original construct. Charlie, how about the industries part of the question that Patrick asked?

CHARLIE MUNGER: Well, if Patrick isn’t the smartest person in the room, there can’t be many in his class. You are getting questions from a very able man, and he’s deliberately made them very difficult. (Laughter) And that whole issue is too complex for me to usefully discuss here. There are also certain limitations on ability that enter the equation. (Laughter)

31. Class A stock may be exchanged for Class B at any time

WARREN BUFFETT: So we’ll go to zone 10. (Laughter)

AUDIENCE MEMBER: Good day, gentlemen. My name is Bill Rodenberg (PH) from Dayton, Ohio. I’m a shareholder, and my daughter Sarah, who is 13, is also a shareholder. She chose not to join me in the limelight. I think the hot dogs had a higher appeal to her.

WARREN BUFFETT: Not to mention —

AUDIENCE MEMBER: And I’d like to say that it’s very reassuring to know that Uncle Warren and Uncle Charlie are taking care of her college fund. And it’s easy to sleep at night. I have two questions, one related to a question my wife asked me, which I was unable to fake a good answer to, and a second one related to my daughter’s one share of Berkshire A. My wife asked me, in the annual report you stated that if anyone out there has a good company like FlightSafety, please let you know and you’d be glad to look it over and give an answer within five minutes or less. And her question is, how can he do that? Where does he get the information to make that decision? And how does he know that that information is valid? My second question has to do with my daughter. She’s 13. In five years she’ll be off to college, perhaps UNL, perhaps not. In any case, she’s going to face a significant capital gains when she sells that one share of stock.

WARREN BUFFETT: I hope so. (Laughter)

AUDIENCE MEMBER: You mentioned earlier, and I believe this is correct, you said that you could trade one share of A for 30 shares of B this afternoon. And I thought, wait a minute, I thought there was a limited window on that. We happened to be out of the country at the time that exchange took effect, and we missed it.

WARREN BUFFETT: No, the exchange exists forever. You can —

AUDIENCE MEMBER: Forever?

WARREN BUFFETT: You can always exchange a share of A for 30 shares of B. You cannot do it in reverse. You cannot shift 30 shares of B into one share of A. But there was no window or timetable on that. The A stock is forever exchangeable for 30 shares of B. I don’t recommend that she does it, because it’s always an option, and in the meantime she gets the shareholder-designated contribution, and there’s always the chance that the A will sell slight — at a price slightly above 30 shares of B. It doesn’t do it very often and it won’t be very much if it does, but — We didn’t want to create an incentive for people to exchange A for B, but we — they will always have the right to do so.

32. Just takes 5 minutes to know if we’re interested in a company

WARREN BUFFETT: The five minute test is a — you know — Charlie and I have — we’re familiar with virtually every company of a size that would interest us in the country. I mean, if you’ve been around for 40 or more years looking at businesses, it’s just like if you were looking at — you know, studying baseball players every day. You get to know all the players after a while. And that’s the way it works. Then we have a bunch of filters we’ve developed in our minds over time. We don’t say they’re perfect filters. We don’t say that those filters don’t occasionally leave things out that should get through. But they’re very — they’re efficient. And they work just as well as if we spent months and hired experts and did all kinds of things. So we really can tell you in five minutes whether we’re interesting in something, and — We’d never owned shares in FlightSafety but we’d been familiar with the company for at least 20 years, wouldn’t you say, Charlie?

CHARLIE MUNGER: Sure, I had a partner who bought a lot of it 20 years ago. Yeah.

WARREN BUFFETT: Yeah. But that’s true of almost any business. And we know — we’ve got a fix on what we don’t understand, and then we don’t care to know any more about them, particularly, although we’ll pick up a little as we go along, maybe. And then the ones that are — we’re capable of understanding, we’ve probably gotten about as far as we’ll get already. So we do know in five minutes. Now, when we do something with FlightSafety, before the purchase and even for somewhat — a little after the purchase — I’d never been — I’d never set foot on a piece — they have 40 or so training centers around the world — I’d never set foot on one of them. I’d never been to their headquarters. We never looked at a lease. We never look at title of the properties. I mean, we don’t do all of those things. And I will say this: to date, that’s never cost us a penny.

What costs us money is when we misassess the fundamental economic characteristics of the business. But that is something we would not learn by what people generally consider due diligence. We could have lawyers look over all kinds of things, but that isn’t what makes a deal a good deal or a bad deal. And we don’t kid ourselves by having lots of studies made and lots of reports made. They’re going to support whatever they think the guy that pays them, you know, wants anyway. So they don’t mean anything. They’re nonsense. But we do care about being right about the economic characteristics of the business, and that’s one thing we think we’ve got certain filters that tell us in certain cases that we know enough to assess. And then we make some mistakes. Charlie?

CHARLIE MUNGER: I’ve got nothing to add to that, except that people underrate the importance of a few simple big ideas. And I think that to the extent Berkshire Hathaway is a didactic enterprise teaching the right systems of thought, I think that the chief lessons are that a few big ideas really work, as I think these filters of ours have worked pretty well. Because they’re so simple.

WARREN BUFFETT: Yeah, I think most of the people in this room, if they just focused on what made a good business or didn’t make a good business and thought about it a little while, they could develop a set of filters that would let them, in five minutes, figure out pretty well what made sense or didn’t make sense. I mean, there may be some reason after five minutes we don’t get together on a deal of some sort, but — Another thing you can usually tell — at least you can tell it in the extreme cases — you can tell whether you’ve got the kind of manager, very quickly, that you want to have. I mean, if you’ve got somebody that’s been batting .400 all their life, and fortunately age doesn’t change that picture, in terms of business performance, and they love what they do, it’s going to work. If the seller cares a lot about the money, you’re probably not going to make a very good deal.

If their real interest is going in the — is what they’re going to do with the money, they may fall out of love or have less interest in their business subsequently. We love working with people who are just plain nuts about their businesses. And it works very well. And you can usually spot that. Now, having said that, we’ll have a few people figuring out how to fake that attitude, you know, when they try and sell us some piece of junk here, but — (Laughter) Charlie says we can get conned by some guy with a green eyeshade, you know, and a low-rent office and all that. But we won’t get taken in by the guy with the suede shoes. (Laughter)

33. Buffett describes a “normal” day

WARREN BUFFETT: Zone 11.

AUDIENCE MEMBER: Mr. Buffett and Mr. Munger, thank you for having me here today. My name is Dorsey Brown from Baltimore, Maryland. I have two quick questions for you. Could you please comment on any observations that either of you may have concerning executive compensation and option issuance, a topic that seems to be getting a lot more media attention? And are we going to — getting a little bit of excesses in that area? And my second question to you, Mr. Buffett, could you just give us some idea of what a normal day, how you would like to spend a reasonable, normal day and — working on the investment side of the equation, or analysis, or reading, or just to give us some flavor of that? Thank you.

WARREN BUFFETT: OK, I’ll answer the second question first. Very easy. I just — I read a lot, and I talk on the telephone a fair amount. We have no meetings. We have no committees. We have no slide presentations. You know, we have nothing, I mean it — (Laughter) And so I read a lot. I read annual reports. I read business publications. I could do it in way less time, but I enjoy doing it so I make it last, I mean, you know, like some other activities in life. The - (laughter) So it’s — there’s really — it’s the most boring job to anybody watching it, but I’m in love with it, you know. And so I like doing that. And I don’t like talking about it a lot, I just like to kind of keep up with what’s going on. Like I say, by this point in life I could filter out so much of that I would — I just don’t need to do that much of it.

But I kind of enjoy just seeing what’s going on vicariously through doing a lot of reading. And I spend some time on the phone, and I’m on the computer a lot playing bridge, and I get to do what I like all the time. We’ll let Charlie describe what he does, which is even more bizarre. (Laughter) And then we’ll talk about compensation and options.

CHARLIE MUNGER: Well, there’s a little more foolishness in my life than Warren’s, and — including being chairman of a large hospital. I’m not suggesting that hospitals are foolish, I’m just suggesting that it takes a certain quirk of mind to be willing to be the chairman of a hospital. And so my life is even more — it’s less rational than Warren’s. Warren lives one of the most rational lives I’ve ever seen. And it’s almost unbelievable, and — (Laughter)

WARREN BUFFETT: He’s got me wondering why I’m here today. (Laughter)

34. Abuse of stock options as executive compensation

WARREN BUFFETT: Well, we’ll talk about comp then, a little.

CHARLIE MUNGER: Yeah, comp, yeah.

WARREN BUFFETT: The — comps — there are three or four aspects to that. On the subject of options, I would say that most options are constructed poorly, from the standpoint of the owner, but they’re constructed very well from the standpoint of the person who receives them, which is not entirely unexplainable because the — it’s a very strange form of negotiation when the beneficiary is the one that also really does all the design and hires the experts to come in and tell him what is good for the company when the expert knows that the guy who signs the check would be quite interested also in hearing what’s good for him. There’s nothing wrong with options per se, at all. Frankly, in terms of Berkshire, it would have been perfectly appropriate if a properly designed option had been given to me or to Charlie. I mean, we have responsibility for the whole enterprise, and we believe that any kind of incentive for performance should be related to the area in which you have responsibility. We feel that if you want a typist to type 100 words a minute, that you ought to pay for typing 100 words a minute, not what the earnings per share were last year.

We feel if a salesman gets paid for how many of the product is sold, he should get paid for that and not for some production quotas met. So we believe in tying incentive comp to performance for which you have responsibility. And there are certain areas of a business that don’t lend themselves to that staff performance and so on. But that would lead to the corollary, that the people that are responsible for the entire results of the business, it’s perfectly appropriate to compensate them by options that in some way reflect the performance of that entire business. The trouble is that stock prices reflect other things than the performance of the business. For one thing, over a period of time, they reflect simply the reinvestment of earnings. You know, I have pointed out in the past that if you gave me an option on your savings account — to manage your savings account — and you reinvested all the interest, I would take away a significant payment at the end of ten years simply because you left the interest in.

With a company that pays no dividend like Berkshire, if you’re going to leave all your capital in every year, for me to get a fixed-price option for ten years would mean that I was getting a royalty on money that you left with me. And I made the choice to have you leave it with me. So that does not strike me as equitable. So I think any option should have a step-up in price that reflects the fact that money is reinvested by the shareholders annually. That if somebody wants to pay out a hundred percent of the earnings every year, then I’d say that you can have a fixed-price option. If you give me the money every year, and you do more with the money that’s left with you than the original sum, that’s fine. But if money is left with someone for ten years, there’s going to be some increase in value even if they spend every day golfing. And to give a piece of that away simply over — to have a royalty on the passage of time for them is a mistake. I think options ought to be granted, basically, at the fair value of the business at the time they’re granted.

Sometimes that’s the market price, sometimes it isn’t the market price, but — Certainly the management of a company would not give an option on their business to some third party at a market price they felt was way too low, so I find it a little disingenuous when managements say that they’re — when they get a takeover bid, they say that the company’s really worth twice that much, but they’re perfectly willing to issue options to themselves at this price which they say is totally inadequate, when the owners get the option elsewhere. But options, properly structured, for people with responsibility for the business, I think, makes — can make sense. And I think that if something happened to me and to Charlie, in terms of the manager of the business subsequently, if it was structured properly, I would not see anything wrong with an option arrangement. We carry this philosophy down to our subsidiaries where they generally get incentive arrangements that relate to the operation of their business.

But they don’t have incentive arrangements that relate to Berkshire overall, because if Chuck Huggins does a wonderful job at See’s Candy, as he has done, and I fall on my face, in terms of allocating capital, Berkshire stock will go no place despite what Chuck does. And to penalize him, or to tie his rewards to something over which he has no control, I think, is kind of silly. So we tie it instead to the operations of the candy business. In terms of overall level of compensation, the real sin is having a mediocre manager. I mean, that is what costs owners very significant amounts of money over time. And if a mediocre manager is paid a relatively small sum, it’s still a great mistake. And if they’re paid huge sums, it’s a travesty. And that happens sometimes. It’s almost impossible to pay the outstanding manager a sum that’s disproportion to the value of that outstanding manager, when you get a large enterprise. Coca-Cola had a market value of $4 billion when Roberto Goizueta took over.

It had stagnated during the previous decade under an earlier management, despite having the same product and those great Mean Joe Greene commercials you saw, that was — Mean Joe Greene was in the ’70s. The “Teach the World to Sing” commercial was in the ’70s. All these great commercials. But the company didn’t do much. Roberto — if we’d bought the entire Coca-Cola Company — I wish we had — in 1981 or ’2, whenever he came in, for 4 billion and we now had a business worth 150 billion, Roberto would have earned more money with us than he’s earned under the present arrangement. I mean, having the right person in place is just enormously important. How much they should take is another question. That’s more a philosophical question. Tom Murphy, best manager, you know, in the world, he just didn’t feel like taking a lot of money out of it, you know. And you know, I tip my hat to him, but I don’t think that necessarily makes it wrong for somebody else to take more money for doing the job. But I think it ought to be related to doing the job.

When I ran a partnership in the 1960s, I took a quarter of the profit over 6 percent a year. And I didn’t get paid any salary, but I could make a lot of money doing that. And that thought occurred to me as I ran the place from day to day, and I think it probably helped a little. (Laughter) So I don’t think it’s a terrible thing to have somebody get paid for making money for the shareholders. But they ought to get paid for really making it, not simply because the shareholders reinvest money with them. They ought to make it based on the fair value of what they had when they took over, and they ought to make it really for just excellent performance. Charlie?

CHARLIE MUNGER: Well, we have remarked in previous Berkshire Hathaway meetings that we regard present mandated corporate accounting, with respect to stock options as weak, corrupt, and contemptible. And it is.

WARREN BUFFETT: Otherwise, we’re undecided. (Laughter)

CHARLIE MUNGER: If something is so wonderful as a standard technique of compensation, why does it have to be masked under weak, corrupt, and contemptible accounting? I think it is no credit to our civilization that we’ve drifted into this particular modality. And you can get, if you overuse stock options, where the whole thing is sort of a chain letter. I mean, in Silicon Valley there’s one company that practically paid everybody in options, and as long as the chain letter galloped, it worked as far as the income account because nothing went through expense. And then once everybody is issuing stock options, everybody else feels that he has to do it. And the practice spreads. So I am not totally wild about the extreme prevalence of the stock option modality in American corporate life. Personally, I would vastly prefer different modalities, which would probably involve stock instead of stock options. I’m all for sharing with the kind of people who are doing the important work pretty well down in the organization in a place like Costco or Coca-Cola or any other such company. But I don’t much like the present scheme that civilization has drifted into.

With respect to the subject of do we have some wretched excesses in American corporate compensation, my answer would be yes. I don’t think the excess is necessarily the guy who got the most money. In many cases I agree with Warren, that the money has been deserved. But such is the envy effect that the practice spreads to everybody else. And then the taxi driver and everybody starts thinking the system is irrational, unfair, crazy. And I think that’s what causes some people, as they rise in American corporations, to, at a certain point of power gaining and wealth gaining, they start exercising extreme restraint as a sort of moral duty. And that’s what Warren was saying about Tom Murphy. And I would argue that the Tom Murphy attitude is the right attitude. And it goes way, way back in the history of civilization. The word “liturgy” comes from a Greek word which is just the same. I mean, if you were an important citizen of Athens, it was a lot like being an important person in Jewish culture. I mean, you had duties to give back and to act as a certain example. And the civilization had social pressures that enforced those duties.

And I would argue that the Berkshire Hathaway compensation system, considering what the people at the top already have, it would be better if we saw a little more of it.

WARREN BUFFETT: A few —

CHARLIE MUNGER: I think Warren and I do all right. (Laughter and applause)

WARREN BUFFETT: A few years — I think an added problem is the sort of, in terms of the accounting, the sort of hypocrisy that it pushes people into, and then which becomes accepted and sort of a norm, particularly when leaders do it. And you know, you had a situation a few years back when there’s no question that any manager would say that stock options are a form of compensation. They would say that compensation is a form of expense, and they would say that expense belongs in the income account. But they didn’t want to have stock options counted because they felt that it might restrict their use. So when the federal — the FASB, Financial Accounting Standards Board — came up with a proposal to actually have reality reflected en masse, corporate chieftains descended on Washington to pressure legislators to have Congress start enacting accounting standards, which as I mentioned, one time in Indiana in the 1890s, there was a legislator that introduced a bill to have the value of pi changed to an even 3 because he thought that 3.14159 was too tough for the schoolchildren and it would ease computational problems.

Well, that sort of behavior by corporate chieftains when they are in there, you know, arguing that black is white, in order to feather their own nest and maybe create a little higher stock prices, I think that it means that they forfeit, to some degree, their right to be taken seriously when they claim they’re operating for the good of the Republic, and march on Washington in other regards. And I just think that when the organization recognizes its hypocrisy and so on, I think there’s a degradation that can set in through an organization that — whose leaders are also leaders in hypocrisy. Like I say, we have no strong feelings on this subject, but — (Laughter) Charlie, do you have anything?

CHARLIE MUNGER: It’s rather interesting, though. There’s an earlier example. Commodore Vanderbilt took no salary from his railroads. After all, he controlled the railroads. They paid all the dividends that he needed, and he got the fun of running the whole railroad, and he thought it was beneath Commodore Vanderbilt to take a salary. We’ve never quite reached the Vanderbilt standard, but — (Laughter)

WARREN BUFFETT: We don’t have any dividends, Charlie.

CHARLIE MUNGER: Yeah, yeah. (Laughs) Well, maybe that’s the reason. (Laughter)

Afternoon Session

1. When opportunity knocks …

WARREN BUFFETT: OK. If we’re live now — what we might do is maybe have just — I think maybe we only need four microphones for the afternoon session. So we’ll have two on each side, one toward the back, one toward the front. And we’ll just go around in four microphones. Are we OK on that? And we’ll start just one second. Everybody has a chance to get to their seats. Charlie has promised to stop tapping the Coke can during this — (laughter) — session.

CHARLIE MUNGER: I only did that when somebody else was talking. (Laughter)

WARREN BUFFETT: Number 2? OK. I used to have a friend that was a stock salesman many years ago. And when you’d have lunch with him, he would just keep going like this: (knocking sound). And finally, it would get to you. And you’d say, “What’s that?” And he’d say, “That’s opportunity.” (Laughter) He was pretty good.

2. How to buy a business

WARREN BUFFETT: OK, let’s — Kelly tells me we should start with number 2, zone 2. So we’re going to start with zone 2.

AUDIENCE MEMBER: Yes. I’m Fred Cooker (PH) from Boulder, Colorado. And this is a question about intrinsic value. And it’s a question for both of you because you have written that, perhaps, you would come up with different answers. You write and speak a great deal about intrinsic value, and you indicate that you try to give shareholders the tools in the annual report so they can come to their own determination. What I’d like you to do is expand upon that a little bit. First of all, what do you believe to be the important tools, either in the Berkshire annual report or other annual reports that you review, in determining intrinsic value? Secondly, what rules or principles or standards do you use in applying those tools? And lastly, how does that process, that is the use of the tools, the application of the standards, relate to what you have previously described as the filters you use in determining your valuation of a company?

WARREN BUFFETT: If we could see, you know, looking at any business, what its future cash inflows or outflows from the business to the owners — or from the owners — would be over the next, we’ll call it, a hundred years, or until the business is extinct, and then could discount that back at the appropriate interest rate, which I’ll get to in a second, that would give us a number for intrinsic value. In other words, it would be like looking at a bond that had a whole bunch of coupons on it that was due in a hundred years. And if you could see what those coupons are, you can figure the value of that bond compared to government bonds, if you want to stick an appropriate risk rate in. Or you can compare one government bond with 5 percent coupons to another government bond with 7 percent coupons. Each one of those bonds has a different value because they have different coupons printed on them. Businesses have coupons that are going to develop in the future, too. The only problem is they aren’t printed on the instrument. And it’s up to the investor to try to estimate what those coupons are going to be over time.

As we have said, in high-tech businesses or something like that, we don’t have the faintest idea what the coupons are going to be. When we get into businesses where we think we can understand them reasonably well, we are trying to print the coupons out. We are trying to figure out what businesses are going to be worth in ten or 20 years. When we bought See’s Candy in 1972, we had to come to the judgment as to whether we could figure out the competitive forces that would operate, the strengths and weaknesses of the company, and how that would look over a ten or 20 or 30-year period. And if you attempt to assess intrinsic value, it all relates to cash flows. The only reason for putting cash into any kind of an investment now is because you expect to take cash out. Not by selling it to somebody else, because that’s just a game of who beats who, but, in a sense, by what the asset, itself, produces. That’s true if you’re buying a farm. It’s true if you’re buying an apartment house. It’s true if you’re buying a business. And the filters you describe.

There are a number of filters which say to us we don’t know what that business is going to be worth in ten or 20 years. And we can’t even make an educated guess. Obviously, we don’t think we know to three decimal places, or two decimal places, or anything like that, precisely what’s going to be produced. But we have a high degree of confidence that we’re in the ballpark with certain kinds of businesses. The filters are designed to make sure we’re in those kinds of businesses. We, basically, use long-term, risk-free government bond-type interest rates to think back in terms of what we should discount at. And, you know, that’s what the game of investment is all about. Investment is putting out money to get more money back later on from the asset. And not by selling it to somebody else, but by what the asset, itself, will produce. If you’re an investor, you’re looking at what the asset — you’re looking at what the asset is going to do — in our case, businesses.

If you’re a speculator, you’re primarily focusing on what the price of the object is going to do independent of the business. And that’s not our game. So we figure if we’re right about the business, we’re going to make a lot of money. And if we’re wrong about the business, we don’t have any hopes — we don’t expect to make money. And in looking at Berkshire, we try to tell you as much as possible as we can about our business, of the key factors. Those are the things that Charlie and I — With the things we put in our report about those businesses are the things that we look at ourselves. So if Charlie had nothing to do with Berkshire but he looked at our report, he would probably, in my view, he would come to pretty much the same idea of intrinsic value that he would come to from being around it, you know, for X number of years. The information should be there. We give you the information that, if the positions were reversed, we would want to get from you.

And in companies like Coca-Cola or Gillette or Disney or those kind of businesses, you will see the information in the reports. You have to have some understanding of what they’re doing. But you have that in your everyday activities. You’ll get that kind of knowledge. You won’t get it, you know, in terms of some high-tech company. But you’ll get it with those kind of companies. And, then, you sit down and you try to print out the future. Charlie?

CHARLIE MUNGER: I would argue that one filter that’s useful in investing is the simple idea of opportunity cost. If you have one opportunity that you already have available in large quantity, and you like it better than 98 percent of the other things you see, well, you can just screen out the other 98 percent because you already know something better. So the people who have a lot of opportunities tend to make better investments than people that don’t have a lot of opportunities. And people who have very good opportunities, and using a concept of opportunity cost, they can make better decisions about what to buy. With this attitude, you get a concentrated portfolio, which we don’t mind. That practice of ours, which is so simple, is not widely copied. I do not know why. Now, it’s copied among the Berkshire shareholders. I mean, all of you people have learned it. But it’s not the standard in investment management, even at great universities and other intellectual institutions. Very interesting question. If we’re right, why are so many eminent places so wrong? (Laughter)

WARREN BUFFETT: There are several possible answers to that question. (Laughter) The attitude, though — I mean, if somebody shows us a business, you know, the first thing that goes through our head is would we rather own this business than more Coca-Cola? Would we rather own it than more Gillette? It’s crazy not to compare it to things that you’re very certain of. There’s very few businesses that we’ll find that we’re certain of the future about as companies such as that. And therefore, we will want companies where the certainty gets close to that. And, then, we’ll want to figure that we’re better off than just buying more of those. If every management, before they bought a business in some unrelated deal that they might not have even heard of, you know, more than a short time before that’s being promoted to them, if they said, “Is this better than buying in our own stock, you know? Is this better than even buying, you know, buying Coca-Cola stock or something,” there’d be a lot fewer deals done.

But they don’t — they tend not to measure — we try to measure against what we regard as close to perfection as we can get. Charlie, anything?

CHARLIE MUNGER: Well, I will say this, that the concept of intrinsic value used to be a lot easier, because there were all kinds of stocks that were selling for 50 percent or less of the amount at which you could’ve easily liquidated the whole corporation if you owned the whole corporation. Indeed, in the history of Berkshire Hathaway, we’ve bought things at 20 percent of thenliquidating value. And in the old days, the Ben Graham followers could run their Geiger counters over corporate America. And they could spill out a few things. And you could easily see, if you were at all familiar with the market prices of whole corporations, that you were buying at a huge discount. Well, no matter how bad the management, if you’re buying at 50 percent of asset value or 30 percent or so on down, you have a lot going for you. And as the world has wised up and as stocks have behaved so well for people, good stocks, generally, have gone to higher and higher prices. That game gets much harder. Now, to find something at a discount from intrinsic value, those simple systems, ordinarily, don’t work.

You’ve got to get into Warren’s kind of thinking. And that is a lot harder. I think you can predict the future in a few places best if you understand a few basic ideas that come from a good general education. And that’s what I was talking about in that talk I gave at the USC Business School. In other words, Coca-Cola’s a simple company if it’s stripped down and analyzed in terms of some elemental forces.

WARREN BUFFETT: When Charlie —

CHARLIE MUNGER: It’s not hard to understand Costco, either, you know — There are certain fundamental models out there that do not take — you don’t have the kind of ability that quantum mechanics requires. You just have to know a few simple things and really know them.

WARREN BUFFETT: When Charlie talks about “liquidating value,” he’s not talking about closing up the enterprise. But he’s talking about what somebody else would pay for that stream of cash, too, I mean —

CHARLIE MUNGER: Yeah.

WARREN BUFFETT: You could’ve looked at a collection of television stations owned by Cap Cities, for example, in the early to mid — well, 1974. It would’ve been worth, we’ll say, four times what the company was selling for. Not because you’d close the stations, but just their stream of income was worth that to somebody else. It’s just that the marketplace was very distressed — depressed. Although, like I say, on a negotiated basis, you could have gone and sold the properties for four times what the company was selling for. And you got wonderful management. I mean, those things happen in markets. They will happen again. But part of investing and calculating intrinsic values is if you get the wrong answer when you get through — in other words, if it says don’t buy, you can’t buy just because somebody else thinks it’s going to up or because your friends have made a lot of easy money lately or anything of the sort. You just — you have to be able to walk away from anything that doesn’t work. And very few things work these days.

You also have to walk away from anything you don’t understand which, in my case, is a big handicap.

CHARLIE MUNGER: But you would agree, wouldn’t you, Warren, that it’s much harder now?

WARREN BUFFETT: Yeah. But I would also agree that almost anytime over the last 40 years that we’ve been up on a podium, we would’ve said it was much harder in the past, (laughs) too. But it is harder now. It’s way harder. Part of it being harder now, too, is the amount of the capital we run. I mean, if we were running $100,000, our prospects for returns would be — and we really needed the money — our prospects for return would be considerably better than they are running Berkshire. It’s very simple. Our universe of possible ideas would expand by a huge factor. We are looking at things today that, by their nature, a lot of people are looking at. And there were times in the past when we were looking at things that very few people were looking at. But there were other times in the past when we were looking at things where the whole world was just looking at them kind of crazy. And that’s a decided help.

3. Stocks look high, but not as high as they look

WARREN BUFFETT: Zone 3?

AUDIENCE MEMBER: My name is Bakul Patel (PH). I’m from upstate New York. I’ve got a few questions. And I need your permission to ask each question separately and wait for the answer.

WARREN BUFFETT: Well, we’ll take a couple, but — I got through college, you know, only answering three or four questions. So I don’t want to go through that again. (Laughter)

AUDIENCE MEMBER: They are unrelated questions.

WARREN BUFFETT: OK. OK. We’ll give you a couple, then we’ll let other people have a chance. How about two, OK?

AUDIENCE MEMBER: Fine. Mr. Market is valuing Dow Jones at about 7,000 and S&P at about 800. By your valuation model, at the current interest rate and current inflation rate and current growth rate, what is a fair valuation of both these companies?

WARREN BUFFETT: Well, that’s a good question but a tough question. But I would say that if you believed American — the American business, in aggregate, could earn the kind of returns on equity that they have been earning in the last — or has in the last couple of years — and then you postulate no change in interest rates, you can justify 7,000 on the Dow and 800 on the S&P. Now, you know, there’s a couple ifs I threw in there. And if interest rates go higher, the valuation goes down automatically. And more importantly, if the returns on equity of American industry — which are historic highs, and which sort of classical economics would tell you would be hard to maintain — if those returns go down, on average, that also would pull it down. But if you’re willing to accept the current level of returns on equity as being typical of the future case for American business and you’re willing to assume present interest rates are lower, then, you can justify a valuation on the Dow and S&P.

And it’s interesting because I got all that commentary after I wrote that line in the report which was, as I said earlier, designed for a little something else. I’ll give you a little trivia quiz. What two years in this century has the Dow had the greatest overall gain? The two years in the 1900s are 1933, which most of you don’t think of as a banner year, and 1954. And in both of those years, the Dow was up over 50 percent, counting dividends. In March of 1955, because of that, the fact that the Dow had gone up — bear in the mind that the high on the Dow was 381 in 1929 and it took 25 years before that was surpassed. And in 1954, the Dow went from, say, 280 up to 404, or something like that, just a little over 50 percent.

So what did they decide to do? They decided to have congressional hearings about it. And they did. In March of 1955, they had hearings in the Senate Banking and Currency Committee, Chairman Fulbright. And my boss, Ben Graham, was called down to testify. And it’s fascinating reading. Bernard Baruch was there, all kinds of people.

I’ve got the hearings at home. And Ben’s opening comments about the market at that time were that the market looks high, it is high, but it’s not as high as it looks. Well — (Laughter) That’s about the present situation. I mean, it looks very high, just by comparing 7,000, certainly, to the 404 at the end of 1954 when was Ben was testifying. But there are — there have been huge changing in earnings and return on equity on American business in general. And, then, you had this big move in interest rates. Now, those are underlying fundamentals that have had — powered a huge bull market. After a while, as I mentioned earlier, people get captivated simply by the notion of rising prices without going back to the underlying rationale. And that’s when you get very dangerous conditions in terms of possible bubbles. And it would — you know — I have no idea where markets will go. But if you had the kind of conditions that could cause real excesses, just like you had excesses in 1973 and ’4, going back to when you could buy things at 20 cents on the dollar, you had excesses in the other direction.

You know, the country didn’t disappear or anything. It’s just people behave in extreme ways in markets. And over time, that’s very good for people that keep their heads. Charlie?

CHARLIE MUNGER: I’ve got nothing to add.

WARREN BUFFETT: OK. You get one more. (LAUGH)

4. When Berkshire is cheap, other things are usually cheaper

AUDIENCE MEMBER: If Mr. Market goes in the depressed phase that Berkshire Hathaway has got an investment portion of its book value about 28,000 per Class A share, that would put that Berkshire Hathaway share much lower than what it is now. Would Berkshire Hathaway consider buying back its own share? Or has it done so in the past? Or is it out of the question?

WARREN BUFFETT: If the market went in the tank, Berkshire stock would go in the tank, too. And so there shouldn’t be anybody in this room that owns the stock that would not find it palatable, if not become positively enthusiastic, about the stock going down 50 percent. It would not bother Charlie. It wouldn’t bother me, because we would have very intelligent things, then, to do with whatever capital we came into. And we would be generating capital as we went along. We wouldn’t have sold our Coke. We wouldn’t have sold our Gillette. We wouldn’t have sold our businesses. So most of our capital would’ve ridden that down. But at least, we would have intelligent things to do with the money. One of the intelligent things, possibly, could be to buy in our own stock. But that would imply that our own stock was cheaper relative to value than anything else we could find among possible opportunities. And the chances are we could find things that were more attractive. Back in 1973 or ’4, when we were buying Washington Post at a fraction of what it was worth, Berkshire stock may have been cheap then.

But it wasn’t as cheap as the Washington Post. In 1987 or — well, in 1988 and ’89, you know, Berkshire stock may or may not have been cheap. But it wasn’t as cheap as Coca-Cola. And it’s unlikely that among the thousands of the possible investments that Berkshire will be the most attractive at any time. But if it were, you know, obviously, we would buy in our own stock. But I think if the Dow went down 50 percent, we would have plenty of interesting things to do. And we would not be unhappy. Charlie?

CHARLIE MUNGER: Yeah. We don’t have any rule against it. Opportunity cost is the game around here.

5. International earnings in the United States

WARREN BUFFETT: Zone 4.

AUDIENCE MEMBER: I’m David Day from Coppell, Texas. And I’m a Berkshire shareholder. Mr. Buffett, what is your opinion of investing in foreign company stocks?

WARREN BUFFETT: Well, we have a number, well, at least several major businesses, three or four at least, five, six, I mean, as I count along, that derive very significant percentages of their earnings from international operations. Coca-Cola earns 80 percent or more from international operations. Gillette would earn twothirds or more from international operations. So if you look to where earnings are coming from, we get a lot from international companies. They don’t have to be domiciled outside the United States. It’s a slight advantage to us to have them domiciled in this country. For example, their dividends are treated better. We get better treatment on the dividends if they are domestically based rather than based someplace else, just because of the way the U.S. tax laws work. But if Coca-Cola were domiciled in Amsterdam, or Gillette were domiciled in London, they had the same basic businesses, we would be attracted to them to virtually the same degree we are as having them domiciled in Atlanta and Boston. We look at businesses outside this country that are domiciled outside this country. Many don’t meet our size requirements.

But that’s true here, too. We have to look at very big companies. But we have nothing against buying into companies that are domiciled — or even buying the entire business of a company — that’s domiciled outside the United States. We feel slightly less familiar with the tax laws and the corporate cultures, perhaps. But that would not be a huge factor in a great many countries. And, you know, we will keep looking. We need to look everywhere with the kind of money that we have available for investment. Charlie?

CHARLIE MUNGER: Again, we’ve had a wonderful way of playing the rapid development of economies outside the United States. And so far, we haven’t seen anything that attracted us as being better. And if you can sell Coca-Cola, you know, do you really want to get into steel in Malaysia or something? (Laughter)

WARREN BUFFETT: We sold a substantial number of Kirby units outside of the United States last year. And that business has grown very significantly in recent years. And I think it promises to grow. We’re always looking for opportunities. Some things travel very well. And some things don’t. I mean, Gillette travels. Disney travels. McDonalds travels. Coke travels. You know, See’s Candy doesn’t travel as well. It might if you spent 50 years working on it. But it’s not an easy thing to travel. Actually, candy bars, themselves, don’t travel very well. If you look at the top-selling candy bars in France or in England and Japan, you don’t find the similarity that you find in terms of the bestselling soft drinks or movies or fast food hamburgers or razor blades, and —

CHARLIE MUNGER: Except Snickers. For some reason, Snickers. (Laughter)

WARREN BUFFETT: Well.

CHARLIE MUNGER: It travels very well. Don’t ask me why. (Laughter)

WARREN BUFFETT: Yeah. Well, Charlie’s had a lot of experience as he goes around the world. (Laughter) You don’t want to eat where we eat. You may want to invest where we invest, but — (Laughter)

6. Businesses with “natural limits” welcomed at Berkshire

WARREN BUFFETT: OK. Section 1.

AUDIENCE MEMBER: I’m Richard Tomkins (PH) from Gallatin, Tennessee. And I have just two quick questions. Could both of y’all discuss the Kansas Bankers business and its competitors? How big of a moat Kansas Bankers has in the industry and if they’re going to expand, you know, outside of the 22 or 20 states that they’re currently in. And that’s A. And, then, secondly, just clue us in a little bit more on the five-year discount notes that you did that were tied to the Salomon stock. And was that a way to unload it? Or just kind of give us a little more than what we saw in the annual.

WARREN BUFFETT: Sometimes in the insurance business, you have a choice between being a good business or a big business. And fortunately, Don Towle, who runs Kansas Banker Surety, has chosen for a good business. It’s a specialized operation that sells, as its name implies, to bankers, and primarily policies that have fidelity coverage. That is just not a big volume business in the whole United States. They do it exceptionally well. Don knows every, you know, he knows every account. He knows every claim. You know, he runs a fabulous operation. But it’s not an operation that can double or triple in size doing what it does and doing well. There just aren’t — there’s not the opportunity there. On the other hand, I think it’s tough to compete against Don because he brings an element of knowledge and personal attention to the account and factors of that sort that a really large company would have trouble duplicating. Charlie, you want to add anything on Kansas Bankers?

CHARLIE MUNGER: Yeah. There’s a huge class of businesses in America which are very strong and will throw out large amounts of cash in relation to their size but which can’t rationally be expanded very much. And if you try and expand certain kinds of businesses, you’re throwing money down the rat hole. The beauty of the Berkshire Hathaway system is that such businesses are very welcome here because the cash comes into headquarters and is allocated there. If there’s anything sensible to do at the subsidiary level, we always want it done. But there are businesses where — lots of businesses — where there isn’t much of a way of redeploying the cash.

WARREN BUFFETT: Part the reason they have a moat around them is that they’re of a size and have specialized skills that other organizations just can’t get into it. I’ll give you another example, and that’s somewhat the same field. There’s a company called Western Surety. It’s changed ownership a couple of times. Charlie and I went up to see them 15 years ago about buying it at Sioux Falls. They write notary bonds. And they write a whole bunch of things that have $50 premiums or $25 premiums. They have — it was a company doing not that many millions of premiums, but they had 30,000 agents. But each agent, you know, may have done $500 worth of business within a year or a thousand dollars. Well, Chubb can’t go after that business the same way. We certainly can’t at National Indemnity. They have a distribution system that works wonders. But you can’t pump two or three times the volume through that distribution system. And if you could pump it through, there would’ve been more competition.

So there are businesses that have certain natural limits that, you know, you want to be careful that you don’t talk yourself into thinking a business that has limits and find out that it really has way more potential. I mean, it would’ve been a shame if Mr. [Asa Griggs] Candler decided that Coca-Cola only appealed to people in Atlanta or something of the sort. So you have to be a little careful on that. But we — a fellow like Don will be very good at understanding, you know, where his competitive advantages can take him and where they don’t take him. He’s done a terrific job over the years doing it.

7. Debt deals vs. buying stock

WARREN BUFFETT: There was a second question, was there?

AUDIENCE MEMBER: Just the $500 million I think that y’all did, of the discount.

CHARLIE MUNGER: Oh, the Salomon notes.

WARREN BUFFETT: Oh, the Salomon notes. Yeah. Well, that is simply an issue of Berkshire — by Berkshire — of 500 million, as you mention, of a very low-coupon note — low-interest rate note, too — that is convertible — or exchangeable — into Salomon stock anytime during the next five years. And it’s a way of taking the capital out of that block of stock at a low-interest cost to use elsewhere, while retaining a limited portion of the upside in the Salomon stock. And we just — we made that decision, whenever it was, six months ago or so, based on the thought that we might have some good opportunities at some point to use that money, and raising the money at a little over a one percent current cost, or a three percent cost to maturity — and we think the actual cost is likely to be close to the one percent — made sense for us. We have never owned — I mean, we have the convertible preferreds of Champion, of US Airways, and of Salomon. And those are three industries — I don’t think we’ve ever owned an airline stock, common stock.

I don’t think we’ve ever owned a paper company common stock. And we’ve only had a very limited amount of investment in the investment banking businesses. Those are industries that we don’t feel that we’ve got the same kind of long-term economic advantage that we have in something like a Coke or a Gillette. So those are not natural places for us to be common shareholders. And the issuance of that exchangeable debt reflected that view. Charlie?

CHARLIE MUNGER: I agree. (Laughter)

8. Lower tax rate probably won’t trigger Berkshire stock sales

WARREN BUFFETT: OK. Zone 2.

CHRISTINE SHRAM: My name Kristen Schramm (PH). I am from Springfield, Illinois. I am a proud shareholder of Berkshire Hathaway. In light of the upcoming capital gains tax reduction, do you envision any increased selling pressure, such as buying opportunities for Berkshire stock?

WARREN BUFFETT: That’s a good question, Kristen. We’re proud to have you, too. (Applause) A very high percentage of Berkshire shares is owned by people with a very low tax basis. So that if I had to guess, I would say that probably 80 percent, at least, of the shares are owned by people whose cost is less than a hundred dollars a share on the A stock. And that, undoubtedly, contributes to some people’s reluctance to sell, particularly if they’re older, and — But I think it would probably — it might make less difference than you think. I think most people, if there were a lower capital gains rate, I don’t think it would be a huge change in the propensity to sell the stock. I would hope, even if there was a zero capital gains tax, that there really wouldn’t be any rush for the exits. It wouldn’t affect my attitude, particularly. But I think it’s perfectly reasonable to assume that as the tax rate goes down, there will be some greater tendency to sell by people with a low tax basis on their shares. Charlie?

CHARLIE MUNGER: Well, I think the laws of microeconomics and the laws of psychology are such that if you said, “The tax rate will, for one month, go down to zero,” you would have some very dramatic effects in the markets. It’s not going to happen, of course.

WARREN BUFFETT: No. But if you said the tax rate was going to zero for one month, and then going to a hundred percent subsequently, I think you’d get a certain amount of activity. (Laughter)

CHARLIE MUNGER: But then you’d really — So you could tinker with the tax laws in a way that would cause dramatic market effects. I don’t anticipate any such things happening. We had something similar back when they — what was it, ’86 — where the tax rate was 20 percent on long-term capital gains. And it was the last year you could liquidate a corporation and not pay gains taxes on appreciated assets that were disposed of in the liquidation. And we got a great flood of liquidations in that year. So it’s possible to do things to the tax laws that have big market effects. But it gets very unlikely that any such thing is going to happen this year.

WARREN BUFFETT: Yeah. I agree with that.

9. We know our super-cat insurance risks, but many others don’t

WARREN BUFFETT: Zone 2?

VOICE: (Inaudible)

VOICE: What number is this? Is this three or four? What is it?

WARREN BUFFETT: Is there a zone 2?

VOICE: Is this it?

WARREN BUFFETT: The microphone working? Zone 3? Well, we’ll go to zone 3, then.

AUDIENCE MEMBER: I am Charles Parcells (PH) from Grosse Pointe, Michigan. Very glad to be here. I’m a recent stockholder of Berkshire. I’m sorry to say that. (Laughter) But it does not diminish my admiration for past performance or my confidence in future performance. I heard recently a remark by, I think, a very successful investor, whom I think worked with the Bass family in Texas for a while. And one of his comments, if I understand it correctly, said something like this. “Hurricane Andrew destroyed the super-cat industry.” And that’s about all he said. And I know we’re into it. I’m interested in its importance to Berkshire and your comments on it, Mr. Buffett and Mr. Munger.

WARREN BUFFETT: Yeah. I guess I would say I don’t fully understand why he would — or even partially understand — why he would say that. I mean, we are in business in the super-cat business — and I should explain, super-cat business is very much like it sounds. I mean, we write insurance for other insurance companies, other reinsurance companies, to protect them, to pay them at a time when something really big comes along, a super catastrophe. And Hurricane Andrew was certainly a super catastrophe. But that’s the reason people do business with us, so — We pay off infrequently, but we pay off big. And we paid off about 120 million at Hurricane Andrew. But if Hurricane Andrew happened today — well, at least in one of the policies (inaudible) we have — we would certainly be paying off at least, what, 6, 700 million, something like that. And if it happens five years from now, we’ll pay off a lot more than that because we will, undoubtedly, be writing more business at that time. So it’s just part of the game. And there will be super-cats of various kinds.

There will be, you know, huge quakes. There will be more hurricanes than huge quakes. And when that time comes, we will write a big check. But that doesn’t — you know, prices may be firmer after such an event. They may not be. They didn’t firm as much as you might expect after Andrew happened. Andrew was a huge surprise to people. As a digression, you know, people in the insurance business thought that — they all had these models — and some of them were prepared by reinsurance brokers and some of them by various research institutes — as how much they would lose under certain kinds of circumstances. And they couldn’t have been further off with an Andrew, or with the Northridge earthquake. Fortunately, we don’t rely on those. We — I don’t know what exactly we do rely on, but we don’t rely on those. (Laughter) And the — Hurricane Andrew was, you know, that was just — that’s part of business with Berkshire. And we will have another one. And we’ll have another one after that.

So every three, or five, or seven years, or who knows what, we will lose significant money in the super-cat business. And we expect that over 20 or 25 years, we will make more money than we lose. We bring some real advantages to that business, as I wrote about in the report. And it makes sense for us to be in it. It only makes sense for us to be in it when the premium prices are right. But when they are appropriate, we will — we’re more than willing to step up and take on a fair amount of risk. As I wrote in the report, on the California Earthquake Authority, you know, we could, tomorrow, face a demand for roughly a billion dollars. And we are prepared to write a check that day to take care of that. And we will write it, if it happens. And there aren’t many people in the world that an insured can count on to do that. The interesting thing is that the worst exposure, still, for super-cats, are not borne by us. But they’re borne implicitly by some very big direct writing companies that have lots of risk on Long Island or along the New Madrid Fault or other places.

And they have got, well, millions of policies, and maybe hundreds of thousands of exposed policies. And they don’t think of themselves as being in the super-cat business. Well, they really do, but they don’t think, you know, day by day about it. And they are very exposed. Our exposures are limited to a given dollar amount. That dollar amount may be large. But at least we know what it is. And we take risks — that we’re willing to take risks when we think we’re appropriately paid. There’s a mentality to bring to the super-cat business that’s somewhat akin to what you bring to the investment business. So we think we’re well equipped for it. Charlie?

CHARLIE MUNGER: Yeah. A billion dollars would be, what, 2 1/2 percent, or less, of the liquid assets and securities around Berkshire. And so that’s irritating, but it — (laughter) — it’s not going to destroy the enterprise. Whereas, if you have an unwitting super-cat exposure that you don’t even recognize you have, it could destroy your company. Twentieth Century, a very well-run direct writer of insurance, they all but went broke with the Northridge Earthquake.

WARREN BUFFETT: And they didn’t think it was possible, either.

CHARLIE MUNGER: And they had no idea they had a super-cat exposure in what they thought was a simple, little direct writing insurance operation. No, I don’t think we’ve got the main super-cat risks at all at Berkshire.

WARREN BUFFETT: GEICO lost something like 150 million in Andrew. And their initial estimate of the loss was, like, $35 million. And that’s after they thought they’d heard about most of it. You can really get fooled in this business. In fact, 20th Century, which lost a billion dollars at Northridge just at the end of 1996, I think, added $40 million, as I remember, to the reserves for the Northridge Quake, which I think was in January of ’94. Now, you think on an earthquake, you know, you’d kind of know when it was over. But — (laughter) — you can really — you can get fooled. And down at Andrew, I mean, the costs of construction go up dramatically in an area that’s been wiped out. And then there were all kinds of things in the codes. I mean, I think they started requiring architects’ drawings on everything, you know, over $5,000 in the way of repairs, some number like that — don’t hold me to the number. And, of course, the architects had a field day.

And then it turned out that everybody had a homeowner’s policy in the Oakland fire, for example. They all had a $300,000 book collection in their library. And, you know, who knows after the place has burned down? (Laughter) It’s not — you get a lot of surprises in that field. And the surprises in insurance are never symmetrical. They’re all bad. (Laughs)

10. “You need a large margin of safety”

WARREN BUFFETT: Zone 4?

AUDIENCE MEMBER: Yes. My name is (inaudible). I’m from New Mexico. And I’m a shareholder. I have two questions. First, in your ’91 letter, you wrote about investors eventually repeat their mistakes. So what do you do to keep you from making the same mistake twice? And the second question is, in your ’92 letter, you wrote that you tend to deal with a problem of future earning in two ways. The first way is the business you understand. And the second is the margin of safety. And you say they are equally important. But if you — (loud noise) — but if you cannot find the happy combination of faster growth at a low key, which one do you think is more important, faster growth or low key? That’s my two questions.

WARREN BUFFETT: I think we were told by — (loud noise) — we were told by some higher authority which one was more important there for a second. (Laughter) Well, they’re bound together. Obviously, if you understood a business perfectly — the future of a business — you would need very little in the way of a margin of safety. So the more volatile the business is — or possibility is — but assuming you still want invest in it, the larger the margin of safety. I think in that first edition of [Benjamin] Graham — I doubt if I’m right — was it (inaudible) and said, you know, maybe it was worth somewhere between 30 or 110, or some number. He said, “Well, that sounds — how much good does that do you to know that it’s worth between 30 and 110?” Well, it does you some good if it’s selling below 30 or above 110.” That’s — you need a large margin of safety.

Well, if you’re driving a truck across a bridge that holds — it says it holds 10,000 pounds — and you’ve got a 9,800 pound vehicle, you know, if the bridge is about six inches above the crevice that it covers, you may feel OK. But if it’s, you know, over the Grand Canyon, you may feel you want a little larger margin of safety, in terms of only driving a 4,000 pound truck, or something, across. So it depends on the nature of the underlying risk. We don’t get the margin of safety now that we got in a 1973-4 period, for example. The biggest thing to do is understand the business. If you understand the business, and get into the kind of the businesses where surprises — by their nature — surprises are few. And we think we’re largely in that type of business.

11. Learn from the mistakes of others

WARREN BUFFETT: The earlier part about — you know, I’ve said about learning from your mistakes, the best thing to do is learn from other guys’ mistakes, I mean, you know — It’s like, you know, [U.S. General George] Patton used to say, you know, “It’s an honor to die for your country. Make sure the other guy gets the honor,” you know and — (Laughter) So our approach is really to try and learn vicariously. But there’s a lot of mistakes that I’ve repeated, I can tell you that. The biggest one, probably — or the biggest category over time — is being reluctant to pay up a little for a business I knew was really outstanding, or to continue to buy it at higher prices when I knew it was outstanding. So the cost of that has been many, many billions. And I’ll probably keep making that mistake. There are — the mistakes are made when there are businesses you can understand and they’re attractive and you don’t do something about it.

I don’t worry at all about the mistakes that come about because when I met Bill Gates, I didn’t buy Microsoft or something. That’s not my game. But the mistakes are made when you — most of our mistakes have been mistakes of omission rather than commission. Charlie?

CHARLIE MUNGER: Yeah. I think most people get very few, what I call, no-brainer opportunities, where it’s just so damned obvious that this is going to work. And since they are very few and they may be separated by periods of years, I think people have to learn to have the courage and the intelligence to step up in a major way when those rare opportunities come by.

WARREN BUFFETT: Yeah. You got to be willing to take a really big bite. And it’s crazy if you don’t. And it’s crazy if you dabble around at the edges, so you’re not prepared to take a big bite when the time comes.

12. Treasury bonds are yardstick to compare investments

WARREN BUFFETT: We, apparently, have lost mike 4. So we’re just going to use three mikes from now on. And if you’ll just make your way to those mikes, we’ll see how we do with them. How about zone 1?

AUDIENCE MEMBER: Mr. Buffett, my name is Pete Brown (PH) from Columbus, Ohio, a Class B shareholder. I had a couple questions if I could. The first is, I don’t have a very good idea in my mind how our typical insurance operations work. I mean, in particular, how money leaves the insurance pool and enters the investment pool, and how our operations are different than the typical, run-ofthe-mill insurance operation, you know, around the country. Why are we able to generate so much more float than, you know, the XYZ Company, you know, somewhere else? And a second question is, it kind of goes back to an article you wrote for Fortune Magazine back in the late ’70s about the effect of inflation on equity values and that sort of thing. And in it, you asserted that stocks were — in businesses — were really like bonds. They just had their own par. And the par being the average 12 percent return on equity that companies have averaged. You know, a company does better than that has assets that are worth way more than a hundred cents on a dollar. A company does less, you know, will be less, correspondingly.

My question is, when you’re projecting cash flows of a company as a prospective investment, why would you use the interest rate, you know, of risk-free Treasury bills? Why wouldn’t you use the sort of opportunity cost to discount that maybe Charlie was referring to, maybe 12 percent return on equity of average corporations? Maybe, you know, your 15 percent goal may be Coca-Cola’s return on equity as a comparison. I mean, doing that would dramatically change the value of the company that you’re, you know, evaluating, as I’m sure you know. Why would you use the risk-free rate is my question.

WARREN BUFFETT: The risk-free rate is used merely to equate one item to another. In other words, we’re looking for whatever’s the most attractive. But in terms of present valuing anything, we’re going to use a number. And, obviously, we can always buy the government bonds. So that becomes the yardstick rate. It doesn’t mean we want to buy government bonds. It doesn’t mean we want to buy government bonds if the best thing we can find is only — has a present value that works out at a half percent a year better than the government bond. But it’s the appropriate yardstick, in our view, to simply use to compare across all kinds of investment opportunities, oil wells, farms, whatever it may be. Now, it gets into degree of certainty, too. But it’s the yardstick rate. It’s not because we want to buy government bonds. But it does serve to make that a constant throughout the valuation process.

13. Insurance and investing are equal, but distinct, businesses

WARREN BUFFETT: In our insurance business, we really have a group of insurance businesses. And they have different characteristics. The consistent characteristic, actually, is that they’re all very, very good businesses. Some of them are a lot larger and have opportunities to get larger. And some of them are not so large and have limited opportunities, in terms of growth. But every insurance operation we have is a distinct asset to Berkshire. We’ve got smaller — a worker’s comp operation. We’ve got a credit operation — credit card — operation. We’ve got a Homestate operation. We have all these different businesses, Kansas Bankers Surety, whatever. They’re all good businesses. Some of them don’t develop a lot of float relative to premium volume. The nature of Kansas Bankers Surety is that it won’t develop a lot of float. It just happens to be the kind of business they write. The nature of comp is that it develops more float, because comp claims pay more slowly. We — you really should think of each one, though, as having different characteristics. GEICO is entirely different than the super-cap business.

They’re both good businesses. In terms of how we invest the money when it comes in, we invest it when it comes in. I mean, we’ll get a large super-cap premium today. It’s invested. Now, if we have a claim tomorrow, then, we disinvest and in a substantial way. If you take something like GEICO, the cash flow is always going to be positive, probably, on that, you know. We won’t have another Hurricane Andrew, because we’ve backed out of the homeowner’s business to quite an extent. So month by month, the money comes in at a GEICO. And the faster it grows, the more the money that comes in. We have so much capital that we can, basically, put that money into whatever makes the most sense for Berkshire. So we have none of either the mental or psychological constraints, or regulatory constraints, that many insurance companies operate under. Many of them think they sort of should have this portion in this and this portion in that and so on. Investments usually play second fiddle to the insurance business at most companies that are in the insurance business. We look at them as being of equal importance.

And we run them as two distinct businesses. We do whatever makes the most sense on the investment side, whatever makes the most sense on the insurance side. We never do anything on the investment side that will impinge on our business on the insurance side. But you really should look at each one of our businesses separately. GEICO has entirely different characteristics than the super-cat business. They both call themselves insurance. They both develop float. But in economic terms and in terms of competitive strengths and that sort of thing, they’re two very different businesses. And our smaller businesses are different businesses. Some of those may grow reasonably well. We’ll keep working on it. Charlie?

14. Munger on choosing your spouse

CHARLIE MUNGER: Yeah. That — if you look at a corporate stock, it’s obvious you can buy any maturity of government bond you want. So one opportunity cost of buying the stock is to compare it with a bond. But you may find that half the stocks in America, you’re so fearful about or know so little about or think so poorly of, that you’d rather have the government bond. So on an opportunity cost basis, they’re taken out of the filter. Now, you start finding corporations where you like the stocks way better than government bonds. You got to compare them one against the other. And when you find one that you regard as the best opportunity, that you can understand as the best opportunity, now you’ve got one to buy. It’s a very simple idea. It uses nothing but the most elementary ideas from economics or game theory. It’s child’s play as a mental process. Now, it’s hard to make the business appraisals. But the mental process is a cinch.

WARREN BUFFETT: If Charlie and I were forced — told we had a choice of buying stock A, B, C or D and all 2,500 or 3,000, or whatever it may be, listed on the New York Stock Exchange, or buying a ten-year government bond and we had to hold the stock for ten years or the bond for ten years, probably in at least 80 percent of the cases, we’d take the ten-year Government, you know. In many cases, because we didn’t understand the business well enough elsewhere. Or secondly, we may understand it and still prefer the 10 percent Government. So — but we would measure everything that way. And I don’t know, did you come up with 80 percent or where, Charlie? Desert island, ten years. Get to fondle a stock certificate or fondle a government bond. Which one are you going to choose? (Laughter)

CHARLIE MUNGER: I think life is a whole series of opportunity costs. You know, you got to marry the best person who is convenient to find who will have you. (Laughter) Investment is much the same sort of a process. (Buffett laughs)

WARREN BUFFETT: I knew we’d get in trouble after lunch. (Laughter)

15. Why don’t more companies copy Berkshire?

WARREN BUFFETT: Zone 2. (Laughs)

AUDIENCE MEMBER: Hello. Martin Wiegand, Bethesda, Maryland, stockholder. For myself, my family and other small business owners, I want to thank you for the annual reports. They help a lot in helping us make business decisions and life decisions. My question is, many people come here — (Applause) Many people come here to listen to you and to copy and understand your investment philosophy. But why don’t more people, in your opinion, try to copy your investment vehicle, a corporation that pays no dividends?

WARREN BUFFETT: Well, I don’t really think if the right — I think there are other things that are probably better to copy about Berkshire, but they don’t get copied either. It was always interesting to me how few people — everybody read [Benjamin] Graham’s — and they didn’t really disagree with him. They just didn’t like following him because it didn’t promise enough, in a sense. I mean, people really wanted something very quickly. In terms of not paying dividends, we don’t pay dividends because we think we can turn every dollar we retain into more than a dollar of market value. I mean, the only reason for us to keep your money is if it becomes worth more by us keeping it than it would be worth if we gave it to you. And if we can create more than a dollar of market value for every dollar we keep, you’re better off, whether you want to take that dollar out by selling a little piece of your stock, or whether you continue to leave it in. That’s the test.

If we come to the conclusion that we can’t do that, and we could come to that conclusion sometime, then we should distribute it to you. The interesting thing is, we’re in certain businesses, for example, See’s Candy being one — we don’t have a way to intelligently use all of the money that See’s generates within the See’s Candy Company. So if See’s were a standalone company, it would pay very large dividends, not because it, you know, just had some dividend paying policy. It would be simply because we wouldn’t have a way of using, in this case, $30 million a year, intelligently in expanding that business. The Buffalo News is the same way. We don’t have a way of using money within that specific business, intelligently, to use the money it generates. We hope that in the overall Berkshire Hathaway scheme of things that we can intelligently use the money that the companies, in aggregate, generate for us. And we think, so far, we have. And we think the prospects are reasonably good that we can continue to do that.

But dividend policy should really be determined by that criteria, also bearing in mind the possibilities of repurchase of stock, too. But they should be determined by whether a dollar left in the business is worth more to the shareholder than a dollar paid out. Someplace like Coca-Cola, you know, if Coca-Cola paid no dividends and simply repurchased shares and developed the bottling system and done the things that they have, the shareholders probably would’ve been even better off. They’ve been sensationally well off as it is. But they probably would’ve been even better off than they have been with the dividend policy they have had. And that’s true for Gillette and Disney and the companies of that sort that have got these terrific opportunities to use capital within the business, or to repurchase shares of a company that simply can’t be replaced. If — that usually is the best use of capital. It’s probably better than dividends. And, you know, we have written some about that, Martin. But people usually keep doing what they’ve been doing. They’re hard to change. Charlie?

CHARLIE MUNGER: Well, it’s interesting that you take that simple standard, you should retain money if you can make it worth more than it is by retaining it. That is not the standard thing that’s taught in the corporate finance departments of our major universities. Why do we have this simple idea and they have another one? Time after time, we find that so. I’ve tried to understand why they think the way they do. And I have great difficulty with it. I’ve just concluded that they’re wrong, and — (Laughter) But that isn’t enough. There has to be reason why so many smart people are that wrong. And — (laughter) — that’s a story for another day. But there are things gravely wrong with American education that I hope that Berkshire Hathaway is slowly helping to fix.

WARREN BUFFETT: Can you imagine if the — pick any one of you here. And let’s say the two of us were in a business together. You know, it was earning $100,000 a year. How would we decide whether to leave the 100,000 each year? And it’d be exactly what we’ve talked about here. If we thought the 100,000 would translate into a present value of more than 100,000 by some action, we’d leave it in. And if it didn’t, we’d take it out. And it doesn’t seem to register, generally. And incidentally, in our own case, we’ll probably go too long before we come to the conclusion that we’re not really using it that effectively, because there’ll be a certain — denial — we’ll go through. And we’ll say, “Well, that was just temporary last year.” But that will — that is our approach. And we’ll do our best to apply it.

16. Corporate profits can’t stay so high

WARREN BUFFETT: Zone 3?

AUDIENCE MEMBER: Mr. Buffett, Mr. Munger, my name John Shane (PH). I’m from Nashville, Tennessee. You touched on the subject of return on equity in response to a different question. I wonder whether you might be willing to elaborate along the following line. Right now, the Standard & Poor’s 500, in aggregate, have a return on equity of about 22 percent. The average over the decades for corporate America has been more like 12 or 13 percent. How did we get to this point of extraordinary profitability? And how likely do you think we are, over the next ten or 15 years, to revert back to the mean of the low teens?

WARREN BUFFETT: Well, I would say is, I never thought it would happen. So I start out with the fact that if you’d listened to me, you’d have been dead wrong, in terms of what the return on equity in 1996 or 1995, 1997 would be. It does not seem to me that 22 percent returns on equity are sustainable in a world where the long-term interest rate is 7 percent, and where the capability of saving large amounts in the economy, you know, are quite dramatic. You would just think that there would be some sort of leveling effect between 7 and the 22 you named, that as savings got directed within the economy and as the competitive forces operate that we’ve been taught will operate over time, would come into play. But, you know, I’ve been wrong on that subject. And that’s why I say these levels are not unjustified if those kinds of returns can be made. Because let’s just say that you had a 22 percent perpetual bond. And you had the ability — and let’s say that a quarter of that — a third of that coupon — would be paid out.

So you got a bond with a 22 percent coupon and, say, 7 percent is paid out, being the dividend payout on the S&P, we’ll say. And the other 15 percent is reinvested in more 22 percent bonds with similar characteristics. Now, what’s that instrument worth on a present-value basis in a 7 percent world? It’s worth a lot of money. In fact, it’s worth so much money that it becomes a mathematical fallacy at some point, because when the compound rate becomes higher than the discount rate, you get into infinite numbers, which are — or you get into infinity. And that’s a number — that’s the concept we like to think about around Berkshire — (laughs) — we haven’t figured out how to attain it. There’s a book called “The Petersburg Paradox” — there’s an article called “The Petersburg Paradox and the Growth Stock Fallacy.” I think that’s the name of it, by a fellow named, I think, David Durand, written about 25 years ago. And it gets into this bit where the growth rate is higher than the discount rate.

And it shouldn’t work for an extended period of time. But it’s sure fun while it’s going on. Charlie?

CHARLIE MUNGER: Yeah. I think a couple of things contributed to this phenomenon that we so carefully mispredicted. Number one, it became very fashionable for corporations to buy in shares. And I think that we helped, in a very small way, bring on that enlightenment. And I think that was a plus, in terms of rational corporate decision making. The other thing that happened is that the anti-trust administration got way more lenient in allowing people to buy competitors. And I think those two factors helped raise returns on capital in the United States. But that can’t — you wouldn’t think that can go on forever. And what 15 percent per annum compounded will do is grow way faster than the economy can grow, way faster than aggregate profits can grow, over a long pull. So, sooner or later, something has to happen. I don’t think we’ve reached a new order of things where the laws of mathematics are somehow repealed.

WARREN BUFFETT: If real output in this country grows at, say, 3 percent a year — or real GDP grows at 3 percent a year — and the capitalized value of industry in the country grows at 10 percent a year, at some point you get into mathematical absurdities, I mean, at the low inflation rates. You know, you can’t have it — if we have an economy that’s seven or eight trillion now in GDP and seven or eight trillion in equity valuation, that may or may not make sense. But if you have one that’s 15 billion in GDP and 75 billion in equity valuation — 75 trillion in equity valuation — you know, you get to things that don’t — can’t make any sense. So if you get these differential rates of growth among items that have some relationship, however tenuous, or at least non-specific in the short run, it doesn’t work after a while. And, you know, nobody wants to think about that. They don’t want to think about their own death. But I mean, it doesn’t go away just because you don’t want to think about it.

And we haven’t gotten to any point like that. But you can project out numbers. And they just won’t make any sense after a while.

CHARLIE MUNGER: Yeah. Corporate profits can’t be 200 percent of GNP.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: Indeed, they can’t be 50 percent of GNP. So these high rates of compounding just go automatically into absurdity.

WARREN BUFFETT: Yeah. They really can’t be 20 percent of GDP or some number like that. So if — and if you start saying you can’t have a multiple of more, you get differential rates. And they just simply — you leave the tracks after a while.

CHARLIE MUNGER: And all you people should be aware of this because all the people who are professional sellers of investment advice and brokerage service, et cetera, et cetera, have an immense vested interest in believing that things that can’t be true are true. (Laughter)

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: And not only that, they’ve been selected in a Darwinian process to have formidable sales skills and large energy. (Laughter) And this is dangerous to the rest of us. (Laughter)

WARREN BUFFETT: Yeah. Well, you’ve been selected to be the recipients of their advice. (Laughs)

CHARLIE MUNGER: Right. Furthermore, they figure out who we are and come in about 6 o’clock in the evening. (Buffett laughs)

17. “It’s not share of market. It’s share of mind that counts”

WARREN BUFFETT: Zone 1 again.

AUDIENCE MEMBER: Mike Assail (PH) from New York City. Could you explain a little more about what you call the “mind of the consumer” and the “nature of the product” and explain how you actually apply these concepts to find the companies with the growing demand and the best investment potential? And thank you for being two of the greatest professors I’ve ever had.

WARREN BUFFETT: Thanks. (Applause) You know, what you really — when you get into consumer products, you’re really interested in finding out — or thinking about — what is in the mind of how many people throughout the world about a product now, and what is likely to be in their mind five or ten or 20 years from now? Now, virtually every person on the globe — maybe, well, let’s get it down to 75 percent of the people on the globe — have some notion in their mind about Coca-Cola. They have — the word “Coca-Cola” means something to them. You know, RC Cola doesn’t mean anything to virtually anyone in the world, you know, it does to the guy who owns RC, you know, and the bottler. But everybody has something in their mind about Coca-Cola. And overwhelmingly, it’s favorable. It’s associated with pleasant experiences. Now, part of that is by design. I mean, it is where you are happy. It is at Disneyland, at Disney World. And it’s at ballparks.

And it’s every place that you’re likely to have a smile on your face, including the Berkshire Hathaway meeting I might add. (Laughter) And that position in the mind is pretty firmly established. And it’s established in close to 200 countries around the world with people. A year from now, it will be established in more minds. And it will have a slightly, slightly, slightly different overall position. In ten years from now, the position can move just a little bit more. It’s share of mind. It’s not share of market. It’s share of mind that counts. Disney, same way. Disney means something to billions of people. And if you’re a parent of a couple young children and you got 50 videos in front of you that you can buy, you’re not going to sit down and preview an hour and a half of each video before deciding what one to stick in front of your kids. You know, you have got something in your mind about Disney. And you don’t have it about the ABC Video Company. Or you don’t even have it about other — you don’t have it about 20th Century.

You know, you don’t have it about Paramount. So that name, to billions of people, including lots of people outside this country, it has a meaning. And that meaning overwhelmingly is favorable. It’s reinforced by the other activities of the company. And just think of what somebody would pay if they could actually buy that share of mind, you know, of billions of people around the world. You can’t do it. You can’t do it by a billion dollar advertising budget or a $3 billion advertising budget or hiring 20,000 super salesmen. So you’ve got that. Now, the question is what does that stand for five or ten or 20 years from now? You know they’ll be more people. You know they’ll be more people that have heard of Disney. And you know that there will always be parents that are interested in having something for their kids to do. And you know that kids will love the same sort of things. And, you know, that — (Munger accidentally knocks over his microphone) — what’s? (Laughter) He emphasizes the key points when we get to those.

(Laughter) But that is what you’re trying to think about with a consumption product. That’s what Charlie and I were thinking about when we bought See’s Candy. I mean, here we were. It’s 1972. You know, we know a fair amount about candy. I know more than when I sat down this morning. (Laughs) I mean, I had about 20 pieces already. (Laughter) But, you know, what — whose, you know — does their face light up on Valentine’s Day, you know, when you hand them a box of candy and say, you know, it’s some nondescript thing and say, “Here, honey, I took the low bid,” you know, or something of the sort, and — (Laughter) No. I mean, you want something — you know, you’ve got tens of millions of people — or at least many millions of people — that remember that the first time they handed that box of candy, it wasn’t that much thereafter that they got kids for the first time or something. So it’s — the memories are good.

The association’s good. Total process. It isn’t just the candy. It’s the person who takes care of you at Christmastime when they’ve been on their feet for eight hours, and people have been yelling at them because they’ve been in line with 50 people in line, and that person still smiles at them. The delivery process. It’s the shop in which they get all kinds of things, the treat we give them. It’s all part of the marketing personality. But that position in the mind is what counts with a consumer product. And that means you have a good product — a very good product — it means you may need tons of infrastructure, because you’ve got to have that — I had a case of Cherry Coke awaiting me at the top of the Great Wall when I got there in China. Now that — you’ve got to have something there so that the product is there when people want it. And that happened — in World War II, General Eisenhower, you know, said to Mr. Woodruff that he wanted a Coca-Cola within arm’s length of every American serviceman in the world.

And they built a lot of bottling plants to take care of that. That sort of positioning can be incredible. It seems to work especially well for American products. I mean, people want certain types of American products worldwide, you know, our music, our moves, our soft drinks, our fast food. You can’t imagine, at least I can’t, a French firm or a German firm or a Japanese firm having that — selling 47 or 48 percent of the world’s soft drinks. I mean, it just doesn’t happen that way. It’s part of something you could broadly call an American culture. And the world hungers for it. And Kodak, for example, probably does not have quite the same — and George Fisher’s doing a great job with the company. This goes back before that. But Kodak probably does not have the same place in people’s mind worldwide quite as it had 20 years ago. I mean, people didn’t think of Fuji in those days, we’ll say, as being in quite the same place. And, then, Fuji took the Olympics, as I remember, in Los Angeles.

And they just — they put them — they pushed their way to more of a parity with a Kodak. And you don’t want to ever let them do that. And that’s why you can see a Coca-Cola or a Disney and companies like that doing things that you think, well, this doesn’t make a hell of a lot of sense. You know, if they didn’t spend this $10 million, wouldn’t they still sell as much Coca-Cola? But, you know, that — I quoted from that 1896 report of Coca-Cola and the promotion they were doing back then to spread the word. You never know which dollar’s doing it. But you do know that everybody in the world, virtually, has heard of your product. Overwhelmingly, they’ve got a favorable impression on them and the next generation’s going to get it. So that’s what you’re doing with consumer products. With See’s Candy, you know, we are no better — we want — no better than the last person who’s been served their candy or the last product they’ve been served.

But as long as we do the job on that, people can’t catch us. You know, we can charge a little more for it because people are not interested in taking the low bid. And they’re not interested in saving a penny a bottle on colas. Remember we’ve talked about in these meetings, private labels, in the past. And private label has stalled out in the soft drink business. They want the real thing. And 900 and some odd million eight-ounce servings will be served today of Coca-Cola product around the world. Nine-hundred million, you know. And it’ll go up next year, the year after. And I don’t know how you displace companies like that. I mean, if you gave me a hundred billion dollars — and I encourage if any of you are thinking about that to step forward — (laughter) — if you gave — and you told me to displace the CocaCola Company as the leader in the world in soft drinks, you know, I wouldn’t have the faintest idea of how to do it. And those are the kind of businesses we like. Charlie?

CHARLIE MUNGER: Yeah. I think the See’s Candy example has an interesting teaching lesson for all of us. Warren said we were — it’s the first time we really stepped up for brand quality. And it was a very hard jump for us. We’d been used to buying dollar bills for fifty cents. And the interesting thing was that if they had demanded an extra $100,000 for the See’s Candy company, we wouldn’t have bought it. And that was after Warren had been trained under the greatest professor of his era, and had worked 90 hours a week.

WARREN BUFFETT: And eaten a lot of chocolates, too. (Laughs)

CHARLIE MUNGER: Yeah. Absorbing everything in the world. I mean, we just didn’t have minds well enough trained to make an easy decision right. And by accident, they didn’t ask the extra $100,000 for it. And we did buy it. And as it succeeded, we kept learning. I think that shows that the name of the game is continuing to learn. And even if you’re very well-trained and have some natural aptitude, you still need to keep learning. And that brings along the delicate problem people sometimes talk about: two aging executives. (Laughter) I don’t know what the hell that means as an adjective because I don’t know anybody that is going in the other direction. (Laughter and applause) But you people who hold shares are betting, for a while at least, until younger successors come along, you’re betting to some extent on what we’ll now tactfully continue to call “aging executives” continuing to learn.

WARREN BUFFETT: Yeah. Well, if we hadn’t have bought See’s, with some subsequent developments after that because that made us aware of other things, we wouldn’t have bought Coca-Cola in 1988. I mean, you can give See’s a significant part of the credit for the, I guess, $11 billion-plus profit we’ve got in Coca-Cola at the present time. And you say, “Well, how could you be so dumb as not to be able to recognize a Coca-Cola?” Well, I don’t know, but —

CHARLIE MUNGER: You were only drinking about 20 cans a day.

WARREN BUFFETT: Yeah. Right. It wasn’t that I hadn’t been exposed to it, or — (Laughter) It’s amazing. But it just made us start thinking more. I mean, we saw how decisions we made in relation to See’s played out in a marketplace and that sort of thing. And we saw what worked and didn’t work. And it made us appreciate a lot what did work and shy away from things that didn’t work. But it led — it definitely led to a Coca-Cola. And we’ve had the good luck to buy some businesses themselves in their entirety that taught us a lot. You know, we bought — and it’s worked in the other direction. I mean, we were in the windmill business, one time. I was. Charlie stayed out of the windmill business. But I was in the windmill business and pumps and — third-level department — or second-level — department stores. And I just found out how tough it was and how it didn’t — you could apply all kinds of energy to them. And it didn’t do any good.

It made a great deal of sense to figure out what pond to jump in. And what pond you jumped in was probably more important than how well you could swim. Charlie?

CHARLIE MUNGER: I don’t think it’s necessary that people be as ignorant as we were, as long as we were. (Laughter) I think American education could be better, but not in the hands of any of the people who are now teaching. (Laughter)

WARREN BUFFETT: Is there any group we’ve forgotten to offend? I mean — (Laughter)

18. Life advice: “You will do well in what you enjoy”

WARREN BUFFETT: OK. Zone 2.

AUDIENCE MEMBER: Yes. Good afternoon, Mr. Chairman and Mr. Vice Chairman. My name is Ha Tsin Tsu (PH) and originally from China. Now, I’m living Kansas. And it’s my honor to speak to you both. My question is, if someone like to form a company doing what you did 30 or 40 years ago, what is your suggestion to them? And would you share some of your wisdom with us? Thank you.

WARREN BUFFETT: First thing we’d suggest is they send us a royalty. (Laughter) Charlie, you take over on that. You’ve thought more about starting over again than I have. (Laughter)

CHARLIE MUNGER: I want to frankly say that that’s a question I ordinarily duck. I always believe in getting the fundamental mental tools in place. And I always believe in running reality, as it comes in, preferably vicariously through the newspaper, et cetera, instead of through personal painful experience, through the filter of these sound ideas. And I not only think that that works in life to create success, I think it makes life more fun. So I argue for sound thinking. But the exact specific techniques of turning yourself into another Warren Buffett, I leave to you. (Laughter)

WARREN BUFFETT: Well, the one thing I would advise is I would be — A, I think there’s a ton of opportunity out there. And I would do something I enjoyed. I wouldn’t do something because I thought it was going to get me to a life I was going to enjoy later on, because if I made a lot of money I was going to be a lot happier, or anything like that. I’ve never done that. And I think that you will do well in what you enjoy. And I think it’s crazy in life to endure a whole lot that — I don’t mean — Charlie and I worked in a grocery story. We didn’t really jump up and down over it all the time. But in terms of making a commitment to really being a business that you’re only in it for the money, I think that’s crazy. And if we were in this only for the money, you know, we’d have quit a long time ago, obviously. It just — you ought to have fun while you’re doing it. It should not be jam tomorrow and not jam today.

It just doesn’t make any sense to me. And I think you’ll get better results that way, too.

19. Buffett rejects criticism of Disney over same-sex benefits

WARREN BUFFETT: Zone 2? Or did we just do zone 2? I think we did. Yeah. It’d be zone 3.

AUDIENCE MEMBER: Dave Youberg (PH) from Sac City, Iowa. And I must — I haven’t heard you on the moral and ethical considerations of stocks like ABC and Disney. They are now getting more and more criticism from mainstream religious groups in this country, main — their reliance on sex and violence and their cronyism — homosexuality — and —

VOICE: Did they hear it? I couldn’t hear it. (Scattered applause)

WARREN BUFFETT: I didn’t — we didn’t cut anybody off there.

CHARLIE MUNGER: (Inaudible)

WARREN BUFFETT: What? The — what I would — I would say, you know, I’m delighted to have my grandchildren exposed to the full range of Disney product. (Applause) You know, I’d love to take them to Disneyland or Disney World or take them to Disney movies or Disney videos. You know, I think the Disney Company is being run in an absolutely first-rate way. And I have no problem whatsoever with gays being employed or receiving benefits or anything of the sort. (Applause)

20. We don’t care who is buying or selling securities

WARREN BUFFETT: Zone one?

AUDIENCE MEMBER: Good afternoon, Mr. Buffett. Good afternoon, Mr. Munger. My name is Bashir Narema (PH) from Arlington, Texas. I see in the USA Today article about the shortage of labor in the state. And I was wondering when you analyze a company, do you take that into consideration by choosing companies who are not dependent so much on labor? The second question is, I heard you in the beginning of the meeting that so much capital coming from foreign country, you mentioned so many different country, who buy — who bought the Berkshire Hathaway. And I’m sure they buy all companies in the Dow. Do you feel like the analyst who analyze the Dow had that into consideration that the Dow now is becoming as the Walmart of the security business in the world, where all the national different country, they bypass their market and they come in and buy in the United States. And as a result that the idea of [Federal Reserve Chairman] Mr. [Alan] Greenspan, as far as exuberant, it’s moot because if you remember how the Japanese were when they start to buy the real estate in America, they force us to pay high premium for the price.

And I think that’s what’s going to happen in the market. And we, as Americans, who’ve been accustomed to low P/Es, now we’re going to miss on and the price is going to continue going up. And the third question is —

WARREN BUFFETT: Maybe we better stop at two. (Laughs)

AUDIENCE MEMBER: Alright. Thank you.

WARREN BUFFETT: OK. Thanks. We pay very little attention — we don’t pay any attention — to capital flows. In other words, we don’t really care who’s buying or selling any securities. Somebody is buying or selling each one. So, obviously, there’s, you know, you could focus on the buyers. You could focus on the sellers. But — you can say now that there’s 20 billion a month or so going into equity funds and all. But it doesn’t make any difference to us. All we’re interested is what the business is worth. And what people are paying attention to, in terms of capital flows or whatever — or market signals or whether the Fed’s going to move, that all changes. Do you remember ten years ago, it was, you know, it was M2 that everybody — every — whatever day of the week it was, you know, what’s M2 this week? I always thought of having a mystery, you know, about whatever happened to M2? (Laughter) There’s always something that people are talking about.

There’s so much time to fill with chatter, you know, and pages to fill, that they write about all these things that, to us, don’t make much difference, because we don’t care if the market closes for the next five years. We care how much Coca-Cola has sold five years from now, and what percentage of the world market they have, and what they’re charging for it, and how many shares are outstanding, and that sort of thing. But we just — we don’t care who’s buying or selling it in the least, except we like it when the company’s buying it. The same way with Gillette. We care about whether people are trading up in the shaving experience. So capital flows and all of those macro factors that people like to write about a lot just have nothing to do with what we do. We’re buying businesses. And I really think it is not a bad mindset, whenever you buy a stock to say, “Would I be happy buying this stock if the market closed for five years?” Because then you’re buying a business, if you say yes to that.

If you don’t say yes to that, you may not be focusing on the proper thing. By its nature, the U.S. is running a substantial trade deficit, merchandise trade deficit. If you buy more from the rest of the world than you’re selling them, which is what happens when you’re running a trade deficit, you have to balance the books. I mean, they get something in exchange. And what happens is they get some sort of capital asset in exchange. They may get a government bond. They may get a piece of the U.S. business or something. But the key thing in economics, whenever somebody makes some assertion to you about economics, you always want to say, “And then what?” In fact, it’s not a bad idea to say that about everything in life. But you always have to say, “And then what?” So when you read that the merchandise trade deficit is nine billion, what else does that mean? Well, it means that somehow we have to have created nine billion of capital assets, claims on our production in the future, with somebody else in the world. So they have to invest.

They don’t have any choice. When somebody says, “Won’t it be terrible if the Japanese sell all their government bonds?” They can’t sell all their government bonds without getting something else in exchange, you know, they get some other American asset in exchange because there’s no other way to do it. They could sell it to the French. But then the French have the same problem. So trace through where the transactions go anytime someone starts talking about one specific action in economics.

21. “We like a business with low labor costs”

WARREN BUFFETT: Question about labor. Generally speaking, obviously, we like a business with low labor costs. But we like a business with low costs of every kind, I mean, because the rest is profit. So it would be true that on balance we would not be high on labor-intensive companies. But there’s some very good businesses that are labor intensive. (BREAK IN TAPE)

WARREN BUFFETT: But if you say, “Would I rather have a labor intensive business or a nonlabor intensive business and everything else is equal,” the answer is the less labor intensive business. Charlie, you want to comment on either one?

CHARLIE MUNGER: No. I don’t think I’ve got anything more. (Laughter)

22. Subsidiaries make own decisions on accepting American Express

WARREN BUFFETT: Area two?

AUDIENCE MEMBER: First, I’d like to thank you both for being so generous with your time and with your ideas for us today. (Applause)

WARREN BUFFETT: Thank you. We get paid by the hour, so — (Laughs)

AUDIENCE MEMBER: Well, I’ll try and talk quickly then.

WARREN BUFFETT: Oh no. (Laughs)

AUDIENCE MEMBER: My name is Bob Costa (PH) from Evansville, Indiana. I’ve been a shareholder for four years. This is my first visit to Omaha. And I went to the mega mart. And I actually bought something there. And I tried to pay for it with American Express card.

WARREN BUFFETT: Uh huh.

AUDIENCE MEMBER: And they told me, just like the ad, you can’t use it here. I hope you’d both comment on that or at least one of you. But my real question is that I just stumbled across the idea of intellectual capital and how that might be useful in valuing a business. And I was hoping that one or both of you could clarify that for me and whether that’s useful to us as investors or just another academic theory that we’d be better off ignoring.

WARREN BUFFETT: Yeah. Harvey Golub, who runs American Express and has done a terrific job of running it, has written me about the Furniture Mart as well as about See’s. And we, basically, let our managers run their own businesses. So, the people at each entity — Borsheim’s takes American Express. Others of our businesses do, too. We let every manager make his decisions. As soon as I start telling the managers that they ought to, say, take American Express or not take Visa or whatever it may be, you know, at that point, they’ve lost some of the responsibility for their operations and, perhaps, to an extent even, you know, some of the pride that comes from running them. Most of our managers do not need to work for a living. They run their businesses for the same reason Charlie and I run Berkshire. They love doing it. They jump out of bed in the morning because it’s exciting to do.

And the one thing that would keep the two of us, or drive the two of us away from Berkshire, is if we were getting second-guessed all the time or somebody else was telling us when to swing or not to swing. We would have no interest in running it. We’d go run — we’d do something else then. And maybe our other managers aren’t as extreme as we are in that respect. But we feel they’ve built successful businesses. They know how to do it. We do allocate the excess capital they generate. But aside from that, we really let them make their own decisions. So we have no companywide policy on virtually anything that I can think of, except send money to Omaha. (Laughter) But — and, you know, we’re delighted to have American Express give the Furniture Mart the reasons why the Furniture Mart will be better off using American Express. And my guess is they have some very good reasons. But they’re going to have to sell them on that, and just like any vendor of anything has to sell each operation.

We wouldn’t tell the people at See’s who to buy the nuts from, or who to buy the container from, or anything of the sort, how to design the stores, or whatever it may be. And that’s just the Berkshire philosophy on that. Charlie, you want to comment?

23. Berkshire’s intellectual capital is its managers

CHARLIE MUNGER: Yeah. Let me shift to intellectual capital. Berkshire has a lot of intellectual capital in these very able executives in the various businesses. And we hope we’ve got some intellectual capital in the few hundred square feet at headquarters. (Laughter) But we are not in the business of designing oil refineries with armies of engineers, or developing software with armies doing complicated accounting work all over the world. We just haven’t drifted into that kind of a business. And intellectual capital has gotten to be a new buzzword, because we’ve now developed huge businesses, like Microsoft, which really didn’t exist on that scale not so very long ago. And so people have suddenly realized, my God, there’s really a lot of money in the aggregation effects and momentum effects when you get a bunch of really bright people working in the same direction. And that’s what’s made the concept so fashionable. By and large, we’ve avoided the field. Again, it’s hard for us to understand.

WARREN BUFFETT: Yeah. We look for brains and energy and integrity in people that we work with. And if you get that combination and you’re in a decent business, you know, you can own the world. And, you know, whether you call it intellectual capital or anything — you know, you can stick the names on it. And that’s who we try to associate with. I mean, it’s a lot easier than doing it yourself. And when we get, in our own businesses — you saw that group there at the end of the movie — I mean, that’s a huge asset to Berkshire. They talk about getting into accounting for it. That’s nonsense in my view. I mean, you don’t need to do that. But you should pay for it. And you should pay for it as shareholders. You should pay for it as managers. When we get people, you know, whether it’s Tom Murphy, or Al Zeien at Gillette, or Roberto Goizueta, or Michael Eisner, I mean, those people have added billions of dollars of value.

And, it’s just — you know, that’s who we want to be associated with. And we don’t want to be associated with the mediocre managers because the difference is just — is huge. But we don’t go through an elaborate exercise. We just recognize the people that have got those — we think we — we try to recognize the people who have got those qualities. And, then, we — and then if they’re in a good business and they’ve got those qualities, we want to take a big bite.

CHARLIE MUNGER: But take intellectual capital. People think patents. They think copyrights. Patents and copyrights have gotten to be way more valuable, as a percentage of the investment assets of the world. And so people are very much more interested in intellectual capital. Think of the great drug companies and how small they were 20 years ago and how everything they have is, basically, intellectual capital. It’s the few products that have — that really work that have the patents. But by and large, we’re not in drug companies.

WARREN BUFFETT: No. But that’s — there are different forms — as Charlie said, there’s businesses you sort of think of that way as their whole being being intellectual capital. But I would argue that when Roberto Goizueta, 15 years ago, saw how to make the future of Coke — same product — dramatic — and basically the same system, although it required some changes — but saw how to make that dramatically more valuable by doing a lot of little things over a long period of time and doing them consistently and not getting his eye off the ball. Michael Eisner did the same thing. Disney hadn’t gone anyplace, you know, in the 15 years or so after Walt died. Now, you know, we all knew who Mickey Mouse was and everything. But Michael really saw what the future should be. And he still does, you know. And you say it’s easy when it’s all over. But how many people were doing something about it at the time? The place was languishing, basically, 15 years ago. They had the assets.

And, to me, that’s — you know, it’s different than what Bill Gates does or Andy Grove does. But it’s our form of intellectual capital. And it’s what we can understand better.

24. “Mistake” to not buy pharmaceutical stocks

WARREN BUFFETT: Zone, what do we have? Three.

AUDIENCE MEMBER: Mr. Buffett and Mr. Munger, my name’s Will Jacks. (PH) I’m from Chicago, and I’m a happy shareholder. I, first, want to thank both of you for the unusual privilege you give us for your time and your expertise. This is very unusual. And I think it’s to be commended. (Applause) And my question has to do with one of the major American industries that, unless I missed something in the reading, that is the pharmaceutical industry, the companies that make medicines. I wonder under what circumstances you might consider those industries for investment by Berkshire Hathaway?

WARREN BUFFETT: Well, those industries — the pharmaceutical industry’s, obviously, been a terrific industry to invest in. We have trouble, or at least I have trouble, distinguishing among the companies, in terms of seeing which ones, ten years from now, might be the best ones to be in. I mean, it’s easy for me to figure out that Coca-Cola’s the soft drink company to be in, or Gillette is the shaving company to be in, or Disney’s the entertainment company to be in, than it is for me to figure out which one in the pharmaceutical. But that — I’m not saying you can’t do it. I’m just saying that that’s difficult for me. We have — we started buying one of them a couple of years ago. And we should’ve continued, but we didn’t because it went up an eighth, and — (Laughter) Your chairman was a little reluctant to follow it, a terrible mistake.

But I would say the biggest — and we could’ve bought the whole industry and done very well at various times, particularly when the threat of — what people thought was the threat of the Clinton health program cast a big cloud over the pharmaceutical industry. That was the time you could’ve just bought the whole industry and done very well. We didn’t do it. It was a mistake. Charlie?

CHARLIE MUNGER: Well, it’s hard to think of any industry that’s done more good for consumers, generally. When you think of the way children used to die and now, they very seldom die. And it’s been a fabulous business. And it’s been one of the glories of American civilization. But it’s — we’ve admired it. But we haven’t been part of it.

WARREN BUFFETT: We’ve missed a lot of things. And I’m dead serious about that. And we’ve missed things that should not have been beyond our capacity to grasp. A lot of things that should be beyond our capacity to grasp, but there’s some that haven’t been. And we’ve just plain missed them.

25. Munger: Good general education helps investors

WARREN BUFFETT: Zone 1?

AUDIENCE MEMBER: Hello. I’m another Chicagoan, (inaudible), and a share owner. This question is directed, first, to Mr. Munger, and then to Mr. Buffett. Mr. Munger, I am intrigued by your marshalling of the Commodore [Cornelius Vanderbilt] and Aristotle to support your points. Very few of today’s money managers would, or could, do that. Could you elaborate on what role a study of history of civilization plays in developing a sound investment philosophy? Thanks.

CHARLIE MUNGER: Well, I don’t want to praise Aristotle too much. You know, he was the one who thought that women had a different number of teeth from men — (laughter) — and never looked in his wife’s mouth. (Laughter)

WARREN BUFFETT: Maybe his wife did. (Laughter)

CHARLIE MUNGER: I’m all in favor of a good general education. And I think it helps investment performance. And it helps business performance. And it helps one be a better citizen. And some of the things people say are quite memorable. And therefore, they’re helpful to the mind by the very ease of which they’re remembered. And I think you’d be surprised how many bright investment professionals could talk a lot about Aristotle, or even people I can’t stand — (laughter) — like [German philosopher Georg Wilhelm Friedrich] Hegel.

WARREN BUFFETT: You want to quote a little more from anybody to reinforce your —? (Laughs)

CHARLIE MUNGER: One of my favorite quotations in the whole world is from Einstein. He says everything should be made as simple as possible, but no more simple. And I think that describes the reality that we all face.

WARREN BUFFETT: Charlie’s favorite, though, is Ben Franklin. That’s probably true, isn’t it, Charlie?

CHARLIE MUNGER: Yeah.

WARREN BUFFETT: We get more from Ben than anybody else. “Keep thy shop and it will keep thee,” that sort of thing. I mean, we’re just — we’re loaded with that stuff. (Laughter)

CHARLIE MUNGER: “Three removes are as good [bad] as a fire.” “It’s hard for an empty sack to stand upright.” (Laughter) That’s the bible around Berkshire.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: I once heard Warren say, “The reason I’m so financially conservative is I don’t want to find out how badly I might behave if I were stretched.” (Laughter)

WARREN BUFFETT: I think we better cut him off here. (Laughter)

26. “Why risk losing what you need and have for what you don’t need and don’t have?”

WARREN BUFFETT: Zone 2. You better cut the thumping there.

CHARLIE MUNGER: Yeah. (Laughter)

AUDIENCE MEMBER: My name is Stanley Watkins and — from Manhattan, Kansas. And I’m a shareholder. And I have two questions. And the first one, I know the answer. So you can just say yes or no. (Laughs) Would you consider investing in indexes such as OEX? Pure speculation, you’re going to say yes. And number two, would you encourage investors to, if they were trying to get a lot of their investment, to use LEAPS on investments such as Coca-Cola instead of buying the stock?

WARREN BUFFETT: Use what on? I missed that —

CHARLIE MUNGER: LEAPS.

WARREN BUFFETT: Leak?

CHARLIE MUNGER: LEAPS, L-E-A-P-S.

WARREN BUFFETT: Oh, I see. We’re still on options.

CHARLIE MUNGER: (Inaudible)

WARREN BUFFETT: Oh yeah.

WARREN BUFFETT: Both the questions relate to futures of one sort, calls, or whatever they may be, and — I think that investors should stick to buying ownership in businesses. It’s not that you can’t come up with a theoretical argument for buying, say, a — I mean, if you think Coca-Cola’s attractive, you can say, well, I’d rather buy a five-year option on Coke than buy the stock directly because it introduces leverage without the risk of going broke. But I think that that’s a dangerous path to start down, because it — If it works well, it’s so — it’s dynamite to start playing with things that can expire and become worthless, or can be bought with very low margin, as the OEX options you were talking about. Borrowed money usually — or frequently — leads to trouble. And it’s not necessary.

I mean, if you had some compelling reason — if you’re going — if you had to double your money by the end of the year or be shot, you know, then, I would head for the futures market because, you know, you need to do it. I mean, you have to introduce borrowed money. But you really ought to figure out how you can be happy with the present amount of money you’ve got and, then, figure that everything else is, you know, all to the good as you go along, and — I don’t think people — once they start focusing on short-term price behavior, which is the nature of buying calls, or LEAPS, or speculating in index futures, once you start concentrating on that, I think you’re very likely to take your eye off the main ball, which is just valuing businesses. I don’t recommend it. Charlie?

CHARLIE MUNGER: Well, this is a group of affluent investors. I don’t think many of them did it in LEAPS. (Laughter)

WARREN BUFFETT: Yeah. It’s certainly true. If we’d operate Berkshire with considerable borrowed money over the years, you know, it would’ve done very much better than it has. But nobody knew what that amount of borrowed money would have — the appropriate level would have been. And it wouldn’t have made any difference to us. I mean, we have just as much fun doing what we’ve done than if we’d owned it on leverage and had it been twice as much. I mean, it just — it’s just — it’s not the way we approach it. If you have X and you think you’re going to be way happier when you’ve got 2X, it’s probably not true. You really ought to enjoy where you are at a point. And if you can make, you know, if you can make 12 or 15 percent a year, and you desire to save, and you like piling it up, you know, it’ll all come in time.

And why, you know, why risk losing what you need, you know, and have, for what you don’t need and don’t have? It’s never made a lot of sense to us.

CHARLIE MUNGER: Warren wrote a letter when they were developing the security options businesses. And he urged the civilization not to allow the new exchanges. And you can see how much attention they paid to him. (Buffett laughs)

WARREN BUFFETT: The usual amount.

CHARLIE MUNGER: Yeah, right.

27. Haven’t looked at hazardous waste business, but have seen toxic waste in markets

WARREN BUFFETT: Area 3?

AUDIENCE MEMBER: Hi, my name’s Greg Collart (PH), a shareholder from Calgary, Canada, the home of Bre-X Minerals. (Laughter) My question for you is, the companies in the hazardous waste disposal industry have underperformed the market for about a decade now. Do you see any value in that area?

WARREN BUFFETT: We’ve never looked at that business. I’m familiar with the names of the companies. But that’s been a business that I’ve never looked at. And maybe Charlie knows more about it than I do. He almost has to. (Laughs)

CHARLIE MUNGER: No. We have never really looked at the hazardous waste business. We’ve observed a lot of toxic waste in the securities market. (Laughter) Maybe we’d get our fill that way. (Laughter)

28. Lesson of State Farm’s improbable success story

WARREN BUFFETT: Area one.

AUDIENCE MEMBER: My name is Hugh Stephenson. I’m a shareholder from Atlanta, Georgia. My question involves GEICO. If I remember correctly from last year, GEICO had about 2 percent of the insurance market and had approximately $4 billion in float. My question is, as their market share expands, will the float, in your expectation, expand in a somewhat linear fashion? And related to that, what is your guess might be the top end? Could they ultimately become as dominant as a Gillette or a Coke and their businesses? Or is the nature of it such that, you know, they might stop at ten percent of the market or 15 percent when they start to hit a significant hurdle? And second, to follow up on this other gentlemen’s question, if you don’t adjust for risk by using higher discount rates, how do you adjust for risk? Or do you?

WARREN BUFFETT: Well, the second question: we adjust by simply trying to buy it at a big discount from that present value calculated using the risk-free interest rate. So if interest rates are 7 percent and we discount it back to flows — which Charlie says I never do anyway and he’s correct — but in theory, if we discount them back at 7 percent then we would look at a substantial discount from that present value number in order to warrant buying. The question about

GEICO: the float will grow, more or less proportionately, to premium volume. There’s a moderate amount of our float, a very small amount of the float, that’s accounted for by some discontinued lines from the past. And, of course, that won’t grow the same way. But if we double the size of GEICO on premium volume, we’ll come close to doubling the size of the float. You know, the history of auto insurance is quite interesting. It’s something that isn’t studied at business schools and should be studied, because the great insurance companies of the early 1900s were, you know — whether it’s Aetna, Hartford, Travelers — they had these agency forces nationwide, and wrote what was then more property business. They wrote a lot of fire business in those days. And, of course, the automobile only came in, you know, in the early 1900s. And so their orientation was to property business. But they had this huge agency force throughout the United States. There were property insurance agents representing these big companies in every — throughout the country. And they had lots of capital.

And now, if you look at the business in 1997, something well over 20 percent — probably close to 25 percent — of the personal, auto, and homeowners business in insurance is written by a company called State Farm. And State Farm was started, I believe, in the ’20s, by a fellow in Bloomington, Illinois with no capital to speak of, no agency force initially, and started as a mutual company, no incentive, I mean, no stock options, no capital invested where he could become a billionaire if he built the business up or anything. So here this company starts without any of the capitalist incentives that are we are taught are essential to a business growing, and in a huge industry, becomes the dominant player — has more than twice the market share of Allstate, the second player — becomes the dominant company against these extremely entrenched competitors with great distribution systems and loads of capital. Now I say that’s — and incidentally, State Farm, on the Fortune 500 list of companies, has the third largest net worth of any company in the United States. Number three from Bloomington, Illinois with a guy with no money in it. Now, how does that happen?

Well, I would say that’s a subject worth studying, you know, in business schools, because it — You know, Darwin used to say that any time he got any evidence that flew in the face of his previous convictions, he had to write it down in the first 30 minutes or the mind was such that it would reject contrary evidence to cherished beliefs. And certainly, there’s some cherished beliefs around business schools that might, at least, find some interesting aspects in studying how a company could become the third largest company in net worth in the country with no apparent advantage going in. There’s another company down in Texas called USAA, United States — It’s for the United Services Auto Association. And it’s been enormously successful, has billions of net worth, loads of satisfied policy holders, the highest renewal ratio among policy holders in the country. Nobody studies that, to my knowledge, either. The people who started GEICO came from that company. In 1936, Leo Goodwin and his wife, who had worked for USAA, went over and started this little GEICO company with practically no capital. And, now, it’s — we have about 2.7 percent of the market.

And we’re — we’ll write probably 3 1/2 billion of voluntary auto this year. Catching a State Farm is going to be very difficult. So I wouldn’t want to predict we’d do that. I will predict that we will gain very materially in market share over the next ten years. And we’ll gain materially this year. But we will — we have got a very good mousetrap. I said in the report that 40 percent of you would save money insuring with — I didn’t say a hundred percent or 80 percent or 60 percent, because there are areas and professions where somebody else is going to have a lower price than we are. But across the country, we are going — and for all classes of citizens — we are going to have a low price — the low price — more often than anyone else. And we’ve got that because we’ve got low costs. And our costs are going to get lower. And we’ve got a virtuous circle going, in terms of it feeding on itself. So GEICO will grow a lot. But I — State Farm is plenty tough.

So I’m not going to predict catching State Farm. I’m not even going to predict catching Allstate. But we’ll catch somebody. And Charlie, you want to say anything more?

CHARLIE MUNGER: Well, I love your example of State Farm. I mean, the idea of picking some extreme example and asking my favorite question, which is what in hell is going on here — (laughter) — that is the way to wisdom in this world. And it is too bad. A lot of the mutual companies are now trying to demutualize, helped by a bunch of consultants and so forth. And they are not looking at State Farm. They’re looking at some other model, and — Everybody can’t be a State Farm. That place got some fundamental values into its operating mechanics, the way it selected personnel, the way it selected agents, the way it discarded agents. It was huge discipline, wouldn’t you agree, in that operation?

WARREN BUFFETT: Yeah. Somebody would — you would say somebody had to do something very right. But the question — I don’t know anybody studying what they did that was right. You know, they don’t want to because it doesn’t fit the pattern. And you know, when something like a State Farm happens in this world, you should try to understand it. When something like a GEICO happens in this world, you should try to understand it. In 1948, I think it was two-thirds or three-quarters — I think it’s two-thirds — of GEICO was for sale because the fellow that had originally backed these two people from USAA died. And so they had the stock for sale in 1948. You couldn’t sell it. That’s how Ben Graham ended up buying it for Graham-Newman, because they hocked it all over for six months. They went to all the big insurance companies.

And the insurance companies, who could see this company on a very, very tiny scale offering a product for way less money and making lots of money doing it, they simply couldn’t shake themselves loose from the mists of the past to step up and buy it. They could’ve bought it for a million-two-hundred-thousand dollars, as I remember, and owned the whole company. And instead, they’ve watched their own distribution system get their heads beaten in, you know, over the years. And all the time, you know, with these ideas from the past. So you have to be very careful to look hard at what’s really happening. You know, as Yogi Berra https://en.wikipedia.org/wiki/Yogi_Berra said, “You can observe a lot just by looking.” (Laughter)

29. Love it when a wonderful business buys back its stock

WARREB BUFFETT: OK. Zone one?

EVERETT PUREE: I’m Everett Puree (PH) from Atlanta, Georgia. And I wanted to ask you if you could comment on the matter of intrinsic value as it applies to some of “The Inevitables,” given that the overpayment risk now is high and the share repurchases that are going on there.

WARREN BUFFETT: Yeah. Well, we won’t stick a price on them. We just — we tell you that they are absolutely wonderful businesses run by sensational people, and that they are selling at prices that are higher than they sold at most of the time. And then — but that — you know — They may be — they may well be worth it and worth a lot more, even in terms of present terms. Or it may turn out they’re a couple years ahead of themselves. We don’t know the answer to that. We know we’re very happy owning them. Gillette does not repurchase its shares, or hasn’t in any significant quantity for many years. Coke consistently repurchases its shares. We generally like the policy of companies that have really wonderful businesses repurchasing their shares. There aren’t that many super businesses in the world. And the idea of owning more and more of a company like that over a period of time has an appeal to us, and almost an appeal regardless of price. The problem is that most companies that repurchase their shares, you know, are so-so — are frequently — so-so businesses.

And they’re being done for motivations other than intensifying the interests of the shareholders in a wonderful business. But we really know you have a wonderful business. And we think most of the ones we own are anywhere from extremely good to wonderful. We think it usually makes a lot of sense. It’s hard to do things intelligent with money in this world. And Coke has been very intelligent about using their capital to, particularly, to fortify and improve their bottler network around the world. I mean, they’ve done a terrific job that way. That was a neglected area for a long time. And that comes first. But there’s only so far you can go with that — and to enhance the ownership of the shareholders in a company like Coca-Cola — when we bought our first Coca-Cola in ’88, we bought about 6.2 percent of the company. And at that time, they may have been 600 million servings — not any more than that — a day. So we had an interest in 36 or 37 million servings. Now we have 8 percent of 900 million-plus. So we have an interest in 75 million or so servings a day.

Seventy-five million people are drinking Berkshire Hathaway’s share of Coca-Cola products today, in an eight-ounce serving. And you know, the profit’s gone up a little per serving. So that gets pretty attractive. And we’d just as soon they keep doing that.

30. Coca-Cola history lesson: “One of the dumbest contracts” ever

WARREN BUFFETT: The bottling thing’s actually kind of interesting. And a fellow from Omaha — or at least lived in Omaha for a long time — Don Keough, had a lot to do with this. And Roberto had plenty to do with it, too, obviously. But Candler — Asa Candler — back in the late 1880s, in a series of transactions — I think some of it’s a little fuzzy, exactly, as to the timing of them — but he essentially bought the whole Coca-Cola Company for $2,000. And that may be the smartest purchase in the history of the world. And, then, in 1899, I believe it was, a couple of fellows from Chattanooga came down. And in those days, soft drinks were sold over the counter to people in drug stores, primarily. But there was a little bottling going on. There already was somebody bottling in Mississippi, as I remember. But a couple fellows came down. And they said, “You know, bottling’s got a future. And you’re busy on the fountain side of the business. So why don’t you let us develop the bottling system?”

And I guess Mr. Candler didn’t think much of bottling. So he gave them a contract, in perpetuity, for almost all of the United States, for a dollar he sold it to them, and gave them the right to buy Coca-Cola syrup at a fixed price forever. So Asa, who had scored with his $2,000 — (laughs) — in a rather big way, managed to write what — you know, it’s easy for us to look back — but certainly looks like one of the dumbest contracts in history. (Laughs) And, of course, as the years went by, and particularly around World War II when the price of syrup was — the primary ingredient, in terms of cost, in syrup was sugar. And sugar went wild during and after World War I in price. And so here was a guy that, in effect, had contracted to sell sugar at a fixed price forever. And he’d also given these people perpetual rights and so on. In those days, they sold the subrights to bottler contracts. And those were usually the distance that a horse could go in a day and come back. That was sort of the circle that you gave people.

And the Coca-Cola Company was faced, over the years, with a problem of having the bottling system, which soon became the dominant system for distribution of Coke, being subject to a contract where there was no price flexibility and where the contracts ran in perpetuity. And, of course, every bottler on his death bed would call his children, his grandchildren around. And he propped himself up and croak out in his last breath, you know, “Don’t let them screw with the bottling contract.” You know, and then he’d croak. (Laughter) So the Coca-Cola Company faced this for decades. And they really couldn’t do much about that bottling system for a long time. And Roberto and Don Keough and some other people spent 20 or 25 years getting that rationalized. There were lawsuits back in the ’20s and some things. But it was a huge project. But it made an enormous difference over time in the value of the company.

And that’s what I mean when I talk about intellectual capital, because you know you aren’t going to get results on that in a day, or a week, or a month, or a year, if you set out to get that all rationalized. But they decided that to get the job done, they had to do this. And that took capital. And they used capital to get that job done. But they used capital beyond that to repurchase shares in a big way. And it’s been very smart. And I hope they keep — you know, I — they are repurchasing shares, probably, as we talk. And that’s fine with me. Charlie?

CHARLIE MUNGER: Well, I do think Coca-Cola Company is one of the most interesting cases in the history of business. And it ought to be way more studied than it is. And there’s just lesson after lesson after lesson in the history of the Coca-Cola Company. But it’s too long a story for today. (Buffett laughs)

31. Wesco is part of Berkshire due to “historical accident”

WARREN BUFFETT: Section two?

AUDIENCE MEMBER: I’m Jolene Crowley (PH) from San Diego. And I want to say I feel very lucky to be here today. When I tried to buy my first Baby Berkshire share last year, my stockbroker, who’s a value investing devotee, tried to talk me out of it, telling me that it was overvalued. So I feel lucky to be here. I’ve recently also discovered Wesco stock. And I’d like you to explain to me the ownership and management relationships between Berkshire Hathaway and Wesco, and how you use them together. And since I may not understand the answer to that question, could you just tell me, is it possible that buying Wesco today at about $20 a share is like buying Berkshire Hathaway was 20 years ago?

CHARLIE MUNGER: Well, if you could buy Wesco today at $20 a share, you should buy all you can.

WARREN BUFFETT: (Laughs) No, no —

AUDIENCE MEMBER: Beg your pardon. Two —

WARREN BUFFETT: Two-hundred dollars a share.

AUDIENCE MEMBER: Two-hundred.

WARREN BUFFETT: Yeah. Charlie is — (laughter) — chairman of Wesco. And why don’t you talk about it first, Charlie?

CHARLIE MUNGER: Wesco’s 80 percent owned by Berkshire. And in terms of operating businesses now, it’s got two. And it has an immense percentage of its net worth in marketable securities in its insurance subsidiary. It’s a very quiet company. And as the chairman of Wesco, I have always delighted in saying that we have way less human value in the executive staff than Berkshire Hathaway does. It’s a — it’s a — what is it Daniel Webster said about Dartmouth? He says, “A small school but there are those who love her.” Well, Wesco’s a small place. And it’s there in Berkshire as sort of an historical accident. But the main current of Berkshire is right here in the Berkshire shares.

WARREN BUFFETT: Yeah. I don’t know which one I would rather buy at present prices. I mean, I think it’s — you could flip a coin. It does not have dramatically better growth potential just because it happens to sell at $200 a share instead of 38,000 a share than Berkshire. I mean, I think the prospects, probably, are relatively close between the two. And they’re run by the same people, pretty much, in effect. Charlie may spend a little more time on Wesco than I do, but — they are — they’ve got the same prospects. But one problem that Wesco would have is that if people — and this is not a huge problem — but if people want to do a share exchange deal, they’re going to want to do it, probably, with Berkshire rather than Wesco. At Wesco, we have small acquisitions in fields we knew — Wesco’s a logical place to put them unless they happen to be in areas that Berkshire’s already in. And for the really large things, you know, Berkshire can do them and Wesco can’t.

But there’s nothing — I don’t think there’s anything significantly superior or inferior about investment in Wesco compared to Berkshire.

CHARLIE MUNGER: Well, the long-run record of Berkshire is better.

WARREN BUFFETT: Yeah. The one thing — It is a mistake to think that just because it’s cheaper per share on a dollar price that it’s got way more potential, I think, because that just isn’t the case. A very large percentage of Wesco’s value is represented by its interest in Freddie Mac. And a very large percentage of Berkshire’s interest is represented — Berkshire’s value — is represented by an interest in Coke, for example. So there’s different emphasis between the two places. I think Wesco owns some Coke. And Berkshire owns some Freddie, but in different proportions. That’s an historical accident. We’d love to see them both do well, obviously. There’s another family that’s in Wesco that we like a great deal. And we would hope that Wesco would perform as well or better than Berkshire. It’s performed fine over the years. But it hasn’t performed quite as well as Berkshire.

32. How Buffett surpassed Benjamin Graham

WARREN BUFFETT: Area 3?

AUDIENCE MEMBER: Yes. Hi. It’s Jeff Hawthorne (PH), Toronto, Canada. Mr. Buffett and Mr. Munger, you’re both a positive influence on all of us and our generations to come. There were a few significant individuals that had helped to guide your way in the beginning. Could you please share the current percentage of impact and evolution on your investment philosophy and approach between Graham-Dodd’s — Graham and Dodd’s versus Philip Fisher, and comment on each please.

WARREN BUFFETT: Charlie, you want to —? If you’ve got it worked out there. Calibrate —

CHARLIE MUNGER: Weren’t you —

WARREN BUFFETT: Do you want that to tenths of a percent or hundredths of a percent? (Laughs)

CHARLIE MUNGER: You were closer to Ben Graham.

WARREN BUFFETT: Yeah. Well, Ben — yeah — things would’ve happened — good things would’ve happened with following either party irrespective the other. Graham, obviously, had way more influence on me than Phil. I worked for Ben. I went to school under him. And his — what I call the three basic ideas that underlie successful investing — which is to look at stocks as businesses, and to have the proper attitude toward the market, and to operate with a margin of safety — they all come straight from Graham. I didn’t think of any of those. And Phil Fisher opened my eyes more to the idea of trying to find the wonderful business. Charlie did more of that than Phil did, actually, so you’d have to put Charlie — But Phil was espousing that entirely. And I read his books in the late ’50s, early ’60s. So, you know, I — Phil’s still alive as you know. And, you know, I owe Phil a lot. But I — it doesn’t compare to what I owe Graham. And that, in no way, reflects poorly on Phil. Ben was one of a kind. Charlie?

CHARLIE MUNGER: Ben Graham was a truly formidable mind. And he also had a clarity in writing. And we’ve talked over and over again about the power of a few simple ideas thoroughly assimilated. And that happened with Graham’s ideas, which came to me indirectly through Warren, but also some directly from Graham. The interesting thing for me is to watch Buffett the former protégé — and by the way, Buffett was the best student Graham had in 30 years of teaching at Columbia. And — but what happened — and since I knew both men — was that Buffett became way better than Graham. That is a natural outcome. It’s what Newton said. He said, “If I’ve seen a little farther than other men, it’s by standing on the shoulder of giants.” And so Warren may have stood on Ben’s shoulders, but he ended up seeing farther. And no doubt, somebody will come along in due course and do a lot better than we have.

WARREN BUFFETT: I enjoyed making money more than Ben. I mean, candidly. With Ben, it just — it really was incidental, at least by the time I knew him. It may have been different when he was younger. But it just didn’t — the process didn’t — of the whole game did not interest him more than a dozen other things may have interested him. With me, I just find it interesting. And therefore, you know, I’ve spent way more — a way higher percentage of my time thinking about investing and thinking about businesses. I’ve probably thought way more about businesses than Ben ever did. He had other things that interested him. So I’ve pursued the game a little — quite a bit — differently than he did. And therefore, measuring the record is really — the two records — it’s not a proper measurement. I mean, he was doing victory laps while I still thought I was out there running against, you know, the whole field.

CHARLIE MUNGER: But Graham had some blind spots, partly of sort an ethical professorial nature. He was looking for things to teach that would work for every man, that any intelligent layman could learn and do well. Well, if that’s the limitation of what you’re looking for, they’ll be a lot of reality you won’t go into, because it’s too hard to figure out and too hard to explain. Buffett, if there was money in it, had no such restriction. (Laughter)

WARREN BUFFETT: Yeah. Ben sort of thought it was cheating if we went out and talked to the management, because he just felt that the person who read his book, you know, living in Pocatello, Idaho, could not go out and meet the management. So he didn’t — and we didn’t do it. I mean, when I worked for Graham-Newman, I don’t think I ever visited a management in the 21 months I was there. He just — But, you know, he wasn’t sure whether it would be useful, anyway. But if it would be useful, you know, that meant that his book was not all that was needed, that you had to add something to it. I found it fun to go out and talk about their businesses with people, or to check with competitors, or suppliers, or customers, and all that. But — Ben didn’t think there was anything wrong with that. He just felt that if you had to do that, then his book was not the complete answer.

And he didn’t really want to do anything that the reader of his book couldn’t do if he was on a desert island, you know, basically, with just one line to a broker.

CHARLIE MUNGER: But if you stop to think about it, Graham was trying to play the game of “Pin the Donkey,” wearing very dark glasses. And Warren, of course, would use the biggest search light he could find. (Laughter)

WARREN BUFFETT: And we still can’t find any donkeys these days. (Laughter)

33. Gillette customers more loyal than McDonald’s customers

WARREN BUFFETT: OK. Area 1.

AUDIENCE MEMBER: I’m Joe Nobbe (PH) from Seattle, a shareholder. Mr. Buffett and Mr. Munger, I wonder if you could comment a little bit further on McDonald’s, carrying forward your comments of this morning, but more oriented toward how McDonald’s would stack up against “The Inevitables” in international-type business. What your vision would be on their growth potential in places like Germany, China, so on and so forth.

WARREN BUFFETT: Yeah. I guess I just would have to stick with my comment that you won’t get the inevitability in food that you will get in a single consumer product, you know, such as blades. I mean, if I’m using a Gillette Sensor blade today, the chances are I’ll try the next generation that comes out. It’ll be the Sensor Excel right now. But I will try the next one that comes out, obviously. But I will not fool around at all in between. And a very high percentage of people that shave, including women in shaving, they’re happy with the product. You know, it’s not expensive. It’s 20-odd dollars a year, you know, if you’re a typical user. And if you’re getting a great result, you’re not going to fool around. Whereas a great many of the decisions on fast food, as to where you eat, is simply based on which one you see. I mean, convenience is a huge factor.

So if you are going by a McDonald’s, or a Burger King, or a Wendy’s, and you happen to be hungry at that point, if you’re traveling on the road and you see one of those signs up, you’re probably going to stop at — you may very well — stop at the one you see. So there’s — there is not the — there’s a loyalty factor, but it’s just not going to be the same in food. People want to vary their — I don’t. I mean, I’m happy to eat there every day. But most people want to vary where they eat as they go through the week, or the month, or the year. And they don’t really have any great desire to vary their soft drink the same way. It’s not the same thing. So it’s no knock on McDonald’s at all. It’s just the nature of the kind of industry they’re in. Charlie?

CHARLIE MUNGER: I can’t think of anybody else who, before McDonald’s, ever did what McDonald’s did to create a chain of restaurants on such a scale, that worked.

WARREN BUFFETT: Oh, Howard Johnson’s tried.

CHARLIE MUNGER: Yeah. There were a lot of failures. Some of you are old enough around Omaha to remember Reed’s.

WARREN BUFFETT: Harkert’s.

CHARLIE MUNGER: Or Harkert’s — Harkett’s Hamburgers.

WARREN BUFFETT: Harkert’s.

CHARLIE MUNGER: Harkert’s Holsum Hamburgers.

WARREN BUFFETT: Right.

CHARLIE MUNGER: Yeah. And they came and they went, those chains, and — but the — It is a much tougher business that McDonalds is in.

WARREN BUFFETT: It’s price sensitive, too, I mean, obviously.

CHARLIE MUNGER: Part of that’s comparative. You can spend a lot more money on hamburgers in the course of a year than razor blades. I mean, you can’t save that much by changing razor blades.

WARREN BUFFETT: Yeah. The average person will buy 27 — in the United States — 27 Sensor Excels a year. You know, that’s one every, roughly, 13 days. And I don’t know what the retail price is because they give them free to us as directors, but the — (laughter) — you know — If they’re a dollar, it’s 27 bucks, I mean, and — It makes a lot of difference. That’s what’s happening, of course, around the world is people that are using cheap double-edged blades, or whatever is, they keep moving up the comfort scale — the comfort ladder. And Gillette is a direct beneficiary of — If it’s a difference between having great shaves and very so-so shaves, and lots of nicks and scratches and everything, is ten bucks a year or 12 bucks a year. I mean, that is not going cause many people to change their habits, and — Incidentally, the Sensor for women has just been a huge success.

I think they’ve had more razors go out on that in the same period than when the original Sensor was — came out for men. So that’s been an enlargement of the market. I would not have guessed that would work that well. Before that, all the women just used the disposables, or their husband’s — boyfriend’s — razor. But thank God they’ve gotten over that. (Laughter)

34. “Invisible hand does not work perfectly”

WARREN BUFFETT: Area 2.

AUDIENCE MEMBER: Gentlemen, my name is Ted Downey. I live in Mankato, Minnesota. Mr. Munger, your reference to Einstein, I happen to have an article called “Strange Is Our Situation Here On Earth,” which is somewhat related to my question. This morning, you brought up the shortcomings of accountability. And I would like you to address the aspects of the environmental impact in our accounting system and how this might relate to a social screen for investment in other areas.

CHARLIE MUNGER: Well, again, that is broad enough and tough enough so that I think I should pass. (Applause)

WARREN BUFFETT: Yeah. The — I would say the “unseen hand” — or [Adam Smith’s] “invisible hand” — you know, does not work perfectly for all aspects of an economy, so — But in terms of accounting for it — in terms of an individual balance sheet or income account, you know, that would be way beyond me. But there are things that the “invisible hand” won’t do, and therefore, that unfettered market-driven economic action will not lead to the best result for society in my view. I think the market works awfully well in an awfully — in a tremendous number of ways. It produces what people want in increasing quantities. And it — you know, it’s enormously beneficial to have a market-driven society. But a pure market-driven society will do things that will have anti-social consequences.

CHARLIE MUNGER: You certainly need environmental rules.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: The pioneers died like flies because the drinking water was too near the sewage. And one of the glories of the world we live in now is that the sewage systems are so good. And, you know, you don’t think about it much, but it’s dramatically changed our prospects and the general quality of how we live. And there are a lot of other places where you need environmental rules. All that said, some of the environmental stuff has gone way too far. But it’s too complicated to try and offer precise lines.

35. Aim to increase both operating earnings and investments

WARREN BUFFETT: Area 3.

AUDIENCE MEMBER: My name is Gul Asnani (PH). I’m from Allentown, Pennsylvania. I have a question concerning page four of the annual report where you talk about the investments per shares, et cetera.

WARREN BUFFETT: Right.

AUDIENCE MEMBER: And my question is, how much claim do the operating businesses have on these marketable securities?

WARREN BUFFETT: Yeah. Well, that table’s a very important table in my view. And we measure our progress, to some extent, by the figures in both columns of that table, one of which shows the investments per share. And the other shows the operating earnings from everything other than investments. The operating businesses have first claim on anything that relates to their business. I mean, if See’s is going to buy a new plant, which it probably is now — or buy an additional building, I shouldn’t say a new plant — you know, that comes first. The business has grown. It’ll produce some economies and all that. We do that. You know, we try and do it as intelligently as possible. But that comes first. The — That doesn’t use but a small fraction of the capital. All of those needs don’t use but a small fraction of the capital that Berkshire will generate. The investments reside largely in insurance companies because that’s where largely the liquid funds are. They have to have capital strength, obviously, because they have huge promises outstanding. But where they reside does not determine who manages them.

Lou Simpson manages GEICO’s portfolio specifically. But in effect, Charlie and I manage everything else. So where they precisely reside really makes no difference. I mean, they’re sitting someplace. They’re not for the operating management to use in projects that are far afield from what they’re doing. But if they need money in any operating business, you know, we’ll have a check there that day. FlightSafety, for example, will be a fairly capital-intensive business. I mean, if our project with Boeing goes as we hope it goes, you know, there will be substantial money in there because there — you know, we will have many more simulators around the world, and we’ll be paying our proportional cost of it. But they don’t need to keep money around to prepare for that day, which they would if they were a standalone operation. We can — money’s fungible. We can deploy it all the time. And whenever anybody needs it, we’ll come up with it. But we don’t leave it around awaiting the day when some specific operation needs it. Charlie?

CHARLIE MUNGER: The odds are very good that the marketable securities will keep going up, even as the businesses expand. That’s the way the game has worked in the past. And we hope it’ll keep going that way.

WARREN BUFFETT: What we are doing is trying to increase the numbers in both columns. We don’t have any favoritism for this over that or anything of the sort. But we’re looking, all the time, for things that will do — will help both columns. And we’d be disappointed if five or 10 years from now that they both haven’t increased significantly. But which column will increase at the greater rate, we don’t know.

36. “We wouldn’t be surprised” if stock returns are lower

WARREN BUFFETT: Area 1?

AUDIENCE MEMBER: Good day, my name is John Semanovich (PH) from Ottawa, Canada, which, incidentally, has nothing to do with Bre-X whatsoever. (Laughter) My question more goes back to the discussion of intellectual capital, in particular, perhaps, your intellectual reserves. And so, speaking of “Security Analysis,” the first edition in 1934, Ben Graham talked about the development of the “New Era Theory” and its consequences on the security business. In today’s terms, we see a lot of the same words and phrases being repeated by analysts on Wall Street. And with the historical returns on common stocks, dating back to the 1800s, coming in at about 7 percent, pair that together with the concept of regression to the mean in statistics, do you not think that we’re in a very dangerous period?

WARREN BUFFETT: Well, the answer — we never know, I mean, we — in terms of what markets will do, we — I don’t think that the Coca-Cola Company’s in a dangerous position, you know — in a dangerous era — or Gillette is in a dangerous era, or McDonald’s, or Wells Fargo, or whatever, but — or See’s Candy, or the businesses we own in their entire, Kirby, whatever it may be. Whether valuations are too high gets back to the question that we said — we talked about earlier. If businesses, in aggregate, they keep earning very high returns on equity and interest rates stay where they are, we are not in an overvalued period. If it turns out that these returns are not sustainable, or interest rates go higher, we will look back and say this was a high point, at least for a while. But we have no notion on that. And we really don’t think about it, basically, because we don’t know. You know, our job is to focus on things that we can know and that make a difference.

And if something can’t make a difference or we can’t know it, you know, we write that one off. So we’re looking for the —

CHARLIE MUNGER: But Warren, you would expect average returns from stock market indextype investing to regress somewhat down —

WARREN BUFFETT: Oh, I don’t think the —

CHARLIE MUNGER: — where they’ve have they been the last few years?

WARREN BUFFETT: I don’t think you’ll get the investment result from owning the S&P over the next 10 years that you’ve gotten over the past 10 years. I would — if someone wanted to put some real money on that, they would find a taker with me. That’s very unlikely to happen.

CHARLIE MUNGER: That’s not predicting a crash.

WARREN BUFFETT: No.

CHARLIE MUNGER: It’s just saying that the guaranteed result from the next 10 years is almost certain to be less than —

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: — that of the last.

WARREN BUFFETT: It wouldn’t surprise — I mean, this is no way predictive. But I mean, it wouldn’t surprise us in the least if stocks averaged 4 percent a year, you know, for the next 10 years. That doesn’t mean they will. We don’t know the number. But that would not be a surprising outcome. And it wouldn’t bother us particularly, either. Charlie?

CHALIE MUNGER: No.

37. “We don’t want to talk down something in order to buy it”

WARREN BUFFETT: Two.

LARRY WHITMAN: Hello. My name is Larry Whitman (PH) from Minot, North Dakota. You have both talked today about the shrinking universe of stocks you could purchase, less margin of safety than ever, and a higher opportunity cost. And you’ve also talked about looking to, potentially, purchase your great companies that you already have at reasonable prices. And so I wonder if by talking so positively about some of your stocks — in particular Disney, such as in the ’95 annual report when you talked about actually telling everyone that you were buying more shares on the open market and, again, at the ’97 meeting — at their meeting — when you talked about maybe not selling the shares — those were both opportunities, maybe, when Disney may have dropped, because of such things as increased debt, or even people’s concern about the Ovitz compensation package. And I just wondered if that may hurt your ability to buy these great companies at reasonable prices by talking so positively about them when, in fact, maybe you could buy them at lower prices when people get irrational.

WARREN BUFFETT: Yeah. You’re saying that — which I probably agree with — that if we would say the world is going to hell at Coke or Disney or Gillette — (laughs) — we might be better off, in terms of being able to buy more stock. But, you know, I got asked the question at Disney and I answered it. And that’s my general approach, that — I think it’s usually a bad mistake to sell your interest in wonderful businesses. I don’t think people find them that often. And I think they get hung up, if they’ve sold them at X that they want to buy them back at 90 percent of X, or 85 percent of X, so they’ll never go back in at 105 percent of X. I think, on balance, if you are in a business that you understand and you think it’s a really outstanding business, that the presumption should be that you just hold it and don’t worry. And if it goes down 25 percent in price or 30 percent in price, if you have more money available, buy more. And if you don’t, you know, so what?

Just look at the business and judge how it’s doing. But there’s no question. I mean, we try not to talk very much about the businesses, except maybe to use them as an illustration in a teaching mode or something of the sort. We’re not touting anything. And I did try to stick those precautions in when I do talk about them as being wonderful businesses, so people don’t take it as an unqualified buy recommendation or something of the sort. But we won’t try and put any spin on any — when we’re talking about businesses generally. We may not talk about them at all. You know, if we’re buying something, we might be — particularly if no one knows that we’ve been in that stock at all — we might be somewhat quiet about the fact. But we don’t want to talk down something in order to buy it. Charlie?

CHARLIE MUNGER: Well, I always — Jerry Newman, as I understand it, didn’t like Ben Graham giving all these courses explaining what Newman and Graham were doing, and — But Graham’s attitude was that he was a professor first. And if he made just slightly less money by being very accurate in what he taught, why so be it. And I think it’s fair to say that Warren has assimilated a bit of that ethos. And I think it’s all to the good. And if it costs us a tiny, little bit of money from time to time, there are probably compensating benefits. And if there aren’t, it’s probably the right way to behave anyway.

WARREN BUFFETT: Charlie, if you were in a less charitable mood, I might point out I didn’t behave that way till I got rich. (Laughter and applause) Actually, I used to teach a course at what was then the University of Omaha. And we’d use all these current examples. And things were cheap then — (laughs) — that nobody paid any attention.

38. We don’t want to “hear stories” or buy from “jerks”

WARREN BUFFETT: Area 3.

AUDIENCE MEMBER: Hello, Mr. Munger and Mr. Buffett. My name is Liza Rema (PH) from Burbank, California. I wanted to find out — earlier, you mentioned you looked at — you used filters to look at a company. So could you elaborate on what those filters are?

WARREN BUFFETT: Charlie, you want to —?

CHARLIE MUNGER: Well, we’ve tried to do a good deal of that, and — Opportunity cost is a huge filter in life. If you’ve got two suitors who are really eager to have you, and one is way the hell better than the other, you do not have to spend much time with the other. And that’s the way we filter stock buying opportunities. Our ideas are so simple, people keep asking us for mysteries, when all we have is the most elementary idea.

WARREN BUFFETT: Yeah. The first filter we probably put it through is whether we think — and we know instantly — whether it’s a business we’re going to understand, and whether it’s a business that — if it passes through that, it’s whether a company can have a sustainable edge, you know. And that gets rid of a very significant percentage of the things people have — They always want to tell you some story or anything. And I’m sure they regard me and Charlie as very arbitrary, in terms of, you know, in the middle of the first sentence saying, “Well, you know, we appreciate the call, but we’re not interested.” I mean, you know, they just think if they explain something — and I get letters on this all the time. But we really can tell, in the middle of the first sentence, usually, whether those two factors exist. And if we can’t understand it, obviously, it’s not going to have — we can’t make a decision as to whether it has a sustainable edge.

And if we can’t understand it, we, very often, can come to the conclusion that it’s not the kind of the business where it will have a sustainable edge. So 98 percent of the conversations we can end, you know, in the middle of somebody’s first sentence, which, of course, goes over very big with the caller, but — (Laughter) And then, sometimes if you’re talking about an entire business, we can tell by who we’re dealing with whether a deal’s ever going to work out or not. I mean, it — if there’s an auction going on, we don’t want to — we have no interest in talking about it. And it just isn’t going, you know, it isn’t going to work. If someone is interested in, essentially, doing that with their business, you know, they’re going to sit down and want to renegotiate everything with us all over again after the deal is done. And we’re going to have to buy the business two or three times before we get through. You just see all these things coming.

And on the other hand, we’ve had, you know, terrific experience, basically, with the people we have associated with. So it works. It’s efficient. You know, we don’t want to listen to stories all day. And we don’t read brokerage reports of anything of the sort. It’s just — there’s other things to do with your time. Charlie?

CHARLIE MUNGER: Yeah. Another filter that Warren was eluding to is this concept of the “quality person.” And, of course, most people define “quality person” as somebody very much like themselves. (Laughter) But —

WARREN BUFFETT: Identical, actually, is the word you’re searching for. (Laughter)

CHARLIE MUNGER: But there’s so many wonderful people out there. And there’s so many awful people out there. And there’s signs frequently, like flags, particularly over the awful people. And generally speaking, those people are to be avoided. It just — the amount of misery you bring into your life by trusting some awful person and the amount of felicity that you can bring in by making the right business associations — look around this room. And there’s some wonderful people who have created some wonderful businesses. And their customers can trust them. The employees can trust them. The problems can trust them to be fairly faced and reasonably solved. And those are the kind of people you want. And people who take their promises seriously. I had some experience, recently, with a company. And they have their brand on a particular product. And somebody invented a better product in the same field. And they’re taking their brand off their product. (Laughs) If it isn’t the best, they don’t want their brand on it. People who think like that frequently do very well in business. And the flags are flying.

WARREN BUFFETT: It’s like they got a sign on their chest that just says, “Jerk. Jerk. Jerk.” (Laughter) And then you think you’re going to buy the business and they aren’t going to be a jerk, you know, anymore. I mean, it’s — (Laughter)

39. Why Dr Pepper has a future

WARREN BUFFETT: OK. Area 1.

AUDIENCE MEMBER: Hi. David Winters, Mountain Lakes, New Jersey, shareholder. I’m just wondering if there’s an organizational model where you deal with a plethora of information so you can physically and intellectually organize it so you have your maximum output and retain focus. And secondly, if I may, in the domestic soft drink business, is it winner take all? I mean, is there room for three competitors? And, honestly, does Dr Pepper have a future?

WARREN BUFFETT: Yeah. I would say Dr Pepper has a future. I’ll answer the second one. But sure, there’s room for more than one. I think Coke’s market share will go up pretty much year after year. But not — you know, we’re talking tenths of a percent in that business. But tenths of a percent are important. The U.S. market is what? It must be 10 billion cases. So, you know, one percent’s a hundred million cases. There will be — Dr Pepper appeals to a lot of people. It’s interesting how regional tastes can be. I mean, Dr Pepper will have a share in Texas that’s, you know, far higher than it will be in Minnesota or something. But there are people who are going to prefer it. And an interesting thing, though, is that the high percentage of people that prefer cola, for example. Although the cola percentage has gone down a little bit, the fastest growing big beverage at Coke is Sprite. Sprite has had huge gains in sales. It does well over a billion cases a year.

And it sells very well in a whole bunch of countries. So they’ll — you can make money with a soft drink company that doesn’t dominate the business. You’ll do a lot better with one that does dominate. But it’s not a winner take all. It’s not like two newspapers in a town of 100,000 or 200,000. There are certain businesses that are winner take all, clearly, but soft drinks, not one of them.

40. “Advantage of accumulation of useful information”

WARREN BUFFETT: What was the first question? Oh, the part about organizing —

AUDIENCE MEMBER: Oh, I’m just wondering, for those of us on the other side of the table, we get barraged with information. And I’m wondering how do you both — do you just read annuals, 10-Ks, and talk to people, and ignore everything else? And how do you keep track of everything, intellectually —?

WARREN BUFFETT: Well, we don’t keep track of everything. But the beauty of — to some extent — of evaluating businesses — large businesses — is that it is all cumulative. I mean, if you started doing it 40 or so years ago, you really have got a working knowledge of an awful lot of businesses. But there aren’t that many, to start with, that are, you know — And you can get a fix. You know, how many — what are there? Seventy-five, maybe, or so important industries. And you’ll get to understand how they operate. And you don’t have to start over again every day. And you don’t have to consult a computer for it or anything like that, it — So it has the advantage of accumulation of useful information over time. And, you know, you just add the incremental bit at some point. You know, why did we decide to buy Coca-Cola in 1988? Well, it may have been, you know, just a couple small incremental bits of information. But that came into a mass that had been accumulated over decades.

And it’s a very — it’s a great business that way. It’s why we like businesses that don’t change too much, because the past is useful to us. Charlie?

CHARLIE MUNGER: I can’t add a thing to that.

41. We’d “push” to buy cheap stocks, but not enough to lose sleep

WARREN BUFFETT: OK. Over there in 2.

AUDIENCE MEMBER: I’m Barbara Morrow (PH) from Wisconsin and New York. If you both live as long as I believe you will, it could happen that they’ll be a year when you write two big checks for super-cat claims when the market is throwing away things at really silly prices. Could you share your thinking about how much debt you would consider taking on to buy great businesses that’s cheap in that kind of a situation?

WARREN BUFFETT: Well, if we had both a big hurricane in the northeast or in Florida, and we had a big quake in California in the same year, and we had a financial market — the financial markets tanked, perhaps because of those events, but perhaps for other reasons, we would be thinking about ways — it might not be borrowing money directly — but we would be thinking to ways to buy securities if they got cheap enough. I mean, any time securities get cheap — Charlie, you’re thumping again here — (laughter) — any time securities get cheap, you know, we don’t like to go to the office and not write a ticket. I mean, that, so — We certainly would have the ability to borrow some money. We would never borrow a ton of money, relative to capital. We’re just not set out that way. We don’t want to disappoint anybody in this world. We don’t even want to worry about disappointing anybody in this world. So, we’re not going to do that. But we have a lot of extra firepower overall.

And I would say under almost any conditions that cause securities to get very cheap, we would find a way to buy some of them. Charlie?

CHARLIE MUNGER: The beauty of our situation is that it has enormous flexibility built into it. If something were large enough and cheap enough, we could stop writing super-cats. We’re measuring opportunities one against the other, and we understand the way the numbers interplay. And so we have a lot of different options. And that’s a huge advantage. There’s so many places in business life where you have practically no options at all. You’re just in a channel that you have to — waltz down the channel and you don’t have any options to do anything else. We have enormous options. We may not exercise them. But we have enormous flexibility.

WARREN BUFFETT: Yeah. We know they’re there, and —

CHARLIE MUNGER: Yeah.

WARREN BUFFETT: — and there’s no reason to push on anything now. At least, we don’t have any reason to push ourselves. But if it ever became advantageous to push somewhat, we would push, although never to a degree that, in any way, causes us to lose a minute of sleep about fulfilling every obligation we had.