Morning Session

1. Meeting introduction and welcome

WARREN BUFFETT: Good morning. Well, first thing I’d like to do is to thank everybody that’s helped us put this on. As you saw in the movie, I think, at the time, we may have had 45,000 or so people working with Berkshire, with 12.8 at headquarters. We’re probably up to about 60,000 now, and we still have 12.8, and they take care of putting on this whole meeting. We get help from people in internal audit, and we get terrific help from the people at all of our companies who work very hard to put on the exhibits. And we hope that you not only visit them, but patronize them, and we’ll give you ample time to do that. As you can see, I enlisted my family for the movie, and I want to thank them. I want to particularly thank Kelly Muchemore and Marc Hamburg for their work in putting this on.

It’s a real project to — (Applause) A lot of companies have a whole department that does this and, at Berkshire, Kelly processes 25,000 requests for tickets, and coordinates everything with the exhibitors, and it’s a fabulous job. Now, we’ll follow our usual routine. We do have a surprise at — a small surprise — at 11:45. It’s not that Charlie’s going to say anything — that would be a big surprise, but — (laughter) — we’ll — well, we’ll have this small surprise for you at 11:45. The plan is to go through the business part of the meeting here in just a second, and we’ll run from 9:30 to 12:00. Then, after conducting the business meeting, we’ll take your questions. We’ll go around the room. We have 10 stations. I guess we’ll probably only be using eight stations in this room. And we have microphones everyplace that the eight stations — that you’ll see, and you can step up to those. And we’ll just keep answering questions.

And we’ll break at 12 o’clock, and there will be food available down below, where you can also purchase things from us. And we’ll reconvene about 12:45, and then we’ll stay until 3:30 and we’ll try and answer whatever questions you have. And then we will have to cut it off at 3:30. We have — we had about the same number of ticket requests as in the past, but we had a different mix this year. We — as most of you know — we had change the venue, and the time, because Ak-Sar-Ben is winding down. And so, there’s a little different rhythm to this meeting. A much higher percentage of our tickets than usual were requested by people from Omaha. And, of course, you’ve heard me say before that we’re a little suspicious of these figures because we know that a lot of people claim to be from Omaha that aren’t, for status reasons, and so — (laughter) — we can’t really give you the geographical breakdown we normally would.

2. Introduction and election of BH directors

WARREN BUFFETT: I’d like to introduce, first, our directors, and then we’ll proceed into the formal business of the meeting. On my left here is the ever-animated Charlie Munger, our vice chairman. (Applause) And if the other directors will stand up as I announce their names. We have the better voice in the movie, my wife, Susan Buffett. Susie? (Applause) We have Howard Buffett. (Applause) You can see we find these names in the phone book, I mean — And Kim Chace. Kim? (Applause) Walter Scott, the star of “How to be a Gillionaire.” (Applause) And Ron Olson. Ron? (Applause) OK, we’ll now take on the formal part of the meeting. We’re going to try to set a new record, I think, 5:38.4, but the four-minute mile has always been our ambition on this. So I will go through this and then we’ll get to the questions. The meeting will now come to order.

I’m Warren Buffett, chairman of the board of directors of this company. I welcome you to this 2000 annual meeting of shareholders. I’ve introduced the directors. Also with us today are partners in the firm of Deloitte & 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 D. Hamburg. Does the secretary have a report of the number of Berkshire shares outstanding, entitled to vote, and represented at the meeting?

FORREST KRUTTER: I do. Yes, I do. As indicated in the proxy statement that accompanied the notice of this meeting that was sent by first-class mail to all shareholders of record on March, 3, 2000, being the record date for this meeting, there are 1,341,174 shares of Class A Berkshire Hathaway common stock outstanding, with each share entitled to one vote on motions considered at the meeting, and 5,385,320 shares of Class B Berkshire Hathaway common stock outstanding, with each share entitled to 1/200th of one vote on motions considered at the meeting. Of that number, 1,116,151 Class A shares and 4,342,959 Class B shares are represented at this meeting by proxies returned through Thursday evening, April 27th.

WARREN BUFFETT: Thank you. That number represents a quorum and we will therefore directly proceed with the meeting. The first order of business will be a reading of the minutes of the last meeting of shareholders. I recognize Mr. Walter Scott Jr., who will place a motion before the meeting.

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

WARREN BUFFETT: Do I hear a second?

VOICE: I second the motion.

WARREN BUFFETT: The motion has moved and seconded. Are there any comments or questions? We will vote on this question by voice vote. All those in favor say, “Aye.”

VOICES: Aye.

WARREN BUFFETT: Opposed? You can signify by saying, “I’m leaving.” The motion is carried. (Laughter) The one item of business of this meeting is to elect directors. 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 the meeting officials in the aisles who will furnish a ballot for you. Would those persons desiring ballots please identify themselves, so that we may distribute them? 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, Charles T. Munger, Ronald L. Olson, and Walter Scott Jr. be elected as directors.

WARREN BUFFETT: Is there a second?

VOICE: I second the vote.

WARREN BUFFETT: It’s been moved and seconded that Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace, Charles T. Munger, Ronald L. Olson, and Walter Scott Jr. be elected as directors. Are there any other nominations? Is there any discussion? The nominations are ready to be acted upon. If there are any shareholders voting in person that should — they should now mark their ballots on the election of directors and allow the ballots to be delivered to the inspector of election. 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 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 Thursday evening, cast not less than 1,136,497 votes for each nominee. That number far exceeds a 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, Becki. Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace, Charles T. Munger, Ronald L. Olson, and Walter Scott Jr. have been elected as directors. 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 that this meeting be adjourned.

WARREN BUFFETT: Is there a second? A 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: All opposed, “No.” This meeting’s adjourned. Thank you. (Applause) We will advise Guinness of those results, and maybe we’ll get in the book. Just want to make one more announcement and then we’ll start in the questions with area 1, which I believe will be right over here. About — I think about 3,500 of you are attending the ballgame tonight. You know what you’re supposed to do, incidentally. And we — in the past, we’ve had some traffic jams at — where the interstate goes off into 13th Street. So, the police, who are wonderfully cooperative throughout this whole weekend, in many ways, are going to do their darnedest to make sure that we don’t have much of a jam. But if those of you who are attending the game would like to go a little early, that will probably be quite helpful.

And I might say that we have probably got — well, we think it’s probably the best zoo in the world here, thanks in very large part to our director, Walter Scott, and his wife Sue, who have really turned our zoo into a huge attraction, draws well over a million people a year. It’s right adjacent to the ballpark. So if you get out a little early, and you want to go to the zoo, and then you won’t even have to move your car. You can come over to the ballpark, and then there’s also food there. And we have a — we serve Coca-Cola products. And if you don’t all try to come at 6:45, it will be a help to us. I will be pitching at 7:05, but my fastball will arrive at the plate almost instantaneously with the moment that it leaves my hand, so unless you’re there, you’ll miss it. And — (Laughter)

3. Aesop’s investing primer: Birds in hands and bushes

WARREN BUFFETT: So look with that, let’s start in area 1, and we will go around. And feel free to ask any questions. You might identify yourself and where you’re from before asking your question. Area 1?

AUDIENCE MEMBER: Good morning, Mr. Buffett and Mr. Munger. My name is Steve Yates (PH), I’m from Chicago. I’m a Berkshire shareholder and this is my sixth year coming to this meeting. I’d like to thank you for all your time and advice through the years. It’s been great. I’d also like to thank all those wonderful people who sold Berkshire this year for giving us an opportunity to purchase more of the world’s greatest company for dirt-cheap prices. (Applause)

WARREN BUFFETT: We will convey your thanks. (Laughter)

AUDIENCE MEMBER: I own another stock, which sells for four times current trailing earnings. Every quarter we get a report. Earnings go up, sales go up, cash flow goes up, the equity base expands, they gain market share, and the stock goes down. The company has a 60 percent five-year annualized growth rate and sells at four times earnings. I have two related questions. First, is this is a growth stock or a value stock, and could you please give us your definitions of these terms? Second, the company sells recreational vehicles. Demographic trends in the recreation and leisure areas, RVs, cruise lines, golf equipment, et cetera, seem to be quite good. Do you see any opportunities for Berkshire here? Thanks.

WARREN BUFFETT: Well, the question about growth and value, we’ve addressed in past annual reports. But they are not two distinct categories of business. Every business is worth the present — If you knew what it was going to be able to disgorge in cash between now and Judgment Day, you could come to a precise figure as to what it is worth today. Now, elements of that can be the ability to use additional capital at good rates, and most growth companies that are characterized as growth companies have that as a characteristic. But there is no distinction in our minds between growth and value. Every business we look at as being a value proposition. The potential for growth and the likelihood of good economics being attached to that growth are part of the equation in evaluation. But they’re all value decisions. A company that pays no dividends growing a hundred percent a year, you know, is losing money. Now, that’s a value decision. You have to decide how much value you’re going to get. Actually, it’s very simple. The first investment primer, when would you guess it was written?

The first investment primer that I know of, and it was pretty good advice, was delivered in about 600 B.C. by Aesop. And Aesop, you’ll remember, said, “A bird in the hand is worth two in the bush.” Now incidentally, Aesop did not know it was 600 BC. He was smart, but he wasn’t that smart. (Laughter) Now, Aesop was onto something, but he didn’t finish it, because there’s a couple of other questions that go along with that. But it is an investment equation, a bird in the hand is worth two in the bush. He forgot to say exactly when you were going to get the two in the — from the bush — and he forgot to say what interest rates were that you had to measure this against. But if he’d given those two factors, he would have defined investment for the next 2,600 years. Because a bird in the hand is — you know, you will trade a bird in the hand, which is investing. You lay out cash today.

And then the question is, as an investment decision, you have to evaluate how many birds are in the bush. You may think there are two birds in the bush, or three birds in the bush, and you have to decide when they’re going to come out, and when you’re going to acquire them. Now, if interest rates are five percent, and you’re going to get two birds from the bush in five years, we’ll say, versus one now, two birds in the bush are much better than a bird in the hand now. So you want to trade your bird in the hand and say, “I’ll take two birds in the bush,” because if you’re going to get them in five years, that’s roughly 14 percent compounded annually and interest rates are only five percent. But if interest rates were 20 percent, you would decline to take two birds in the bush five years from now. You would say that’s not good enough, because at 20 percent, if I just keep this bird in my hand and compound it, I’ll have more birds than two birds in the bush in five years.

Now, what’s all that got to do with growth? Well, usually growth, people associate with a lot more birds in the bush, but you still have to decide when you’re going to get them. And you have to measure that against interest rates, and you have to measure it against other bushes, and other, you know, other equations. And that’s all investing is. It’s a value decision based on, you know, what it is worth, how many birds are in that bush, when you’re going to get them, and what interest rates are. Now, if you pay $500 billion — and when we buy a stock, we always think in terms of buying the whole enterprise, because it enables us to think as businessmen, rather than as stock speculators. So let’s just take a company that has marvelous prospects, is paying you nothing now, and you buy it at a valuation of 500 billion.

Now, if you feel that 10 percent is the appropriate rate of return — and you can pick your figure — that means that if it pays you nothing this year, but starts paying next year, it has to be able to pay you 55 billion in perpetuity, each year. But if it’s not going to pay until the third year, then it has to pay you 60.5 billion in perpetuity — in perpetuity — to justify the present price. Every year that you wait to take a bird out of the bush means that you have to take out more birds. It’s that simple. And I question, in my mind, whether — sometimes, whether people who pay $500 billion implicitly for a business by buying 10 shares of stock at some price, are really thinking of the mathematical — the mathematics — implicit in what they are doing. To deliver, let’s just assume that’s — there’s only going to be a one-year delay before the business starts paying out to you, and you want to get a 10 percent return and you pay 500 billion. That means 55 billion of cash that they have to be able to disgorge to you year, after year, after year.

To do that, they have to make perhaps $80 billion, or close to it, pretax. Now, you might look around at the universe of businesses in this world and see how many are earning 80 billion pretax, or 70, or 60, or 50, or 40, or 30. And you won’t find any. So it requires a rather extraordinary change in profitability to give you enough birds out of that particular bush to make it worthwhile to give up the one that you have in your hand. Second part of your question, about whether we’d be willing to buy a wonderful business at four times earnings, I think I could get even Charlie interested in that. But let’s hear it from Charlie.

CHARLIE MUNGER: I’d like to know what that is. (Laughter)

WARREN BUFFETT: He was hoping you would ask that. That fellow that’s got all his net worth in this stock — (laughter) — and who has a captive audience. Tell us what it is. You’ve got to tell us. We’re begging you. (Laughter)

AUDIENCE MEMBER: You want the name of the company?

WARREN BUFFETT: We want the name of the company. We’re dying to get the name. Wait till I get my pencil out. (Laughter)

AUDIENCE MEMBER: It’s called National RV, and it’s based in California, and they sell recreational vehicles.

WARREN BUFFETT: OK, well, you’ve got a crowd of people with — who have birds in the hand, and we will see what they do — (laughter) — in terms of National RV. Charlie, do you have anything further on growth and value, et cetera? Watch him carefully, folks. (Laughter)

CHARLIE MUNGER: Well, I agree that all intelligent investing is value investing. You have to acquire more than you really pay for, and that’s a value judgment. But you can look for more than you’re paying for in a lot of different ways. You can use filters to sift the investment universe. And if you stick with stocks that can’t possibly be wonderful to just put away in your safe deposit box for 40 years, but are underpriced, then you have to keep moving around all the time. As they get closer to what you think the real value is, you have to sell them, and then find others. And so, it’s an active kind of investing. The investing where you find a few great companies and just sit on your ass because you’ve correctly predicted the future, that is what it’s very nice to be good at.

WARREN BUFFETT: The movie was G-rated even though — (Laughter) Is that it, Charlie? (Laughter)

4. Munger on internet stocks: “If you mix raisins with turds, they’re still turds”

WARREN BUFFETT: OK. We will move to area 2.

AUDIENCE MEMBER: Good morning, gentlemen. Wayne Peters. And where I come from our ladies are referred to as birds. (Laughter) And I’m sure I know a lot that would trade one in the hand for two in the bush — (laughter) — irrespective of the interest rate. (Laughter) I have two small questions. Firstly, with the speculation, and some would say rampant speculation, in the high tech and internet arenas, could you share your views on the potential fallout from the speculation for the general economy? And secondly, how long did it actually take you to perfect that curveball, and are we going to see it tonight?

WARREN BUFFETT: The — I don’t think I want to give anything away about my pitches tonight. (Laughter) Ernie Banks may be in the audience, I know he’s in town, and I just can’t afford to do that. But you’ll see it tonight, and you can describe it anyway you’d like. The question about the high tech stocks and possible fallout, any time there have been real bursts of speculation in the market, you know that — it does get corrected, eventually. Ben Graham was right when he said that in the short run it’s a voting machine, and the long run it’s a weighing machine. Sooner or later, the amount of cash that a business can disgorge in the future governs the value it has — that the stock commands — in the market. But it can take a long time. And, I mean, it’s a very interesting proposition. For example, if you take a company that, in the end, never makes any money, but trades — changes hands — representing a valuation of 10 or $20 billion for some time, there’s no wealth created.

There’s a tremendous amount of wealth transferred. And I think you will see, when we look back on this era, you will see this as a period of enormous amounts of wealth transfer, but in the end the only wealth creation comes about through what the business creates. There’s no magic to it. If a company that’s not worth anything sells for 20 billion and 5 percent of it changes hands, somebody takes a billion dollars from somebody else. But investors as whole gain nothing. They all feel richer. It’s a very interesting phenomenon. But they can’t be richer except — as a group — unless the company makes them richer. And it’s the same principle as a chain letter. If you’re very early on a chain letter you can make money. There’s no money created by chain letters. In fact, there’s the frictional cost of envelopes, and postage, and that sort of thing. So the net, there’s some money destroyed a little bit. And there’s money destroyed by the frictional cost of trading and investing, and that comes out of investor’s pockets.

But the manias that periodically take place — and not just in stocks. We had a similar mania — not necessarily similar — we certainly had a mania in farmland here in Nebraska 20 years ago. And land which couldn’t produce, we’ll say, more than 70 or $80 an acre would sell for 2,000 an acre at times when interest rates were 10 percent. Well, that math will kill you. And it killed the people who bought it at those prices, and it killed a great many banks here in Nebraska who lent based on that sort of thing. But while it was going on everybody thought it was wonderful, because every farm was selling for more than the similar farm had sold for a month earlier. And it was momentum investing in farmland. And, in the end, valuation does count. But it can go on a long time, and when you get a huge number of participants playing with ever increasing sums, you know, it creates its own apparent truth for a — what can be for a very considerable period of time. It doesn’t go on forever.

And whether it has fallout to the whole economy, like it probably did in the late ’20s, or whether it’s just an isolated industry where the — or sector — where the bubble bursts and it really doesn’t affect other values, who knows? But five or 10 years from now, you will know. Charlie?

CHARLIE MUNGER: Well, I think the reason we use the phrase “wretched excess” is that there are wretched consequences. If you mix the mathematics of the chain letter or the Ponzi scheme with some legitimate development, like the development of the internet, you are mixing something which is wretched and irrational, and has bad consequences, with something that has very good consequences. But, you know, if you mix raisins with turds, they’re still turds. (Laughter)

WARREN BUFFETT: That’s why they have me write the annual report. (Laughter)

5. Evaluating the internet’s threat to Berkshire’s businesses

WARREN BUFFETT: So, I think we better move on to sector 3. (Laughter) Way back there.

AUDIENCE MEMBER: My name —

WARREN BUFFETT: Yeah.

AUDIENCE MEMBER: My name is Thomas Kamay (PH). I am 10 years old and I go to Bacich School in Kentfield, California. I have been a shareholder for two years. This is my third annual meeting. Here’s my question. I know you won’t invest in technology companies, but are you afraid that the internet will hurt some of the companies that you do invest in, such as The Washington Post or Wells Fargo? Thank you.

WARREN BUFFETT: Well, that’s an absolutely terrific question. You know, I may turn my money over to you. (Laughter and applause) There’s probably no better question we’ll get. And I hope Charlie answers in an appropriate vein considering your age. (Laughter) We do not — we have no — you know, it’s no religious belief that we don’t buy into tech companies. We just don’t — we have never found one — as conventionally defined — we’ve never found one where we think we know enough about what the business will look like in 10 years that we can make a rational decision as to how much we pay now for that business. In other words, we have not been able to find a business where we think we know what that bush will look like in 10 years, and how many birds will be in it, so that we know how many birds we can give up today to participate in that future. Not any — there will be wonderful things, as Charlie so colorfully explained, that will evolve from many of these companies, but we don’t know how to make that decision.

And you’re absolutely right that we should be thinking all of the time about whether developments in that tech area threaten the businesses that we’re in now, how you might counter those threats, how we might capitalize in opportunities because of it. It’s a very, very, very important part of business now and will become more important in the years to come, including many of our businesses. For example, you mentioned The Washington Post. Even closer to home, we own a newspaper called The Buffalo News in Buffalo, New York. We own all of that. So we’re in a position to make our own decisions of an operating nature as to what we should do in respect to the internet. And believe me, Stan Lipsey, who’s here today, who runs that paper, and I have talked many, many hours, including considerable time yesterday about what we are doing on the internet, what we should be doing, what other people are doing, how it threatens us, how we can counter those threats, all of that sort of thing. And newspapers are a category that, in my view, are very threatened by the internet because we had an example — The internet is terrific for delivering information.

We have a product, World Book, that’s terrific for delivering information. And 15 years ago, print encyclopedias were the best tool, probably, for educating not only young children, but for educating me or Charlie when we wanted to look up something on a subject. And the World Book is a marvelous product. But it requires chopping down trees, and it requires operating paper mills, and it requires binding it and printing, and it requires a delivery of a 70 pound, you know, UPS package. And it’s a — It was put together in a way that was, for 4- or 500 years, the best technique for taking that information and moving it from those who assembled it to those who wanted to use it. And then the internet changed that in a very major way. So we have seen firsthand, and experienced the business consequences of the improvement offered by the internet and the delivery of information. And newspapers, although not as immediately susceptible to that problem, still face that overpowering factor.

When you eliminate the delivery cost — I mean, we pay a significant percentage of our circulation revenue to our carriers, and we pay additional money to the district managers, and we pay for the trucks to deliver the product out, and we pay for huge printing presses, and all of that sort of thing. And people do chop down trees in order to give us the raw material to transmit information in Buffalo, you know, about what the Buffalo Bills did yesterday, on Sunday, with all the details. And now you have the internet that has virtually no incremental unit cost to anything and can deliver the information instantaneously. So it’s a big factor for newspapers. And the newspaper world in my view will look very, very, very different in not that many years. And I find it kind of interesting, because the people in the newspaper business are a little schizophrenic about this. They see this. They’re afraid of it. They’re, in almost all cases, trying to combat it on some way operationally.

But some of them, at least, continue to go out and buy papers at a price that sort of reflects the economics that used to exist 20 years ago, when it’s — to me it’s very clear that it doesn’t exist anymore. So they sort of have their billfold, you know, in the past, even though they see the future. And, you know, I think, probably, they’re making mistakes in many cases. All of our businesses, virtually — Coca-Cola will not be affected in any significant way by the internet, you know? The razor and blade business won’t be. Although you could dream up things about distribution or so on, but I think that it’s very unlikely. But other businesses we have — our insurance business, particularly at GEICO, will be very affected by the internet. Now, that may turn out to be a big advantage to us over time. I wouldn’t be surprised if it is. But our retailing businesses are all threatened in one way or another by internet developments, and there may be some opportunities there, too. But it’s a change.

It’s a change in — it’s going to be change in the world — how the world gets entertainment. It’s going to be a change in the world — how the world gets information. And it is incredibly low cost compared to the — most of the methods of conveying entertainment and information now. Charlie?

CHARLIE MUNGER: Well, he asked if we were afraid that the internet would hurt some of our business and I think the answer is yes. (Laughter)

WARREN BUFFETT: I’m learning to appreciate these short answers, though, more as the day goes by. (Laughter) I want to thank you for coming to our meeting, incidentally. You’re way ahead of me. I didn’t buy my first stock until I was 11, and so you’ve got a real jump on me. And I wish you well.

6. “There’s nothing magic about a one-year period”

WARREN BUFFETT: OK. Area 4.

AUDIENCE MEMBER: Warren and Charlie, good morning. This is Mo Spence (PH), Waterloo, Nebraska. In 1999, Berkshire Hathaway managed to produce a positive gain in net worth of one-half of one percent. That means that since present management took over 35 years ago, Berkshire Hathaway has realized a positive gain each and every year, and produced an average annual gain of 24 percent. Including the years you ran the Buffett Limited Partnership, you have had a run of 48 consecutive years of positive gains and net worth without one single down year, producing a compounded rate of return of almost 26 percent annually. On behalf of the long-term shareholders of Berkshire Hathaway, we want to thank you from the bottom of our pocketbooks. (Applause)

WARREN BUFFETT: Well, thank you. I hope your question isn’t going to be whether we can continue that, but go — you have a question?

AUDIENCE MEMBER: My question is, don’t you think you could have ended the millennium with a bigger bang than one-half of one percent? (Laughter)

WARREN BUFFETT: Well, I certainly wish we could have. But the interesting thing about those figures — and, actually, the figures go back before that, because the very best period was prethe partnership days, because the amount I was working with was so small. But the — there’s nothing magic about a one-year period. I mean, it’s the way the measurements come out. We’ve — if you took all the half-year periods, for example, I’m sure — well, I know that there were a number that were down, you know — There’re going to be lots of years in the future — assuming I live long enough, that — we will have plenty of down years. It’s been a fluke, to some degree, that we have not had any down years in terms of underlying value. The stock has gone up and down in ways that are not related to intrinsic value a few times, but that is totally a fluke. I mean, we’re not going to be up every day. We’re not going to be up every week.

We’re not going to be up every month, or even every year. And it’s — the fact that, you know, the Earth revolves around the sun really is not totally connected to most business activities, or the fruition of most investment ideas, or anything of the sort. So we have to report every year, and, you know, I care about the yearly figures in that sense. I don’t really care about them, totally, as a measure of what we’re doing. And, like I say, if we could’ve — we were — the capital allocation job that I did in 1999 was very, very poor. And it was partly because some of our main businesses did poorly. I mean, Coca-Cola and Gillette had bad years last year. They’ll have good years over time. I wrote a few years ago — it’s interesting, I called their soft drink business and their razor and blade business as “Inevitables.” And the truth is they’ve got a higher market share now than they’ve ever had in history. They’re selling more units than any year in history.

But certain other factors hurt their business and therefore hurt their stock performance. But I would still call the soft drink — Coca-Cola’s position in the soft drink business, and Gillette’s position in the razor and blade business — I would characterize them as “inevitable,” that they will gain share over time. Gillette has over 70 percent of the blade and razor business in the world, which is — measured by value. And that’s an extraordinary share. Coke has 50 percent of the soft drink business in the world. That’s well over a billion eightounce servings per day. A billion per day. Eight percent of those are for the account of Berkshire, so over 80 million eight-ounce servings of soft drinks per day are being consumed by people for — where the economic benefit comes to Berkshire Hathaway. In effect, we have over six percent of the — for Berkshire Hathaway’s account — of the blade and razor business in the world. And it’ll go up. So I don’t worry about the businesses in the least, long term. They will have bad years from time to time.

And when they do, our performance will not look good in those years. Charlie?

CHARLIE MUNGER: Well, it’s been a very interesting stretch. One of the most interesting things about the stretch is that, during pretty much the whole period, the company has owned marketable securities in excess of its net worth. And so you have this extraordinary liquidity in a company that has performed very well, to boot. That advantage has not gone away and, in fact, it’s been augmented. Give us reasonable opportunities and we are prepared.

WARREN BUFFETT: Well you’ve heard what you’re supposed to do, now we’ll do the rest. Just give us the opportunities.

7. We want a “mathematical edge in every transaction”

WARREN BUFFETT: Area 5.

AUDIENCE MEMBER: My name is Greg Blevins (PH) from Bargetown, Kentucky. I have a question about intrinsic value. It comes from comments that you made in your annual report this year. In there, you describe the extraordinary skills of [Berkshire reinsurance chief] Ajit Jain in judging risk. When I think about Berkshire and its ability to increase intrinsic value, it seems to me that judging risk has been at least as important as an ability to calculate a net present value. So my question to each of you is, would you give us some comments on how you think about risk?

WARREN BUFFETT: Well, we think of business risk in terms of what can happen — say five, 10, 15 years from now — that will destroy, or modify, or reduce the economic strengths that we perceive currently exist in a business. In some businesses that’s very — it’s impossible — to figure — at least it’s impossible for us to figure — and then we just — we don’t even think about it then. We are enormously risk averse. We are not risk adverse, in terms of losing a billion dollars if there were an earthquake in California today. And we’re thinking of writing a policy, for example, in the next week or so, on a primary insurance risk of over a billion dollars. That doesn’t bother us as long as the math is in our favor. But in terms of doing a group of transactions like that, we are very risk averse. In other words, we want to think that we’ve got a mathematical edge in every transaction. And we think that we’ll do enough transactions over a lifetime so that, no matter what the result of any single one, that the group expectancy would — gets almost to certainty.

When we look at businesses, we try to think of what can go wrong with them. We try to look [for] businesses that are good businesses now, and we think about what can go wrong with them. If we can think of very much that can go wrong with them, we just forget it. We are not in the business of assuming a lot of risk in businesses. That doesn’t mean we don’t do it inadvertently and make mistakes, because we do. But we don’t intentionally, or willingly, voluntarily, go into situations where we perceive really significant risk that the business is going to change in a major way. And that gets down to what you probably heard me talk about before, is, what kind of a moat is around the business? Every business that we look at we think of as an economic castle. And castles are subject to marauders. And in capitalism, any castle you have, whether it’s razor blades, or soft drinks, or whatever, you have to expect the — And you want the capitalistic system to work in a way that millions of people are out there with capital thinking about ways to take your castle away from you, and appropriate it for their own use.

And then the question is, what kind of a moat do you have around that castle that protects it? See’s Candy has a wonderful moat around its castle. And Chuck Huggins has taken that moat, which he took charge of in 1972, and he has widened that moat every year. He throws crocodiles, and sharks, and piranhas in the moat, and it gets harder and harder for people to swim across and attack the castle. So they don’t do it. If you look, since 1972, Forrest Mars tried with Ethel M — I don’t know, 20 years ago. And I hate to think of how much money it cost him to try that. And he was a very experienced businessman. So we think of the — we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business. And to our managers, we say we want the moat widened every year. You know, that does not necessarily mean that the profit is more this year than last year, because it won’t be sometimes. But if the moat is widened every year, the business will do very well.

When we don’t have a — when we see a moat that’s tenuous in any way — getting back to your question — it’s just too risky. We don’t know how to valuate that, and therefore we leave it alone. We think all of our businesses — virtually all of our businesses — have pretty darn good moats, and we think the managers are widening them. Charlie?

CHARLIE MUNGER: How could you say it better? (Laughter)

WARREN BUFFETT: Here, have a — have some peanut brittle on that one. (Laughter)

8. Insurance “attracts chicanery” and we’ll have surprises

WARREN BUFFETT: OK, 6.

AUDIENCE MEMBER: Good morning.

WARREN BUFFETT: Good mrning.

AUDIENCE MEMBER: My name is Hugh Stevenson (PH). I’m a shareholder from Atlanta. WARREN BUFFETT (to Munger): Why don’t you open that?

AUDIENCE MEMBER: My question involves the company’s activities before and shortly after the Gen Re acquisition. I remember you saying once that, in insurance, virtually all surprises are negative ones. And I’m wondering, given the company’s operating experience in insurance over long period of time, could you tell us what happened in the Unicover situation? How come in Gen — with Gen Re’s experience and the company’s experience, that it happened, they didn’t foresee it, we didn’t foresee it? What has the company done? I know they’ve taken a large reserve for the situation. And how do they plan to operate in the future to prevent these things, find them out, and strengthen the company from these kind of situations in the future?

WARREN BUFFETT: Yeah, the Unicover situation was discovered in about, I don’t know, February of last year, or thereabouts. And it was a mistake, I mean, it should not have been made. A lot of other people made the same mistake, but that still didn’t mean that we should have made that mistake. We set up a reserve of $275 million when the mistake was discovered, and that reserve looks like it’s about right still. There have been quite a few developments at Unicover that have defined the limits of it better and resulted in the resolutions of many of the issues attached to it. Still looks like about a $275 million mistake. Now, that’s a big mistake, but we’ve made bigger ones. We had one in the mid-’70s that probably cost Berkshire, measuring opportunity cost and everything, because we didn’t know how bad it was going to be — I would say that Berkshire would now be worth at least 10 percent more if that mistake hadn’t occurred. Wouldn’t you say so, Charlie? The Omni situation?

CHARLIE MUNGER: Absolutely.

WARREN BUFFETT: Yeah, so we had a mistake whose present value would be 8 or $9 billion. It cost us at least that.

CHARLIE MUNGER: Yeah, it cost us less than 4 million at the time.

WARREN BUFFETT: Yeah. Though, it — but we didn’t know it for sure it was 4 million, so it tied our hands in other respects, too. In insurance you will get surprises. Now, the test of good management is how many surprises you get. But there’s no way you’ll get no surprises. And if you look at our history, you will see some years when our float cost us a lot of money. You will also see a history where over 33 or so years that it’s been a very, very attractive business. But we have had cases, I mean, our name causes problems. I think National Indemnity — we had a fraud, as I remember, down in Texas where an agent was using our paper, which incidentally was the same problem we had, the one that cost us so much. And some guy is out there writing bonds on — surety bonds — on construction of schools. And he says he represents National Indemnity and the contract proceeds, and of course, we’ve never heard of the guy.

But if you get a school district in Texas with a half-finished school, and the choice is whether the taxpayers ante up more or whether you find that this guy had apparent authority as an agent, and so on, and therefore we should pay on a policy we never heard of, written by a guy we never heard of, you know, on a school we never heard of. You know, we’ll end up paying. So the surprises are unpleasant nine times out of 10. We’ll have more. We had another one last year that shouldn’t have happened. But they do happen. And General Re has a terrific record over time. We knew last year would not be a good business in the reinsurance business. It was worse than we thought it would be. But that had nothing to do — if you told me the figures that General Re would have at the end of the year, we would have made the same deal in a moment. And, you know, we didn’t do so well with Coke and Gillette ourselves. So that the ratio of mistakes was probably fairly equal between the two organizations with me contributing our — my share.

I think insurance, which will continue to have surprises in it, will turn out to be a very, very good business for Berkshire over time. It’s the best one I know about that we can do in increasing scale over time. As a matter of fact, some of you may not have noticed but we announced another small insurance acquisition just last week. It’s a tough field. The average company is going to do poorly. We think we have some very special companies, and we really do think, over time, we will acquire and utilize float at a cost that’s very, very attractive. It won’t be zero like it’s been in the past. I mean, we are in some lines of business where intentionally — I mean, we would be crazy to try to hold it to zero, because it’s way better to have twice as much money at one or two percent as have half as much money at 0 percent. But we will fully acknowledge that — I mean, Unicover was a surprise. But I don’t know how many surprises I’ve had in insurance over the 33 years or so we’ve been in it.

One of the surprises, incidentally, you know, worked to our incredible benefit. GEICO has been a great, great company since I first went down to Washington, and even before that, and met Lorimer Davidson almost 50 years ago. But they made a mistake in the early ’70s that really did bankrupt the company. But fortunately, there was an insurance commissioner named Max Wallach in the District of Columbia, who saw that it could be resuscitated, and that mistake enabled us to make many, many billions of dollars. So mistakes can be useful on occasion, too. Charlie?

CHARLIE MUNGER: All that said, it is perhaps the most irritating way to lose money there is, is to be taken by a sort of obvious lie. And — but it happens. I don’t think it’s likely to happen again on that scale.

WARREN BUFFETT: Well, I wouldn’t say that. (Laughs) I would say that it’s unlikely that — in any 20 year period, or anything like that, we will get a big surprise. And it will come about, very often, through one form or another of three or four methods of obvious fraud that we’ve observed in the past. But they spring up again. And there are plenty of people that are, I’d have to say, “crooked,” in insurance because it’s a product where you deliver a piece of paper and somebody hands you money. And that intrigues people. You know, you don’t even hand them a Dilly bar, you know, or — (laughter) — or anything in exchange. They hand you a lot of money and you give them a little piece of paper. And of course, when you get into reinsurance and all that, then you hand that little piece of paper to somebody else and try and get them to hand you money.

And all the way along the line you have brokers who are getting big chunks of money for sort of papering over some of the weaknesses in the project, and sometimes they may even be in on it. So it’s a field that attracts chicanery. And often they — the same people — come back again and again. It’s amazing to me. So, I would say that we will get a surprise or two over any 10-year period in insurance. It’s almost impossible to avoid. We should try to minimize it. We do try to minimize it, but I would not want to bet my life that we’ve seen the last of a Unicover-type situation. They’re always just a little bit different enough so that it doesn’t get spotted, or somebody down the line doesn’t get the message, but — I don’t know. Don’t you think, Charlie, we’ll see another one? (Laughs)

CHARLIE MUNGER: Well, perhaps so, but it was a long time from one to the other, and maybe I’ll be able to get through without another. (Laughter) One of these fraud artists, Warren caused me to meet years ago, and his proposition was that he had this perfectly marvelous business. He says, “I — we only write fire insurance on concrete bridges that are under water.” He says, — (laughter) — “It’s like taking candy from babies.” And —

WARREN BUFFETT: We were the babies. (Laughter)

CHARLIE MUNGER: I looked in his eye. I thought he was kidding or something. He wasn’t kidding. I mean, these people believe this kind of stuff.

WARREN BUFFETT: The truth is Charlie — if Charlie and I could see everybody we dealt with, we would screen out some perfectly honest people, too. I think we could probably screen out the crooked propositions. I mean, they do have similar characteristics to them. And what happens is you get somebody out in the field who is eager to write business or is being wooed by producers, and the intermediaries get very good at it. It’s the same way lousy stocks get sold. I mean, you’ll get people who are getting paid very well to part, you know, separate you from your money. And that’s worked over the years. The good salesmen find out they can make more money, you know, selling phony products with big tickets attached to them than they can selling lollipops.

9. Rules and fees for Buffett’s 1950′s partnerships

WARREN BUFFETT: Number 7.

AUDIENCE MEMBER: Good morning Mr. Buffett, and good morning Mr. Munger. My name is Monish Pabrai (PH) and I’m from Long Grove, Illinois. I have been a student and disciple of yourself, Mr. Buffett, for some time, and especially Mr. Munger. And I have adopted, quite intensely, your theories of capital allocation, in the manner in which I run my business, as well as my portfolio, and quite pleased with the results so far. My question has to do with the original 1950s Buffett partnerships. There is some conflicting data in the various books about you pertaining to the rules of the partnership and the fees of the partnership. What I wanted to understand is, I think some of the books allude to the principle being guaranteed — I think six percent a year being guaranteed — and then you took a fourth, and the partners got three-fourths. In some cases they talk about four percent, and some cases they say there was no guarantee. I would just appreciate a clarification on that.

WARREN BUFFETT: OK, we’ll make it short because I’m not sure how much general interest there is to that. But there was never any guarantee. There was a guarantee that I wouldn’t get a penny myself — there was none of this one percent fee and all that sort of thing that hedge funds now normally have. After a short period of time I told people I’d have all my capital in it, basically. So there was a guarantee I would follow — have a common destiny. There was never any guarantee of principle of any sort. Originally, the thing started by accident, so that there 11 different partnerships before they all got put together on January 1st, 1962, into Buffett Partnerships. So with the 11 different partnerships, they had different — some different arrangements — based on the preferences of the limited partners. I offered them an option of three or four different choices, and different families made different choices. When we put them together we settled on the 6 percent preferential with a quarter of the profits over that, with a carry forward of all deficiencies. Nobody was guaranteed anything on them. Charlie had a much better partnership.

His was a third, as I remember, wasn’t it Charlie? (Laughter) ?

CHARLIE MUNGER: Yes, but we were smaller and operating specialist posts on the stock exchange. (Buffett laughs) The facts were different.

WARREN BUFFETT: Yeah.

10. American Express isn’t “inevitable” but has “huge value”

WARREN BUFFETT: OK. Let’s go to 8.

AUDIENCE MEMBER: Mr. Buffett, Mr. Munger, good morning. My name is Pete Banner (PH), and I’m from Boulder, Colorado. In the 1996 annual report, Mr. Buffett, you stated companies such as Coca-Cola and Gillette might well be labeled “The Inevitables,” and you just reaffirmed your view of Coca-Cola and Gillette. My question to you is, do you have the same view of American Express? That is, do you view American Express as, quote, “The Inevitable”?

WARREN BUFFETT: Yeah. I would like to clarify one point, too. I didn’t really say I regard the companies as “Inevitables.” I regarded the businesses, their dominance of soft drinks, or their competitive strength in soft drinks and in razors and blades. And as a matter of fact, I actually pointed out in talking about that — a few paragraphs later, I pointed out the danger of having a wonderful business is the temptation to go into less wonderful businesses. And to some extent, for example, Gillette’s stumble in the last year or two has not been the product of their razor and blade business, but it has been some other businesses, which are not at all inevitable. And that, you know, that is always a risk. And it’s a risk I pointed out, that when a company with a wonderful business gets into a mediocre business, that usually the reputation of the mediocre business prevails over the supposed invincibility of the management of the wonderful business.

American Express, an interesting case study, because it does have a — we always think in terms of share of mind versus share of market because, if share of mind is there, market will follow. People — virtually — probably 75 percent of the people in the world — have something in their mind about Coca-Cola. And overwhelmingly it’s favorable. Everybody in California has something in their mind about See’s Candy, and overwhelmingly it’s favorable. The job is to have it in a few more California minds — or world minds in the case of Coke — over the years, and have it even be a little more favorable as the years go by. If we have that, everything else follows. And consumer product organizations understand that. American Express was — had a very special position in people’s mind about financial integrity over the years, and ubiquity of acceptance. When the banks closed in the early ’30s, American Express traveler’s checks actually substituted, to some extent, for bank activity during that period.

The worldwide acceptance of this name meant that when American Express sold traveler’s checks — for many years, their two primary competitors were what are now Citicorp — First National City — and the Bank of America. And, despite the fact that American Express charged you one percent when you bought your traveler’s checks, and you had two other premier organizations, Citicorp, imagine, and BofA, and — actually, Barclays had one and Thomas Cook had one. And American Express still had two-thirds of the market after 60 or 70 years — two-thirds of the worldwide market — while charging more for the product than these other very wellknown competitors charged. Anytime you can charge more for a product and maintain or increase market share against wellentrenched, well-known competitors, you have something very special in people’s minds. Same thing came about when the credit card came around. Originally, American Express wanted the credit card because they thought they were going to get killed on traveler’s checks. And they thought it was going to be a substitute, and therefore, they had to go into — it was a defensive move.

It came about because a fellow named Ralph Schneider, and Al Bloomingdale, and a couple people came up with the Diners Club idea. And the Diners Club idea was sweeping, well, initially New York, and then the country in the mid-’50s. And American Express got very worried because they thought, you know, people are going to use these cards. Nobody had ever heard of Visa at that point, or anything of the sort. But people were going to use these cards instead of traveler’s checks. So they backed into the traveler’s check business — I mean, it backed into the credit card business. Immediately, despite the jump the Diners Club had on the — on this business — because Diners Club had the restaurants signed up already, and they already had the high rollers carrying around their card, and nobody had an American Express card. But American Express went in and they started charging more than Diners Club for the card, and they kept taking market share away.

Well, that is a great position to be in people’s minds where they are willing to — when faced with a choice — they’re willing to go with the newer product, at a higher price, and leave behind the entrenched product. And it just showed the power of American Express. American Express had a special cache. It identified you as something special. When you pulled out your American Express, as opposed to your Diner’s Club card, and as opposed to the Carte Blanche card, which was the third main competitor at the time. Visa still did not exist. And you could see this dominance prevail. That told you what was in people’s minds. It’s why I bought into the stock in 1964. We bought 5 percent of the company for — a huge investment at the time for us. I was only managing $20 million at the time. But you could see that this share of mind, this consumer franchise had not been lost. In the — considerable period of time, American Express got into other businesses, they got into — Fireman’s Fund Insurance was a very big acquisition. And, to some extent, they let the Visas of the world and all of those get established.

They still had this preeminent cache position, but it was eroding. But I would say that Harvey Golub, along with a lot of other people in the management, have done an extremely good job of reaffirming — intensifying — the cache. There will be probably $300 billion worth of charges, something in that area, put on American Express this year. The — 300 billion, those are big numbers, even in today’s world. The average discount fee is about 2.73 percent. If you look at the average discount fee on Visa, MasterCharge, you know, it’s going to be a —probably, a full percentage point beneath that. So you’ve got a percentage point on $300 billion, which is $3 billion of revenue that your competitor doesn’t get. You can do a lot of things for your clientele. And they’ve segmented the card, as you know. They’ve even recently gone to this black card, and — which sells for a thousand dollars. It’s got a very special cache.

I would say that — I wouldn’t use the word “inevitable,” but I would say that nourished properly, that the American Express name has had — excuse me — has huge value and is very, very likely to get stronger and stronger as the years go by. But I don’t — I think that what they went through showed that it could take quite a beating and come back. But I don’t want to — I don’t think you’d want to test it that way indefinitely. Incidentally, that’s one of the things we look for in businesses, is how — you know, if you see a business take a lot of adversity and still do well, that tells you something about the underlying strength of the business. The classic case was on that was — to me, is AOL. Four or five years ago — you know, I’m no expert on this, but I got the impression there for a period of time when they were having a lot of problems, that a very significant percentage of AOL’s customers were mad at them. But the number of customers went up every month. And that’s a terrific business.

I mean, if you have a business where your customers are mad at you and you’re growing, you know, that has met a certain test, in my mind, of utility. And you might argue that American Express had that, to some degree. It wasn’t that bad. But they had a lot of merchant unrest and all of that. So, occasionally, you will find that an interesting test of the strength of a business. Coca-Cola had some problems, you know, in Europe. But it comes back stronger than ever. They certainly had problems with New Coke, and they came back stronger than ever. So you do see that underlying strength. And that’s very impressive as a way of evaluating the depth and impenetrability of the moat that we talked about earlier. Charlie?

CHARLIE MUNGER: Well, I think it would be easier to screw up American Express than it would Coke or Gillette. But it’s an immensely strong business, and it’s wonderful to have it.

WARREN BUFFETT: We own about 11 percent of American Express. So when there are 300 billion of charges, we’re getting 33 billion of those for the account of Berkshire, and it’s growing at a pretty good clip. The first quarter, it grew very substantially in both cardholders and charges. My guess is that our 11 percent becomes more valuable over time. It’s hard to think of anything that would destroy it.

CHARLIE MUNGER: The business is very interesting. They made a deal to put American Express cards into Costco. I think that is a very intelligent thing for American Express to have done. And it’s a very aggressive place that does a lot of interesting things.

WARREN BUFFETT: Charlie is a director of Costco, so he’s a — Costco is an absolutely fabulous organization. We should have owned a lot of Costco over the years and we — I blew it. Charlie was for it, but I blew it.

11. “We don’t think in terms of absolutes”

WARREN BUFFETT: OK, we’ll go to number 1 again.

AUDIENCE MEMBER: My name is Jin Xi Wan (PH) from San Diego, California. First, I would thank both of you. My question is also about growth and value. If you look at the business in this country, most of them, if not all of them, are cyclical to various degrees. Certain businesses are, of course, more cyclical than other businesses. So when you buy a business or make a investment in a new stock, do you ever cut off — like if a business lose money in a downturn, we are not going to buy. If its earning begin to decline or downturn, we’re not going to buy. But if the earning growth slows down, then we can look at a business and make an investment. So do you have a cutoff, in terms of this cyclical factor? And also, when you buy a business — in terms of the current P/E ratio, also do you have a cutoff? Let’s say, if it’s P/E ratio is more than 15, 16, we are not going to buy the business, no matter how much the earning will grow in the future. So basically, it’s about the growth and the value.

WARREN BUFFETT: Yeah, we have — to answer your question directly — we have no cutoff, whatsoever. We don’t think in terms of absolutes that way because, again, we are trying to think of how many birds are in the bush. And sometimes the number that are currently being shown could be negative. One of the best buys we ever made was in 1976 when we bought a significant percentage — what became through repurchases — 50 percent of GEICO at a time when the company was losing a lot of money and was destined to lose a lot of money in the immediate future. And, you know, the fact they were losing money was not lost on us, but we thought we saw a future there that was significantly different than the current situation. So it would not bother us in the least to buy into a business that currently was losing money for some reason that we understood, and where we thought that the future was going to be significantly different. Similarly, if a business is making some money — there’s no P/E ratio that we have in mind as being a cutoff point at all.

There are businesses — I mean, you could have some business making a sliver of money on which you would pay a very, very high P/E ratio. But it’s basically — We look at all of these as businesses. We’re, for example, in — at Executive Jet — NetJets — we’re losing money in Europe. Well, we expect to lose money in Europe getting established. So does that mean it’s a bad thing to buy a hundred percent of, if you own the whole company, or three percent of, if Executive Jet was a public company and you were buying into? No. I mean, it — There are all kinds of decisions that involve the future looking different, in some important way, than the present. Most of our decisions relate to things where we expect the future not to change much. But you get this — well, American Express was a good example. And when we bought it in 1964, a fellow named Tino DeAngelis had caused them incredible trouble. You know, it was one of those decisions that looked, for a time, as if it could break the company.

So, we knew — if you’d been charging for what Tino had stolen from the company against the income account that year, or the legal costs that were going to be attached to it, you were looking at a significant loss. But the question was, what was American Express going to look like 10 or 20 years later? And we felt very good about that. So there are no arbitrary cutoff points. But there is that focus on, how much cash will this business deliver, you know, between now and Kingdom Come? Now as a practical matter, if you estimate it for 20 years or so, the terminal values get less important. So — but you do want to have, in your mind, a stream of cash that will be thrown off over, say, a 20-year period, that makes sense discounted at a proper interest rate, compared to what you’re paying today. And that’s what investment’s all about. Charlie?

CHARLIE MUNGER: Yeah, the answer is almost the exact reverse of what you were pointing toward. A business with something glorious underneath, disguised by terrible numbers that cause cutoff points in other people’s minds, is ideal for us, if we can figure it out.

WARREN BUFFETT: And we’ve had a couple of those in our history that have made us a lot of money. I mean, we don’t want to wish anybody ill, but —

CHARLIE MUNGER: Oh, I wouldn’t go that far —

WARREN BUFFETT: OK, well Charlie — (Laughter) I think he’s speaking for both of us. (Laughter)

12. Speculate a bit in tech? Not if we don’t understand it

WARREN BUFFETT: OK, we’ll move on to number 2.

AUDIENCE MEMBER: Mr. Buffett, I would like to start my question by giving you and Charlie 10 lashes with a wet noodle, not because of 1999 and what happened to your net worth or our net worth, but because you have spoiled your shareholders into expecting 25 percent growth every year, since 1965. And then comes the bad, bad 199[9] and it hits all of us. But by my calculations, you personally, Mr. Buffett, have lost over 10 billion dollar — not million — billion dollars during 1999. So I don’t think we should get too mad at you because probably all of us have, at this point in our life, increased our net worth and made a lot of money. So you don’t get a wet noodle today. (Laughter)

WARREN BUFFETT: Hmm.

AUDIENCE MEMBER: And the shareholders have, I’m sure, lost thousands. And some have lost millions of dollars during the year 1999. Now after reading your biography in November of 1998 — unfortunately I didn’t know about you earlier — I started investing on November the 24th of ’98. And of course, I’m a poor little investor, so I bought your B stock at 23.08. Then, because the market dropped, I bought some more on the 4th of December at 22.29. And then I bought, on January the 24th of 2000 at 16.89, so I do believe in dollar-cost averaging and I’ve been doing that for probably 30 years of my life. My January investment, I’m happy to say, is up 15 percent, so the worst may be over. Now, I read your annual report and I want to compliment you that that is the easiest and most entertaining annual report I think created in the whole world. And your — and I hope you continue that kind of a report. (Applause)

WARREN BUFFETT: Thank you.

VOICE: (Inaudible) Your name and —

AUDIENCE MEMBER: Oh!

VOICE: — where you’re from

AUDIENCE MEMBER: I’m sorry. I was just told that I should have said who I am. My name is Gaylord Hanson and I’m from Santa Barbara, California — where investor Munger puts his big, multimillion-dollar boat in the water. (Laughter)

WARREN BUFFETT: I’m not going to make any comment on that.

AUDIENCE MEMBER: Please don’t. (Laughter) Now, with technology, computers, electronics, and software transforming our entire world — not just here — the world, I must admit that I personally invested in four technology computer software and aggressive growth mutual funds and made up all of my 1999 losses on Berkshire Hathaway. (Laughter and applause) Are we asking too much as shareholders of Berkshire Hathaway for you men to put your brains to work and possibly speculate a little bit, maybe 10 percent of our money, into the only play in town, which seems to be technology, electronic? And I read your report, and I understand a lot of your reasoning that it’s difficult — and it is difficult — to project earnings of a lot — people are going to be a little bankrupt. Are they going to out of business? But isn’t there enough left in your brainpower to maybe pick a few and — (laughter) — see what’s going on? Because I made over a hundred percent profit in 1999 on my aggressive position in the technology field, so that’s —

WARREN BUFFETT: OK, well —

AUDIENCE MEMBER: — my question.

WARREN BUFFETT: The answer is we will never buy anything we don’t think we understand. And our definition of understanding is thinking that we have a reasonable probability of being able to asses where the business will be in 10 years. But, you know, we’d be delighted — we have a man here who’s done very well. And if he has any business cards, you know, you could always invest with him, and — (Laughter) And we’d welcome — you know — you can — we’ll give you a booth in our exhibitor’s section. And anybody that wants to do that is perfectly — obviously — free to do it with you or through any other — through anybody else that they select. Now, you have a whole bunch of people out there that say they can do this. And maybe they can and maybe they can’t and maybe you can spot which ones can and can’t. The only way we know how to make money is to try and evaluate businesses. And if we can’t evaluate a carbon steel company, we don’t buy it.

It doesn’t mean it isn’t a good buy. It doesn’t mean it isn’t selling for a fraction of its worth. It just means that we don’t know how to evaluate it. If we can’t evaluate the sensibilities of putting in a chemical plant or something in Brazil, we don’t do it. If somebody else knows how to do it, you know, more power to them. There are all kinds of people that know how to make money in ways that we don’t. But, you know, it’s a free world and everybody can invest in those sort of things. But they would be making a mistake, a big mistake, to do it through us. I mean, why pick a couple of guys like Charlie and me to do something like that with — when you can pick all kinds of other people that say they know how to do it. I would say this. Incidentally, you mentioned a point earlier, which is how the popular press tends to think of things. But we don’t consider ourselves — Charlie and I don’t — richer or poorer based on what the stock does.

We do feel richer or poorer based on what the business does. So we look at the business as to how much we’re worth. And we do not look at the stock price, because the stock price doesn’t mean a thing to us. I mean, it doesn’t for a variety of reasons, but beyond that, imagine trying to sell hundreds of thousands of shares at the stock price. We can always sell the business — we’re not going to do it — but we could always sell it for what the business is worth. We can’t sell our stock for what the — necessarily — what the stock price is. So we look at the business, entirely, in terms of evaluating our net worth. We figure our net worth went up very, very, slightly — very slightly — in 1999. And we would figure that no matter what the stock was selling for — it just doesn’t make any difference — because we do look at the businesses. We really look at it as if there wasn’t any quote on the stock. Because we don’t know what the stock is going to do.

If we do — if the business gets worth more at a reasonable rate, the stock will follow, over time. But it won’t necessarily follow week by week, or month by month, or year by year. We had a lousy year in 1999, but the stock price did not calibrate with that in any perfect, or close to perfect, manner. And we’ve had good years other times, when the stock price is way overpriced or overdescribed what happened during the year. So we really measure all the time by the business. We think of it as a private business, basically, for which there’s a quotation. And if it’s handy to use that quotation, either in buying more stock or something of the sort, we may do it. But it does not govern our ideas of value. Charlie?

CHARLIE MUNGER: Yeah. Generally, I would say that if you have a lot of lovely wealth in a form that makes you comfortable, and somebody down the street has found a way to make money a lot faster, in a way you don’t understand, you should not be made miserable by that process. There are worse things in life than being left behind in possession of a lot of lovely money. I mean — (Laughter)

WARREN BUFFETT: Would you want to name a couple? (Laughter) No, Charlie made — I mean, when farmland was — went from — farmland probably tripled here in the late ’70s, without any real change in yields per acre or the price of the commodity. You know, are we going to sit around and stew because, you know, they — we didn’t buy farmland at the start? You know, are we going to stew because all kinds of stuff — uranium stocks in the ’50s — or you can go back — all kinds of things that have — the conglomerates in the late ’60s, the leasing companies, I mean, you can just go down the line. And it just doesn’t make any — we’re not in that game. We would know how to create a chain letter, believe me. I mean, we’ve seen it down some many times. You know, we know the game. But it just isn’t our game. Charlie? (Applause)

13. Currencies are “important but not knowable”

WARREN BUFFETT: Number 3?

AUDIENCE MEMBER: Good morning Mr. Buffett, Mr. Munger. My name is Stacey Braverman (PH). I’m 15 years old, and I’m from South Setauket, New York. It was very nice meeting you Mr. Buffett, yesterday.

WARREN BUFFETT: Thank you.

AUDIENCE MEMBER: I especially appreciated your internet stock tips. (Laughter)

WARREN BUFFETT: (Laughs) Yeah, keep it — keep it to yourself now, Stacey. That’s our deal. (Laughs)

AUDIENCE MEMBER: I bought the B shares two years ago, when I decided that I needed to save some money for college. When the share price dipped below 1,500 I decided to investigate correspondence courses. (Laughter)

WARREN BUFFETT: Maybe you can get a scholarship. (Laughs)

AUDIENCE MEMBER: So I’m glad to see that things are back on track now. My question is, a lot of the companies that you invest in, like Coca-Cola and Gillette, seem to do better when the dollar is weak and interest rates are falling. That seems to be the opposite of what’s happening now. So how is Berkshire positioning itself to take advantage of the current economic position, with that assessment in mind?

WARREN BUFFETT: Yeah, well, that’s a good question. But if we thought we knew what the dollar was going to do, or interest rates were going to do, we would — we won’t do it — but we would just engage in transactions involving those commodities, in effect, or futures directly. In other words, it would not be — if we thought that the dollar was going to weaken dramatically — and we won’t get those kind of thoughts — but if we did, you know, we would buy other currencies. And it would be — it might benefit Coke, in dollar terms, if that happened. But it would be so much more efficient, directly, to pursue a currency play or an interest rate play than an indirect way through companies that have big international exposure. We would probably do it directly. We don’t really think much about that. Because — just take currency. If you look at what the yen has traded at, you know over the last — well, since World War II, you know. From — what was it? Three-sixty down to — what? Seventy-some, Charlie? At lowest?

CHARLIE MUNGER: Uh-huh.

WARREN BUFFETT: And, you know, back up to 140-some. And now, I don’t know, 105, or wherever it may be. I mean, those moves are huge. But, in the end, we’re really more interested in whether more people in Japan are going to drink Coca-Cola. And, over time, we’re better at predicting that than we are at predicting what the yen will do. And if Coca-Cola satisfies people’s needs — liquid needs — for more and more people, we will probably get a reasonable percentage of their purchasing power of those people around the world for their right to drink Coca-Cola, or for shaving, or whatever it may be. So, if the world’s standard of living improves, bit by bit over time, in an irregular fashion, and we supply something the world wants, we will get our share in dollars, eventually. And what it — quarter-to-quarter or year-to-year — how that moves around, because of currency moves, really doesn’t make any difference to us.

It makes a difference to reported earnings in that quarter or — but in terms of where CocaCola’s going to be 10 or 20 years from now, it would be a big mistake, I think, to focus on currency moves as opposed to focusing on the product itself. And Japan offers a good example of that because you had this — I mean, you really had a move from 360, or whatever it was, to the high 70s or thereabouts. I mean, that is an incredible move in currency, and it can overshadow in the short run, even, what’s happening in the business. But long-range, what’s really made Coca-Cola strong in Japan is the fact that the Japanese people have accepted their products in a big way. And Coca-Cola’s built this tremendous, for example, vending machine presence. And the Japanese market is very different than all the rest of the markets in the world, virtually, in that such a high percentage flows through vending machines. And my memory is that, you know, we may have something like 900-and-some thousand, out of something over 2 million, vending machines in the country. So we’ve got this tremendously dominant position.

It’s a little like billboards might be in this country. Plus, we have this terrific product, Georgia Coffee, which is huge over there. And that’s the sort of thing we focus on, because that’s something we understand. We don’t understand what currencies are going to do week-to-week or month-to-month or year-to-year. And we always try to figure on what — focus on what’s knowable and what’s important. Now, currency might be important, but we don’t think it’s knowable. Other things are unimportant, but knowable. But what really counts is what’s knowable and important. And what’s knowable and important about Coca-Cola is the fact that more and more people are going to consume soft drinks around the world, and have been doing so year after year after year, and that Coca-Cola’s going to gain share, and that the product is extraordinarily inexpensive relative to the pleasure it brings to people.

Coca-Cola — in the ’30s, when I was kid, I bought, you know, for — six for a quarter and sold them for a nickel each. That was a 6 1/2 ounce bottle for a nickel, at Coke. And you can buy a 12-ounce can now at — pick a supermarket sale — for not much more than twice per ounce what it was selling for in the ’30s. You won’t find many products where that kind of value proposition has developed over the years. So that’s the kind of thing we focus on. And interest rates and foreign exchange rates, important as they may be in the short term, really are not going to determine whether we get rich over time. The best time to buy stocks, actually was, in recent years, you know, has been when interest rates were sky high and it looked like a very safe thing to do to put your money into Treasury bills at — well, actually the primary got up to 21 1/2 percent — but you could put out money at huge rates in the early ’80s. And, as attractive as that appeared, it was exactly the wrong thing to be doing.

It was better to be buying equities at that time, because when interest rates changed, their values changed even much more. Charlie?

CHARLIE MUNGER: Yeah, we have a willful agnosticism on all kinds of things. And that makes us concentrate on certain other things. This is a very good way to think, if you’re as lazy as we are. (Laughter)

14. We’ll “probably” own M&T Bank stock 10 years from now

WARREN BUFFETT: We’ll go to 4, please.

AUDIENCE MEMBER: Jerry Zucker, Los Angeles, California. Good morning, boss. (Laughter) Calling your attention to the annual report and major investments, I’d appreciate your comments on two companies. Number one, M&T Bank, a new name to that list, but not exactly a household name, at least on the West Coast. And company number two, definitely a household name, but missing from the list this year, the Walt Disney Corporation.

WARREN BUFFETT: Well, we don’t comment much on our holdings, particularly as to purchases or sales, but we do have the CEO — longtime CEO — of M&T here today, Bob Wilmers. Bob, would you stand up? He should be up here somewhere. There he is. (Applause) Bob is a terrific businessman, a terrific banker, and a terrific citizen. I’ve known him a long time. A good friend of Stan Lipsey, our publisher in Buffalo. Bob runs the kind of a bank that allows Charlie and me to sleep very comfortably. Someone once said there are more banks than bankers, which is something worth thinking about a little bit. But believe me, Bob is a banker and he’s done a lot for Buffalo. And he runs — he’s got a — he has a very big ownership position, which he achieved, at least in very large part, through purchase with his own money, as opposed to having options. He’s got one of the largest ownership positions, probably, among the hundred largest banks in the United States.

And it’s just a very attractive business for us to be in, and we’re very comfortable with it. And 10 years from now, Bob will be here, and I hope I’m here. We will — we’ll probably own M&T. The Disney Company, our ownership in that fell below the threshold level which we used, although we had ownership. And we think Disney is a terrific business. Michael Eisner’s done a great job there. We have — as we put in the annual report — we have mildly reduced equities as prices began to — generally — began to get more and more full. We do not think the general ownership of equities is going to be very exciting over the next 10 or 15 years, so we would like to buy businesses. We bought a few last year. We had this one we announced last week in the insurance field. We got another small acquisition where we’ve got an agreement with somebody. It’s very small. But we would love it if those were 10 times that size or 20 times that size, because — you will see more of that, relative to marketable securities, as we go along. Charlie?

CHARLIE MUNGER: Yeah, regarding equities generally, I think that Fortune article, which was sent out to the Berkshire shareholders this year, should be absolutely must-reading for everybody. In fact, it would be a good thing to read two or three times. The ideas there sound so simple, that — you know, people have the theory that they must understand it. But I think the world is more complicated than that. I think we are in for reduced expectations eventually, with respect to the kind of returns people have had from investing in stocks.

WARREN BUFFETT: You want to offer any thoughts as to what — that might — what the corollary might be?

CHARLIE MUNGER: Well, I think if you have very unreasonable expectations of life, it makes life much more miserable. Much better to get your expectations within reason. It’s much easier to reduce expectations to some reasonable level than it is to get superhuman achievements.

WARREN BUFFETT: That’s why my kids were almost delirious when they heard that announcement I was going to give them $300 each and they — (Laughter) How to be — do you want to be a zillionaire, or whatever it was. Incidentally, that was terrific of Regis Philbin to do something like that. I mean, all of those appearances [in the video shown to shareholders] are nonpaid, I can assure you. (Laughter) And those people are good — very, very, good sports. And I thank them.

15. We’ll “never have a conventional dividend policy”

WARREN BUFFETT: OK, we’ll go to zone 5.

AUDIENCE MEMBER: My name is Monty Leffoltz (PH) from Omaha, Nebraska. I have a two-part question. What is Berkshire’s philosophy on paying dividends and under what circumstances would Berkshire pay a dividend in the future?

WARREN BUFFETT: Well, that’s a good question. We paid a dividend in — what, 1969, Charlie? At 10 cents a share. The — I can’t remember it, but it’s in the records. We would pay — we would be very likely to pay either very large dividends or none at all, because our test is whether we think we can use money at a rate — in a way — that it creates more than a dollar of market value for every dollar we retain. Obviously, if we can keep a dollar and it becomes, on a present-value basis, worth more than a dollar, it’s foolish to pay it out. Forget all about taxes. Assume it’s a tax-free society. We would have exactly the same dividend policy up to this point, whether there was any tax on dividends, capital gains, or anything else, or whether we were entirely tax-free.

Because we have retained money because, to date, we have felt that if we keep a dollar and use it in buying other businesses, or whatever it may be, that it becomes worth more than a dollar on a present-value basis — I mean, not that it’s going to be worth a dollar-ten four years from now — but that it’s worth more than a dollar when we look at what it’ll be four years from now. That’s subjective, but any given decision like that is subjective. Over time, you get an objective test as whether that’s met by — whether we do indeed create more value than — each dollar retained earnings, we create an extra dollar-plus of value. If that changed — and it could change — then we would give the money to the shareholders. And it might be done through repurchases or it might be done through dividends, but we would — there’s no reason to keep a dollar in the business that’s worth 90 cents if you keep it in the business. And there are companies that do that, but they don’t — they’re not necessarily intentionally doing it.

They may have higher aspirations as they go along, but they’re not realized. We, I think, would be fairly objective about trying to figure out whether we are indeed creating value or destroying value by retaining earnings. We would never have a conventional dividend policy. I mean, the idea of paying out 20 percent of your earnings, or 10 percent, or 30 percent of earnings in dividends strikes us as nuts. I mean, you may get yourself in a position where you have to do it because you build these expectations in people’s minds, but it is — there is no logic to it whatsoever. The logic is basic. If you create more than a dollar value for a dollar retained, why in the world would you pay it out, because the people who want to get that dollar as a dividend can instead get a dollar-ten by selling the stock for — or whatever it may be — a dollar-twenty— for the value that was maintained — or retained. So, that — it’s a very simple dividend philosophy, and one, I think, that’s in one of the past annual reports. We explain the logic of it.

And I see no — nothing that would change, in terms of the principles of it. Evaluating whether that’s the case — I mean, obviously we aren’t going to make a decision every week based on whether we can employ money that week at a higher rate of return, or every month. But in terms of a reasonable expectancy over a couple-year period, whether we think we can use retained earnings advantageously, that’s our yardstick. Charlie?

CHARLIE MUNGER: Yeah, what’s interesting about what Warren is saying about logical dividend policy is that if you went to all the leading business schools of the United States, all the leading economics departments, all the professors of corporate finance — this wasn’t — wouldn’t be the way they teach the subject. In other words, we’re basically saying we’re right and all the rest of academia is wrong. (Laughter)

WARREN BUFFETT: We love it when we do that. (Laughter)

16. We never sell a business and rarely sell a stock

WARREN BUFFETT: OK, we’ll go to 6.

AUDIENCE MEMBER: I’m Mark Chere (PH) from Hong Kong. And Mr. Buffett, I’d like to ask you a couple of questions. The first one is how many insurance companies does Berkshire Hathaway own?

WARREN BUFFETT: Let me —

AUDIENCE MEMBER: I can’t figure out the total.

WARREN BUFFETT: Let me answer that and then you go on to your second one. We have a great number of companies because, in many cases, a given strategy or a given operation operates through multiple companies. The company we announced the purchase of the other day is really one business, but it has three companies. I wouldn’t be surprised — I’ve never looked at the number — but it wouldn’t surprise me if we have 20 insurance companies or something. Maybe 25 or 30, who knows? We have about nine or 10 basic insurance operations for which a given management has responsibility, but there’s a lot of state laws applicable to insurance companies and different regulations. It’s often advantageous to have a number of companies operating under one management to achieve one operational goal. The big operations are General Re, and GEICO, and the National Indemnity reinsurance operation run by Ajit [Jain]. And then we have a group of about five different operations that are all very decent businesses, but are not as big as the three I mentioned. Go ahead.

AUDIENCE MEMBER: Thank you. Yeah, my main question is this. Much has been written by you, and a lot more by other people, about your criteria, or the criteria you use when you make a purchase of a company, either in full or in part. But almost nothing has been written by you, at any rate as far as I can tell, on your criteria for selling a company that you have already — you have previously purchased. And I wonder if you could outline the criteria you might apply today to a sale of a company, and whether you would go — well, the simplest way to put it is this: Would you agree with Philip Fisher, who said there were two reasons to sell a company — or a stock? One was when you’d discovered you’ve made a mistake in your analysis and the company was not what you thought it was. And the second when — was when the — something within the company had changed, the management had changed or so on, so it no longer met your original criteria. Would you — are those the principles that you apply or would you say there are different ones or others? Thank you.

WARREN BUFFETT: I’m glad you brought up Phil Fisher, because he is a terrific mind and investor. He’s probably in his 90s now, and — but his — A couple of books he wrote in the early ’60s are classics and I advise everybody here who’s really interested in investments to read those two books from the earlier ’60s. And he’s a nice man. I went out to — 40 years ago, I dropped into his office in San Francisco, a tiny office. And he was kind enough to spend some time with me. And I’m a huge admirer of his. The criteria that we use for selling a business that we own control of are articulated in the annual report, under the ground rules. So in terms of businesses that we own, we have set forth — and I direct you there — we’ve written those same ground rules every year since 1983. And actually, we had those in our head for decades before that.

And we have this quirk, which you should understand, and we want our shareholders to understand it, that even though we got offered a price that was far above its economic value, as we might calculate it going in — but if we got offered a price for that for a business that we have now, we have no interest in selling it. You know, we just — we don’t break off the relationships that we develop simply because we get offered a fancy price for something. And we’ve had a chance to do that sometimes. That may help us, actually, in acquiring businesses, because both of the companies that I’ve committed to buy in the last few weeks, both of them are very concerned about whether they have found a permanent home or not. And people who build their businesses lovingly over 30, or 40, or 50 years, frequently care about that. A lot of people don’t care about that. And that’s one of the things we evaluate when buying a business. We look at the owner, and we say, “Do you love the — ” in effect, we ask ourselves, “Does he love the business or does he love the money?”

Nothing wrong with liking the money. In fact, we’d be a little disappointed if most of them didn’t like the money. But in terms of whether the primacy is loving the money or loving the business, that’s very important to us. And when we find somebody that loves their business — and likes the money — but loves their business, we are a very, very desirable home for them, because we’re just about the only people that they can deal with, of size, where we can commit that they are going to be part of this operation, really, forever, and be able to deliver on that promise. I tell sellers that the only person that can double-cross them is me. I can double-cross them. But there’s never going to be a takeover of Berkshire. There’s never going to be a management consultant come in and say, “I think you’d better do this.” There’s never going to be a response to Wall Street saying, “Why aren’t you a pure play on this or that and therefore you ought to spin this off the—?” None of that’s going to happen.

And we can tell them, with a hundred percent assuredness, that for a very long time — that if they make a decision to come with Berkshire, they — that decision will be the final decision as to where their company resides. So, unless those couple conditions, which are extremely unusual, that are described in the ground rules prevail, we will not be selling operating businesses, even though someone might offer us far more than, logically, they’re worth. The question about stocks is, we’re not quite with Phil Fisher on that, but we’re very close. We love buying stocks where we think the businesses are so solid, have such economic advantage, that we can essentially ride with them forever. But you’ve heard me talk about newspapers earlier today. We would have thought newspapers — 20, 25 years ago, I think Charlie and I probably thought a daily newspaper, you know, in a single newspaper town — which practically all are — is probably about the solidest investment you could find. We might have thought a network TV-affiliated station was about as solid as you could find. And they were very solid.

But events have, over the last 20 or 25 years, have certainly changed that to some degree and maybe to a very, very big degree. So we will occasionally reevaluate the economic characteristics that we see 10 years out from the ones that we saw 10 years ago and maybe come to a somewhat different conclusion. The first 20 years of investing for me — or maybe more — my decision to sell almost always was based on the fact that I found something else I was dying to buy. I mean, I sold stocks at — you know, at three times earnings to buy stocks at two times earnings 45 years ago, because I was always running out of money. Now, I run out of ideas. I’ve got a lot of money but no ideas, and —. (Laughter) You know, I’d — I’m not sure which is better. What do you think, Charlie? (Laughter)

CHARLIE MUNGER: I think you were way better off when you had 50 years ahead of you — (laughter) — and less money.

WARREN BUFFETT: I still think I have 50 years ahead of me, Charlie. (Laughter) You want to elaborate any more on selling?

CHARLIE MUNGER: Yeah. We almost never sell an operating business. And when it does happen, it’s usually because we’ve got some trouble we can’t fix.

17. Compensation based on stock price is a “lottery ticket”

WARREN BUFFETT: OK, number 7.

AUDIENCE MEMBER: Hello, I’m Martin Wiegand from Chevy Chase, Maryland. And, though you’ve given yourself a D in capital allocation, on behalf of the shareholders, we would like to give you an A-plus in honesty and accounting, temperament for a long-term investing view, and hosting an annual meeting.

WARREN BUFFETT: Thanks. (Applause) I went to school with Martin’s father. Good to see you here.

AUDIENCE MEMBER: Thank you. Now my question. Do General Re’s competitors pay their employees with a rational incentive plan aimed at growing float and reducing its cost, or do they use something similar to General Re’s old plan, and is this a new, sustainable, competitive advantage for General Re?

WARREN BUFFETT: Well, I think a rational compensation plan — and I think we have rational compensation plans — we certainly aim at that, and we don’t care what convention is. Over time, we’ll select for people who are rational themselves, who have confidence in their abilities to deliver under a rational plan, and who really appreciate operating in that kind of an environment. Now, who wouldn’t want a lottery ticket, you know? I mean, if anybody here wants to buy a few lottery tickets at the lunch break and come up and present them to me, I’ll be glad to take them. I don’t think it will have anything to do with, you know, my performance at Berkshire Hathaway or anything in the future. And so, we try to make plans that are very rational. And incidentally, we’ve never had any real problems at all in working with managements to do just that. The two operations that I’ve just recently agreed to buy, we will have rational compensation plans at those places.

And they’ll be somewhat different, perhaps, than the ones they’ve had in the past, although not much different, as I think about it. I think it’s been a huge advantage at GEICO to have a plan that is far more rational than the one that preceded it. And I think that advantage will do nothing but grow stronger over time because, in effect, compensation is our way of speaking to employees, generally. And with a place as large as GEICO, you can’t speak to them all directly. But it speaks to them all the time. It says what we think the rational measurement of productivity and performance in the business is. And over time, that gets absorbed by thousands and thousands of people. And it’s the best way to get them to buy into their goals. Whereas, if you use as your test what the stock market is going to do, people, I think, inherently know they got a lottery ticket. I mean, you’ve seen that in a lot of tech stocks in the last three or four months.

You will find all kinds of options being repriced, or issued in great abundance at lower prices without repricing them because they don’t want to have the accounting consequences. Those people know they’re getting lottery tickets, basically. And, you know, the market’s attitude toward tech stocks is what’s going to determine results far more than their own individual results. So, it’s silly to think of somebody working very hard at some very small job at Berkshire, with our aggregate market value of 90 billion, thinking that their efforts are going to move the stock. But their efforts may very well move the number of policy holders we gain or the satisfaction of policy holders. And if we can find ways to pay them based on that, we are far more in sync with what they can do. And they know it makes more sense. So, I hope our competitors do all kinds of crazy things on comp and everything else. I mean, the more dumb things they do, the better life is for us. And I think that — Well, we’ve had incredible success at keeping managers.

I don’t think there’s probably any company in the United States of size that has had better luck on that than Berkshire. And partly, it’s because we appreciate, in terms of the comp plan, and partly because we just appreciate, generally, managers that do a terrific job for us. And we’ve got the best group in the world. Charlie?

CHARLIE MUNGER: Yeah, here again, we’re very much out of step with the conventions of the world. When I read annual reports, and I read a lot of them, I’m very frequently irritated by the presence of things that are totally absent from the Berkshire Hathaway annual report. I think promising people free medical care forever, between age 60 and the grave, and maybe for a younger spouse after the grave, but the first one, regardless of what’s invented and regardless of what it cost, I don’t see how anybody who cared about the shareholders would be making promises like that. There’s a lot of insanity in conventional corporate conduct on the pay front. And — but if convention determined what was sane and what was insane, we’re the oddballs. I mean, we’re the unusual example.

WARREN BUFFETT: I think per — and I think it’s very subconscious, but I think, sometimes, that the desires of the top person to get an outrageous amount gets pyramided through the organization. Because if they’re going to have some scheme that rewards them based on a lottery ticket, they feel they have to give lottery tickets to everybody else, although on a much-reduced scale. And they really do. I mean, it’s just — it becomes accepted in the course. And then you hire consultants who come around and say, “Well, you’re getting more lottery tickets at someplace else. And we’ve got some added new schemes.” It becomes very, very reinforcing. But what has happened at the top level is really unbelievable. I mean, it — if an executive said to his company, “I want an option on 300 — just for working here — I want an option on $300 million worth of S&P futures for the next 10 years,” you know, people would regard that as outrageous. They’d say, “What have you got to do with that?”

But in effect, if they get one on their own stock and it goes up based on the fact the S&P appreciates over 10 years, they think that that’s perfectly acceptable to have that kind of a ride. So I would say that, you know, there’s been a lot of talk about the huge gap between, you know — that exists in pay. But it seems to me that the primary gap that is eating at American CEOs is the gap between the rich and the super-rich. That seems to be motivating the adoption of many plans. It’s really — it’s gotten out of hand, but it isn’t going to change. The CEO has his hand on the switch as a practical matter. I know people, and I’ve been on them myself, but on comp committees. And as a practical matter, you don’t stand a chance.

CHARLIE MUNGER: Yeah, a lot of the corporate compensation plans of the modern era worked just about the way things would work for a farmer or if you put a rat colony in the grainery. It — (Laughter)

WARREN BUFFETT: Put him down as undecided. (Laughter) Good to see you, Martin.

18. We ignore book value for our stock investments

WARREN BUFFETT: OK, let’s go to 8.

AUDIENCE MEMBER: Good morning Mr. Buffett and Mr. Munger. My name is Ram Tarecard (PH) from Sugar Land, Texas. I’ve been a Berkshire shareholder since 1987 and always battling with the idea of what really is the intrinsic value for the company. We have seen that, over time, a change in book value is a big indicator of the change in intrinsic value of Berkshire. Although in absolute terms, you have said again and again, that intrinsic value far exceeds book value. In calculating the book value of Berkshire, our partly-owned businesses, like Coke and Gillette, are valued at their market value. This component of book value fluctuates, often irrationally, depending on the mood of the market. Do you think that using a look-through book value, just like you used look-through earnings, is a superior measure for tracking changes in intrinsic value? In fact, I had written a letter to you last August and I was very pleased to get a response from you personally saying that this approach makes sense. My question is, does this approach really give you a better measure for tracking intrinsic value? And if so, would you consider publishing it in the annual report? Thank you.

WARREN BUFFETT: Yeah, thanks for the question. I would say that — I’m not sure how you phrased it when you wrote me and how I phrased it going back, but look-through book value would not mean much, actually. The very best businesses, the really wonderful businesses, require no book value. They — and we are — we want to buy businesses, really, that will deliver more and more cash and not need to retain cash, which is what builds up book value over time. Admittedly, the prices of marketable securities, at any given time, are not a great indication of their intrinsic value. They are far better, though, than the book value of those companies in indicating intrinsic value. Berkshire’s book — Berkshire’s intrinsic value, in a very general way, and trends in it, are better reflected in book value than is the case at a very high percentage of companies. It’s still a very — it’s not a great proxy. It’s the best — it’s a proxy that is useful in terms of direction, in terms of degree, in a general way over time.

But it’s not a substitute for intrinsic value. It — in our case, when we started with Berkshire, intrinsic value was below book value. Our company was not worth book value in early 1965. You could not have sold the assets for that price that they were carried on the books, you could not have — no one could make a calculation, in terms of future cash flows that would indicate that those assets were worth their carrying value. Now it is true that our businesses are worth a great deal more than book value. And that’s occurred gradually over time. So obviously, there are a number of years when our intrinsic value grew greater than our book value to get where we are today. Book value is not a bad starting point in the case of Berkshire. It’s far from the finishing point. It’s no starting point at all of any kind in — you know, whether it’s The Washington Post or Coca-Cola or Gillette. It’s a factor we ignore. We do look at what a company is able to earn on invested assets and what it can earn on incremental invested assets. But the book value, we do not give a thought to. Charlie?

CHARLIE MUNGER: Well, I think that’s obviously correct. (Laughter)

WARREN BUFFETT: Oh. He’ll come back next year.

19. Markets: “Wild things create their own truth for a while”

WARREN BUFFETT: Number 1. (Laughter)

AUDIENCE MEMBER: Hello, gentleman. My name’s Dan Sheehan. I’m from Toronto, Canada. First of all, I’d like to thank you for this weekend. It’s become more and more important to me as it’s become more and more difficult to find a rational discussion about the stock market. And this weekend really is a breath of fresh air for most of us, I think. One of the places I refer to a lot is Benjamin Graham. And what worries me now is what he referred to — is a period in 1929, in the early ’30s — as a lab experiment that — where normal intrinsic values and margins of safety broke down, or seemed to, anyway. And I wonder how much you think that might happen now or in the next few years, and how much you worry about that with the investments you’re making.

WARREN BUFFETT: Well, we generally believe you can just see anything in markets. I mean, just extraordinary what happens in markets over time. It gets sorted out, you know, eventually. But, I mean, we have seen companies sell for tens of billion dollars that are worthless. And at times, we have seen things sell for 20 percent — a number of things, not hard to find, perfectly decent running them — sell for literally 20 percent or 25 percent of what they were worth. So we have seen and will continue to see everything. It’s just the nature of markets. They produce wild, wild things over time. And the trick is, occasionally, to take advantage of one of those wild things and not to get carried away when other wild things happen. Because the wild things create their own truth for a while and you have to — you know, you — that’s the reason they’re happening, and people are getting pleasant experiences and all that. You’ll see everything if you’re around markets for a reasonable period of time. We don’t see any great cases of dramatic undervaluation by this market.

So it isn’t like we’re seeing — because there’s this — perhaps this speculative mania in a particular area of the market, we do not see that creating incredible undervaluation other places. What’s happening there may lead to undervaluation, you know, a few years from now. Or it may not, I don’t know that, but we’re — It isn’t like you can find things that are worth double or thereabouts what you’re paying because, frankly, there’s so much money sloshing around that if you found such a thing, it would be very likely corrected by some buyout types. I mean, we would love to find businesses that are selling for half of what they’re intrinsically worth. We don’t find that. We do find a lot of cases where we think the evaluations on the high side are just — are unbelievable. We have been in periods in the past where we felt almost everything was being given away, too. So you’ll get those extremes.

Most of the time the market’s in a position where there’s a little of both, but every now and then, it gets into a position where there’s a lot of one or the other. And we would — you know, we would love it if we could find a lot of reasonable-sized companies that were selling at what we thought were half of the intrinsic value. We’re not finding them. Charlie?

CHARLIE MUNGER: Well, I do think that the present time is a very unusual period. It’s hard to think of a time when residential real estate, and common stocks, and so on, rose so rapidly in price and there was so much easy money floating around. I mean, this is a very unusual period.

WARREN BUFFETT: What’s fascinating — and I’m sure you’ve thought of it — is that you can now have a business — we saw a few of them, you know, earlier this year we’ll say — that might’ve been selling for $10 billion where the business itself could not have borrowed, probably, a hundred million dollars in debt, with an equity evaluation of 10 billion. But the business itself would not — as a private business — would not have been able to borrow a hundred million. But the owners of that business, because it’s public, can borrow many billions of dollars on their little pieces of paper, because they have this market valuation. If it’s a private business, the company itself couldn’t borrow one-twentieth or so of what individuals could borrow. That’s happened, to a degree, before. But this has probably been as extreme as anything that’s happened, probably, including the ’20s. That doesn’t mean there’s a parallel to it, but it’s been pretty extreme. Charlie?

CHARLIE MUNGER: I think it probably is the most extreme that has happened in modern capitalism. In my lifetime, I would say the ’30s were the — it created the worst recession in the English-speaking world in 600 years. And it was very extreme. You could buy a “all-you-can-eat” in Omaha through the ’30s for a quarter from Henderson’s Cafeteria. And now we’re seeing the other face of what capitalism can do. And this is almost as extreme as the ’30s were, but in a different direction. It’s zero unemployment, rampant speculation, et cetera, et cetera. It’s an amazing period.

WARREN BUFFETT: That does not make it easy to predict, however, the outcome. It says to us, though, certain things we want to stay away from. I mean, basically that’s — it’s precautionary to us. It does not spell opportunity. Although, there’s no question that the — in the last year, the ability to monetize shareholder ignorance has never been exceeded, I think. Wouldn’t you say so, Charlie? (Laughter)

20. “It’s so easy to copy in the internet”

WARREN BUFFETT: OK, number 2.

AUDIENCE MEMBER: Good morning, gentleman. David Winters, Mountain Lakes, New Jersey. Thanks again for Berkshire Fest 2000 and having it on Saturday, for those of us who tap dance to work on Monday. (Buffett laughs) You know, over the previous 30 years or so, Berkshire has been a tactical participant in the insurance business. With the acquisition of Gen Re and the broadening of GEICO’s scope, the company’s been transformed into a mainstream activity. How will this transformation result in growth and low cost float over time? I.e., how do you avoid becoming average? And to follow on with the very perceptive 10-year-old from California’s question, will Berkshire’s newspaper interest be able to make the successful transformation to the new electronic world, especially the unique content of the Washington Post? Thank you.

WARREN BUFFETT: Those are both good questions. I think, to answer your second one, I think the Buffalo News will do just as well as, if you take the top 50 papers in the country, in making a transition. How well the top 50 will do is really an open question. And — but there is — you know, the industry factors will, in my view, just overwhelm any specific strategy. Because any strategy is — It’s so easy to copy in the internet. That’s one of the problems of the internet. It’s one of the problems of capitalism. I mean, if you open a restaurant that’s successful, somebody’s going to come in and figure out what your menu is and how — you know, the whole thing. And then they’re going to try to do it in a little bit better location, or at a lower price, or whatever. That’s what capitalism’s all about and it’s terrific for consumers. The internet accentuates that process. I mean, it gives everybody in the world real estate. You know, there are no prime locations to speak of.

I mean, I can give you the argument for how you develop one and all of that, but it really changes the world in a big way. You know, if you were at 16th and Farnam in Omaha in the ’20s, with Woolworth — that’s the place where the streetcar tracks crossed, you know, and a whole bunch of them were going north/south there and east/west — and there wasn’t any better real estate in town. I’m not sure if that’s worth as much now in nominal dollars as it was in the 1920s. But — and that looked permanent, incidentally. Who was going to rip up the streetcar tracks or — in 1910 or whenever it was? So now, you rip up the tracks every day. You know, and so the fluidity is incredible, in terms of moving economic resources around compared to what it was. The newspaper industry is going to try and figure out how to be a very important information source in a new medium. And it may solve that problem, to a degree, and still have lousy economics.

That’s — you know, that’s — unfortunately, the newspaper industry’s always — Historically, the way the industry structure worked, once you got into the majority of households and everything, somebody else could bring out a way better paper, but it wasn’t going to go any place against you. I mean, you had such structural advantages that you could, you know — you could put your idiot nephew in and he would do fine — wonderfully — you know. And nothing could happen to him except when this different medium came along. Now you can put in a genius and whether that will make any difference is an open question. I would say that it’s quite doubtful. If you own a newspaper, you want to do everything that you can think of and, fortunately, everything anybody else can think of, because you can copy them so fast. And it may work in terms of product and it may not work in terms of product. And it may work in terms of product and still not work in terms of economics very well. And I don’t know the answer to that question. I know that we will play it out — at the Buffalo News, for example — as strongly as we can.

I don’t think other people are going to get way better results than we are. I don’t know what the other people are — what their results are going to be and how it will work. It would be crazy to sit on the sidelines and simply ignore what’s going on. So we will do our darnedest to have good economics when this is all through. But nobody knows how it’s going to play out, in my view.

21. “Average is going be terrible in insurance”

WARREN BUFFETT: The question about insurance, about whether we become average — average is not going to be good insurance. Average is going be terrible in insurance over time. It’s not — It’s a commodity businesss, in many respects. And if you are average, you’re going to have a very poor business. You may limp along because you got a lot of capital that’s supporting the lousy business, but it’s not — it won’t be a good business, per se. But I think in GEICO, and in General Re, and some — and our other operations as well — we do not have average businesses, and there is nothing about the way the industry is going that would force us or lead us to have average operations. I mean, we have special things we bring to the party in both cases I’ve named, and actually, in other cases as well. We have things we bring to the party that should make us considerably better than average.

It’ll show more in some periods than others, and it’ll be different in the way it is applied at GEICO or at General Re or at National Indemnity’s reinsurance operation. But none of those, in my view, will be average. But average — and there will be a lot of average, by definition — average is not going to be good. The other problem about it is average is not going to go away, either. So that is an anchoring effect, to some extent, on what even the skillful operator can achieve. I think insurance will be a very good business for us over time. Charlie?

CHARLIE MUNGER: Yeah. Every once in a while, we have a business sort of die under us. Trading stamps is now off 99 3/4 percent from its peak volume, and we were able to do nothing to prevent that except wring all the money out and multiply it by about 100. (Laughter)

WARREN BUFFETT: We actually did about, what, 120 million, in the late ’60s, per year in trading stamps, far more dominant in our area than S&H was nationally. And we have — by skillful management, Charlie and my constant attention to detail — have taken that business from 120 million a year down to, what, about 300,000 a year or so?

CHARLIE MUNGER: Oh, way less than that. (Laughter)

WARREN BUFFETT: We thought of having the sales chart here and turning it upside down to impress you, but it wouldn’t have worked very well.

CHARLIE MUNGER: I think it’s the nature of things that some businesses die. It’s also in the nature of things that, in some cases, you shouldn’t fight it. There is no logical answer, in some cases, except to wring the money out and go elsewhere.

WARREN BUFFETT: Yeah, and that’s very tough for managements, too. In fact, they almost never face up to that. It’s very, very rare. And it’s logical that it’d be rare. In a private business, you can understand why people face up to it. In a public company, if you take the equation of the manager, he or she may be far better off ignoring that reality than accepting it.

22. Competitive advantage is more important than short-term profits

WARREN BUFFETT: Let’s go to number 3.

AUDIENCE MEMBER: Good morning, gentleman. My name’s Marc Rabinov from Melbourne, Australia. You’ve emphasized the importance of the moat around a business, or the sustainable competitive advantage. My question really relates to learning more about that. Professor Michael Porter at Harvard has made a detailed study of this. Did you find his work useful and can you recommend any other sources of information on this?

WARREN BUFFETT: Yeah, I’ve never really read Porter, although I’ve read enough about him to know that we think alike, in a general way. So I can’t refer you to specific books or anything. But my guess is that what he writes would be very useful for an investor to read. I mean, I — again, I’ve never — I’ve just seen him referred to in some commentary. But I think he talks about durable or sustainable competitive advantage as being the core of any business. And I can tell you that that is exactly the way we think. I mean, that — in the end, you — if you are evaluating a business year-to-year, you want to — the number one question you want to ask yourself is whether the — could the competitive advantage have been made stronger and more durable before — and that’s more important than the P&L for a given year. So I would suggest that you read anything that you find that’s helpful or — Actually, the best way to do it is study the people that have achieved that and ask yourself how they did it and why they did it.

I mean, why is it that in razor blades, which could — I mean, everybody grows up in business school hearing that as a great example of a product that’s very profitable and why — With it obvious that there’s going to be no reduction in demand for the next hundred years for the product, why are there no new entrants into the field? What it is that gives you that moat around the razor blade business? Normally, if you’ve got a profitable business, you know, a dozen people want to go into it. If you’ve got a dress shop here in town and it looks like it’s doing well, you know, a couple of other people are going to want to open up a shop next door to it. And here’s a worldwide business, nothing can go wrong with the demand, to speak of. And yet, people don’t go into it. So, we like to ask ourselves questions like that. We like to ourselves, “Why was State Farm successful, you know, against people that had incredible agency plants and lots of capital?”

And here’s some farmer out in Bloomington, Illinois named George Mecherle , you know, who’s in his forties. And he sets up a company that defies capitalistic imperatives. I mean, it has no stock, it has no stock options, it has no big rewards. It’s, you know, it’s kind of half socialistic. And all it does is take 25 percent of the market away from all of these companies that had all these characteristics. We believe you should study things like that. We think you should study things like Mrs. B out at the Nebraska Furniture Mart, who takes $500 and turns it, you know, over time, into the largest home furnishing store in the world. There has to be some lessons in things like that. What gives you that kind of a result and that kind of competitive advantage over time? And that is the key to investing. I mean, if you can spot that — particularly if you can spot it when others don’t spot it so well — you’re on the — you know, you will do very well. And we focus on that. Charlie?

CHARLIE MUNGER: Yeah, it — these factors — every business tries to turn this year’s success into next year’s greater success. And they all use pretty much every advantage they have in every direction from this year to make next year’s better. Microsoft did exactly that, year after year after year and happened to win big. And it’s hard to see — for me at least — to see why Microsoft is sinful because they tried to improve the products all the time and make next year’s business position stronger than last year’s business position. (Applause) If that’s a sin, every subsidiary at Berkshire is a sinner, I hope. (Laughter)

WARREN BUFFETT: Yeah, yeah, yeah. We declare ourselves for sin. (Laughter)

23. Promo for See’s Candies Barbie doll

WARREN BUFFETT: At this moment, I think we have a small interruption in the program here. Charlie, on your left. (Laughs) It’s just a sample of what it’s like to be an officer at Berkshire. (Laughter) Oh, OK. This is the new See’s Barbie doll. And — never before seen, it will be in the exhibitors section, lower level. And believe it or not, we’ve come up with three more just like this young woman. And they will be down there to take your orders. We can’t ship them now, we won’t charge your credit card until they — until they’re available for shipment, which will probably be, I guess, around September or so. But we wanted our shareholders to be the first ones to have a shot at this new product, and — The model is not included in the — (laughter) — delivered price.

Afternoon Session

1. Most companies hide the true cost of stock options

WARREN BUFFETT: OK, if area one is ready, we’re ready to start answering.

AUDIENCE MEMBER: Hi.

WARREN BUFFETT: Hi.

AUDIENCE MEMBER: My name is Steve Check. I’m from Costa Mesa, California. My question is regarding stock options. I’ve taken your suggestion and have been attempting to subtract stock option compensation from reported income when evaluating companies. When I read annual reports, I usually find companies estimating option costs using the Black-Scholes model. However, the assumptions going into the Black-Scholes model seem quite different from company to company. These assumptions, of course, are what is used for risk-free interest rates — quote unquote, “risk-free” interest rates, expected option lives — even though options have stated lives, and expected volatility. Help me out a little bit. What is the best way to calculate option costs? Do you think BlackScholes is appropriate? If so, how should we normalize the assumptions? And just one short follow-up: how can we possibly estimate future earnings for companies, when companies, such as even Microsoft last week, in response to a lower stock price, simply reissue a bunch of new options?

WARREN BUFFETT: Yeah, the — I can tell you, from some personal experience, that companies attempt to use the lowest figure they can, even though it doesn’t hit the income account. So they like to make fairly short assumptions as to the life of the options, even though they’re granted on a ten-year basis. Because they’ll make certain assumptions about exercise date or forfeiture and so on. I think the most appropriate way, when you’ve got a pattern, which you have at many companies, of what they do on options, is simply to make an educated guess as to the average option issuance that they’re going to incur, or they’re going to elect to do over time. And, generally, what you really want to — if you were to be precise — you would try to figure out what they could’ve sold those options for in the open market. Because that’s the opportunity cost of giving them to the employees instead of selling the same option in the market.

I think you’ll find, generally, that if you take a value of about a third, for a ten-year option, if you take a value of about a third — obviously, it depends on dividend rate and volatility and a whole bunch of things — but about a third of the market value, strike price, at the time they’re issued, that’s the expectable cost. We believe in using the expectable cost versus the actual cost. I mean, that is how we would look at it. If we were issuing options at Berkshire, and we issued options on $100 million worth of stock a year, we would figure it was costing us, probably in our case, with no dividend, at least $35 million a year to issue those options. And we would figure that if we gave people $35 million in some other form of result-oriented compensation, that it would be a wash. And that is not the way most managements, of course, figure. At least that’s my experience.

And we would figure we could use that 35 million in a more shareholder-oriented way and one where the employee (who) was productive would be sure of getting results, as opposed to having it be at the whims of the market. And I think you’ll see a lot of option repricing. Everybody says they won’t reprice their options, until they do it. And, you’ll see that with a lot of schemes. It would be interesting to see whether CONSICO is willing to bankrupt all the executives who made loans to buy the stock and had those loans guaranteed by the company. And the company initially said they would enforce those loans. And we’ll see whether they do it. I would say, in many cases, they won’t. I don’t know what CONSICO will do. But, a lot of things that are said in connection with executive option schemes and that sort of thing are what they’ll do if it works in their favor. And then they’ll do something else if it doesn’t work in their favor. And that’s not spelled out in the initial approval that’s granted. Charlie, you have anything to add?

CHARLIE MUNGER: Well, Warren’s somewhat critical attitude is very understated compared to mine. (Laughter)

WARREN BUFFETT: We’re going to leave raisins out of this particular — (laughter) — analysis. Let’s go to area 2. We do believe, incidentally, if a company is going to end up giving out 10 percent of the, company over a 10-year period or 15 percent on options, that is like buying an apartment house and letting the seller keep a 10 or 15 percent interest in the upside. Or it’s like buying an oil field and giving somebody a 10 or 15 percent interest-free override. It changes the value of the property. Make no mistake about it. It is a — it has a huge economic impact on the value of a property. And just go out and try and sell your house and say, “I want to keep 15 percent of the appreciation in it,” and ask the buyer whether he’s going to pay the same price for the house. Options subtract value the moment they are granted. And, like I say, unless companies — some companies follow a practice of making a mega-grant every three or four or five years. A lot of them just issue a fairly constant amount annually. And you can figure out the cost.

And, you know, they don’t want to tell the shareholders there’s a cost. And that’s why they fought through Congress and everything else in order to prevent it from being the truth. But, you know, Galileo had that problem many years ago and finally won out. So maybe we will, too. (Laughs)

2. Moody’s moat has “poisonous characters”

WARREN BUFFETT: Yeah, area 2.

AUDIENCE MEMBER: My name is Dennis Jean-Jacques from Chatham, New Jersey. I first would like to thank you personally for taking the time out of your busy schedule to visit MBA students throughout the country on a regular basis. In fact, I consider your visit to the Harvard Business School campus many years ago my personal rational awakening. My question is in regard to Dun & Bradstreet. Many academics would argue that two of the many factors that determine a firm’s sustainable competitive advantage are the threat of new interest through imitation, and the threat of substitution through technological advances, such as, you know, the internet and things of that nature. My question is, how deep is the moat around Moody’s and the operating company?

WARREN BUFFETT: Yeah, we don’t want to go into too much detail about our marketable investments. But I would say that the moat is, just in our view, is far wider, deeper, and infested with far more poisonous characters, in the case of Moody’s, than in the case of the operating company. We’ve had experience — just in terms of making decisions about how you either obtain credit information, in the case of the operating company, or if you want to obtain ratings on securities or something — I think you’d conclude that Moody’s is a much stronger franchise than the operating company. Doesn’t mean the operating company can’t turn out to be a better business. It might have more upside under certain circumstances, too. But if you’re really thinking of, you know, what bad can happen to you, I think that you would regard Moody’s as a considerably stronger franchise than the operating company. Charlie?

CHARLIE MUNGER: Well, I’d certainly agree. The — Moody’s is a little like Harvard. It’s a self-fulfilling prophecy. (Laughter) You know, I hate to think of how much you could mismanage Harvard now and still have it work out pretty well.

3. Harvard Business School isn’t affected by supply and demand

WARREN BUFFETT: If you cut the price of the admission to the Harvard Business School by $10,000 a year, you would have less demand, in all probability, than an increase in demand. I mean, it’s totally counterintuitive in that respect. Because the cachet of the school, in that case, is not only reinforced, it almost makes it necessary, that it be priced toward the top. So, it — you can throw away the demand and supply curves that they teach you in Economics 101 on something like that. I — frequently, I have a little fun with — when I attend business schools. Because I ask them, you know, what the definition of a wonderful business is, and we go through all this stuff. And then I say, you know, I tell them that — really — the best business I’ve seen is the Harvard Business School or the Stanford Business School, because the more they increase the price, the more people want to get in, and the more people think the product is worth. And that is a marvelous position to be in.

(Laughter) And I thank you for your comments on the — you know, I was lucky enough to have a great, great teacher in Ben Graham at Columbia. And Ben didn’t need to go up to Columbia once a week, on Thursday afternoon, to talk to a bunch of us. So it — I really feel it’s — I enjoy, sort of, passing that along. I haven’t had any original ideas in this field at all. But I, you know, I had a terrific teacher. And it’s fun to talk to students. If you talk to a bunch of guys my age, nothing happens. I mean, they just want to be entertained. (Laughter) But they want predictions always and that sort of thing. So I don’t do any of that at all. I’d rather talk to students. And I thank you for coming.

4. Energy and transportation need a lot of capital

WARREN BUFFETT: Let’s go to number 3.

AUDIENCE MEMBER: My name’s Jared Placeler (PH). I’m 15 from St. Louis. Are you considering investing in energy and transportation companies, such as ones that deal with fuel cell and environmentally friendly energy resources? And if you are, will you thus be replacing any other energy-based investments you may currently hold, such as your newly acquired holdings in MidAmerican Energy?

WARREN BUFFETT: Yeah. I would say that energy and transportation, in the very broad sense, are both things that we’ve at least got a chance of understanding. So those are the kind of areas in which, we would think about making investments. We would probably think about it less in connection with new technology. We might expect the people who run MidAmerican Energy to be thinking about that all the time. But Charlie would be better at it than I am, because he has a different background and thinks better about that, anyway, in terms of evaluating newer technologies. I wouldn’t be very good at it at all. But those fields are, they’re big, in terms of capital investment, for one thing. So they’re very big fields. And then secondly, we would probably think we were capable of evaluating the potential, some years down the road, of many companies in energy and transportation. So those would be fields we would consider. And of course, as you mentioned, we made an investment in MidAmerican Energy. I doubt if the technology changes dramatically in any near term as to the product that they’re delivering.

But if there were changes on the horizon, I think we’ve got the management there that would be very good at spotting that ahead of time and capitalizing on it in a proper way. I wouldn’t take that function on myself. Charlie?

CHARLIE MUNGER: Well, historically, we’ve done very little in either field. And mostly, the past is a pretty good guide to the future.

WARREN BUFFETT: Historically, the transportation field, I mean, it’s been a terrible place to have money, and, whether it’s been in airlines or in the rails. If you — we’ve mentioned Value Line from here — from time to time. If you go to the rail transportation section and just run your eye across on the revenues and look at the capital investment, the amount of capital required to produce incremental revenues is just — is horrible. And on the other hand, there’s not much alternative here in the game to doing that. So there — many railroads will spend hundreds and hundreds and hundreds of millions of dollars. And it will not move the top line hardly at all. The ones where the top line has changed is where there’s been acquisitions or mergers. Airlines, you’ll see just the opposite. You’ll see this great movement in the top line, but again, a disastrous amount of capital investment and very little in the way of returns. So, it hasn’t been a great field. Most fields that require heavy capital investment, most of the time, they don’t turn out very well over time.

There are plenty of exceptions to that. But if you find a business that has to keep adding up huge sums of money every year, there always will be a reason why they’re doing it. But the net result, after five or 10 or 20 years usually isn’t very good. Charlie, got anything?

5. Buffett defends Coca-Cola CEO Doug Ivester’s big exit package

WARREN BUFFETT: Area 4?

AUDIENCE MEMBER: Good afternoon, Mr. Buffett and Mr. Munger. My name is Bob Odem (PH) from Seattle, Washington. I’d like to say, first of all, how nice it is to come out to Omaha, and how I am made to feel comfortable by its people. I hope you both are as enthusiastic about the meeting as you seem to be in years to come.

Mr. Munger, by the way, I am looking forward to your book coming out. My question has to do with Doug Ivester’s severance package and what justifies it, considering he had a very short tenure as CEO and that he took the reins from some very strong performance from Goizueta and to be relieved of his dismal performance by Doug Daft. My brother, still in the bottling and distribution business of Coke, cut this article from Bottlers’ World Magazine concerning the severance package. He said he also would retire, if he were offered this — (laughter) — 97.4 million in stock, 3 million per year for 2000 to 2002, 2 million per year, 2002 to 2007, 1.4 million per year from 2007 for the rest of his life.

Anyway, I don’t see how — or here, car and cell phone, he gets that. That’s a Mercury Grand Marquis and mobile telephones, laptop computer, and the like. I don’t know why he’d need that. (Laughter) Anyway, I have been wondering how you voted on this, whether you supported it or not, or what degree, considering executive pay at Berkshire hasn’t risen except, perhaps, for the CFO who last got a raise, I believe, in 1997.

WARREN BUFFETT: You asked — no, CFO’s gotten a raise every year. But the — you asked whether I supported it. Yeah, I can tell you, I supported it. Because with my 35 percent interest in 8 percent of Coca-Cola, I paid almost 3 percent of it myself, personally. I probably paid more severance pay than any man in the history of the world, personally. (Laughter) I was not on the comp committee. But I will say this. Doug Ivester did all kinds of really wonderful things for the Coca-Cola Company, over time. He was — for many, many years, when Roberto was running things, Doug — working with Don Keough, too, and I had this first hand from both of them. I wasn’t in Atlanta. But there was no question that he was a huge, huge asset and conceived and carried out many of the things that other people may have gotten even more credit for. Most of what you described, not the little things at the end, but most of what you described was contractually in place at the time that he left.

I mean, those were deals that were made, restricted stock and all of that, that really occurred, in significant part, when Roberto was the chief executive officer and at Roberto’s recommendation. Doug’s devotion to Coke, his knowledge of Coke, I mean, he lived and ate and breathed Coke. But in my opinion, Doug Daft was the man for the job. And a change was made. But it was not because of any lack of attention by Doug Ivester. It was not because he hadn’t done great things as CFO of the company. But I think he was not the right man at the time he took over as CEO. He took over, as you know, when Roberto died quite suddenly. And there wasn’t any real option in terms of the — He was Roberto’s hand-picked successor. It’s almost inconceivable that somebody else would’ve been chosen at that time. And we made a decision, within a couple of years, that the company would move faster and better with Doug Daft in charge. And we made a deal in severance which was about 80 percent, or some very high percentage, embedded.

And like I say, I paid more of it than anybody else. So it isn’t like it was all academic. And I think, considering some other factors, which maybe I’ll put in a book sometime, that entered into it, it was definitely the right decision for the Coca-Cola Company. Whether the computer should’ve been included or the car or anything, I can’t — I would not want to defend small item by small item. But I can — I think the Coca-Cola shareholders are going to be many billions of dollars ahead over time by what was done then. And it wasn’t easy to do. We’ll go to 5 — Charlie, do you have anything to add on that? You paid a fair amount, too.

6. Excessive CEO pay creates “hostility” to corporations

CHARLIE MUNGER: Generally speaking, I think it’s a mistake for corporate America to create as much hostility as it does, which is based on the way it compensates principal officers of corporations. It is simply maddening to add a little clause that the corporation will scratch the guy’s back for just tiny, little bits of stuff that looks terrible. To me, that is extremely stupid. And I see it where the corporation helps him prepare his tax return for 10 years after he leaves and so forth. I think that makes a terrible impression on shareholders, generally. And I think corporate America’s crazy to do it. They get sold this stuff by these damn consultants. (Laughter)

WARREN BUFFETT: I agree with Charlie. And what — it is true — (applause) — what Charlie says. We don’t have a contract, at least that I can think of, at Berkshire. It’s perfectly easy to run a company without them. We’ve got wonderful managers. You know, we’ve got things that might be called contracts. I mean, we’ve got deals with them, in terms of we work out compensation arrangements and all that. But I can’t remember a case of anybody that’s been with us that ever has called in a lawyer or anything of the sort, or where we even had to reduce things to writing, basically. And it works fine. And it is a little maddening, as Charlie says, to have a CEO, you know, show up with a lawyer with a 20-page contract. It’s become standard operating procedure.

And once you get a big, public company with committees, consultants to the committees, consultants who, usually, are picked by the officers of the company, they look around at what everybody else is doing and say, “Well, that’s the way the other guy does it. So I’ll do it.” I think you can — I think the proxy statements of the last 20 years, what that’s induced in the way of behavior by people at somewhat comparable companies that look at the proxy statements of their competitors and then say to their lawyer, “Well, Joe Blow got this. Why shouldn’t I have it?” It just escalates and escalates and escalates. And it ratchets. And it won’t stop. I have never seen a compensation consultant come into a public company and suggest a plan that, net, reduces the cost of compensation. At — and I see all kinds of people leave companies with — who have made tremendous amounts of money. And nobody wants to hire them at half the price, or a quarter of the price, or a tenth of the price. I mean, it’s not a market system. CEO compensation is not a market system.

And it’s not subject to market tests. And I don’t know what you do about that, particularly. But I — it doesn’t seem to bother shareholders very much. The ones that could change it —

CHARLIE MUNGER: Oh, I think it bothers them a lot, Warren. It’s just they feel powerless.

WARREN BUFFETT: Yeah, but institutional shareholders could change that. My guess is that the top 30 institutions, probably, control — what — two-thirds of the big companies in the country. And they don’t seem to care that much. They — actually, they spend their time on what I regard as peripheral issues, usually. They talk about other things. They get involved in rituals of corporate governance that, frankly, don’t mean a damn in terms of how the company performs. And they seem to ignore these other issues. But, you know, there’s — we’ve got enough to do running Berkshire. So we can’t reform the world on that. We will run Berkshire in a rational manner. And we have yet to hire a compensation consultant. And we’ve yet to lose an important manager.

7. Buffett: Economists aren’t needed

WARREN BUFFETT: OK, we’ll go to number 5. (Applause)

AUDIENCE MEMBER: Hello.

WARREN BUFFETT: Hi.

AUDIENCE MEMBER: I am Diane Ryan (PH) from Prairie Village, Kansas. This is the fourth year I’ve attended the stockholder meeting. And I’d like to say, every year, I feel like I’ve learned a little bit more. This year, my question is, do you see a deflationary trend in the global economy? And if so, what is your investment advice?

WARREN BUFFETT: Well, Diane, I’m no good on the macro questions. And I’ve proven that by being way too worried about inflation for, probably, the last 20 years. Fortunately, it hasn’t made much difference, the fact that I’ve been wrong on that. So I don’t really think my judgment is any better than yours, at all, in terms of assessing what’s going to happen to global prices over time. My opinion would be that the world is not going in a deflationary situation. But, you know, I’ve not earned any stars for my past economic predictions. And the good thing about my economic predictions, even if I do make them, is that I pay no attention to them myself, so. (Laughter) I really — and the way we pick our investments is we just don’t get into the macro factors. I can’t recall a time when Charlie and I have looked at a business, either buying it in its entirety or buying pieces of it through the stock market. I just — macro conclusions are — just never enter into the discussion. I mean, I’ll pick up the phone.

We’ve had these two in recent months. And I’ll tell Charlie about it. And, you know, we talk about a few things. But we don’t talk about anything remotely macro. And that’s really the way it’ll stay. You know, I’ve seen a lot of bank mergers recently. And one of the things they do, because they want to cut the costs and justify a merger, which they’re dying to do, I mean, that’s the reason — so they cut costs they wouldn’t have cut if they weren’t dying to do the merger in the first place and get bigger. But frequently — I know one in particular that I’m thinking of — you know, they’ll cut out the economics department. You know, I always wondered why the hell they had it in the first place. (Laughter) You know, because what do they do? You know, I mean —the guy comes in and says, “I think GDP will be 4.6 this year instead of 4.3.” So what?

You know, I mean, you’re still trying to make every good loan you can make. You’re still trying to take in deposits as cheap as you can. And you should be trying to cut costs wherever you can. It’s got nothing to do with running the business. But, you know, it’s fashionable. And every bank had its economist and economics department. And when a big client would come in, they’d take him to lunch. And it just — it always has struck me as just a lot of nonsense. So if we ever get an economics department at Berkshire, sell the stock short. (Laughter)

WARREN BUFFETT: Number 6, please. Oh, Charlie, I didn’t —

CHARLIE MUNGER: (Inaudible)

WARREN BUFFETT: Oh, OK. (Laughter) He’d rather eat peanut brittle.

8. “Take on the qualities of other people you admire”

AUDIENCE MEMBER: Hello, Mr. Buffett —

WARREN BUFFETT: Hi. AUDIENCE MEMBER — Mr. Munger. My name is Aaron Wexler (PH). And I’m from Santa Maria, California. I have — my question has two parts. The first part is, when you and Bill Gates had a television show some time ago, you were asked about the people who were — had different role models. And you said, “Well, if I know a person’s role model, I can pretty well tell the kind of a person he is and what kind of a future he has.” Mr. Buffett, my role model is Warren Buffett. Do you think I have a chance? (Laughter)

WARREN BUFFETT: Well, I hope you’re choosing me on the basis you hope to expect to live to an advanced age. I like to think that that’s what I bring to the party. It does pay to have the right models. I mean, I was very lucky, early, very early in life, that I had certain heroes — and I’ve continued to develop a few more, as I’ve gone along — and they’ve been terrific. And they never let me down. And it takes you through a lot. And I think that, you know, it just stands to reason that you copy, very much, the people that you do look up to, and particularly if you do it at an early enough age. So I think, if you can influence the model — the role models — of a 5-year-old or an 8-year-old or a 10-year-old, you know, it’s going to have a huge impact. And of course, everybody, virtually, starts out with their initial models being their parents. So they are the ones that are going to have a huge effect on them.

And if that parent turns out to be a great model, I think it’s going to be a huge plus for the child. I think that it beats a whole lot of other things in life to have the right models around. And I have — like I say, even as I’ve gotten older, I’ve picked up a few more. And it influences your behavior. I’m convinced of that. And if you — you will want to be a little more, or a lot more, depending on your personality, like the person that you admire. And I tell the students in classes, I tell them, you know, “Just pick out the person you admire the most in the class and sit down and write the reasons out why you admire them. And then try and figure out why you can’t have those same qualities.” Because they’re not the ability to throw a football 60 yards, or run the 100 in ten flat, or something like that. They’re qualities of personality, character, temperament, that are — can be emulated. But you’ve got to start early. It’s very tough to change behavior later on.

And you can apply the reverse of it. Following Charlie’s theory, you can find the people that you don’t like — (laughter) — and say, “What don’t I like about these people?” And then you can look — if, you know, it takes a little strength of character. But you can look inward and say, you know, “Have I got some of that in me?” and — It’s not complicated. Ben Graham did it. Ben Franklin did it. And it’s not complicated. Nothing could be more simple than to try and figure out what you find admirable and then decide, you know, that the person you really would like to admire is yourself. And the only way you’re going to do it is take on the qualities of other people you admire. Anyway, that’s a two-minute answer on something Bill and I did talk a little bit about. Charlie? (Applause)

CHARLIE MUNGER: Yeah. There is no reason, also, to look only for living models. The eminent dead are the — are, in the nature of things, some of the best models around. And, if it’s a model is all you want, you’re really better off not limiting yourself to the living. Some of the very best models are — have been dead for a long time. (Laughter)

WARREN BUFFETT: Charlie has probably read more biography than any three people in this room put together. So he has put this into practice. And, as somebody mentioned earlier, Janet Lowe has a biography of Charlie coming out here in — later this year. So you can read all the secrets of Charlie’s life. (Applause)

9. Buffett and Munger have no interest in running the Federal Reserve

WARREN BUFFETT: OK, number 7.

AUDIENCE MEMBER: Good afternoon, gentlemen. My name is Gary Bradstrom (PH) from here in Omaha, Nebraska. And my question is, if Alan Greenspan just decided to retire, and that job was offered, to either of you, would you take it?

WARREN BUFFETT: Well, I can tell you my answer is no, in a hurry. (Laughter) I think Charlie will give you his answer.

CHARLIE MUNGER: I would say “no” more quickly. (Laughter)

WARREN BUFFETT: You notice, we gave you very unequivocal answers. And of course, that alone would disqualify us from the job at the Fed. (Laughter) I think it was Alan that said to one senator, he said, “Since you, you know, since you’ve seem to have stated my remarks so accurately, you must’ve misunderstood them.” (Laughter) I don’t think you could find a job in public life that would entice either one of us. And the truth is, we’re having too much fun. I mean, this — we’ve got the best job in the world. We get to work with people we like and admire and trust every day of the year. We get to do what we want to do the way we want to do it. We should pay, and this is true of some other CEOs, too, but we should pay to have this job. I mean, it is really interesting.

I’ve often thought, if you could get, you know, you had a sealed envelope, and you got — and you had the compensation committee say what they would pay to have the job filled, but then you had the chief executive also say what he would do before he would leave, there would be a huge, huge gap. And I mean, it’s — there are all kinds of — I mean, it’s a lot of fun to start with interesting problems you come up with, interesting things to do, something different every day. You can’t beat the job. And to get paid for it is just the frosting on the cake. And I don’t see any jobs like that in public life, myself. Charlie, have you got anything to add? Charlie takes on these public jobs. He runs a hospital and a few things. And he can tell you the wonders of it. Charlie?

CHARLIE MUNGER: Oh, yeah. There’s an old saying that, “He lied like a finance minister on the eve of a devaluation.” I never wanted to have a job where lying was a required part of the activity. (Laughter and applause)

10. Berkshire is the “Metropolitan Museum of businesses”

WARREN BUFFETT: Number 8.

AUDIENCE MEMBER: Mr. Buffett, Mr. Munger, my name is Norman Rentrop. I’m from Bonn, Germany. I want to thank you very much for so patiently listening and answering and sharing yesterday and today. And I’m a shareholder since 1992. And this is my first meeting. I came here being inspired by Robert Miles’ book, “101 Reasons to Own Berkshire Hathaway.” And I was very careful, listening to you, the reasons how you pick good people, that it’s love for the business and not so much love for the money. And I’d like to hear a little bit more on your philosophies, now that Berkshire Hathaway is more and more buying companies. On this, how you make sure that it’s true love and how you pick people.

WARREN BUFFETT: It’s a terrific question. I don’t know exactly how to answer. Maybe Charlie will think of it while I’m stumbling around, but — I really — I think I can do that quite well. But I don’t know of any way to give somebody else a set of questions to ask, or, you know — I don’t know how to tell someone else how to select managers using those criteria: do they love the business or do they love the money? It’s very, very important. I mean, it’s crucial. Because it — well, we see it all the time. I mean, you’ve got people around who love the money. And you see them in public companies and doing things that we wouldn’t want to have associated with us. And on the other hand, if they love the business, and we’ll tell — I’ll tell an owner this. I will say to them, “You built this business lovingly for 50 years, and maybe your parents before you, maybe even your grandparents.” One of these businesses we’re buying is fourth generation.

And the clincher, in fact, I used it with Jack Ringwalt back in 1967. I said to Jack, who had built it over a long period of time, “Do you want to sell this? You know, do you want to dispose of this, the most — you know, your creation, your painting? Or do you want some 26-year-old trust officer to do it the day after you die?” And the thought of who was going to handle this masterpiece, which he’d created himself, was important to him. And I tell him, If they want to put it in our museum, we will make sure, A, it doesn’t get resold, that it gets the proper respect, and that you can keep painting it. We won’t come in and tell you to use reds instead of yellows or anything like that. So even though it’s a masterpiece now, you can keep adding to it. So we like to think that we’re the Metropolitan Museum of businesses and that we can get really outstanding creations to reside in our museum.

But it — we’ve got to deliver the kind of museum to these painters of businesses, in effect, that we would want, if we were doing the same sort of thing. To some people, that doesn’t mean a damn thing. I mean, all they want to do is auction their business, you know. And they probably cheat on their figures a little in the last year or two before they sell it to dress it up. And they do all kinds of things. And they employ some investment banker who pretends that he’s getting bids from other people to jack it up some more. And that’s standard procedure for a lot of people. We have no interest in buying in with them at any price because we don’t want to be on the other side of the table for the rest of our lives with somebody that’s going to do that. If somebody loves their business — and I love Berkshire, I mean, you create something over a period of time — it means something to you. Some people get it out of how they decorate their home, or some people get it out of all kinds of different things, their golf game or whatever.

But some of us get it out of building a business. And it has to be enormously important, what kind of a home it finds. And there comes a time, in many situations, for estate taxes, or because the kids don’t get along, or whatever the hell it may be, why people need to do something with that business. But they don’t want it auctioned off. And we get — we have a good home for that. I think I can tell pretty well what people’s motivations are when they come in with a business. And so far, we’ve batted pretty well. We’ve made mistakes. There’s no question about that. But in a sense, I think they’ve gotten fewer over the years. And we have — our disappointments with people have been very, very few. We’ve been wrong about the economics of the business sometimes. But that’s our mistake, not theirs. We’ve seldom been wrong about the people. And I wish I could give you a checklist that you could go down, and you could say, “Well, this guy loves the money.

So he’s going to be gone in six months. And this one loves the business. So as long as I leave him alone to do his job and appreciate what he does, be fair with him, that he’s going to stay around here as long as he can.” Charlie, have you got any thoughts on how you separate these people out?

CHARLIE MUNGER: I think our culture is very old fashioned. In other words, I think it’s Ben Franklin and Andrew Carnegie. It’s very old fashioned. And what I think is amazing about Berkshire is how well these very old-fashioned ideas still work. Can you imagine Andrew Carnegie calling in a compensation consultant or — (laughter) — an investment banker to tell him whether he should buy another steel mill? Or — We don’t get imitated much. We’re imitating the behavior of a period that has been gone for a long time. But, I don’t see — a lot of the businesses we buy are kind of cranky like us and old fashioned. And I hope we continue it that way.

WARREN BUFFETT: They’re sitting out there, Charlie. (Laughter)

CHARLIE MUNGER: Yeah, yeah. Well, but I think the businesses do have standards. See’s has standards. It has its own personality. But it’s — but maintaining standards is a huge part of it.

WARREN BUFFETT: Charlie hit on one thing. The idea of asking investment bankers or somebody to evaluate the businesses you’re going to buy, I mean, that strikes us as idiocy. If you don’t know enough about a business to decide whether to buy it yourself, you’d better forget it. It does not make sense. (Applause) You bring in somebody who’s going to get a very large check if you buy it, and a very small check if you don’t, that displays a faith in human nature that would strain Charlie and me. (Laughter) It’s a key point, which you raise. And frankly, if I think there’s anything we’re good at, I think we’re pretty good at what you’re talking about there. It’s an important part of capital allocation. Because we do not — we are not in a position to manage the businesses ourselves. And we want management as well as the business. And we’ve gotten it. And we’ve gotten it in spades from people that stay on and have done a terrific job for us.

And it makes life a lot easier, too.

11. What Buffett means when he can’t “understand” a business

WARREN BUFFETT: Let’s go to number 1 again.

AUDIENCE MEMBER: Hello, Warren. Hello, Charlie. My name is Doug Paterson. I’m from here in Omaha. I teach down the road at the University of Nebraska at Omaha. And I teach in theater, which is also the greatest job in the world. And I have to say that I enjoy the theater that you provide every year. Thanks so much.

WARREN BUFFETT: Thank you.

AUDIENCE MEMBER: Just sitting here, there are so many questions that come to those of us who have been sitting here for three or four hours. I’ve got three very disconnected questions.

WARREN BUFFETT: OK, we’ll do them one at a time.

AUDIENCE MEMBER: Cool. In terms of these tech stocks, you say that you don’t understand them. Can you say if you think — I can’t imagine you not understanding something.

WARREN BUFFETT: Oh, we understand the product. We understand what it does for people. We just don’t know the economics of it 10 years from now. That, I mean, you can understand all kinds — you can understand steel. You can understand home building. But if you look at a home builder and try and think where it’s going to be in five or 10 years, the economics of it, that’s another question. I mean, it’s not a question of understanding the product they turn out or the means they use to distribute it, all of those sort of things. It’s the predictability of the economics of the situation 10 years out. And that — that’s our problem.

AUDIENCE MEMBER: Right, and I’m not trying to provoke you into doing it. I’m glad you haven’t. Because I probably would’ve gone into cardiac arrest this last couple of months.

WARREN BUFFETT: Well, so would we.

AUDIENCE MEMBER: Yeah. So your projection is that you are not going to try to make an attempt to understand it. You think it’s — is it not comprehensible? Is that it, it’s not comprehensible?

WARREN BUFFETT: Yeah. Every business I look at, I think about its economics. It’s built into me. It’s built into Charlie. So it isn’t like, when some — if I’m with Andy Grove, or actually, I knew Bob Noyce back at Grinnell in 1968 and ’69, when they were starting Intel. I — when he talked to me about starting Intel, or anybody talks to me about a business, I think about its economics. I’ll think about the economics of UNO, you know, if we talk for three or four minutes. But — I — so it isn’t that we shut off the valve. It’s just that we don’t get anyplace. We don’t know what it’ll look like. And it’s, you know, there are a lot of things in life that, you can — they’re just beyond comprehension for many of us. And —

AUDIENCE MEMBER: So you’d say that like, nobody, really, probably, can understand this, where it’ll be in 10 years. Nobody could understand it.

WARREN BUFFETT: We would be very skeptical about it. I would say that — and incidentally, my friend, Bill Gates, would say the same thing. And actually, Bob Noyce would’ve, and Bob died some years ago, but — or Andy Grove — they would say the same thing. I’ve taken long walks with Andy. And they would not want to put down on paper their predictions about where 10 companies you would choose in the tech field would be in 10 years, in terms of their economics. They would say, “That’s too hard.”

12. Buffett: Berkshire will be fine if I’m hit by a truck

AUDIENCE MEMBER: Cool. A second question, again, not related. But I’ve heard this question several times today. And it comes up every year. I’d like to couch it in sort of a different phrase. Let’s say that you stepped outside of this building and were hit by a bus.

WARREN BUFFETT: Yeah. We’ve got one fellow who objects to that here who’s a shareholder. It’s normally a truck.

AUDIENCE MEMBER: A truck, OK.

WARREN BUFFETT: And he happened to be in the trucking business, so he —

AUDIENCE MEMBER: Or, given —

WARREN BUFFETT: Just so it isn’t a GEICO driver. But — (Laughter)

AUDIENCE MEMBER: Given Omaha, it could be a road grader. What kind, I mean, that would be a sudden — maybe you’d come out of it with a great fastball. Maybe that’s it. But you wouldn’t have your facility at stocks. What kind of advice would you give people that hold Berkshire Hathaway at a moment such as that?

WARREN BUFFETT: Well, it’s — I’ve got the ultimate test on that. Because my estate, at that point, would be 99 3/4 percent invested in Berkshire. And I feel totally comfortable, considering the arrangements that have been made, and the businesses we own, and the managers we have in place, in terms of that. But no one will be more affected, financially, let alone in other manners, by that truck than me. (Laughter) So it’s a thought that’s crossed my mind. And it’s a more important question to me than to anybody else. And I’ve answered it to my satisfaction. The directors have some of my thoughts on the subject. But the world will go on. The businesses will go on. And I think you’ll have terrific management in place.

AUDIENCE MEMBER: Thank you. I appreciate that. And thank you for taking all three of these. They’re so disconnected.

WARREN BUFFETT: OK, thank you.

13. Buffett: No interest in buying the Omaha World-Herald newspaper

AUDIENCE MEMBER: Given your comments about newspapers, may we assume that you are probably not going to buy the Omaha World-Herald?

WARREN BUFFETT: I think that’s a fair assumption. But that would probably be true regardless of my thoughts about newspapers. Because they’re not going to sell. Charlie, have you got anything to add on any of those?

CHARLIE MUNGER: Well, that story about the World-Herald is interesting. The truth of the matter is that, if Warren had been offered the Omaha World-Herald 20 or 25 years ago, he would’ve cheerfully bought it. And now he doesn’t want it. And that isn’t because of the economics.

WARREN BUFFETT: That’s true. Yeah, I mean, there’s no question — I have not been offered it, never will be offered it. And all — the ownership’s all set. But what Charlie said is true. If it were still owned by an individual, and they offered it to me, for economic reasons, I wouldn’t want to buy it. And for other reasons, I wouldn’t want to buy it.

CHARLIE MUNGER: But you wouldn’t want to buy it now, because your life would be less congenial afterward than before. There’d be more people after you.

WARREN BUFFETT: There’d be no plus in life to owning the World-Herald, at all. Yeah. (Laughter) And, as Charlie said, that’s probably not the way we would’ve thought 30 years ago.

CHARLIE MUNGER: Not at all.

WARREN BUFFETT: I think we’re right now.

14. Internet is good for society, bad for businesses

WARREN BUFFETT: Number 2.

AUDIENCE MEMBER: Hi, Howard Winston (PH) from Chicago, Illinois. I wanted to thank Charlie and you for your hospitality. My question is, Berkshire has benefitted enormously over the years from the low cost of its float. Do you think the internet will make the insurance business more competitive and, therefore, raise the cost of your float?

WARREN BUFFETT: Well, that’s a good question. I would say that the internet, from what I see now, is unlikely to increase the cost of Berkshire’s float. It will have different effects on different aspects of our insurance business. And it will change the insurance industry in some ways, not — and I can’t tell you exactly what. But I — You know that any system of distribution is going to be affected by something that changes the economics of distribution as much as the internet does. So there’s no question it’ll have an impact. I think in the end, the competitive advantages we have among our group of insurance companies, net, will not be hurt by the internet. But I could be wrong on that. And therefore, I don’t think that our cost of float will be changed much. I don’t think industry economics, in aggregate, for insurance companies, are going to be changed very much. The economics haven’t been that good. I think they’ll be about, you know, in that same range. And I don’t think our competitive advantage will be cut.

So therefore, I think our cost of float, in the future, is going to be higher than it has been in the past. But that’s for reasons other than the internet. I still think we’ll have an attractive cost of funds over time on float. It’s a good business for us. I don’t think it’s necessarily a good business for the average company. Charlie?

CHARLIE MUNGER: Well, there’s a marvelous issue buried in your question. Will the internet, by making competition so much more efficient, make business generally harder for American corporations, meaning more competitive, lower returns on capital? And my guess would be yes.

WARREN BUFFETT: Yeah. My guess would be yes, too. I would say that, on balance, for society, the internet is a wonderful thing. And for capitalists, it’s probably a net negative.

CHARLIE MUNGER: So all of you can be happy that the progress of the species will affect your economic futures for the worse. (Laughter)

WARREN BUFFETT: A sacrifice, at which our ages, we’re willing to do. But we wouldn’t be at your age. (Laughter) That — incidentally, that — there’s plenty to think about there. The internet, I mean, if you analyze it, you have to think it’s much more likely that it will reduce the profitability of American business and improve it. It will improve the efficiency of American business. But all kinds of things improve the efficiency of American business without making it more profitable. And I think that the internet is likely to fall into that category. So far, it’s improved the monetized value of American business. But that will eventually follow the underlying economics of what the internet does. And I think it’s way more likely to make American business, in aggregate, worth less than compared to what it would’ve been otherwise.

CHARLIE MUNGER: By the way, that’s perfectly obvious and very little understood. (Laughter)

WARREN BUFFETT: So there. (Laughter)

15. Egos and proxy statements fuel excessive CEO pay

WARREN BUFFETT: OK, number 3.

AUDIENCE MEMBER: Yes, good afternoon. My name is Tom Gayner from Richmond, Virginia. And in the current environment, it seems that the attacks on the moats of wonderful businesses are coming from inside the castle, in the form of option-based compensation, just as much as from outside competitors. One of your role models, Ben Franklin, said, “Even a small hole can sink a great ship.” It seems like the holes are getting bigger. Can you discuss what, if any, forces may cause this to change? Is it a problem that will get worse or get better? My second is specifically, in your role as directors of companies like Coke and Gillette, are you seeking to change these practices? And what kinds of success do you expect there? Do they let you on the comp committee? And three, if these compensation practices are irrational, does Berkshire benefit from this irrationality? Thank you.

WARREN BUFFETT: Well, to carry the castle analogy further, we not only look for a great economic castle, but we look for a great knight in charge of that castle. Because that’s important. He’s the one that throws the crocodiles into the moat and widens the moat over time. And of course, the question is, you know, how much does the knight get of the castle for doing that? And I think, generally speaking, at Berkshire, you get a very fair deal in terms of the amount that — We’ve got a lot of castles around. And we try to pay people fairly. But I don’t think that the division of — is unfair between the owners of the castle and the knights that are around there, protecting the moat. The — it’s hard for me to imagine how the compensation practices — the question of how much the knight gets of the castle — how that changes in favor of the owners of the castle over time. The ratcheting effect is just unbelievable.

No one, no compensation committee in America, will be listening to a consultant who walks in and says, “I think your management should have an arrangement that ends up in them being in the lower half.” And if no one wants to be in the lower half, believe me, the median is going to move up. I mean, there is no way around that. I mean, these people meet yearly or more often. And they sit there with a proxy statement of every other company in their business. You know, and they pick out the ones that have the biggest numbers in them. And they say, “Well, gee, we need a management at least as good as this. And how are we going to attract people?” and all this other stuff. And it’ll only ratchet upward. And I think that’s a fact of life. And I think that it’s important for shareholders to understand that. I’ve been on the board of 19 companies, not counting any Berkshire subsidiaries or anything like that. The last comp committee I was on was at Salomon. And I was chairman of the comp committee, I think. I may be wrong on that.

There were three of us. And the other two guys were terrific guys. And the earnings came in one year, $100 million or so — I think it was 1990 — below the previous year. And comp was up a fair amount. And I’d found that there had been some earlier issues involved and so on. I just said, I couldn’t swallow it anymore. And I voted against it. I can’t remember whether I was chairman or not. But in any event, it was two to one against me. And I think it would’ve been two to one against me if I’d been chairman. And the other two fellows were perfectly rational. They said, “How do we keep these people? And, you know, how can we repudiate our management?” All the sort of things you get. So as a practical — I’ve got one friend, terribly well-regarded businessman — and he’s been — they don’t throw you off the comp committee. They just don’t re-nominate you. And he’s been bounced from two of them simply by raising some questions that — about things you would find outrageous.

I’m not on the comp committee. I’ve been on only one comp committee. And they saw what I did. So that was the end of it. People say, “We love your ideas,” And, you know, “You think creatively. We don’t want to hear about your thoughts on compensation.” And that, you know, it’s understandable. You know, and every — and you run into some terrific cases of people. I mean, the fellow who runs Fastenal, for example, they are just outstanding. And there are a number of cases where people behave very well. But most of them, I think some — I don’t think it’s money so much, sometimes. I just think it’s ego. They just can’t stand to see some guy that they think is batting .280, and they’re batting .300, and he’s getting paid more money. And, you know, and that process is endless. And that, I, you know, that’s understandable. It’s like who gets top billing in a movie or something of the sort.

People care about, you know, where their name is compared to somebody else’s. And their name, in this case, is compensation. And it — I doubt if it reverses itself. Charlie?

CHARLIE MUNGER: No, I think we can confidently expect that the situation will get worse. And I think we can confidently expect that that is bad for Berkshire Hathaway to the extent that it’s a passive shareholder in big corporations. There is one place where we get an advantage: our own culture and attitude being so different, it does attract some of these people that own wonderful businesses. I mean, we literally, on occasion, find people for whom we’re the only acceptable buyer. They don’t like this culture of other big corporations any better than you do. And that does give us an advantage.

WARREN BUFFETT: Yeah. You asked us a question, also, about the — how active we might be in saying this. We’re not going to ever sit here and tell you what we say in other boardrooms, because it would reduce any effectiveness we might have. And we probably don’t have that much effectiveness anyway. But — You can only belch so many times at the dinner table and get invited back. And — (laughter) — we’ve probably done enough of our share of that. And you — we try to run Berkshire in a way that we find admirable. And we try to spell out our reasoning on it and everything else. And we hope that maybe somebody latches onto that as a model someplace. But going around condemning people by name does not work. And so we, you know, we hate the sin and love the sinner and all that sort of thing. And it doesn’t have much effect.

16. Hard to predict how demographics will affect markets

WARREN BUFFETT: Number 4.

AUDIENCE MEMBER: Good afternoon, Warren and Charlie. My name is Erras (PH). I’m from Winnipeg, Manitoba, Canada. And my first time in Nebraska, in Omaha, first time hearing you guys live. And there’s a big ice cream man behind you.

WARREN BUFFETT: Hmm. There we go!

FEMALE VOICE: Here you go.

CHARLIE MUNGER: Oh, thank you.

WARREN BUFFETT: And you think there are no management perks at Berkshire.

AUDIENCE MEMBER: Oh, boy. (Laughter) All right, let’s get down to business.

WARREN BUFFETT: OK.

AUDIENCE MEMBER: My question is in reference to your article in Fortune magazine last November, where you talked about corporate earnings and what the market — are you guys listening? Or…

WARREN BUFFETT: I’m listening. (Laughter) We can chew gum and listen at the same time.

AUDIENCE MEMBER: All right, all right, all right. As I was saying —

WARREN BUFFETT: But if we had —

AUDIENCE MEMBER: — the point in your article in Fortune about corporate earnings and what the market is paying for them, painting a pretty gloomy picture for equities and market levels going forward. Now, as you may know, there exists a very strong trend in demographics. We see, in Canada and the United States, the aging of the population and, more importantly, the bulk of this population reaching their peak savings years, all at the same time.

WARREN BUFFETT: You’re getting a little rude. But go ahead. (Laughter)

AUDIENCE MEMBER: I can’t believe this. Warren actually called me rude.

WARREN BUFFETT: I wanted to prove to you I was listening. Go ahead. (Laughter)

AUDIENCE MEMBER: Anyways, OK, so there’s a major retirement crisis as a majority of Canadians and Americans between the ages of, especially between 22 and 55, are worried that they won’t have enough money to fund their retirement or let alone, last. So for this reason, I mean, this population is expected to invest in equities, as opposed to fixedincome instruments, to get the necessary long-term rates of return to fund their nest egg for retirement. And therefore, many are calling for massive amounts of money to flow into the markets over the next five, 10, 15 years through stocks and mutual funds and, consequently, fueling market prices and market levels. Many predicting the biggest growth ever in the stock markets. So what is your opinion on this potential trend, separately or in conjunction with what you said in that article in Fortune? Thanks very much.

WARREN BUFFETT: Good. To be, I’m not being rude here, but we don’t think it means a thing, frankly. (Laughter) The savings rate, the private savings rate, you know, is not high now. It doesn’t need to be high. What really determines how the people who are either aged or very young, because either way, the people who are in their nonproductive years depends, in aggregate, on aggregate production of goods and services, and then the division between those who are in their productive years and in their nonproductive years. And that’s what Social Security argument’s about and everything. The biggest single thing working for people in their nonproductive years on both ends, young and old, is the fact that the pie keeps growing. And that makes it easier to attack the problems of the nonproductive. And when I say, “nonproductive,” there’s obviously no — nothing derogatory about that term. It just relates to who’s in the employable age and who isn’t.

And our society is going to do extremely well in terms of being able to take care of the people in their nonproductive years. If there — there is a shift, obviously, as people live longer. And of course, there should be a shift, perhaps, in defining — I think there should be — in defining what’s productive, because 65 was decided back in the ’30s. And I think that’s changed. But the fact that the pie keeps growing is what makes it — it makes the problem easy. And — not easy — but it’ll be easier 30 or 40 years from now, in my view, you know, than it was 30 or 40 years ago. Because there’ll be so much more in the way of goods and services produced per capita that the productive can take care of the nonproductive and the — or the aged — in a way that will be easier for them to sustain than it was in the past. When — It’s low amounts of output that strains society. I mean, when you get very small amounts of output, or huge disparities in the division of that, that you put real strains on a society.

But a society whose output is growing 3 percent a year and whose population is growing 1 percent a year is going to have way less in the way of strains than existed 20, 30, 50, 100 years ago. The — But, you know, we will need no big boom in savings or anything of the sort. The present savings rate will do — will just do fine for the world. In the United States, I mean, I’m not speaking to the — I shouldn’t speak to the whole world on that. Charlie?

CHARLIE MUNGER: Well, generally, you can say that stocks are valued in two different ways. One, they’re valued much the way wheat is valued, in terms of its perceived practical utility to the user of the wheat. And there’s a second way that stocks are valued, which is the way Rembrandts are valued. And to some extent, Rembrandts are valued high, because in the past, they’ve gone up in price. And once you get a lot of Rembrandt element into the stock market, and you fuel the stock market with massive retirement system purchases, you can get stocks selling at very high prices by past historical standards. And that can go on for a long, long time. That’s what makes life so interesting. It isn’t at all clear how it’s going to work out. It isn’t even clear what the level of interest rates is going to be. And nobody in this room ever expects to see 3 percent interest rates continue for a long time again. But that could happen. That would have an enormous effect on the price of equities. You live in a world where you can’t really predict these macroeconomic changes.

WARREN BUFFETT: No, you can argue that increases in savings will drive down the returns on capital. The more capital is around, that the lower the returns will be on capital. But I don’t think you’ll — I don’t think it will help you make any decisions about businesses, you know, over your lifetime by — actually by thinking about matters like that. We’re a little biased on that. But you’ll find all kinds of guys that will tell you. I mean, that’s what books are written about. Because everybody likes predictions and books. So, you could all — Go ahead.

CHARLIE MUNGER: In addressing this question, you can see that we have acted much as one of my old Harvard Law professors acted. He used to say, “Let me know what your problem is. And I’ll try and make it more difficult for you.” (Laughter)

17. Buffett: The best book on how I invest

WARREN BUFFETT: Area 5, please.

AUDIENCE MEMBER: My name is Eric Tweedie from Shavertown, Pennsylvania. Thanks again for another great meeting. During last year’s meeting, my wife picked up a copy of a book called “Buffettology” at one of the shops around town that is written by Mr. Buffett’s former daughter-in-law, a very wellwritten book, very interesting. And it attempts to outline the Warren Buffett approach to investing. My question is, I don’t know if either of you gentlemen are familiar with the content or have read it. And if so, if you could comment on if you think it is a good outline of that type of investing. My second question related to that, I wonder if you — if Mr. Buffett could comment on why you bought the original textile mill in Massachusetts, and if that represented an earlier phase, when you were more of a strictly Graham-style, value investor, versus your current investing style.

WARREN BUFFETT: Probably the best, I would say, the most representative book on my views is the one that Larry Cunningham has put together, because he essentially has taken my words and rearranged them in a more orderly — he’s taken from a number of years. And what he has put together there best represents my views. We’ve got 20 years of annual reports or so, or more, on the internet, plus articles in Fortune, all kinds of things. So it’s probably a bias I have. But I would — I like to think that I laid out those views better than somebody who’s rewriting them. But that’s — I’ll let you make that decision. But I do think Larry’s done a very good job of taking a number of those reports and rearranging them by topic in a way that makes it a lot easier to read than trying to go through year after year. And actually, you’ll have this book about Charlie, pretty soon, to read, too.

We’ve said what — we’ve said in these meetings, we’ve said in the annual reports, we’ve said exactly what we do. And some of the books, I would say, try to take that and — because people are looking for mechanistic things or formulas or whatever it may be. They try to hold — they may try to hold out that there’s some secret beyond that. But I don’t think there probably is. Charlie? You’ve read the books.

CHARLIE MUNGER: Oh, I skimmed that book. The — I think what we have done all these years is, it wasn’t all that hard to do. And it’s not that hard to explain. All that said and done, I think a lot of people just don’t get it. (Laughter) As Samuel Johnson said, famously, “I can give you an argument, but I can’t give you an understanding.” (Laughter)

18. Buying Berkshire Hathaway was a “terrible mistake”

WARREN BUFFETT: What was the second part again?

AUDIENCE MEMBER: I just asked you if you could maybe comment on why you bought the original —

WARREN BUFFETT: Oh.

AUDIENCE MEMBER: — Berkshire textile mill.

WARREN BUFFETT: That’s why I didn’t remember. (Laughter)

AUDIENCE MEMBER: If I could say —

WARREN BUFFETT: It was —

AUDIENCE MEMBER: — one of the things, someone tapped me on the shoulder and asked me for you not to forget to give the current year’s recommended books.

WARREN BUFFETT: It’s — I’ve got to recommend the book on Charlie. But I’ll let Charlie recommend one, too. The original purchase of Berkshire was a terrible mistake and my mistake. No one pushed me into it. It was — I bought it, because it was what we used to call the cigar — It was a cigar butt approach to investing, where we would look around for something with a free puff left in it. You know, it was soggy and kind of disgusting and everything. But it was free. (Laughter) And Berkshire was selling below working capital, had a history of repurchasing shares periodically on tender offers. And it was selling, the first purchase was, I think, at $7 1/2 a share. In fact, I’ve got the broker’s ticket up in the office, 2,000 shares. And they — it looked to me like they were going to have a tender offer periodically. And it would probably be at some figure closer to working — net working capital — which might’ve been 11 or $12 a share, some such number. And we would sell on the tender.

And that was — we had other securities we owned that way. And we bought some that way. And then, actually, I met Seabury Stanton one time, who was running Berkshire. And he told me and made me an insider, so I couldn’t do anything, but he said he was thinking of having a tender. And he wondered what price we’d tender at. And I — as I remember, I may be wrong on this, I could look back on it, but I think I said, “11 3/8.” And he said again to me, “Well, if we have a tender at 11 3/8, will you tender?” And I said, “Yes, I will.” And then I was frozen out, obviously, of doing anything with the stock for a little while. But then he came along with the tender offer. And as I remember, I opened the envelope, and it was 11 1/4. I may be wrong. It may have been 11 1/2, 11 3/8. But it was 1/8 below what he had said to me and what I had agreed to. So I found that kind of irritating.

And I didn’t tender. And then I bought a lot of stock. Kim Chace was a director. His father had some members of the family, not his direct family, but related family, that wanted to sell a block. And we bought several blocks. And before long, we controlled the company. So at an eighth of a point difference, we wouldn’t have bought it, the company, if they’d actually tendered at that price. We had a somewhat similar thing happen with Blue Chip, actually, later on, too. We would’ve been much better off, if we hadn’t bought it. Because then things like National Indemnity and all of that, instead of buying it into a public company with a great many other shareholders, we would’ve bought it privately in the partnership. And our partners would’ve had a greater interest. So Berkshire was exactly the wrong vehicle to use for buying a bunch of wonderful companies over time. But I sort of stumbled into it. And we kept moving along. And when I disbanded the partnership, I distributed out to Berkshire. Because it seemed like the easiest and best thing to do. And I followed through. And I enjoyed it enormously.

I’m glad it all worked out this way. It did not work out the best way, economically, in all probability. It was the wrong base to use to build an enterprise around. But maybe, in a way, that’s made it more fun. Charlie, do you have anything to add on that? You can tell them about the Blue Chip story. (Laughs)

CHARLIE MUNGER: No, one such story is enough. (Buffett laughs) But it is interesting that a wrong decision has been made to work out so well. We’ve done a lot of that, scrambled out of wrong decisions. I’d argue that’s a big part of having a reasonable record in life. You can’t avoid the wrong decisions. But if you recognize them promptly and do something about them, you can frequently turn the lemon into lemonade, which is what happened here. Warren twisted a lot of capital out of the textile business and invested it wisely. And that’s why we’re all here.

WARREN BUFFETT: But Berkshire comes from three companies that came together: Diversified Retailing, Blue Chip Stamps, and Berkshire. Those were the three base companies. And Diversified started when we bought a company called Hochschild Kohn in Baltimore in 1966, a department store. And that company disappeared over time. Fortunately, in 19 — I think — 70, we sold it to Supermarkets General. Blue Chip, we’ve told you about the record of that. So, we started out with three disasters, and put them all together. (Laughter) And it’s worked out pretty well. But it was a mistake to be working from that kind of a base. Don’t follow our example in that respect. Start out with a good business and then keep adding on good businesses.

CHARLIE MUNGER: But the example of quickly identifying the mistakes and taking action, there, our example is a good one.

WARREN BUFFETT: Yeah.

19. Buffett would never trade Berkshire stock for gold

WARREN BUFFETT: OK, number 6.

AUDIENCE MEMBER: Good afternoon, Mr. Buffett, Mr. Munger. Kathleen Lane (PH) from New York. I have a question out of left field for you. You say you like to be entertained? This question will entertain you. It’s also a serious question. I know you don’t like to speculate about the future. You won’t do so. I appreciate that. But some people do. For example, Edgar Cayce was one. He didn’t pick stocks or investments. But if he had, he would’ve probably gone for that farmland that you were talking about earlier this morning. Because he had a dream that in the year 2158, Omaha would be located on the west coast of the United States. And you know how beachfront property goes. So it would be a good bet.

WARREN BUFFETT: It will be good for our super catastrophe business, if that happens. (Laughter)

AUDIENCE MEMBER: As you both said earlier, we’re living in an extraordinary time, financially especially. You can’t help but to hear disaster scenarios concerning the impending collapse of worldwide financial markets, about major physical changes in the world as we know it, about a future when the world’s resources will be better measured by their prospects for ensuring our basic survival than their value as speculative commodities. That’s where that farmland would come in again. Nobody does better what you two do. But even if your investment acumen wasn’t what it is, I would invest with you, because you’re honest. In short, I came here to ask you, what would you tell a single mother to exchange her Berkshire share hold for gold coins? When, under what circumstances?

WARREN BUFFETT: Well, I can’t imagine ever exchanging any of my shares for gold coins. But — I would rather trust in the intrinsic value of a bunch of really fine businesses run by good managers selling products that people like to buy and have liked to buy for a long time, and then exchanging their future efforts, the money that comes from their wages, for See’s Candy or Coca-Cola or whatever, than take some piece of metal that people dig out of the ground in South Africa and then put back in the ground at Fort Knox, you know, after transporting it and insuring it and everything else. (Laughter) I’ve never been able to get real excited about gold. Now, my dad was a huge enthusiast for a gold standard. So I grew up in a family where gold was revered, if not possessed. And I would — I gave it its full chance. But I’ve never understood what the intrinsic value of gold is. And, you know, we’ll sell you some at Borsheims, but I would never exchange — The idea of exchanging a producing asset for a nonproducing asset would be pretty foreign to me.

20. Why Buffett ignores predictions

WARREN BUFFETT: And I would say this: in terms of the predictions, and I know the spirit in which you asked the question, but in terms — there’s a market out there all the time. And people love to hear predictions. If I said I was going to offer a bunch of predictions today, we would have a million people here. I mean, they’re dying to have predictions and speeches at rotary clubs or trade associations or whatever. That’s — they just plain love it. And that’s what a whole industry is built upon, you know, the people coming out of Washington to talk about political predictions and the — I don’t read those in the paper at all. Because it’s just — it’s space fillers, basically. And, you mentioned Edgar Cayce. Ben Graham knew Edgar Cayce pretty well. But I just have never seen any utility to any of that at all. There will be some huge surprises in the world. There’s no question about that. But I don’t think that betting on any specific one is a very smart policy.

In fact, our — we usually bet against them, in terms of super catastrophes. We know there will be a 7.0 or greater quake in California in the next 50 years. We don’t know where it’ll be or when it’ll be or anything like that. We are willing to pay out a lot of money if it happens tomorrow. And because people do worry about catastrophes. And in this case, it’s perfectly proper, with insured values. But it just isn’t any way, in our view, to get through economic life. Charlie?

CHARLIE MUNGER: Well, I suppose the one time when a single mother might want to own gold compared to anything else is if she faced conditions like a Jew in Vienna in 1939, or — I mean, there are conditions you can imagine where some form of transportable wealth would be useful, compared to anything else. But absent those extreme conditions, I think it’s for the birds. Now, silver… (Laughter)

WARREN BUFFETT: It’s hard to think of anything other than fleeing the country. And Charlie and I don’t give a lot of thought to fleeing the country.

21. Buffett: “I’m a little crazy, I don’t mind paying taxes”

WARREN BUFFETT: Although, I must say that the one thing I really find reprehensible is the people that make a lot of money in this country and then leave to, you know, to get another tax jurisdiction or something like this. I really — I don’t — But I’m a little crazy. I don’t mind paying taxes. (Applause)

WARREN BUFFETT: Let’s go to 7. There are plenty of reasons, I think, perfectly valid reasons — I mean, people may want to live someplace else — but the ones who carefully arrange it so that they actually live here as much as they can. I think one of them wanted to be appointed — he wanted to go to some very small entity, where there was no tax. And then he wanted to be appointed an ambassador to the United States, so that he could enjoy living here but enjoy the taxes of something else. And, you know, that is not my role model. Yup.

22. Costs vary for Berkshire’s float

AUDIENCE MEMBER: Hello, Warren. Hi, Charlie. Two questions. First, was anybody dumb enough to sell you Berkshire at less than 45,000 a share?

WARREN BUFFETT: We did not repurchase any shares.

AUDIENCE MEMBER: My second question concerns float. The float has been low cost most years for Berkshire and probably zero cost in many years, except last year, possibly. When you think about float in terms of intrinsic value, do you have an idea in mind when you add new float for how much it will increase the intrinsic value of Berkshire?

WARREN BUFFETT: Well we add — that’s a good question — but we consciously add float sometimes at a given cost. And then we, other times, add float at no cost. So we have different layers of float, if you will, that we’ve entered into. We’ve entered in some transactions in the last month or two, where we will take on some float, which will not have zero cost. But it’s acceptable to us. And we couldn’t get it at zero cost, although we’re also creating float which, I think, will be close to zero cost or better. So, we would be willing to take on float, obviously, at costs only modestly below the Treasury rate, if that was the only way we could get that float, and it didn’t impede our ability to get other float, you know, at zero cost or something. We don’t want to raise the cost overall by a single transaction that would have an effect on other transactions.

But float, if you look at our historical record, and our future record can’t be as good, but it’s not —it’s the cost of float, and it’s the amount of growth of float. I mean, if you told me I could add $50 billion of float and have a 3 percent cost to that, you know, I would take that any day over adding 10 billion at zero cost. So there are a lot of different ways, in the insurance business, that we can and will think about developing float. And usually, one doesn’t preclude another. Occasionally, one bumps into another. But usually, one doesn’t preclude another. And believe me, we spend a lot of time thinking about that. And we’ll continue to as long as we run Berkshire. It’s a big part of our strategy. Charlie?

CHARLIE MUNGER: Well, I’ve been amazed how well we’ve done with the float. And I’ve been watching it from the inside for a long, long time. It is a very wonderful thing to generate millions and millions, and then billions and billions, of dollars of float at a cost way below the Treasury rate. There are people who would kill for such opportunities.

WARREN BUFFETT: Yeah. And of course, that makes it competitive. We do — we — there are plenty of other people that are thinking about it in a similar vein and probably observed what we do and all of that. So like everything else in capitalism, it’s competitive. We think we’ve got an edge in several very important respects. And we think that edge is sustainable for quite a — as far as we can see. And we intend to push it as hard as we can. And then we’ll see where it leads. I would’ve had no idea, 10 or 20 years ago, that we would have the present situation. But we do find, if you just show up every day, like Woody Allen said, and you answer the phone and read the paper, every now and then, you see something that makes sense to do. And we do find them occasionally. The hard part is finding them where they are material relative to our present size. If we were running a very small business, we would find plenty of things that would make good sense. We find a few things that make good sense now, relative to our size.

And there’s really no answer for that except to shrink dramatically, which is not a action we’re contemplating.

23. Munger on Wesco succession

WARREN BUFFETT: Number 8.

AUDIENCE MEMBER: James Pan (PH) from New York City. I really have a question on Wesco, which is your 80 percent-held subsidiary, just a couple questions dealing with that. First question is, last time I checked, that was trading below intrinsic value. And given that most of Wesco’s assets are tied up in Freddie Mac, and Freddie Mac will arguably grow intrinsic value in the low teens for the next couple of years, how are you guys going to manage the, I guess, how would you manage the gap between intrinsic value, and what — the current price, and what intrinsic value will be two or three years from now? And also, is there a succession plan at Wesco or some kind of roll-up plan at Wesco eventually?

WARREN BUFFETT: Charlie is the boss at Wesco. So —

CHARLIE MUNGER: Yes. We have paid almost no attention to the price of Wesco stock. So the chance to make any meaningful gain for the Wesco shareholders by buying in a few shares of Wesco stock is so tiny that we don’t really bother thinking about it very much. The — As to succession, we are gradually making me so useless that I won’t be missed. (Laughter)

WARREN BUFFETT: Yeah, incidentally, you talked about Wesco being significantly undervalued compared to intrinsic value. I’m not sure that’s the case. Charlie, would — you’re more of an expert on that than I am.

CHARLIE MUNGER: Well, there’s certainly no huge gap. And, we don’t spend a lot of time thinking about things that will make, practically, no money. (Laughter)

24. Munger: EVA valuation is “twaddle” and “medieval theology”

WARREN BUFFETT: Number 1.

AUDIENCE MEMBER: Hi, my name is Jason Tang (PH) from Traverse City, Michigan. Before I ask my question, I want to know that it’s true that you guys are going to be here tomorrow at 9:30 to answer more questions. (Laughter) My question, I just recently read the book, “Quest for Value,” by — I think the author is Bennett Stewart, from Stern Stewart consulting firm. And I want to talk to you a bit about — just ask you about different valuation methodologies, and EVA in particular, and how that may or may not be more valid than, let’s say, other benchmarks of value, like P/E, or price-to-book, or price-to-sales. Is that something closer? I noticed that the language that was used in this book was real similar to the type of language you guys use in your writings. So I’d like you to talk a little bit about EVA, if you could.

WARREN BUFFETT: Charlie, why don’t you take EVA?

CHARLIE MUNGER: I think there’s an awful lot of twaddle and bullshit. (Laughter)

WARREN BUFFETT: I knew that’s what he was going to say. And I thought it deserved it, so I — and I didn’t want to say it myself.

CHARLIE MUNGER: In EVA, we keep stating, over and over again, that the game is to turn the retained dollars into something more than dollars. And EVA tends to incorporate cost of capital ideas that just make no sense at all. They make it sound very fashionable. And, God knows, it’s correct that a corporation that earns a huge return on capital and keeps retaining it for a long time has a great record in terms of EVA. But the mental system, as a whole, does not work. It’s like medieval theology. (Laughter)

WARREN BUFFETT: I like that second term better than the earlier one. (Laughter)

25. How Buffett became friends with Bill Gates

WARREN BUFFETT: Number 2.

AUDIENCE MEMBER: Good afternoon. My — excuse me — my name is Stewart Hartman from Sioux City, Iowa. First, I’d like to thank you both for allowing a couple of Berkshire employees to migrate north to Sioux City. I work with Corey Wrenn and Mark Sisley (PH). They’re both great guys. You did a terrific job training them. Mr. Buffett, you’ve known Bill Gates for several years and probably spent more time with him than any of us in this room. Would you feel —?

WARREN BUFFETT: That isn’t the case, if Jeff Raikes is here. I don’t know. Is Jeff here? Anyway, go ahead. But we did have a local fellow who comes from 30 miles from here, Jeff Raikes, who’s a key Microsoft employee. And I think he’s in town this weekend. I thought he was in the meeting.

AUDIENCE MEMBER: I didn’t mean to make the broad generalization to be argumentative. (Laughter)

WARREN BUFFETT: I just didn’t want to think Jeff — I was trying to muscle him out.

AUDIENCE MEMBER: Sure, sure. That being said, I guess, here’s a way I’ll rephrase this. Would you feel comfortable sharing with us how your relationship began and how it evolved with Mr. Gates? And with regard to his spirit and competitive nature, how vigorous do you expect him to defend his company’s position against the government and state’s current antitrust suit? And then for both of you, Mr. Munger included, what, in your opinion, are the odds that the government and the states will prevail and split his company into pieces? And then since Mr. Munger mentioned, I guess I’d ask, could we have an update on the company’s silver position and its future as an investment, as well? (Laughter) Thank you for opening that door.

WARREN BUFFETT: OK, well, he can close them, too. (Laughter) Yeah, I really don’t feel comfortable speaking for Bill at all in terms of what he’s going to do. In fact, I think they’ve been quite outspoken, he and Steve Ballmer both, about what Microsoft will do. So I don’t want to try and rephrase that or modify it or do anything else. Because they know what they’re saying when they say it. And I would take them at their word. And I really shouldn’t be adding anything to it. I met Bill, because a very good friend of mine, Meg Greenfield, was the editorial page editor at the Post. She called me one time, 10 or more years ago. And — she said, “Warren,” — she loved the state of Washington and had grown up out there. So she said, “Can I afford to buy a second home?” She was living in Washington, D.C. now. And so she says, “Can I afford to buy a second home in Washington?”

And I said — and she said, “I’ll send you all my financial information.” I said, “Meg, you don’t need to.” Anybody that asks me whether they can afford something can afford it. It’s the people that don’t ask me that never can afford it. So I said, “Just go do it.” And, “It’ll make you happy.” And so she did. And, then a year or two later, she wanted to have me come out and see what she’d done with my mild encouragement. And so I went out there and visited. It was the July 4th weekend in 1991. And they had this parade on this island and everything she wanted me to see. And she had a few other people out, too. And then, she was a friend of the — of Bill’s parents. And so we went down there, to the Hood Canal, to visit them when I was back there, to meet the parents. And I think Bill didn’t want to come. But Kay Graham was coming. And he wanted to meet her.

He didn’t want to meet me. And, so he came in. And then we hit it off immediately. We had a great time. And, I mean, he had this chimpanzee, to whom he was going to try and explain this technical stuff. But it was a — I was kind of an interesting chimpanzee to him. So, we — and he’s a terrific teacher. So, we spent a number of hours. And we just plain hit it off. And, I found it very interesting, what he had to say. And, we’ve had a good time good time ever since. And we play bridge together and golf together. So I can tell you that he’s quite competitive in those games. But I, can’t tell you anything about Microsoft or anything. I don’t know that much about it. And it wouldn’t be right, if I didn’t know anything personal, to be talking about it. Charlie, you know Bill.

CHARLIE MUNGER: Yeah. Well, I don’t want to speak for anybody else, either. I happen to be quite sympathetic to the Microsoft side of the pending antitrust case. But — (Applause) And regarding silver, all I can say is, so far, it’s been a dull ride. (Laughter)

26. Buffett and Munger on the antitrust case against Microsoft

WARREN BUFFETT: I would say this about the Microsoft case. That — and I’ve expressed this to a couple news organizations who asked the question earlier. Twenty years ago, this country really had sort of an inferiority complex about its place in the world economic order. And we talked about having a country of hamburger flippers. And, we thought we were going to lose our steel industry and our auto industry. And we really didn’t quite see how America fit into the world where it looked like the Japanese and the Germans, to some extent, and all those, were eating our lunch. And that — there are many of you are too young to remember that. But there are many of you in this room who will remember that. And we were very depressed about our economic situation in this country. And then this, whatever you want to call it, information age or whatever, came along, fueled by technology. And we’ve just swept the world aside. I mean, it — we are so far number one that it’s difficult to think who’s number two.

So here we have — And it’s changed — in some way, it’s contributed to a change, I should say — in the national mood. And it — whether — what part of our prosperity is accounted for by it, no one knows. But I think everybody in the room would agree that it’s significant. And that age is going to get — and that development — is going to get more and more important in the years to come. It’s going to be fueling much of what happens in the world and for this country to be the world leader. And like I say, you can’t even see who’s in second place, and moving faster, even, to increase that lead, with all the benefits that brings, you know, I think that — I think we’ve got something working very well that probably doesn’t make a lot of sense to tinker with too much. So I would not want to go in with a meat axe into something that is pulling this country along, in my view, in a huge way. And I just, I don’t like to tinker with success. And it’s an important success.

It’s really an important success. Charlie and I may not understand how to play that, in terms of buying the companies that are going to do well 10 or 15 years from now. But we know some companies will do well. And we certainly know it’ll have a huge benefit to society, even if it makes business less profitable but makes the society more efficient. I mean, that is a huge edge to have. I would love to have the most efficient industry in the world in this country, even though it might pull down returns on capital against the lessefficient system. So we — I think neither one of us would be inclined to go in there and mess around with something that’s working.

CHARLIE MUNGER: I think — (Applause) If you look at the big picture, in patriotic terms, having lost totally in radios, stereos, television sets, et cetera, and in many other places, and having lost position in other major industries to the Japanese and others, we finally get huge leadership in a new and wonderful field — software — that’s needed all over the Earth. And somebody who’s drawing a salary from the United States government gets the bright idea that they should dramatically weaken the one place where we’re winning big. (Applause) And he actually goes home at night and is proud of himself. (Laughter)

27. GEICO benefits from smaller industry-wide profit margins

WARREN BUFFETT: OK, number 3.

AUDIENCE MEMBER: Good afternoon. Joe Levinson (PH) from New York. You mentioned, in this year’s annual report, that the operating environment that GEICO is facing, especially with regard to pricing, is going to get even tougher this year. I’m wondering if this tough environment that GEICO’s been facing over the last few years, is it something cyclical? Or is there something more structural going on here that we should be concerned about?

WARREN BUFFETT: Well, actually, what has happened is that it’s been unduly benign the last few years. So I would regard this as much more a return to normalcy, what’s happening. The profits in auto insurance, industrywide, have been far higher than, I think, are sustainable and higher than I would’ve predicted, five years ago, would’ve occurred. So the industry got very, very lucky for a while. That wasn’t necessarily good for us, incidentally. We made more money than we would’ve otherwise made. But there was a big umbrella over the industry, too, so that less-efficient competitors still did very well. We do not find the environment, which is going to be lower profits, we do not find that undesirable at all. We do not like having a huge umbrella over an industry. We want the most efficient to be the ones that do well and the less-efficient ones to have plenty of problems. So, we are not unhappy about the fact that margins in the auto insurance business are going down. We think they should go down.

We will — as long as we feel that we are adding policyholders at a cost that’s less than their net value to us over time, we will continue to do it. We’ll love to do it. But we won’t be making the kind of money, in the year 2000, that we made in 1999, which was not as good as 1998. But that doesn’t — that’s — as far as we’re concerned, that’s fine. Because we will be the low-cost producer, over time or will — that is our goal. And I think we’ve got a lot of things going in our direction to enable us to do that. The low-cost producer in a huge industry is going to do very well over time. And then question is just — is, it costs money to sign up people and bring them into our fold. Then we have to keep them in our fold. And we lose some every year. It’s an hourglass problem, to a degree. But that’s all part of the equation. And the GEICO equation is fundamentally good.

It’s not as good as it was a couple of years ago, just in terms of overall profitability, because there isn’t this big umbrella over the whole industry. But that umbrella was going to go away. And it doesn’t hurt us to have it go away at all. The second thing is that we are, as I pointed out in the report, it is costing us more to develop inquiries than it did a couple of years ago. We knew that would be the case. It’s going to cost more three years from now than it costs now. So we believe in pouring it on. And we think that we can attract business at a lower cost and then run it at a lower cost than most of the competition, if not all. And we intend to plow ahead with that. We will write — I said, in the annual report, I ventured that the industry might write at three points worse than last year. Well, three points on 120 billion of volume is $3.6 billion difference in the profitability, if that forecast happens to be correct. That bothers us not at all.

In fact, we will not only take that three points of industry worsening, but on top of that, we will spend even more money to bring in business, which will make our figures, specifically, look that much worse in the near term. But that, you know — in the end, it is so much more attractive to bring in that kind of business, we’ll say, than some e-retailer, who is losing cash by the ton, bringing in customers who are spending far, far less than our customers spend with us, and where the retention rate, I would venture to say, will be lower than our kind of retention rate. We’ve got a very good business model. It’s not as good as it was a couple of years ago. It’s probably better than it will be a couple of years from now. But it’s still far superior, I think, to the business model of most of the competition. We’ve got a great machine at GEICO. And we’ve got a sensational man running it in Tony Nicely. He is the best in the world at running that business. And he’s been there since he was 18 years old.

And he knows it every way from Sunday, in terms of how to run that business. I’ve known Tony for a good many years. I’ve never heard him say anything that didn’t make sense. It’s really interesting. If you take a whole bunch of people with 140 IQs, it’s a very uneven performance in what they actually do. Some of them say all kinds of things that make a lot of sense about 90 percent of the time. And then 10 percent of the time, they go crazy. And Tony is — everything Tony says and does makes sense. And he is a huge, huge asset to Berkshire. And he’s working with a business model that — that’s very, very powerful. Charlie?

CHARLIE MUNGER: Nothing to add.

28. MidAmerican Energy: “Decent” but not “extraordinary” returns

WARREN BUFFETT: OK, number 4.

AUDIENCE MEMBER: Good afternoon, Mr. Buffett, Mr. Munger. My name is Andrew Sole. And I’m from New York City. I was hoping, if you wouldn’t mind, turning your attention to MidAmerican Energy. You’ve spoken about how much you respect the management of that company. But if you could elaborate upon what you see are the long-term competitive advantages of MidAmerican Energy, where you see the company 10 years from now, and is it your hope or your intention to make MidAmerican Energy the lowest-cost provider of electricity in the United States?

WARREN BUFFETT: Well, you — you’re not going to do a great deal about the embedded cost that you have in generation. I mean, if you have a group of plants, they are, in the United States, they’re relatively low-cost generation. But if somebody else has a hydro plant or something that has built-in advantages that are going to enable them to turn out electricity cheaper than we can do it in Iowa with coal, so be it. I mean, it — So it is relatively well positioned as a generator, but we have nothing we could do there to specifically, dramatically change the cost of generation compared to other competitors. But — and you shouldn’t expect to make extraordinary profits in a business that is selling an essential, like electricity, to virtually every consumer in the country. The whole idea behind the utility industry is not to allow extraordinary profits. But we think it’s a very good business. We do think that Dave Sokol has demonstrated ability, in the time he has been running that, to come up with a lot of ideas about doing various things that have made sense, various projects. Not everything works. But his batting average is very high.

And a good mind like that, we will expect that he’ll produce more ideas over time. But, it’s not the sort of thing you get fireworks in. It’s conceivable that, you know, we would get a chance to do something very big in that field at some time, just because it’s a big field. It is the kind of field where you can write a $5 billion check. So it’s not the jelly bean business. But whether we do or not depends on a lot of things, including regulatory restraints. Because there are a lot of rules in that business, starting with the Public Utility Holding Company Act of 1935. But there may be ways to do some very big things. And we’ve got the right management to do it. We’ve got the financial wherewithal to do it. And we’ll see what happens. I think MidAmerican is a very — we’ll get, in my view, we’re very likely to get a very decent return on it. But we shouldn’t get an extraordinary return, because it isn’t that kind of business. Charlie?

CHARLIE MUNGER: Nothing to add.

29. We can do almost anything with insurance float

WARREN BUFFETT: OK, number 5.

AUDIENCE MEMBER: Mr. Buffett, my name is John Shayne (PH) from Nashville, Tennessee. I want to join the other shareholders and thank you for the results you’ve achieved, but also for the example that you’ve set for business, generally. My question is about float proceeds and whether they can go into common stocks. You’ve been asked that question before in prior years. Once, I asked you something on that. And I think at least one other shareholder has. But I’m wondering if you might go into a little more detail. If I’ve understood you in the past, you’ve said, “Yes, you can — the float’s available to go into common stocks.” I think it’s an important question because it affects the intrinsic value of that float. If that float is locked into fixed income, it’s worth one thing. If it could go into stocks at one point, it’s obviously worth quite a bit more. What I’ve had trouble understanding is, I think you must have some way that you can guarantee that the policyholders will be protected.

Obviously, you can invest everything in a low market, and the market goes even lower. Is it simply the size of the capital you’ve got that you think that’d be extraordinarily unlikely? Or do you use future insurance revenues, premium revenues, to pay off claims? Would you borrow to pay off claims? If you could give some detail on that, maybe we could get some comfort as to how you’re thinking about that.

WARREN BUFFETT: Yeah. The float, in no way, is limited to fixed-income securities. The float is really available for anything that we feel is the most intelligent at any given time. And the reason we can say that, and other insurance companies can’t say that, is because we have an incredible abundance of capital, plus other streams of earning power which are unrelated to the insurance business. So we could have the float entirely in equities. And we have had that, in the past, or tantamount to that. And we could have a lot of it in operating businesses. We can have it anyplace it makes the most sense. But the only reason we can do that is because we have extraordinary capital. And we don’t have much debt. We run the business differently than, or think about it differently, than probably 90 percent of managements do. We look at the assets on a consolidated basis with a few little exceptions. We look at the asset and the liability side — completely absent any linkage for specific assets and liabilities. So our job at Berkshire is to get the liabilities as cheaply as possible.

We want all the liabilities we can get and not have any worries about fulfilling as cheap as we can, plus a lot of capital. And then we want all the assets to be employed as intelligently as possible. And we don’t match up, you know, a billion dollars of assets on the asset side against a billion of specific liabilities on the right-hand side. There’s one or two exceptions to that, but that’s — where we’re required to — but that’s the basic approach. So, when Charlie and I think about Berkshire, we’re thinking about, how do we get as much money as we can as cheap as we can without, in any way, endangering our ability, ever, to pay anybody, under any circumstances? And then, how do we put it out in a way that we feel the most comfortable on the asset side, at the best returns? And frequently, that will be equities. And it has been, over the past. Sometimes, we — it won’t be. We can’t find them. But that’s the goal. And float is available just like — in virtually all cases — just like common equity.

We don’t distinguish those in our mind. And that gives us — that flexibility gives us some edge and, perhaps, quite an edge, at times, over other — over our competitors. Charlie?

CHARLIE MUNGER: Well, yeah, you can see that in the results to date. We have used that edge in the past. And we hope to use it in the future.

30. Liz Claiborne and Jones Apparel investments

WARREN BUFFETT: Number 6.

AUDIENCE MEMBER: Hi, I am Kevin Pilon (PH) from Simsbury, Connecticut. Let me just say, quickly, that I’m really looking forward to Charlie’s book. And I hope it expands on the talks he gave that were reported in (inaudible) with regard to having a certain number of models that you need to understand and prosper in life. I have two questions. And I’ll ask them quickly, in succession. Because you may want to punt on the first one. The first question is, I’m interested in any comments you might have that would expand on your general interest in the branded apparel companies, Liz Claiborne and Jones. And the second question is, I wonder if you would comment on the future of Freddie Mac with all the current brouhaha. Every year, there’s new brouhaha, as you know, with the buyback of the 30-year bond and the search for a new benchmark and the Treasury saying that, perhaps, the agency securities were not backed by the full faith and credit of the government.

WARREN BUFFETT: Yeah, we — we’re not going to be able to help you too much on some of those. Because we may have some views, but they may be things that we don’t really want to talk about. The Liz Claiborne and the Jones Apparel investments you’re talking about, the Jones Apparel is a decision that was made by Lou Simpson at GEICO. Lou runs a separate portfolio of equities for Berkshire. They’re held in GEICO. But obviously, they’re for the account of Berkshire. And that portfolio is well over 2 billion. And to some extent, it can be expanded or contracted based on what Lou would like to do. And he runs that 100 percent on his own. And he’s compensated based on how that portfolio does. He makes decisions, buying and selling, without talking to me at all, which is the way we like it. Sometimes, there’s an overlap in our decisions. But when I, for example, when I first found out about Jones Apparel, I’d never read an annual report of the company. I didn’t know what they did or anything.

But that’s Lou’s baby. And he’s very good at managing money. And he’s a fellow that has 100 percent of my trust. So I know his general criteria for investing, which is quite similar to mine, not identical, but quite similar to mine. And he’s got a familiarity with businesses that, again, is quite similar to mine but not identical. And he runs a good portfolio. And it makes life a little easier for me, not to have that two and a fraction billion added to all the rest that I’m having trouble investing. Liz Claiborne came about a little differently. I got a call one weekend, actually, on purchasing a large block that someone was going to sell. And we bought that on a Monday morning in London, as I remember. It was never reported on any exchange. I’m not quite sure even how it happened. But the broker that handled it arranged the trade over there. And, you know, they’ve had a very, very decent record. They buy in their shares. I like the business that they run.

It’s not a Coca-Cola-type business or a Gillette-type business or even an American Express business. But we were offered that stock at a very attractive price. And it’s worked out fine. The Freddie question, I’d rather not get into it, frankly. Because there’s a lot of political overtones to that. But Charlie?

CHARLIE MUNGER: I can pass as well as you can.

WARREN BUFFETT: OK. (Laughter)

31. Berkshire’s next CEO won’t be a “caretaker”

WARREN BUFFETT: Number 7.

AUDIENCE MEMBER: Garesh Paku (PH) from Croton, New York. First, regarding — I just have a couple of questions. First, regarding the succession issue. I just can’t imagine that you would allow someone else to paint over your picture afterwards, I guess, post-truck. So I was wondering, would the — is your — is the nature of your succession plans more of a caretaker role of the museum? Or is it more active? That’s the —

WARREN BUFFETT: It would be more active. No, the last thing in the world I would want would be a caretaker. That would be — no, that would not — I would not want that to be my legacy.

32. Potential impacts of inflation on GEICO

AUDIENCE MEMBER: And the second question is regarding inflation. While I appreciate your focus on the specific businesses and your insistence that you not try to predict it, we’ve been very fortunate by successively lower rates of inflation. And I’m wondering, with all of the money sloshing around and between real estate and stocks and all the other places, whether you are concerned about inflation, what effect that would have on the insurance businesses at Berkshire, and what you can do to guard against those risks.

WARREN BUFFETT: My record is just terrible, in terms of predicting the inflation rate. So, it is not something that enters into our decision making. The big danger in — a speed-up of inflation would lead to more dollar volume in the insurance business. And more dollar volume is basically good for us, even though there might be a lag in pricing, that would eventually catch up and all that. So, absent the next factor I’m going to mention, inflation is not necessarily harmful at all to something like a GEICO. As you get into longer-tail liability lines, such as a General Re might have, inflation has this effect of hitting liabilities that were created four, five, 10 years earlier, maybe, and they get resettled in current dollars. And obviously, that ratchets up the cost of settling those liabilities, in kind of an unpredictable way. The danger in inflation to something like GEICO would be that people get, during inflation, they get irritated about the price of everything going up. And there are some things they can do something about. And there’s others they can’t. And then there are some they think they can, even though they can’t.

And one of those might be the cost of insurance. So the people might get very upset with the system of auto insurance, when they see a very significant part of their annual budget. Because an auto insurance policy, on average, is significant to people, and virtually every consumer in the country. And there could be a lot of pressure on legislatures to do a variety of things that might change the system in a major way. It wouldn’t reduce the number of cars that crashed into each other or the injuries that were done or anything else. But it would be a way of striking out against higher rates. And people would be unhappy about those rates. And that also might reflect itself in difficulty getting the increases that were required to take care of the costs that were ratcheting up fast. So net, I think, inflation is bad for the auto insurance business. Although, you can argue that, you know, GEICO — I think when I first got interested in GEICO, they had about a — it was in 1951, I wrote it up in “Security I Like Best.” I think they had about 175,000 policies. And I think they were writing about 7 million of business, which would be about 40 bucks a policy.

Now, if we were getting $40 a policy now, you know, our premium volume would — the company would be a whole lot less valuable than it is. And so one way or another, it ended up going from that period of $40 an average policy to 12 — or $1,100 an average policy without the roof caving in on it. And it has been made more valuable, in dollar terms, by a combination of inflation and a great business model, without it getting destroyed in the process. Nevertheless, I would prefer a noninflationary environment. It’s better for the whole world, over time. And that the way our hope goes. And then we have this, so far, unwarranted fear that the kind of conditions that have existed over the last 15 years might cause a re-ignition of inflation, which to date, it hasn’t. I don’t know any more about what’s going to happen than you do on that. Charlie?

CHARLIE MUNGER: I don’t know anything, either. (Laughter)

33. International expansion: interesting but not easy

WARREN BUFFETT: Number 8.

AUDIENCE MEMBER: Good afternoon, gentlemen. My name is Zeke Turner, and currently finishing up my senior year at Taylor University in Indiana. So four more weeks, and I’m out of there. (Buffett laughs) As someone studying finance, I do appreciate your comments as to the teaching of investment in academia. It certainly has some development it can make there. I do say that with hope that very few grad school admissions officers are listening right now. But I do want to say a special thank you quickly, if I could, to all those professors who do have the intelligence and the guts to actually teach value investing on that level and go away from efficient market theories. I do kind of wish Benjamin Graham were still teaching. Many questions have been asked as far as technology and its development into the business model. I think the greatest effect of this will probably be in the globalization of the economy. This has had, and will continue to have, a significant impact on the business model as we know it today.

Now, except for certain growth opportunities, this may have a smaller effect on companies such as See’s Candy or Nebraska Furniture Mart, but has had and probably will continue to have a dramatic effect on companies like Gillette, Coke, who have significant international presence. My question is, how does your approach change, if at all, in light of the international expansion? I’m particularly interested in the introduction of greater difficulty in understanding the business models, in the understanding of the economic future and the economic risk associated with the international scene. In addition, do you actively search for a global scene for investment opportunities?

WARREN BUFFETT: Yeah. The answer is that we obviously like businesses that are good businesses at present volume and that have the chances to expand significantly with similar economics. And with any business that’s been around the United States a long time, there’s probably more opportunity, potentially anyway, around the rest of the world than here. And Coke has grown faster. Oh, it’s grown well here. But it’s grown faster around the world than here. And that’s been true at Gillette, also, just because we were a more mature market. So we love the idea of products that will travel. Some travel well. Some don’t. I mean, it’s an incredible world that way. Candy bars don’t seem to travel so well, you know. Soft drinks travel terrifically. And razor blades travel terrifically. But the Cadbury bars sell in England. And, you know, and the Hershey bars sell here. And it’s very hard, with some items, to try — In fact, within this country, it’s amazing to me. We talk about having a mobile society. And people are moving all the time.

And we’re all watching the same television and everything else. And the supermarket share of Dr. Pepper in Dallas is 18 and a fraction percent. And in Boston, it’s six-tenths of one percent. I mean, 18 to 0.6, 30 times the market share. Dr. Pepper’s been around forever. You know, people move back and forth and everything. And how can you have that sort of a differential in this country? Royal Crown Cola, 3 percent in Chicago, one-tenth of a percent, you know, maybe, in Detroit, a couple hundred miles away, same kind of people, all that sort of thing. And Royal Crown’s been around for 75 years or whatever it may be, 50 years, at least. And you get these incredible differences in what people do, even within this country. So it’s not easy to predict how — if you can’t predict how Dr. Pepper — if you can’t figure out how to make Dr. — If I owned Dr.

Pepper and was selling 18 percent of the market in the supermarkets of Dallas, it would drive me crazy, you know, I was getting six-tenths of a percent in Boston. Or, I think it’s five-tenths, maybe, in Detroit. That would drive me crazy, although maybe I should just be grateful that I’ve got 18 percent in Dallas. It just — it’s very hard to predict how products will travel. With See’s Candy, you know, we have this incredible penetration in the West and particularly in California. We know it’s the best candy. Now, boxed chocolates just do not sell big in this country. The annual consumption is low. But it still seems that, if we can make a lot of money in California, we ought to be able to make some money in New York or Pennsylvania. But we haven’t figure out how to do it. And we’ve tried a lot of things. So, the answer is we’re always interested in geographical expansion, whether it’s even in the United States or, going beyond that, into other countries. It’s not as easy as it looks.

But when the chance to do it comes, then you ought to just pound and pound and pound. And we occasionally have bought stocks in other countries. I wrote a fellow the other day that I read about in Germany about his business. I’ve never met him or anything else. But it sounded like he had a pretty good business. And it sounded like he might be my type of guy. So I just wrote him a letter. Haven’t heard back, either. But I may. The odds are against it. But it sounded to me like I’d buy his business, if he chose to write back and wanted to do something. And we’re very willing to do business, you know, in any country in the world, where we think we understand the nuances of the corporate governance system and taxation and that sort of thing. We don’t understand all 200 countries, by a long shot. But there’s plenty we’d love to be in business in. We looked at a very significant company in Japan a couple years ago. And some other fellow I know bought it and has done very well. It would’ve made sense for us. And we missed it.

We will continue to look at things, internationally. It makes a lot of sense. And we’ve got a lot of capital to employ. We’re more likely, by some margin, to find things here. But we may find a big one outside of this country. Charlie?

CHARLIE MUNGER: Nothing to add.

34. Spending to expand GEICO’s business

WARREN BUFFETT: OK. Number 1.

AUDIENCE MEMBER: I’m John Bailey (PH) from Boston, Massachusetts. You commented, in the annual report, that only part of GEICO’s marketing expense last year was required to maintain the business. This seems to get to the heart of owner earnings, where, in the first part, you can value the existing business very well through this observation. And you get a direct measure of the dollars invested in new business. And it seems that you should be able to make similar observations about other businesses that you may be interested in investing in. So could you use this as a jumping off point to describe examples, perhaps, of how you contemplate companies’ marginal investment opportunities or their return on marginal capital? And how much weight do you give to the value of the existing business in your investment decisions or the value of the, so to speak, in-force book?

WARREN BUFFETT: Well, we, as we explained earlier, are looking for ways to create more than a dollar of value per dollar we lay out. We’d love to create $3 of value or $4 of value. But we’ll settle for $1.10, if that’s all we can get. We don’t consciously make decisions that are 90-cent decisions for a dollar laid out. None of this is that precise, when you get into the application of it. What we do know, is that there is enough of a margin at, say, a GEICO expansion effort, that it’s pretty compelling that it makes sense. Part of the limitation there, as I explained in the report, too, is a question of infrastructure and all of that. So, it isn’t solely a question of saying, you know, “Can we lay out another dollar?” and “Will that have a value of $1.10?” because if we strain the organization beyond its ability to service people, we may be hurting the business already on the books.

I used the GEICO example in the report, because it’s big enough, so it’s meaningful to shareholders. I mean, we’re doing things all the time that cost us money in the short run that we think will more that produce a commensurate value over time, but not on the scale that we’re doing it at GEICO currently. And we may step up that scale even. So, I thought it important to lay out those figures, even though I can’t be precise. When I say, you know, that it might be $50 million to maintain, I don’t know that figure. It could be 70. It could be 30. Maybe I’m off even more than that. But that’s my best guess. And I think the shareholders are entitled to my best guess. And they’re entitled to know how much we are spending, beyond that maintenance cost, to build the business for the future, which we don’t, obviously, capitalize on the balance sheet. So those — GEICO’s, by far, the most dramatic. And we don’t have comparable expenditures like that going on elsewhere.

But we are spending significant money, for example, to take NetJets to Europe. And we’ll be spending it this year and next year. And then as soon as that starts looking good, we’ll be going to Asia and spending more money. I mean, all of those decisions are made that way. They’re not on the scale of the GEICO decision, though, at all. We want to give you the information in the report that, related to the size of the enterprise, would be material to Charlie or me, if we were reading the report and not involved in the business, in trying to figure out what our investment was all about. That’s the goal in what we write and then to keep it to a size that doesn’t have to be sent UPS.

35. Problems with Berkshire annual report distribution

WARREN BUFFETT: Incidentally, I’m glad I got wandering along on that line. Because we did have a lot of shareholders this year that got their reports even later than they received them in past years. Now, they were delivered — the reports that go to registered holders were put in the mail a few days after we go up on the internet here in Omaha. And they seem to get delivered OK. Street-name holders, which are ten times in number what the registered holders are, so we’re really talking about nine out of ten shareholders, get their reports from a firm in New Jersey that is designated, by their broker, to take the reports from us and re-mail them. And we pay those people a fair amount of money to do that. We know when we deliver those reports to them, which is promptly. And we know when they tell us that they send them out. And we inquire every day, or more than once a day, to find out whether they’ve gone out. And we got a lot of complaints this year that people hadn’t received them at a time when you would’ve thought they would’ve received them.

So, we can either — we know when the designated mailer received them. We don’t know for sure when they got them out. And we don’t know for sure what happens at the post office. But we were — the mailing went out about the same as in previous years. But the receipt, apparently, was somewhat later. And all we can say is that we apologize, but we don’t have any better system. The people that have them in their own name will always get them dropped in the mail a couple of days after the report appears on the internet. We can assure you of that. We can’t assure you of when the street-name holders will get their reports, because that is a mailing that we don’t handle. And no other companies handle them, to my knowledge. There is a firm that seems to do about 95 percent of that and is designated by the specific broker with whom you have your shares. Charlie, you got anything to add?

36. The internet’s effect on GEICO and auto insurance pricing

WARREN BUFFETT: OK, number 2.

AUDIENCE MEMBER: Hi, Mr. Buffett and Mr. Munger. My name is Will Obendorf (PH). I’m from San Francisco, California, and I’m 11 years old. I have been a shareholder for six years at Berkshire Hathaway. My questions are, what are GEICO’s sustainable competitive advantages? And my other one is, what are the implications of the internet on pricing for the auto insurance industry?

WARREN BUFFETT: Well, we — we’re going to get your name and send it to human relations or whatever they call those departments. We want to hire you. (Laughter) The sustainable competitive advantage at GEICO is to be the low-cost producer providing very good service. And there will be a number of companies that provide good services. So that does not distinguish us from a great many competitors. Having the low cost is crucial. There are companies that specialize in given groups of policyholders, but smaller groups, such as USAA, that have very good costs. So they are very, very competitive with us in their chosen area. There’s another company in Los Angeles that, geographically, called 21st Century Insurance, that has costs like ours. And so they are extremely competitive within that geographic area. I don’t think anybody is any better than us who operates nationwide. We don’t operate in Massachusetts or New Jersey. But in the other 48 states, we will have a quote for about anyone. So, in terms of a broad-based insurance — auto insurance competitor — our competitive advantage has to be low cost over time.

Now, we also have to be as good at distinguishing among the risks posed by different kinds of drivers as other people. In other words, we have to be able to select people who are going to be better-than-average drivers. And we have to be able to understand who is likely to be a poorer-than-average driver. But — and the ability to do that, to distinguish those people, would be a competitive advantage. I think that many companies tend to be fairly equal on that point. So it’s really at this cost level. And we care very much about cost, the same way that Charlie mentioned a company called Costco does, you know, in terms of retailing. They figure their expense ratios out to hundredths of a percent. And that is important. So that is the competitive advantage. Now when you get — and we have to sustain and widen that, if possible. The question of the internet, it’s going to be very important. It already is important to GEICO. It will be more and more important. It will be important to the insurance industry.

Because when you have the internet, you have a situation where somebody thinking about insuring a car can click to one place, find out what that rate will be. They can click to someplace else and find out what that rate will be. So, in effect, they can shop all around without going from place to place to place and driving all over town or calling lots of agencies. They can just do it right there in their den. And that makes it very important, again, that we be the low-cost company. I think it’s going to be an advantage for us, over time. For one thing, I think it makes brand very important. Because we want people to be thinking of GEICO as one of the possibilities to call. And if you’ve got the XYZ Company that nobody’s ever heard of, nobody’s going to think about clicking on them. And GEICO’s brand is becoming extremely familiar to people throughout the country, and we’re spending a lot of money to make it even more familiar. So you’ve asked two very good questions. And I think we’re in pretty good shape on both of them. Thank you. Charlie?

37. We’ll do real estate deals, but only at the right price

WARREN BUFFETT: Number 3.

AUDIENCE MEMBER: Good afternoon, Mr. Berkshire and Mr. Hathaway. (Laughter) My name’s Anthony Priest. I’m from Washington, D.C. A couple months ago, I saw an ad in the “Wall Street Journal,” where it said, “Berkshire Hathaway wants to see real estate finance opportunities in excess of $100 million.” I was curious about your thoughts in this area, the real estate field, some of your goals, if you can talk about any of the deals you may have made, and if Donald Trump has given you a call yet. (Laughter)

WARREN BUFFETT: I don’t think Donald Trump will give us a call. We have got about, what, three deals that we’ve put on in the last couple of years in real estate. And they are in this $100-million-and-up category. And we’re willing to put billions and billions of dollars in, if we can find the right sort of opportunities. Or nothing may happen, depending on — just depending on the market. We don’t have — Most — a lot of places have a mortgage department, or they have a real estate department. And they sort of have a budget. And they put money out based on using up the budget. And they have a whole bunch of people that don’t have a job, unless they do that. That’s not the way we operate at Berkshire. We’re willing — if the deals are right, you know, we’ll do many billions. If the deals aren’t right, we don’t have anybody whose job is dependent on keeping busy in a field like that. So, we look at the deals when they come in. Mike Goldberg is in charge of that operation.

And we kick things around. He’s in the office right next to mine. So, if he hears about a deal, you know, we’ll discuss it for three minutes. And we’ll sort of know whether it passes the first threshold. And then we’ll go on to the second and the third. But we don’t waste a lot of time on things. And we don’t care whether we make another deal or not. We’d like to, if the terms are right. And that ad produced some inquiries, not from Donald Trump. And, you know, one or — there’s one or two of — a couple of them are alive at the present time. And we’ll see whether they work out. Real estate deals, by their nature, take longer to put to bed than the kind of thing we normally do. In fact, I can buy a business faster than we can make a real estate deal, usually. That’s just the way they work. But we could end up with a — We’re very happy with the three deals that we’ve got. They’re good uses of money.

And I hope we find a lot more. But if we don’t, I won’t be upset. Charlie, do you have anything to add? Charlie’s our real estate expert.

CHARLIE MUNGER: Hardly.

WARREN BUFFETT: We are not financing Charlie’s boat, incidentally, despite the rumors. (Laughter)

38. Berkshire is not a “fund”

WARREN BUFFETT: Number 4.

AUDIENCE MEMBER: Hi, my name is Joel. I’m an undergraduate student at the University of Virginia. Just — I have two questions. My first question is, how important do you think the structure of your fund is to its long-term success? And by that, I mean, in the last couple weeks, some other legendary investors, like Julian Robertson, Stanley Druckenmiller, have been forced to either close or restructure their funds as a result of a kind of vicious cycle of underperformance and subsequent redemptions and then even worse performance. Do you think that the structure of your fund, as a publically-traded company, as opposed to a private partnership, like Tiger and Quantum, has protected your business from a similar fate? Or phrased a different way, do you think that, if Tiger or Quantum were structured the way that Berkshire Hathaway is, that they might still be in business in the same way today?

WARREN BUFFETT: Yeah, we don’t consider ourselves in remotely the same business as Tiger. I mean, they are managing a securities operation. And we aren’t doing anything like what they do. So that — they have — Thirty years ago, when I had the partnership, it was much more along their lines, although still far from what they do. But it was structured much more like what they did. And I — and, although we had bought control of businesses and all that, we were functioning much more — or, focusing much more on securities. We don’t care whether we own a stock or a bond. We will over the next 20 years. But that’s not what we’re about. We’re not a fund. We are an operating business that generates a lot of capital and uses that to buy other businesses in whole or part. And we prefer in whole. But we sometimes do it in part. But I would — I don’t consider — which is a reason why I don’t consider book value that important, although it — it’s got the importance I attributed to it earlier.

But, we could easily have 90 percent of the value of Berkshire, ten years from now, be represented by businesses that we own and 10 percent by securities. Or we could very easily have 60 or 70 percent represented by securities, depending on how markets develop. I hope it develops in the former way. But I’m perfectly willing to go the other way, too. But it just has no relationship to the kind of funds you talk about. They — We are structured poorly, from a tax standpoint, compared to those fellows, and compared to what I used to have in the ’60s. But that’s, you know, that’s a decision we made. And we’re stuck with it, more or less. It’s not a great tax structure, if you’re going to own securities. But we may not own that many securities over time. Charlie?

CHARLIE MUNGER: Well, I do think that the people in the relative performance game, who are trying to attract so-called hot money, are living in a totally different world from ours. I mean, Soros, in the end, was not willing to have a lot of people make a lot of money in hightech stocks and not be part of that game. And they got killed. We’re perfectly willing to let something we don’t understand very well rage on while a lot of other people make a lot of money we don’t.

WARREN BUFFETT: Yeah, we — it’s just not a securities operation that we have. We own a lot of securities at present. And we’ll probably own a lot five or 10 years from now. But it’s not what Berkshire is necessarily about. Ideally, you know, I would love it if we could move all the money in securities into businesses that we liked. But that’s — that isn’t going to happen, in all probability. It’s too tough, because we can’t find multi-billion-dollar businesses to buy right and left. We find a few. But they tend to be small.

39. We wouldn’t buy a company that lies to itself

WARREN BUFFETT: Number 5?

AUDIENCE MEMBER: My name is Paul Tomasik from Chicago. My question is about intellectual honesty and your incredible ability of rising intellectual honesty in organizations. In particular, you look at General Re, a large, well-managed, publically-traded firm. And if you think about it, if you raise the intellectual honesty in an organization like that, initially, you’re going to have an aberration, as you called it. In particular, Berkshire Hathaway was the first company to write-down the Uni — what is it — Unicover write-down, whereas Aon pushed it on into the year 2000. Can you comment, give us some hints, on how you raise the intellectual honesty in an organization? And somebody whispered in my ear, they wanted to know Charlie’s reading list. I guess they finished “Guns, Germs, and Steel.” Thank you.

WARREN BUFFETT: We really don’t want to buy into any organization that we felt would be lacking that quality, in the first place. Because we really don’t believe in buying into organizations to change them. We may, you know, we may change the comp system a little or something of the sort. But, I’m not going to name names, but there are a whole lot of organizations that, if we bought into them, we wouldn’t move their needle one point in terms of how they operate. And we wouldn’t be comfortable with how they operated. So, we try to buy into organizations that we think are very much like ours, at bedrock. And General Re would’ve recognized that Unicover loss just as quickly if we hadn’t owned it, as we had. Now, that was not true of some other people. But they didn’t need any prodding from us in order to realize something like that. We want people joining us who already are the type that face reality and that tell us, basically, tell us the truth but tell themselves the truth, which is even more important.

And once you get an organization that lies to itself, and there are plenty that do, I just think you get into all kinds of problems. And people know it throughout the organization. And they adopt the norms of what they think is happening up above them. And particularly in a financial organization — really in any organization — but particularly in a financial organization, you know, that is death over time. And we wouldn’t buy into something that we felt had that problem, with the idea that we would correct it. Because we wouldn’t. You know, it — Charlie and I have had a little experience with some organizations that have had that sort of problem. And it’s not correctable, at least, you know, based on the lifespan of humans. It’s too much to commit to. Charlie?

CHARLIE MUNGER: Well, I think you’re totally right about General Re. We didn’t improve behavior at General Re. They already had a behavior just like ours. And regarding a reading list, by the mischances of life, I didn’t read one book last year that I thought was a lollapalooza. Therefore, I didn’t make any recommendations to that bookstore at the airport.

WARREN BUFFETT: Charlie, how many books do you think you’ve read, though? He reads a lot.

CHARLIE MUNGER: Well, I don’t count. And some of them, I skim through pretty fast. But there was no lollapalooza. A book like “Guns, Germs, and Steel” doesn’t come along every year.

WARREN BUFFET: OK —

CHARLIE MUNGER: And by the way, that guy was a little nuts in one way.

WARREN BUFFETT: It’s hard to get an A from Charlie. (Laughter)

40. Berkshire’s competitive advantages in reinsurance

WARREN BUFFETT: OK, is it 6 we’re going to?

AUDIENCE MEMBER: Hello. My name’s James Armstrong (PH) from Pittsburgh, Pennsylvania. Thanks for having us. I’d like you to comment, please, on the reinsurance business and how it might look over the next 10 or 20 years. At Berkshire, we’ve usually bought businesses that are insulated to some degree from easy entry by new competitors and from commodity-type pricing. We want businesses that possess defensible franchises, few substitutes, resistance to cyclical factors, et cetera. The reinsurance business carries a lot of characteristics that are the opposite of what we usually look for. There’s a lot of excess capacity. We’re hindered by irrational and unwise pricing decisions by competitors. For GenRe to prove out as an investment for us, we need better underwriting. And we also need prices to harden. But in a world with great global liquidity, where capital moves very rapidly from place to place, why wouldn’t the reinsurance business gradually evolve into a poor business, where all excess returns are competed away, where price is never firm for very long because a new entrant arises and throws capital at the business?

So I’d like you to comment on how GenRe could be made to work. And also, give us a broad view of how the reinsurance business might unfold in the next 10 or 20 years. Thanks.

WARREN BUFFETT: OK. You made some good points. And, I — we have been, actually, in the reinsurance business, at Berkshire Hathaway, for 30 years. So it’s a business, obviously, that we’ve paid a lot of attention to. And we’ve gotten some scars from it at times. But overall, we’ve done extremely well. And the reason we’ve done extremely well is because we’ve had an absolutely sensational manager in Ajit Jain, who I wrote about, running that business. But Ajit is a good example of what somebody with brains and energy and discipline and the right temperament and some capital behind him can do in a business. It’s not the world’s most efficient business. And it never will be the world’s most efficient business, because it’s not strictly actuarial. It — All excess returns will not be competed away. There will be people that will earn very subnormal returns in the business. There will be people who get killed in the business. And that means there will be quite a deviation from the mean in terms of the results of individual insurers.

And we think that both at National Indemnity, under Ajit, and at General Re, that we have advantages, so that our returns will be significantly better than average. But both of our businesses are subject to getting killed in any single year, will get killed in specific years, but also, in our view, will do better than average and more than satisfactory, in terms of Berkshire Hathaway’s results. You know, I can’t prove that to you now. I can show you what’s happened over the past years. I don’t think the situation in reinsurance is way different than some years back. There’s always dumb competitors. There’s always a lot of capital in the business. In the ’85, 1985, 1986 period, people felt very poor. But it wasn’t really a lack of financial capital. It was psychological capital that disappeared. People were just plain scared. And that was the best of times to be writing business, obviously. You know we like to — Prices are somewhat better now. But there are always people that misevaluate risk.

And when they misevaluate risk, it’s our job to let them have the business. That’s easier to do with Ajit’s business in National Indemnity than it is with General Re, because General Re has long-term relationships with many accounts. And the question of what you do when your competitor offers a price that’s a little too low, with somebody you’ve been doing business with for 50 years, is a very tough decision to make. And so sometimes, they probably do some business that might be labeled as “necessarily evil.” And Charlie always says that he doesn’t mind an occasional transaction like that, as long as you underline evil and not necessary. The nature of people in the business, usually, particularly the frontline guy, who was calling on the account, is to underline necessary. And as owners, our tendency is to underline evil. GenRe has done a terrific job, over the years, of balancing the necessity of continuing a relationship so long with the discipline of making sure they get paid enough. That was not done perfectly last year. And the conditions were very difficult for doing it perfectly, I might add, too.

But I think that, both at Ajit’s operation and at General Re, we have two businesses that will do very well, in terms of what we get out of them and very well compared to their competition, but occasionally will have a very bad year. I mean, we could have something happen tomorrow, you know, a Tokyo earthquake. Or, I can name a bunch of them that would result in a very bad year. And that’s what we’re getting paid for. And if we price with discipline, our 20-year results can’t be bad, no matter what any one year produces. And if we don’t price with discipline, we’ll get killed over time. Charlie?

CHARLIE MUNGER: Yeah. I don’t think the reinsurance business is quite as much of a commodity business as might first appear. It’s not like an execution transaction when you sell government bonds or something, where one broker is roughly just as good as another. There’s such a huge time lag between the time the premium is paid and the time the performance is given that you’re making a — the customer is making a big prediction about the insurer’s, A, willingness to pay what it really owes and, B, its ability to pay what it really owes. I think we have a huge edge in reputation and actuality, with reference to both those two factors.

WARREN BUFFETT: Yeah, we have a reputational advantage. And I think that, in actuality, it’s even stronger than the reputational advantage. I mean, I can’t think of a case where there’s been any problem with having Berkshire or General Re write a check very promptly for anything it owed. I mean, we’ve, you know, we have never been subject to people suing us and getting money later on or anything like that after fighting us out in courts. It just — it’s not the nature, it’s not the attitude we bring toward the reinsurance transaction. And we have a reputational advantage. But like I said, I don’t think it’s quite as wide as it should be in some cases, even. And then we have a huge attitudinal advantage in that we have no need, none, to write more business, or the same amount of business, or even something close to the amount of business, next year that we wrote this year. We — there is no — there are no volume goals at Berkshire Hathaway at all. And that is not true at most insurance organizations.

We report the results as they come in and as we see them, which also, I think, gives us an advantage in being realistic about all aspects of our business. We have huge amounts of capital behind us. So we can take large pieces of attractive business and keep them all for our own accounts. So we have a lot of advantages in the business. And they will translate into something better than the rest of the world gets. I don’t know how much better. And I don’t know how much the rest of the world will get. But it’s not insignificant, the advantages we have in the business.