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2019 Berkshire Hathaway Annual Meeting (Morning) Transcript

1. Welcome and Munger’s insurgency campaign

WARREN BUFFETT: Thank you.

Good morning and welcome to Berkshire Hathaway.

And for those of you who have come from out of state, welcome to Omaha. The city is delighted to have you here at this event.

And for those of you who came from outside of the country, welcome to the United States.

So, we’ve got people here from all over the world. We’ve got some overflow rooms that are taking care of people. And we will just have a few preliminaries and then we will move right into the Q&A period.

We’ll break about noon for about an hour. We’ll come back and do more Q&A until about 3:30. Then we’ll adjourn for a few minutes, and then we’ll conduct the meeting.

I understand that in the room adjacent, that Charlie has been conducting a little insurgency campaign.

I don’t know whether you’ve seen these, but these are the buttons that are available for those of you — you keep asking questions about succession. And Charlie wants to answer that question by getting your vote today. So, it says — this one says, “Maturity, experience, why accept second best? Vote for Charlie.” (Laughter)

I, however, have appointed the monitors who have — collect the votes, so I feel very secure. (Laughter)

2. Berkshire directors introduced

WARREN BUFFETT: The first thing I’d like to do — Charlie is my partner of 60 years, a director and vice chairman, and we make the big decisions jointly. It’s just that we haven’t had any big decisions. So, (laughter) we haven’t — we’re keeping him available for the next big one.

But now at the formal meeting today, we’ll elect 14 directors, and you’re looking at two of them. And I’d like to introduce the 12 that will be on the ballot at 3:45.

And I’m going to proceed alphabetically. And if they’ll stand. If you’ll withhold your applause because some of them get sensitive if certain people get more applause than others, and (Laughter) they’ll — and if you’ll withhold it till I’m finished, then you can applaud or not, as you see fit, having looked at these directors. (Laughter)

So, we’ll start on my left. Greg Abel, who’s both a chairman and a director. Greg? Yeah, oh, there we are. Right, OK. And going along alphabetically, Howard Buffett, Steve Burke, Sue Decker, Bill Gates, Sandy Gottesman— (applause) — Charlotte Guyman, Ajit Jain, who is also a vice chairman, Tom Murphy, Ron Olson, Walter Scott, and Meryl Witmer. Now you can applaud. (Applause)

3. Berkshire’s Q1: Pay attention to operating earnings

WARREN BUFFETT: Now, this morning we posted on our website the quarterly, the 10Q that’s required to be filed with the SEC. We published it at 7 o’clock Central Time. And we also published an accompanying press release.

And if we’ll put slide one up — these figures as usual require some explanation. As we’ve mentioned in the annual report, the new GAAP rule of Generally Accepted Accounting Principles require that we mark our securities to market and then report any unrealized gains in our earnings.

And you can see, I’ve warned you about the distortions from this sort of thing. And, you know, the first quarter of 2019 actually was much like the first quarter of 2018, and I hope very much that newspapers do not read headlines saying that we made $21.6 billion in the first quarter this year against a loss of last year.

These — the bottom line figures are going to be totally capricious, and what I worry about is that not everybody studied accounting in school, or they can be very smart people but that doesn’t mean that they’ve spent any real time on accounting.

And I really regard these bottom line figures, particularly if they’re emphasized in the press, as doing — as potentially being harmful to our shareholders, and really not being helpful. So, I encourage you now, and I encourage all the press that’s here, focus on what we call our operating earnings, which were up a bit. And forget about the capital gains or losses in any given period.

Now, they’re enormously important over time. We’ve had substantial capital gains in the future; we have substantial unrealized capital gains at the present time; we expect to have more capital gains in the future.

They are an important part of Berkshire, but they have absolutely no predictive value or analytical value on a quarterly basis or an annual basis. And I just hope that nobody gets misled in some quarter when stocks are down and people say, “Berkshire loses money,” or something of the sorts. It’s really a shame that the rules got changed in that way, but we will report.

But we will also explain, and we will do our best to have the press understand the importance of focusing on operating earnings, and that we do not attract shareholders who think that there’s some enormous gain because in the first quarter the stock market was up.

There’s one other footnote to these figures that I should point out. It’s already been picked up by the wires from our 7 o’clock filing.

We report on Kraft Heinz, of which we own about 27 percent or so. We report on what they call the equity method. Now, most stocks, when you get dividends, that goes into our earnings account, and their undistributed earnings don’t affect us. They affect us in a real way, but they don’t affect us in an accounting way.

We are part of a control group at Kraft Heinz, so instead of reporting dividends, we report what they call equity earnings.

Kraft Heinz has not filed their 10K for the 2018 year with the SEC. And therefore, they have not released the first quarter of 2019 earnings. Now, normally, we would include our percentage share of those earnings, and we’ve done that every quarter up till this quarter. But because we do not have those figures, we’ve just — we’ve not included anything.

We received 40 cents times — $130 million of dividends in the first quarter from our shares, but that reduces our carrying basis and it is not reflected in the earnings. So, that’s an unusual item which we have mentioned, specifically pointed out in our press release as well as included in our own.

But there is nothing in here, plus or minus, for Kraft earnings, Kraft Heinz earnings this year, whereas there was last year. And when we have the figures, obviously we will report them. Let’s see what beyond that I want to tell you.

4. Berkshire signs 20-year lease for its Omaha headquarters

WARREN BUFFETT: I think — oh yes, I’d wanted to mention to you, the Kiewit Company, which has been our landlord since 1962 — 57 years — has owned the building in which Berkshire is headquartered.

Kiewit Company is moving their headquarters and, in the process, will be doing something with the building. And they very generously, as they always have been, they came and said, “What kind of a lease would you like? Since we’re leaving, and we’ve always sort of worked these things out as we’ve gone along.” And so Bruce Grewcock, who runs Kiewit, said, “You just sort of — you name your terms and what you’d like. So, you — no matter with happens with the building, you’re all set.”

So, I was about to sign a ten-year lease for the present space, but Charlie said, “Ten years might be long enough for me but,” he said he would like me to sign one for 20 years, considering.

And — so we are entering a 20-year lease, and I confess to you that we now occupy one full floor, as we have for decades, and the new lease provides for two floors. So, I just want you to know that your management is loosening up just a little bit. (Laughter)

And whether or not we fill them is another question. But we will have that, and I would like to say to Omaha that I think the fact that Berkshire has signed up for 20 years is very good news for the city over time. It — (Applause) OK.

5. Berkshire employees pitch in for annual meeting

WARREN BUFFETT: And now I would like to tell you something about the people that make all of this possible. This is totally a — this is a homegrown operation.

We started with a few people, meeting in the lunchroom at National Indemnity many years ago. And I think we will probably set another record for attendance today. Yesterday afternoon, 16,200 people came in five hours, and that broke the previous record by a couple thousand.

On Tuesday, the Nebraska Furniture Mart did $9.3 million worth of business. And if any of you are in the retail business, you’ll know that that’s the yearly volume for some furniture stores, and here in Omaha, the 50th or so largest market in the country, maybe even a little less, $9.3 billion (million) I think probably exceeds anything any home furnishing store’s ever done in one day.

And we have people pitching, and we have all the people, virtually all of the people from the home office, some of them, you know, are — they’ll take on any task. We have a bunch of people from National Indemnity, for example, that come over, and they’ve been some of the monitors around.

And in terms of the exhibit hall, more than 600 people from our various subsidiaries give up a weekend to come to Omaha, work very hard, and tomorrow, 4:00 or 4:30, or I should say today at 4:00 or 4:30, they will start packing up things and heading back home. And they come in, and I saw them all yesterday, and they were a bunch of very, very happy, smiling faces. And, you know, they work hard all year, and then they come in and help us out on this meeting.

And then, finally, if we could get a spotlight, I think Melissa Shapiro is someplace here — she runs the whole show. I mean, we — Melissa, where are you? (Applause)

Melissa’s name was Melissa Shapiro before she got married, then she married a guy named Shapiro, so now she’s Melissa Shapiro Shapiro. So — (Laughter) but she can handle that sort of thing. She handles everything, and never — totally unflappable. Totally organized. Everything gets done. Everybody likes her when they get through. So, I — it’s marvelous to get a chance to work with people like this.

I think it’s a special quality that — at Berkshire. I think other people would hire some group to put on the meeting and all be very professional and all of that. But I don’t think you can get — I don’t think you can buy the enthusiasm and energy and help-the-next-guy feeling that you’ve seen out on that exhibition floor, and you’ll see as you meet people here at the hall, and as you meet the people around Omaha. They’re very, very happy that you’re here.

6. Q&A Begins

WARREN BUFFETT: And with that, I would like to start on the questions. We’ll do it just as we’ve done it in recent years. We’ll start with the press group. They’ve received emails from a great many people — perhaps they can tell you how many — and selected the questions they think would be most useful to the Berkshire shareholders.

Yahoo is webcasting this as they’ve done for several years now, they’ve done a terrific job for us.

So, this meeting is going out, both in English and in Mandarin, and I hope our results translate well, or our — (laughs) our comments translate well. Sometimes we have trouble with English. But we’re going to — we’ll start in with Carol Loomis, my friend of 50 years, but you’ll never know it by the questions she’s going to ask me. (Laughter)

CAROL LOOMIS: I’m going to start, very briefly — this is for the benefit of people who send us questions next year. There are kind of two things that you get wrong a lot of the time. You can’t send two-part questions or three-part, et cetera. We need a one-part question. And the other thing is the questions all need to have some relevance to Berkshire, because Warren said when he started it that his hope was that shareholders would come out of the questions with a further education about the company. So, keep those in mind for next year.

7. Munger: “I predict we’ll get a little more liberal in repurchasing shares”

CAROL LOOMIS (RETIRED FORTUNE MAGAZINE EDITOR): Many people — a number of people — wrote me about repurchases of stock. And, hence, the question I picked for my first one.

The question, this particular question comes from Ward Cookie (PH), who lives in Belgium and who was still emailing me this morning in reference to the first quarter report.

And he asked, “My question concerns your repurchase of Berkshire shares. In the third quarter of last year, you spent almost 1 billion buying Berkshire B stock at an average price of $207.

“But then you got to a period between December 26th and April 11th when the stock languished for almost four months under 207. And yet, you purchased what I think of as a very limited amount of stock, even as you were sitting on an enormous pile of 112 billion.

“My question is why you did not repurchase a lot more stock? Unless, of course, there was for a time an acquisition of, say, 80 billion to 90 billion on your radar.”

WARREN BUFFETT: Yeah, the question — whether we had 100 billion or 200 billion would not make a difference — or 50 billion — would not make a difference in our approach to repurchase of shares.

We repurchase shares — we used to have a policy of tying it to book value. But that became — really became obsolete. It did not —

The real thing is to buy stock — repurchase shares — only when you think you’re doing it at a price where the remaining shareholders have had — are worth more the moment after you repurchased it than they were the moment before.

It’s very much like if you were running a partnership and you had three partners in it and the business was worth 3 million, and one of the partners came and said, “I’d like you to buy back my share of the partnership for a billion” — I started out with millions, so I’ll stay with millions — “for $1.1 million?” And we said, “Forget it.” And if he said, “1 million?” we’d probably say, “Forget it,” unless — and if he said, “900,000,” we’d take it because, at that point, the remaining business would be worth 2-million-1, and we’d have two owners, and our interest in value would have gone from a million to a million and fifty-thousand.

So, it’s very simple arithmetic. Most companies adopt repurchase programs and they just say, “We’re going to spend so much.” That’s like saying, you know, “We’re going to buy XYZ stock, and we’re going to spend so much here.” “We’re going to buy a company.” “We’re going to spend whatever it takes.”

We will buy stock when we think it is selling below a conservative estimate of its intrinsic value. Now, the intrinsic value is not a specific point, it’s probably a range in my mind that might have a band maybe of 10 percent. Charlie would have a band in his mind, and it would probably be 10 percent. And ours would not be identical, but they’d be very close. And sometimes he might figure a bit higher than I do, a bit lower.

But we want to be sure, when we repurchase shares, that those people who have not sold shares are better off than they were before we repurchased them. And it’s very simple.

And in the first quarter of the year, they’ll find we bought something over a billion worth of stock, and that’s nothing like my ambitions. But it — what that means is that we feel that we’re OK buying it, but we don’t salivate over buying it.

We think that the shares we repurchased in the first quarter leave the shareholders better off than if we hadn’t — the remaining shareholders — better off than if we hadn’t bought it. But we don’t think the difference is dramatic.

And you will — you could easily see periods where we would spend very substantial sums if we thought the stock was selling at, say, 25 or 30 percent less than it was worth, and we didn’t have something else that was even better.

But we have no ambition in any given quarter to spend a dime unless we think you’re going to be better off for us having done so. Charlie?

CHARLIE MUNGER: Well, I predict that we’ll get a little more liberal in repurchasing shares. (Laughter)

WARREN BUFFETT: I was going to give you equal time, but then — (Laughter)

8. BNSF may adopt “precision-scheduled railroading”

WARREN BUFFETT: OK, Jon Brandt.

JONATHAN BRANDT (RESEARCH ANALYST, RUANE, CUNNIFF & GOLDFARB): Hi, Warren and Charlie. Thanks for having me, as always.

Every major North American railroad other than Burlington Northern has adopted at least some aspects of precision-scheduled railroading, generally to good effect to their bottom line.

Some believe that point-to-point schedule service and minimal in-transit switching is good for both returns on capital and customer service.

Others believe precision railroading has done little for on-time performance, and its rigidity has jeopardized the compact that railroads have had with both regulators and customers.

Do you and current BNSF management believe that it’s now a good idea for BNSF to adopt precision railroading playbook? Or do you agree with its critics?

WARREN BUFFETT: Yeah, precision railroading, as it’s labeled, was probably invented by a fellow named Hunter Harrison. I think maybe he was at the Illinois Central Railroad at the time; there’s a book that came out about Hunter, who died maybe a year ago or thereabouts. And it describes the — his procedure toward railroading. It’s an interesting read if you’re interested in railroading.

And he took that to Canadian National, CN. There are six big railroads in North America, and he took that to CN, and he was very successful.

And actually, Bill Gates is probably the largest holder of CN, and I think he’s done very well with that stock.

And then later, Canadian Pacific was the subject of an activist, and when they — as they proceeded, they got Hunter to join them and brought in an associate, Keith Creel, who — and they instituted a somewhat similar program. Now the same thing has happened at CSX.

And all of those companies dramatically improved their profit margins, and they had varying degrees of difficulty with customer service in the implementing of it.

But I would say that we watch very carefully — Union Pacific is doing a somewhat modified version. But the — we are not above copying anything that is successful. And I think that there’s been a good deal that’s been learned by watching these four railroads, and we will — if we think we can serve our customers well and get more efficient in the process, we will adopt whatever we observe.

But we don’t have to do it today or tomorrow, but we do have to find something that gets at least equal, and hopefully better, customer satisfaction and that makes our railroad more efficient. And there’s been growing evidence that — from the actions of these other four railroads — there’s been growing evidence that we can learn something from what they do. Charlie?

CHARLIE MUNGER: Well, I doubt that anybody is very interested in un-precision in railroading. (Laughter)

WARREN BUFFETT: Well, Jonny, has Charlie answered your question? (Laughter)

JONATHAN BRANDT: Yes, thank you.

9. BNSF trying to improve energy efficiency

WARREN BUFFETT: OK. Station number 1, from the shareholder group up on my far right.

AUDIENCE MEMBER: Good morning. My name is Bill Moyer and I’m from Vashon Island, Washington. And I’m part of a team called “The Solutionary Rail Project.”

Interestingly, only 3.5 percent of the value of freight in the U.S. moves on trains. Berkshire Hathaway is incredibly well positioned with its investments in the northern and southern trans-con through BNSF to grab far more of that freight traffic off of the roads and get diesel out of our communities, as well as harness transmission corridors for your Berkshire renewable energy assets, for which you’re obviously very proud.

Would you consider meeting with us to look at a proposal for utilizing your assets and leveraging a public/private partnership to electrify your railroads and open those corridors for a renewable energy future?

WARREN BUFFETT: No, I — we’ve examined a lot of things in terms of LNG. I mean, they’re — obviously, we want to become more energy efficient, as well as just generally efficient.

And I’m not sure about the value of freight. You mentioned 3 1/2 percent. I believe — I mean, I’m not sure what figure you’re using as the denominator there.

Because if you look at movement of traffic by ton miles, rails are around 40 percent of the U.S. — we’re not talking local deliveries or all kinds of things like that — but they’re 40 percent, roughly, by rail.

And BNSF moves more ton miles than any other entity. We move 15 percent-plus of all the ton miles moved in the United States.

But if you take trucking, for example, on intermodal freight, we’re extremely competitive on the longer hauls, but the shorter the haul, the more likely it is that the flexibility of freight, where a truck can go anyplace and we have rails. So, the equation changes depending on distance hauled and other factors, but distance hauled is a huge factor.

We can move a ton mile 500 — we can move 500-plus ton miles of freight for one gallon of diesel. And that is far more efficient than trucks.

So, the long-haul traffic, and the heavy traffic, is going to go to the rails, and we try to improve our part of the equation on that all the time.

But if you’re going to transport something ten or 20 or 30 miles between a shipper and a receiver, and they’re — you’re not going to move that by rail.

So, we look at things all the time, I can assure you.

Carl Ice is in — well, he’s probably here now, and he’ll be in the other room — and he’s running the railroad. You’re free to talk to him, but I don’t see any breakthrough like you’re talking about. I do see us getting more efficient year-by-year-by-year.

And obviously, if driverless trucks become part of the equation, that moves things toward trucking. But on long-haul, heavy stuff, and there’s a lot of it, you’re looking at the railroad that carries more than any other mode of transportation. And BNSF is the leader. Charlie?

CHARLIE MUNGER: Well, over the long term, our questioner is on the side of the angels. Sooner or later, we’ll have it more electrified. I think Greg (Abel) will decide when it happens.

WARREN BUFFETT: Yeah. But we’re all working on the technology but —

And we’re considerably more efficient than ten, 20, 30 years ago, if you look at the numbers. But it —

One interesting figure, I think right after World War II, when the country probably had about 140 million people against our 330 million now, so we had 40 percent of the population. We had over a million-and-a-half people employed in the railroad industry. Now there’s less than 200,000 and we’re carrying a whole lot more freight.

Now, obviously there’s some change in passengers. But the efficiency of the railroads compared to — and the safety — compared to what it was even immediately after World War II has improved dramatically. Charlie, anything more?

CHARLIE MUNGER: No.

10. Bank CEOS who make bad mistakes should lose all their net worth

WARREN BUFFETT: OK, Becky?

BECKY QUICK (CNBC): This is a question that comes from Mike Hebel. He says, “The Star Performers Investment Club has 30 partners, all of whom are active or retired San Francisco police officers. Several of our members have worked in the fraud detail, and have often commented after the years-long fraudulent behavior of Wells Fargo employees, should have warranted jail sentences for several dozen, yet Wells just pays civil penalties and changes management.

“As proud shareholders of Berkshire, we cannot understand Mr. Buffett’s relative silence compared to his vigorous public pronouncement many years ago on Salomon’s misbehavior. Why so quiet?”

WARREN BUFFETT: Yeah, I would say this. The — (applause) — problem, well, as I see it — although, you know, I have read no reports internally or anything like that — but it looks like to me like Wells made some big mistakes in what they incentivized. And as Charlie says, there’s nothing like incentives, but they can incentivize the wrong behavior. And I’ve seen that a lot of places. And that clearly existed at Wells.

The interesting thing is, to the extent that they set up fake accounts, a couple million of them, that had no balance in them, that could not possibly have been profitable to Wells. So, you can incentivize some crazy things.

The problem is — I’m sure is that — and I don’t really have any inside information on it at all — but when you find a problem, you have to do something about it. And I think that’s where they probably made a mistake at Wells Fargo.

They made it at Salomon. I mean, John Gutfreund would never have played around with the government. He was the CEO of Salomon in 1991. He never would have done what the bond trader did that played around with the rules that the federal government had about government bond bidding.

But when he heard about it, he didn’t immediately notify the Federal Reserve. And he heard about it in late April, and May 15th, the government bond auction came along. And Paul Mozer did the same thing he’d done before, and gamed the auction.

And at this point, John Gutfreund — you know, the destiny of Salomon was straight downhill from that point forward. Because, essentially, he heard about a pyromaniac, and he let him keep the box of matches.

And at Wells, my understanding, there was an article in The Los Angeles Times maybe a couple years before the whole thing was exposed, and, you know, somebody ignored that article.

And Charlie has beaten me over the head all the years at Berkshire because we have 390,000 employees, and I will guarantee you that some of them are doing things that are wrong right now. There’s no way to have a city of 390,000 people and not need a policeman or a court system. And some people don’t follow the rules. And you can incentivize the wrong behavior. You’ve got to do something about it when it happens.

Wells has become, you know, exhibit one in recent years. But if you go back a few years, you know, you can almost go down — there’s quite a list of banks where people behaved badly. And where they — I would not say — I don’t know the specifics at Wells — but I’ve actually written in the annual report that they talk about moral hazard if they pay a lot of people.

The shareholders of Wells have paid a price. The shareholders of Citicorp paid a price. The shareholders of Goldman Sachs, the shareholders of Bank of America, they paid billions and billions of dollars, and they didn’t commit the acts. And of course, nobody did go — there were no jail sentences. And that is infuriating.

But the lesson that was taught was not that the government bailed you out because the government got its money back, but the shareholders of the various banks paid many, many billions of dollars.

And I don’t have any advice for anybody running a business except, when you find out something is leading to bad results or bad behavior, you know, you — if you’re in the top job, you’ve got to take action fast.

And that’s why we have hotlines. That’s why we get — when we get certain anonymous letters, we turn them over to the audit committee or to outside investigators.

And we will have — I will guarantee you that we will have some people who do things that are wrong at Berkshire in the next year or five years, ten years, and 50 years. It’s — you cannot have 390,000 people — and it’s the one thing that always worries me about my job, but — because I’ve got to hear about those things, and I’ve got to do something about them when I do hear about them. Charlie?

CHARLIE MUNGER: Well, I don’t think people ought to go to jail for honest errors of judgment. It’s bad enough to lose your job. And I don’t think that any of those top officers was deliberately malevolent in any way. I just — we’re talking about honest errors in judgment.

And I don’t think (former Wells Fargo CEO) Tim Sloan even committed honest errors of his judgment, I just think he was an accidental casualty that deserve the trouble. I wish Tim Sloan was still there.

WARREN BUFFETT: Yeah, there’s no evidence that he did a thing. But he stepped up to take a job that — where he was going to be a piñata, basically, for all kinds of investigations.

And rightfully, Wells should be checked out on everything they do. All banks should. I mean, they get a government guarantee and they receive trillions of dollars in deposits. And they do that basically because of the FDIC. And if they abuse that, they should pay a price.

If anybody does anything like a Paul Mozier did, for example, with Salomon, they ought to go to jail. Paul Mozier only went to jail for four months. But if you’re breaking laws, you should be prosecuted on it.

If you do a lot of dumb things, I wish they wouldn’t go away — the CEOs wouldn’t go away — so rich under those circumstances. But people will do dumb things. (Applause)

I actually proposed — think it may have been in one of the annual reports even. I proposed that, if a bank gets to where it needs government assistance, that basically the responsible CEO should lose his net worth and his spouse’s net worth. If he doesn’t want the job under those circumstances, you know (Applause)

And I think that the directors — I think they should come after the directors for the last five years — I think I proposed — of everything they’d received.

But it’s the shareholders who pay. I mean, if we own 9 percent of Wells, whatever this has cost, 9 percent of it is being borne by us. And it’s very hard to tie it directly.

One thing you should know, incidentally though, is that the FDIC, which was started — I think it was started January 1st, 1934 — but it was a New Deal proposal.

And the FDIC has not cost the United States government a penny. It now has about $100 billion in it. And that money has all been put in there by the banks. And that’s covered all the losses of the hundreds and hundreds and hundreds of financial institutions.

And I think the impression is that the government guarantee saved the banks, but the government money did not save the banks. The banks’ money, as an industry, not only has paid every loss, but they’ve accumulated an extra $100 billion, and that’s the reason the FDIC. assessments now are going back down. They had them at a high level. And they had a higher level for the very big banks.

When you hear all the talk about — the political talk — about the banks, they had not cost the federal government a penny. There were a lot of actions that took place that should not have taken place. And there’s a lot fewer now, I think, than there were in the period leading up to 2008 and ’09. But some banks will make big mistakes in the future. Charlie?

CHARLIE MUNGER: I’ve got nothing to add to that.

11. “We will spend a lot of money” on buybacks if price is right

WARREN BUFFETT: OK. Jay Gelb from Barclays. Barclays just had a proxy contest of sorts, didn’t it?

JAY GELB (INSURANCE ANALYST, BARCLAYS): That’s right, Warren. (Laughs)

I also have a question on Berkshire Hathaway — I’m sorry — on share buybacks.

Warren, in a recent Financial Times article, you were quoted as saying that the time may come when the company buys back as much as $100 billion of its shares, which equates to around 20 percent of Berkshire’s current market cap. How did you arrive at that $100 billion figure? And over what time frame would you expect this to occur?

WARREN BUFFETT: Yeah. I probably arrived at that $100 billion figure in about three seconds when I got asked the question. (Laughter)

It was a nice round figure and we could do it. And we would like to do it if the stock was — we’ve got the money to buy in $100 billion worth of stock.

And bear in mind, if we’re buying in $100 billion stock, it probably would be that the company wasn’t selling at 500 billion. So, it might buy well over 20 percent.

We will spend a lot of money. We’ve been involved in companies where the number of shares has been reduced 70 or 80 percent over time. And we like the idea of buying shares at a discount.

We do feel, if shareholders — if we’re going to be repurchasing shares from shareholders who are partners, and we think it’s cheap, we ought to be very sure that they have the facts available to evaluate what they own.

I mean, just as if we had a partnership, it would not be good if there were three partners and two of them decided that they would sort of freeze out the third, maybe in terms of giving him material information that they knew that that third party didn’t know.

So, it’s very important that our disclosure be the same sort of disclosure that I would give to my sisters who are the imaginary — they’re not imaginary — but they’re the shareholders to whom I address the annual report every year.

Because I do feel that you, if you’re going to sell your stock, should have the same information that’s important, that’s available to me and to Charlie.

But we will — if our stock gets cheap, relative to intrinsic value, we would not hesitate.

We wouldn’t be able to buy that much in a very short period of time, in all likelihood. But we would certainly be willing to spend $100 billion. Charlie?

CHARLIE MUNGER: I think when it gets really obvious, we’ll be very good at it. (Laughter)

WARREN BUFFETT: Let me get that straight. What’d you say, exactly?

CHARLIE MUNGER: When it gets really obvious, we’ll be very good at it.

WARREN BUFFETT: Oh, yeah. I was hoping that’s what you said. (Laughter)

Yeah, we will be good at it. We don’t have any trouble being decisive. We don’t say yes very often. But if it’s something obvious — I mean, Jay, if you and I are partners, you know, and our business is worth a million dollars and you say you’ll sell your half to me for 300,000, you’ll have your 300,000 very quickly.

12. Buying one share in an oil-rich duck hunting club

WARREN BUFFETT: OK, station two.

AUDIENCE MEMBER: Good morning. My name is Patrick Donahue from Eden Prairie, Minnesota, and I’m with my ten-year-old daughter, Brooke Donahue.

AUDIENCE MEMBER: Hi, Warren. Hi, Charlie.

WARREN BUFFETT: Hi. It’s Brooke, is it?

AUDIENCE MEMBER: It is.

WARREN BUFFETT: Yeah.

AUDIENCE MEMBER: First, I’m a proud graduate of Creighton University. And I need to say a personal thank you for coming over the years to share your insights. And it’s been a tradition since I graduated in 1999 to come to the annual meeting, and thank you for a lifetime of memories.

WARREN BUFFETT: Thank you. (Applause)

AUDIENCE MEMBER: Brooke is a proud Berkshire shareholder and read the letter and had some questions regarding investments that have been made in the past. And she had made some interesting comments about what she thought was a lot of fun.

So, our question for both of you is: outside of Berkshire Hathaway, what is the most interesting or fun personal investment you have ever made? (Laughter)

WARREN BUFFETT: Well, they’re always more fun when you make a lot of money off of them. (Laughter)

Well, one time, I bought one share of stock in the Atled Corp. That’s spelled A-T-L-E-D. And Atled had 98 shares outstanding and I bought one. And not what you call a liquid security. (Laughter)

And Atled happened to be the word “delta” spelled backwards. And a hundred guys in St. Louis had each chipped in 50 or $100 or something to form a duck club in Louisiana and they bought some land down there.

Two guys didn’t come up with their — there were a hundred of them — two of them defaulted on their obligation to come up with a hundred dollars — so there were 98 shares out. And they went down to Louisiana and they shot some ducks.

But apparently somebody shot — fired a few shots into the ground and oil spurted out. And — (laughter) — those Delta duck club shares — and I think the Delta duck club field is still producing. I bought stock in it 40 years ago for $29,200 a share.

And it had that amount in cash and it was producing a lot, and they sold it. If they kept it, that stock might’ve been worth 2 or $3 million a share, but they sold out to another oil company.

That was certainly — that was the most interesting —

Actually, I didn’t have any cash at the time. And I went down and borrowed the money. I bought it for my wife. And I borrowed the money. And the loan officer said, “Would you like to borrow some money to buy a shotgun as well?” (Laughter)

Charlie, tell them about the one you missed. (Laughter)

CHARLIE MUNGER: Well, I got two investments that come to mind. When I was young and poor, I spent a thousand dollars once buying an oil royalty that paid me 100,000 a year for a great many years. But I only did that once in a lifetime.

On a later occasion, I bought a few shares of Belridge Oil, which went up 30 times rather quickly. But I turned down five times as much as I bought. It was the dumbest decision of my whole life. So, if any of you have made any dumb decisions, look up here and feel good about yourselves. (Laughter)

WARREN BUFFETT: I could add a few, but — Andrew?

13. Buffett speaks for himself on politics, not for Berkshire

ANDREW ROSS SORKIN (NEW YORK TIMES/CNBC): Warren and Charlie, this is a question — actually, we got a handful of questions on this topic. This is probably the best formulation of it.

Warren, you have been a long-time, outspoken Democrat. With all the talk about socialism versus capitalism taking place among Democratic presidential candidates, do you anticipate an impact on Berkshire in the form of more regulations, higher corporate taxes, or even calls for breakups among the many companies we own if they were to win?

And how do you think about your own politics as a fiduciary of our company, and at the same time, as someone who has said that simply being a business leader doesn’t mean you’ve put your citizenship in a blind trust?

WARREN BUFFETT: Yeah. I have said that you do not put your citizenship in a blind trust. But you also don’t speak on behalf of your company. You do speak as a citizen if you speak. And therefore, you have to be careful about when you do speak, because it’s going to be assumed you’re speaking on behalf of your company.

Berkshire Hathaway certainly, in 54 years, has never — and will never — made a contribution to a presidential candidate. I don’t think we’ve made a contribution to any political candidate. But I don’t want to say, for 54 years, that — (Applause)

We don’t do it now. We operate in several regulated industries. And our railroad and our utility, as a practical matter, they have to have a presence in Washington or in the state legislatures in which they operate.

So, we have some — a few — I don’t know how many — political action committees which existed when we bought it — when we bought the companies at subsidiaries.

And I think, unquestionably, they make some contributions simply to achieve the same access as their competitors. I mean, if the trucking industry is going to lobby, I’m sure the railroad industry’s going to lobby.

But — the general — well, the rule is, I mean, that people do not pursue their own political interests with your money here.

We’ve had one or two managers over the years, for example, that would do some fundraising where they were fundraising from people who were suppliers of them or something of the sort. And if I ever find out about it, that ends promptly.

My position, at Berkshire, is not to be used to further my own political beliefs. But my own political beliefs can be expressed as a person, not as a representative of Berkshire, when a campaign is important.

I try to minimize it. But it’s no secret that in the last election, for example, I raised money.

I won’t give money to PACs. I accidentally did it one time. I didn’t know it was a PAC. But I don’t do it.

But I’ve raised substantial sums. I don’t like the way money is used in politics. I’ve written op-ed pieces for the New York Times in the past on the influence of money in politics.

I spent some time with John McCain many years ago before McCain-Feingold, on ways to try to limit it. But the world has developed in a different way.

14. Buffett: “I’m a card-carrying capitalist” but some regulations are needed

WARREN BUFFETT: On your question about the — I will just say I’m a card-carrying capitalist. (Applause)

But I — and I believe we wouldn’t be sitting here except for the market system and the rule of law and some things that are embodied in this country. So, you don’t have to worry about me changing in that manner.

But I also think that capitalism does involve regulation. It involves taking care of people who are left behind, particularly when the country gets enormously prosperous. But beyond that, I have no Berkshire podium for pushing anything. Charlie?

CHARLIE MUNGER: Well, I think we’re all in favor of some kind of a government social safety net in a country as prosperous as ours.

What a lot of us don’t like is the vast stupidity with which parts of that social safety net are managed by the government. It’d be much better if — (applause) — we could do it more wisely. But I think it also might be better if we did it more liberally.

WARREN BUFFETT: Yeah, one of the reasons we’re involved in this effort along with J.P. Morgan and Amazon — with (J.P. Morgan CEO) Jamie Dimon and (Amazon CEO) Jeff Bezos — on the medical question, is we do have as much money going — 3.3 or 3.4 trillion — we have as much money going to medical care as we have funding the federal government.

And it’s gone from 5 to 17 percent — or 18 percent — while actually the amount going to the federal government has stayed about the same at 17 percent.

So, we hope there’s some major improvements from the private sector because I generally think the private sector does a better job than the public sector in most things.

But I also think that if the private sector doesn’t do something, you’ll get a different sort of answer. And I’d like to think that the private sector can come up with a better answer than the public sector in that respect.

I will probably — it depends who’s nominated — but I voted for plenty of Republicans over the years. I even ran for delegate to the Republican National Convention in 1960. But — we are not —

I don’t think the country will go into socialism in 2020 or in 2040 or 2060.

15. We don’t try to push Berkshire stock higher or lower

WARREN BUFFETT: OK, Gregg Warren.

GREGG WARREN (FINANCIAL SERVICES ANALYST, MORNINGSTAR RESEARCH SERVICES): Warren, my first question, not surprisingly, is on share repurchases.

Stock buybacks in the open market are a function of both willing buyers and sellers. With Berkshire having two shares of classes, you should have more flexibility when buying back stock. But given the liquidity difference that exists between the two share classes — with an average of 313 Class A shares exchanging hands daily the past five years, equivalent to around $77 million a day, and an average of 3.7 million Class B shares doing the same, equivalent to around 622 million — Berkshire’s likely to have more opportunities to buy back Class B shares than Class A, which is exactly what we saw during the back half of last year and the first quarter of 2019.

While it might be more ideal for Berkshire to buy back Class A shares, allowing you to retire shares with far greater voting rights, given that there’s relatively little arbitrage between the two share classes and the number of Class B shares increase every year as you gift your Class A shares to the Bill and Melinda Gates Foundation and your children’s foundations, can we assume that you’re likely to be a far greater repurchaser of Class B shares, going forward, especially given your recent comments to the Financial Times about preferring to have loyal individuals on your shareholder list, which a price tag of $328,000 of Class A shares seems to engender?

WARREN BUFFETT: Yeah, we will - when we’re repurchasing shares, if we’re purchasing substantial amounts, we’re going to spend a lot more on the Class B than the Class A, just because the trading volume is considerably higher.

We may, from time to time — well, we got offered a couple blocks in history, going back in history from the Yoshi (PH) estate and when we had a transaction exchanging our Washington Post stock for both a television station and shares held — A shares — held by the Washington Post.

So, we may see some blocks of A. We may see some blocks of B. But there’s no question. If we are able to spend 25, 50, or a hundred billion dollars in repurchasing shares, more of the money is almost certainly going to be spent on the B than the A.

There’s no master plan on that other than to buy aggressively when we like the price. And as I say, the trading volume in the B is just a lot higher than the A in dollar amounts. Charlie?

CHARLIE MUNGER: I don’t think we care much which class we buy.

WARREN BUFFETT: Yeah. (Laughter)

We would like — we really want the stock — ideally, if we could do it if we were small — once a year we’d have a price and, you know, we’d do it like a private company. And it would be a fair price and people who want to get out could get out. And if other people wanted to buy their interest, fine. And if they didn’t, and we thought the price was fair, we’d have the company repurchase it.

We can’t do that. But that’s — we don’t want the stock to be either significantly underpriced or significantly overpriced. And we’re probably unique on the overpriced part of it. But we don’t want it.

I do not want the stock selling at twice what’s it worth because I’m going to disappoint people, you know. I mean, we can’t make it — there’s no magic formula to make a stock worth what it’s selling for, if it sells for way too much.

From a commercial standpoint, if it’s selling very cheap, we have to like it when we repurchase it.

But ideally, we would hope the stock would sell in a range that more or less is its intrinsic business value. We have no desire to hype it in any way. And we have no desire to depress it so we can repurchase it cheap. But the nature of markets is that things get overpriced and they get underpriced. And we will — if it’s underpriced, we’ll take advantage of it.

16. We welcome change, but we won’t always adapt to it

WARREN BUFFETT: OK, station 3.

AUDIENCE MEMBER: Hello Charlie Munger and Warren Buffett, (unintelligible). I am Terry (PH) from Shanghai (unintelligible), which aims to catch the best investment opportunities in that era.

So, my question is, as we all know, 5G is coming. It is said that the mode of all industry will be challenged in 5G era. So, what is the core competence that we should master, if (unintelligible) wants to catch the best investment opportunities in this era? Thank you.

WARREN BUFFETT: Well, there’s no core competence at the very top of Berkshire. (Laughter)

The subsidiaries that will be involved in developments relating to 5G, or any one of all kinds of things that are going to happen in this world, you know, the utility of LNG in the railroad, or all those kinds of questions, we have people in those businesses that know a lot more about them than we do.

And we count on our managers to anticipate what is coming in their business. And sometimes they talk to us about it. But we do not run that on a centralized basis.

And Charlie, do you want to have anything to add to that?

Do you know anything about 5G I don’t know? Well, you probably know a lot about 5G.

CHARLIE MUNGER: No, I know very little about 5G.

But I do know a little about China. And we have bought things in China. And my guess is we’ll buy more. (Laughter)

WARREN BUFFETT: Yeah. But I mean, we basically want to have a group of managers, and we do have a group of managers, who are on top of their businesses.

I mean, you saw something that showed BNSF and Berkshire Hathaway Energy and Lubrizol all aware of that. Those people know their businesses. They know what changes are likely to be had.

Sometimes, they find things that they can cooperate on between their businesses. But we don’t try to run those from headquarters.

And that may mean — that may have certain weaknesses at certain times. I think, net, it’s been a terrific benefit for Berkshire.

Our managers, to a great degree, own their businesses. And we want them to feel a sense of ownership. We don’t want them to be lost in some massive conglomerate, where they get directions from this group, which is a subgroup of that group.

And I could tell you a few horror stories from companies we bought, when they tell us about their experience under such an operation.

The world is going to change in dramatic ways. Just think how much it’s changed in the 54 years that we’ve had Berkshire. And some of those changes hurt us.

They hurt us in textiles. They hurt us in shoes. They hurt us in the department store business. Hurt us in the trading stamp business. These were the founding businesses of this operation. But we do adjust. And we’ve got a group, overall, of very good businesses.

We’ve got some that will be, actually, destroyed by what happens in this world. But that’s — I still am the card-carrying capitalist. And I believe that that’s a good thing, but you have to make changes.

We had 80 percent of the people working on farms in 1800. And if there hadn’t been a lot of changes, and you needed 80 percent of the people in the country producing the food and cotton we needed, we would have a whole different society.

So, we welcome change. And we certainly want to have managers that can anticipate and adapt to it. But sometimes, we’ll be wrong. And those businesses will wither and die. And we’d better use the money someplace else. Charlie? OK, Carol.

Charlie, you haven’t had any peanut brittle lately, you know. (Laughs)

17. Kraft Heinz is a good business, but we paid too much

CAROL LOOMIS: This question comes from Vincent James of Munich, Germany. “There has been a lot written about the recent impairment charge at Kraft Heinz. You were quoted as stating that you recognize that Berkshire overpaid for Kraft Heinz. Clearly, major retail chains are being more aggressive in developing house brands.

“In addition, Amazon has announced intentions to launch grocery outlets, being that, as Mr. Bezos has often stated, ‘Your margin is my opportunity.’ The more-fundamental question related to Kraft Heinz may be whether the advantages of the large brands and zero-based budgeting that 3G has applied are appropriate and defensible at all in consumer foods.

“In other words, will traditional consumer good brands, in general, and Kraft Heinz, in particular, have any moat in their future? My question is, to what extent do the changing dynamics in the consumer food market change your view on the long-term potential for Kraft Heinz?”

WARREN BUFFETT: Yeah, actually, what I said was, we paid too much for Heinz — I mean Kraft — I’m sorry — the Heinz part of the transaction, when we originally owned about half of Heinz, we paid an appropriate price there. And we actually did well. We had some preferred redeemed and so on.

We paid too much money for Kraft. To some extent, our own actions had driven up the prices.

Now, Kraft Heinz, the profits of that business, 6 billion — we’ll say very, very, very roughly, I’m not making forecasts — but 6 billion pretax on 7 billion of tangible assets, is a wonderful business. But you can pay too much for a wonderful business.

We bought See’s Candy. And we made a great purchase, as it turned out. And we could’ve paid more. But there’s some price at which we could’ve bought even See’s Candy, and it wouldn’t have worked. So, the business does not know how much you paid for it.

I mean, it’s going to earn based on its fundamentals. And we paid too much for the Kraft side of Kraft Heinz.

Additionally, the profitability has basically been improved in those operations over the way they were operating before.

But you’re quite correct that Amazon itself has become a brand. Kirkland, at Costco, is a $39 billion brand. All of Kraft Heinz is $26 billion. And it’s been around for — on the Heinz side — it’s been around for 150 years. And it’s been advertised — billions and billions and billions of dollars, in terms of their products. And they go through tens of thousands of outlets.

And here’s somebody like Costco, establishes a brand called Kirkland. And it’s doing 39 billion, more than virtually any food company. And that brand moves from product to product, which is terrific, if a brand travels. I mean, Coca Cola moves it from Coke to Cherry Coke and Coke Zero and so on.

But to have a brand that can really move — and Kirkland does more business than Coca Cola does. And Kirkland operates through 775 or so stores. They call them warehouses at Costco. And Coca Cola is through millions of distribution outlets.

So, brands — the retailer and the brands have always struggled as to who gets the upper hand in moving a product to the consumers.

And there’s no question, in my mind, that the position of the retailer, relative to the brands, which varies enormously around the world. In different countries, you’ve had 35 percent, even, maybe 40 percent, be private-label brands in soft drinks. And it’s never gotten anywhere close to that in the United States. So, it varies a lot.

But basically, retailers — certain retailers — the retail system — has gained some power. And particularly in the case of Amazon and Walmart and their reaction to it, and Costco — and Aldi and some others I can name — has gained in power relative to brands.

Kraft Heinz is still doing very well, operationally. But we paid too much. If we paid 50 billion, you know, it would’ve been a different business. It’d still be earning the same amount.

You can turn any investment into a bad deal by paying too much. What you can’t do is turn any investment into a good deal by paying little, which is sort of how I started out in this world.

But the idea of buying the cigar butts that are declining or poor businesses for a bargain price is not something that we try to do anymore. We try to buy good businesses at a decent price. And we made a mistake on the Kraft part of Kraft Heinz. Charlie?

CHARLIE MUNGER: Well, it’s not a tragedy that, out of two transactions, one worked wonderfully, and the other didn’t work so well. That happens.

WARREN BUFFETT: The reduction of costs, you know — there can always be mistakes made, when you’ve got places, and you’re reorganizing them to do more business with the same number of people.

And we like buying businesses that are efficient to start with. But the management — the operations — of Kraft Heinz have been improved over the present management overall. But we paid a very high price, in terms of the Kraft part. We paid an appropriate price, in terms of Heinz.

18. Internet competition for Berkshire’s furniture retailers

WARREN BUFFETT: Jonathan?

JONATHAN BRANDT: Internet-based furniture retailers, like Wayfair, appear willing to stomach large current losses acquiring customers in the hope of converting them to loyal online shoppers.

I’ve been wondering what this disruptive competition might do to our earnings from home-furnishing retail operations like Nebraska Furniture Mart.

If we have to transition to more of an online model, might we have to spend more heavily to keep shoppers without a corresponding increase in sales? The sharp decline in first-quarter earnings from home furnishings suggest, perhaps, some widening impact from intensifying competition.

Do you believe Wayfair’s customers first, profits later model is unsustainable? Or do you think our furniture earnings will likely be permanently lower than they were in the past?

WARREN BUFFETT: I think furnishings — the jury’s still out on that, whether the operations which have grown very rapidly in size but still are incurring losses, how they will do over time.

It is true that in the present market, partly because of some successes, like, most dramatically, Amazon, in the past, that investors are willing to look at losses as long as sales are increasing, and hope that there will be better days ahead.

We do a quite significant percentage of our sales online in the furniture operation. That might surprise you. We do the highest percentage in Omaha.

And what’s interesting is that we — I won’t give you the exact numbers, but it’s large — we do a significant dollar volume, but a very significant portion of that volume, people come to the store to pick up, so that they will order something from us online, but they don’t seem to mind at all — and they don’t have to do it — but they get a pick up at the store.

So, you know, you learn what customers like, just like people learned in fast food, you know, that people would buy a lot of food by going through a drive-in, that they don’t want to stop and go into the place. We learn about customer behavior as it unfolds.

But we did do, now — on Tuesday, we did 9.2 million of — or 9.3 million of profitable volume at the Nebraska Furniture Mart. And I think that company had paid-in capital of $2,500. And I don’t think anything’s been added since. So, it’s working so far.

The first quarter — It’s interesting — the first quarter was weak at all four of our furniture operations.

But there are certain other parts of the economy — well, just home building, generally — it’s considerably below what you would’ve expected, considering the recovery we have had from the 2008-9 period. I mean, if you look at single-family home construction, the model has shifted more to people living in apartment rentals.

I think it’s gone from 69-and-a-fraction percent. It got down to 63 percent. It’s bounced up a little bit. But people are just not building — or moving to houses as rapidly as I would have guessed they would have, based on figures prior to 2008 and ’09, and considering the recovery we’ve had, and considering the fact that money is so cheap. And that has some effect on our furniture stores.

But I think we’ve got a very good furniture operation, not only with the Nebraska Furniture Mart, but at other furniture operations. And we will see whether the models work over the long run.

But I think, you know, they have a reasonable chance. Some things people — we’re learning that people will buy some things that they’ve always gone to the mall or to a retail outlet to buy, that they will do it online. And others don’t work so well. Charlie?

CHARLIE MUNGER: I think that we’ll do better than most furniture retailers.

WARREN BUFFETT: I think that’s a certainty overall, overall. But we’ve got some good operations there.

But we don’t want to become a showroom for the online operations and have people come and look around the place and then order someplace else. So, we have to have the right prices. And we’re good at that at the Furniture Mart.

19. Pension funds should avoid “alternative” investments

WARREN BUFFETT: Station 4.

AUDIENCE MEMBER: Warren and Charlie, my name is Brent Muio. I’m from Winnipeg, Canada.

First, thank you for devoting so much time and energy to education. I’m a better investor because of your efforts. But more important, I’m a better partner, friend, son, brother, and soon-to-be first-time father.

There’s nothing more important than these relationships. And my life is better, because you’re willing to pass on your experience and wisdom.

My path into finance was unconventional. I worked as an engineer for 12 years, while two years ago, I began a career in finance, working for the Civil Service Superannuation Board, a $7 billion public pension fund in Winnipeg.

I work on alternative investments, which include infrastructure, private equity, and private credit. I go to work every day knowing that I’m there to benefit the hardworking current and future beneficiaries of the fund.

Like most asset classes, alternative purchase multiples have increased. More of these assets are funded with borrowed money. And the terms and covenants on this debt are essentially nonexistent.

With this in mind and knowing the constraints of illiquid, closed-end funds, please give me your thoughts on private, alternative investments, the relevancy in public pension funds, and your view on long-term return expectations.

WARREN BUFFETT: Yeah, if you leveraged up investments in just common stocks, and you’d figured a way so that you would have staying power, if there were any market dip, I mean, you’d obviously retain extraordinary returns.

I pointed out, in my investing lifetime, you know, if an index fund would do 11 percent, well, imagine how well you would’ve done if you’d leveraged that up 50 percent whatever the prevailing rates were over time.

So, a leveraged investment in a business is going to beat an unleveraged investment in a good business a good bit of the time. But as you point out, the covenants to protect debtholders have really deteriorated in the business. And of course, you’ve been in an upmarket for businesses. And you’ve got a period of low interest rates. So, it’s been a very good time for it.

My personal opinion is, if you take unleveraged returns against unleveraged common stocks, I do not think what is being purchased today and marketed today would work well.

But if you can borrow money, if you can buy assets that will yield 7 or 8 percent, you can borrow enough money at 4 percent or 5 percent, and you don’t have any covenants to meet, you’re going to have some bankruptcies. But you’re going to also have better results in many cases.

It’s not something that interests us at all. We are not going to leverage up Berkshire. If we’d leveraged up Berkshire, we’d have made a whole lot more money, obviously, over the years.

But both Charlie and I, probably, have seen some more high-IQ people — really extraordinarily high-IQ people — destroyed by leverage. We saw Long-Term Capital Management, where we had people who could do in their sleep math that we couldn’t do, at least I couldn’t do, you know, working full time at it during the day and, I mean, really, really smart people working with their own money and with years and years of experience of what they were doing.

And you know, it all turned to pumpkins and mice in 1998. And actually, it was a source of national concern, just a few hundred people. And then we saw some of those same people, after that happened to them once, go on and do the same thing again.

So, I would not get excited about so-called alternative investments. You can get all kinds of different figures. But there may be — there’s probably at least a trillion dollars committed to buying, in effect, buying businesses. And if you figure they’re going to leverage them, you know, two for one on that, you may have 3 trillion of buying power trying to buy businesses in — well, the U.S. market may be something over 30 trillion now — but there’s all kinds of businesses that aren’t for sale and that thing.

So, the supply-demand situation for buying businesses privately and leveraging them up has changed dramatically from what it was ten or 20 years ago.

And I’m sure it doesn’t happen with your Winnipeg operation, but we have seen a number of proposals from private equity funds, where the returns are really not calculated in a manner than — well, they’re not calculated in a manner that I would regard as honest.

And so I — it’s not something — if I were running a pension fund, I would be very careful about what was being offered to me.

If you have a choice in Wall Street between being a great analyst or being a great salesperson, salesperson is the way to make it.

If you can raise $10 billion in a fund, and you get a 1 1/2 percent fee, and you lock people up for ten years, you know, you and your children and your grandchildren will never have to do a thing, if you are the dumbest investor in the world. But —

Charlie?

CHARLIE MUNGER: Well, I think what we’re doing will work more safely than what he’s doing. And — but I wish him well.

WARREN BUFFETT: Yeah, Brent, you sound — actually, you sound like a guy that I would hope would be working for a public pension fund. Because frankly, most of the institutional funds, you know — well, we had this terrible — right here in Omaha — you can get a story of what happened with our Omaha Public Schools’ retirement fund. And they were doing fine until the manager started going in a different direction. And the trustees here — perfectly decent people — and the manager had done OK to that point, and —

CHARLIE MUNGER: Yeah, but they are smarter in Winnipeg than they are here.

WARREN BUFFETT: Yeah. Well — (Laughter)

CHARLIE MUNGER: That was pretty bad here.

WARREN BUFFETT: It’s not a fair fight, actually, usually, when a bunch of public officials are listening to people who are motivated to really just get paid for raising the money. Everything else is gravy after that.

But if you run a fund, and you get even 1 percent of a billion, you’re getting $10 million a year coming in. And if you’ve got the money locked up for a long time, it’s a very one-sided deal.

And you know, I’ve told the story of asking the guy one time, in the past, “How in the world can you — why in the world can you ask for 2-and-20 when you really haven’t got any kind of evidence that you are going to do better with the money than you do in an index fund?” And he said, “Well, that’s because I can’t get 3-and-30,” you know. (Laughter)

CHARLIE MUNGER: What I don’t like about a lot of the pension fund investments is I think they like it because they don’t have to mark it down as much as it should be in the middle of the panics. I think that’s a silly reason to buy something. Because you’re given leniency in marking it down.

WARREN BUFFETT: Yeah. And when you commit the money — in the case of private equity often — you — they don’t take the money, but you pay a fee on the money that you’ve committed.

And of course, you really have to have that money to come up with at any time. And of course, it makes their return look better, if you sit there for a long time in Treasury bills, which you have to hold, because they can call you up and demand the money, and they don’t count that.

They count it in terms of getting a fee on it. But they don’t count it in terms of what the so-called internal rate of return is. It’s not as good as it looks. And I really do think that when you have a group sitting as a state pension fund —

CHARLIE MUNGER: Warren, all they’re doing is lying a little bit to make the money come in.

WARREN BUFFETT: Yeah. Yeah, well, that sums it up. (Laughter)

20. Amazon buy doesn’t mean portfolio managers aren’t “value” investors

WARREN BUFFETT: Becky?

BECKY QUICK: This question is from Ken Skarbeck in Indianapolis. He says, “With the full understanding that Warren had no input on the Amazon purchase, and that, relative to Berkshire, it’s likely a small stake, the investment still caught me off guard.

“I’m wondering if I should begin to think differently about Berkshire looking out, say, 20 years. Might we be seeing a shift in investment philosophy away from value-investing principles that the current management has practiced for 70 years?

“Amazon is a great company. Yet, it would seem its heady shares ten years into a bull market appear to conflict with being fearful when others are greedy. Considering this and other recent investments, like StoneCo, should we be preparing for change in the price-versus-value decisions that built Berkshire?”

WARREN BUFFETT: Yeah. It’s interesting that the term “value investing” came up. Because I can assure you that both managers who — and one of them bought some Amazon stock in the last quarter, which will get reported in another week or ten days — he is a value investor.

The idea that value is somehow connected to book value or low price/earnings ratios or anything — as Charlie has said, all investing is value investing. I mean, you’re putting out some money now to get more later on. And you’re making a calculation as to the probabilities of getting that money and when you’ll get it and what interest rates will be in between.

And all the same calculation goes into it, whether you’re buying some bank at 70 percent of book value, or you’re buying Amazon at some very high multiple of reported earnings.

Amazon — the people making the decision on Amazon are absolutely as much value investors as I was when I was looking around for all these things selling below working capital, years ago. So, that has not changed.

The two people — one of whom made the investment in Amazon — they are looking at many hundreds of securities. And they can look at more than I can, because they’re managing less money. And their universe — possible universes — is greater.

But they are looking for things that they feel they understand what will be developed by that business between now and Judgement Day, in cash.

And it’s not — current sales can make some difference. Current profit margins can make some difference. Tangible assets, excess cash, excess debt, all of those things go into making a calculation as to whether they should buy A versus B versus C.

And they are absolutely following value principles. They don’t necessarily agree with each other or agree with me. But they are very smart. They are totally committed to Berkshire. And they’re very good human beings, on top of it.

So, I don’t second guess them on anything. Charlie doesn’t second guess me. In 60 years, he’s never second guessed me on an investment.

And the considerations are identical when you buy Amazon versus some, say, bank stock that looks cheap, statistically, against book value or earnings or something of the sort.

In the end, it all goes back to Aesop, who, in 600 B.C., said, you know, that a bird in the hand is worth two in the bush.

And when we buy Amazon, we try and figure out whether the — the fellow that bought it — tries to figure out whether there’s three or four or five in the bush and how long it’ll take to get to the bush, how certain he is that he’s going to get to the bush, you know, and then who else is going to come and try and take the bush away and all of that sort of thing. And we do the same thing.

And it really, despite a lot of equations you learn in business school, the basic equation is that of Aesop. And your success in investing depends on how well you were able to figure out how certain that bush is, how far away it is, and what the worst case is, instead of two birds being there, and only one being there, and the possibilities of four or five or ten or 20 being there.

And that will guide me. That will guide my successors in investment management at Berkshire. And I think they’ll be right more often than they’re wrong. Charlie?

CHARLIE MUNGER: Well I — Warren and I are a little older than some people, and —

WARREN BUFFETT: Damn near everybody. (Laughs)

CHARLIE MUNGER: And we’re not the most flexible, probably, in the whole world. And of course, if something as extreme as this internet development happens, and you don’t catch it, why, other people are going to blow by you.

And I don’t mind not having caught Amazon early. The guy is kind of a miracle worker. It’s very peculiar. I give myself a pass on that.

But I feel like a horse’s ass for not identifying Google better. I think Warren feels the same way.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: We screwed up.

WARREN BUFFETT: He’s saying we blew it. (Laughter)

And we did have some insights into that, because we were using them at GEICO, and we were seeing the results produced. And we saw that we were paying $10 a click, or whatever it might’ve been, for something that had a marginal cost to them of exactly zero. And we saw it was working for us. So —

CHARLIE MUNGER: We could see in our own operations how well that Google advertising was working. And we just sat there sucking our thumbs. (Laughter)

So, we’re ashamed. We’re trying to atone. (Laughter)

Maybe Apple was atonement. (Laughter)

WARREN BUFFETT: When he says, “Sucking our thumbs,” I’m just glad he didn’t use some other example. (Laughter)

21. Buffett: Berkshire insurance businesses are worth more than you think

WARREN BUFFETT: OK, Jay?

JAY GELB: This question is on Berkshire’s intrinsic value. Warren, in your most-recent annual letter, you discussed a methodology to estimate Berkshire’s intrinsic value. However, a major component of Berkshire’s value that many investors find challenging to estimate is that of the company’s vast and unique insurance business.

Could you discuss how you value the company’s insurance unit, based on information Berkshire provides, especially since GAAP book value is not disclosed, of the insurance unit?

WARREN BUFFETT: Well, our insurance business gives us a float that’s other people’s money, which we’re temporarily holding, but which gets regenerated all the time, so as a practical matter, it has a very, very long life. And it’s probably a little more likely to grow than shrink.

So, we have $124 billion that people have given us. And that’s somewhat like having a bank that just consists of one guy. And people come in and deposit $124 billion and promise not to withdraw it forever.

And we’ve got a very good insurance business. It’s taken a very long time to develop it, very long time. In fact, I think we probably have the best property-casualty operation, all things considered, in the world, that I know of, of any size. So, it’s worth a lot of money.

It’s probably — we think it’s worth more to us, and we particularly think it’s worth more while lodged inside Berkshire. We’d have a very, very high value on that. I don’t want to give you an exact number, because I don’t know the exact number. And any number I would have given you in the past would’ve turned out to be wrong, on the low side.

We have managed to earn money on money that was given to us for nothing and have (inaudible) earnings from underwriting and then have these large earnings from investing. And it’s an integral part of Berkshire.

There’s a certain irony to insurance that most people don’t think about. But if you really are prepared, and you have a diversified property-casualty insurance business — a lot of property business in it — if you’re really prepared to pay your claims under any circumstances that come along in the next hundred years, you have to have so much capital in the business that it’s not a very good business.

And if you really think about a worst-case situation, the reinsurance — that’s insurance you buy from other people, as an insurance company, to protect you against the extreme losses, among other things — that reinsurance probably — could likely be — not good at all.

So, even though you’d think you’re laying off part of the risk, if you really take the worst-case examples, you may well not be laying off the risk. And if you keep the capital required to protect against that worst-case example, you’ll have so much capital in the business that it isn’t worthwhile.

Berkshire is really the ideal form for writing the business. Because we have this massive amount of assets that, in many cases, are largely uncorrelated with natural disasters. And we can — we don’t need to buy reinsurance from anybody else. And we can use the money in a more efficient way than most insurance companies.

It’s interesting. The three — In the last 30 years, the three largest reinsurance companies — and I’m counting Lloyd’s as one company — although it isn’t — it’s a group of brokers assembled in — underwriters assembled at a given location. But people think of Lloyd’s as a massive reinsurance market, which it is, not technically one entity. But if you take the three largest companies — and they’re all in fine shape now, they’re first-class operations — but all three of them came close to extinction sometime in the last 30 years, or reasonably close.

And we didn’t really have any truly extraordinary natural catastrophes. The worst we had was Katrina in, whatever it was, 2006 or thereabouts, 2005. But we didn’t have any worst-case situation. And all three of those companies, which everybody looks at as totally good on the asset side, if you show a recoverable from them, two of the three actually made some deals with us to help them in some way. And they’re all in fine shape now.

But it’s really not a good business if you keep your — as a standalone insurer — if you keep enough capital to really be sure you can pay anything that comes along, under any kind of conditions.

And Berkshire can do that. And it can use the money in ways that it likes to use.

So, it’s a very valuable asset. I don’t want to give you a figure on it. But we would not sell it. We certainly wouldn’t want to sell it for its float value. And that float is shown on the balance sheet as a liability. So, it’s extraordinary.

And it’s taken a long time to build. It’d be very, very, very hard for anybody to — I don’t think they could build anything like it. It just takes so long.

And we continue to plow new ground. If you went in the next room, you would’ve seen something called “THREE,” which is our movement toward small and medium business owners for commercial insurance. And there’s an online operation.

And it will take all kind — we’ll do all kinds of mid-course adjusting and that sort of thing — and we’ve only just started up in four states.

But we’ll, you know — ten or 20 years from now, that will be a significant asset of Berkshire, just like Geico has grown from two and a fraction billion of premium to, you know, who knows, but well into the mid-30 billion, just with Tony Nicely. And when I said, in the annual report, that Tony Nicely, who’s here today —

CHARLIE MUNGER: Warren, is there anybody in the world who has a big casualty insurance business that you’d trade our business for theirs?

WARREN BUFFETT: Yeah, oh, no, it’s taken a long time. And it’s taken some tremendous people. And Tony Nicely has created more than 50 billion — with his associates, and he’s got 39,000 of them, probably more now, because he’s growing this year — he’s created more than $50 billion at GEICO — of value — for Berkshire. (Applause)

CHARLIE MUNGER: It’s pretty much what you’d expect. It’s such an easy business, taking in money now in cash and just keeping the books and giving a little of it back.

There’s a lot of stupidity that gets into it. And if you’re not way better than average at it, you’re going to lose money in the end. It’s a mediocre business for most people. And it’s good at Berkshire only because we’re a lot better at it. And if we ever stop being a lot better at it, it wouldn’t be safe for us, either.

WARREN BUFFETT: And Ajit Jain has done a similar thing. He’s done it in a variety of ways within the insurance business. But I would not want to undo — somebody would have to give me more than $50 billion to undo everything he has produced for Berkshire.

And he walked into my office on a Saturday in the mid-1980s. He’d never been in the insurance business before. And I don’t think there’s anybody in the insurance world that doesn’t wish that he’d walked into their office instead of ours, at Berkshire. It’s been extraordinary. It’s truly been extraordinary.

But we have Tom Nerney. We have Tim Kenesey at MedPro. We have Tom Nerney at U.S. Lability.

We have — at GUARD Insurance — we only bought that a few years ago, and that’s a terrific operation. It’s based in Wilkes-Barre, Pennsylvania. Who would expect to find a great insurance operation in Wilkes-Barre?

But we’ve got a great insurance — really great — insurance operation right here in Omaha, about two miles from here. And it was bought by us in 1967. And you know, it changed Berkshire. We built on that base.

We’ve got a — we really got a great insurance business. And I won’t give you a number, but it’s probably a bigger number than you’ve got in your head for — and it’s worth more within Berkshire than it would be worth as an independent operation.

Somebody can say, “Well, this little gem, if it was put out there, would sell at a higher multiple,” or something of the sort. It works much better as being part of a whole, where we have had two tiny operations — two tiny insurance operations — many, many years ago. And they both went broke. The underwriting was bad. But we paid all the claims. We did not walk away. We paid every dime of claims.

And nobody worries about doing any kind of financial transaction with Berkshire. And you know that today — on Saturday — about 9 in the morning, I got a phone call. And we made a deal the next day committing Berkshire to pay out $10 billion, come hell or high water, no outs for, you know, material adverse change or anything like that. And people know we’ll be there with $10 billion.

And they know, in the insurance business, when we write a policy that may come — be payable during the worst catastrophe in history, or may be payable 50 years from now, they know Berkshire will pay. And that’s why we’ve got $124 billion of float.

22. “Don’t go overboard on delayed gratification”

WARREN BUFFETT: OK, station 5.

AUDIENCE MEMBER: Hey, Warren and Charlie. I’m Neel Noronha. I’m 13 years old and from San Francisco.

I feel like I see you in our living room a lot. My dad is constantly playing these videos of you at these meetings. And he teaches me a lot of lessons about you guys. But many of them require the delayed gratification skill. (Laughter)

I want to know, is there any way that kids can develop the delayed gratification skill? (Laughter and applause)

CHARLIE MUNGER: I’ll take it, if you want me to, Warren.

WARREN BUFFETT: Go to it.

CHARLIE MUNGER: I’ll take that, because I’m a specialist in delayed gratification. I’ve had a lot of time to delay it. (Laughter)

And my answer is that they sort of come out of the womb with the delayed gratification thing, or they come out of the womb where they have to have everything right now. And I’ve never been able to change them at all. So, we identify it. We don’t train it in.

WARREN BUFFETT: Charlie’s had eight children, so he’s become more and more of a believer in nature versus nurture. (Laughter)

CHARLIE MUNGER: You’ll probably see some nice, old woman of about 95 out there, in threadbare clothing. And she’s delaying gratification right to the end and probably has 4,000 A shares. (Laughter)

It’s just these second- and third-generation types that are buying all the jewelry.

WARREN BUFFETT: It’s interesting. If you think about — we’ll take it to a broader point. But if you think of a 30-year government bond paying 3 percent, and you allow for, as an individual, paying some taxes on the 3 percent you’ll receive, and you’ll have the Federal Reserve Board saying that their objective is to have 2 percent inflation, you’ll really see that delayed gratification, if you own a long government bond, is that, you know, you get to go to Disneyland and ride the same number of rides 30 years from now that you would if you did it now.

The low interest rates, for people who invest in fixed-dollar investments, really mean that you really aren’t going to eat steak later on if you eat hamburgers now, which is what I used to preach to my wife and children and anybody else that would listen, many years ago. (Laughs)

So, it’s — I don’t necessarily think that, for all families, in all circumstances, that saving money is necessarily the best thing to do in life. I mean, you know, if you really tell your kids they can —whatever it may be — they never go to the movies, or we’ll never go to Disneyland or something of the sort, because if I save this money, 30 years from now, you know, well, we’ll be able to stay a week instead of two days.

I think there’s a lot to be said for doing things that bring you and your family enjoyment, rather than trying to save every dime.

So, I — delayed gratification is not necessarily an unqualified course of action under all circumstances. I always believed in spending two or three cents out of every dollar I earn and saving the rest. (Laughter)

But I’ve always had everything I wanted. I mean, one thing you should understand, if you aren’t happy having $50,000 or a hundred-thousand dollars, you’re not going to be happy if you have 50 million or a hundred million.

I mean, a certain amount of money does make you feel — and those around you — feel better, just in terms of being more secure, in some cases.

But loads and loads of money — I probably know as many rich people as just about anybody. And I do not — I don’t think they’re happier because they get super rich. I think they are happier when they don’t have to worry about money.

But you don’t see a correlation between happiness and money, beyond a certain place. So, don’t go overboard on delayed gratification. (Applause)

23. Munger on succession: “You’re just going to have to endure us”

WARREN BUFFETT: Andrew?

ANDREW ROSS SORKIN: This question comes from a shareholder of yours for more than 20 years, who asked to remain anonymous, but wanted me to start by saying, “Warren and Charlie, I want to preface this question by saying it comes from a place of love for both of you and the beautiful painting you’ve drawn for us in the form of Berkshire.”

WARREN BUFFETT: But. (Laughter)

ANDREW ROSS SORKIN: “Now, please update us on succession planning. And as you think about succession, would you ever consider having Greg (Abel) and Ajit (Jain) join you onstage at future annual meetings and allow us to ask questions of them and Ted and Todd, as well, so we can get a better sense of their thinking?”

WARREN BUFFETT: That’s probably a pretty good idea. And we’ve talked about it. (Applause)

We have Greg and Ajit here. And any questions that anybody wants to direct to them, it’s very easy to move them over.

So, we thought about having four of us up here. And this format is not set in stone at all.

Because you — I can tell you that, actually, the truth is, Charlie and I are afraid of looking bad. Those guys are better than we are. (Laughs)

You could not have two better operating managers than Greg and Ajit. I mean, they are — it is just fantastic, what they accomplished.

They know the businesses better. They work harder, by far. And you are absolutely invited to ask questions to be directed over to them at this meeting. I don’t think —

Yeah, this format will not be around forever. And if it’s better to get them up on the stage, we’ll be happy to do it.

Ted (Weschler) and Todd (Combs), they’re basically not going to answer investment questions. We regard investment decisions as proprietary, basically. They belong to Berkshire. And we are not an investment advisory organization. So, that is counter to the interests of Berkshire for them to be talking about securities they own. It’s counter to the interests of Berkshire for Charlie or me to be doing it.

We’ve done better because we don’t publish every day what we’re buying and selling. I mean, if somebody’s working on a new product at Apple, or somebody’s working on a new drug or they’re assembling property or something of the sort, they do not go out and tell everybody in the world exactly what they’re doing every day.

And we’re trying to generate ideas in investment. And we do not believe in telling the world what we’re doing every day, except to the extent that we’re legally required. But it’s a good idea. Charlie?

CHARLIE MUNGER: Well, one of the reasons we have trouble with these questions is because Berkshire is so very peculiar. There’s only one thing like it.

We have a different kind of unbureaucratic way of making decisions. There aren’t any people in headquarters. We don’t have endless committees deliberating forever and making bad decisions. We just — we’re radically different. And it’s awkward being so different. But I don’t want to be like everybody else, because this has worked better. So, I think you’re just going to have to endure us. (Laughter and applause)

WARREN BUFFETT: We do think that it’s a huge corporate asset, which may only surface very occasionally and depending very much on how the world is around us. But to be the one place, I think, in the world, almost, where somebody can call on a Saturday morning and meet on Sunday morning and have a $10 billion commitment.

And nobody in the world doubts whether that commitment will be upheld. And it’s not subject to any kind of welching on the part of the company that’s doing it. It’s got nothing involved over than Berkshire’s word. And that’s an asset that, every now and then, will be worth a lot of money to Berkshire. And I don’t really think it will be subject to competition.

So — and Ted and Todd, in particular, are an additional pipeline, and have proven to be an additional pipeline, in terms of facilitating the exercise of that ability. I mean they — things come in through them that, for one reason or another, I might not hear about otherwise.

So, they have expanded our universe. In the markets we’ve had in recent years, that hasn’t been important. I can see periods where they would be enormously valuable. Just take the question that was raised by the fellow from Winnipeg about weak covenants and bonds.

I mean, we could have a situation — who knows when, who knows where, or who knows whether — but we could have a situation where there could be massive defaults in the junk-bond-type market. We’ve had those a couple times. And we made a fair amount of money off of them.

But Ted and Todd would multiply our effectiveness in a big way, if such a period comes along, or some other types of periods come along. They are very, very, very useful to Berkshire.

The call happened to come in on Friday from Brian Moynihan, CEO of Bank of America. And he’s done an incredible job. But we have a better chance of getting more calls and having them properly filtered and everything — appropriately filtered — the next time conditions get chaotic than we did last time. And that’s important.

Charlie?

CHARLIE MUNGER: Well, I do think it’s true that if the world goes to hell in a hand basket, that you people will be in the right company. We’ve got a lot of cash and we know how to behave well in a panic. And if the world doesn’t go to hell, are things so bad now?

24. Munger invited to happy hour by the bitcoin people

CHARLIE MUNGER: And I also want to report that your vice chairman is getting new social distinction.

I’ve been invited during this gathering to go to a happy hour put on by the bitcoin people. (Laughter)

And I’ve tried to figure out what the bitcoin people do in their happy hour, and I finally figured it out. They celebrate the life and work of Judas Iscariot. (Laughter)

CHARLIE MUNGER: Is your invitation still good? (Laughter)

WARREN BUFFETT: Bitcoin — actually — on my honeymoon in 1952, my bride, 19, and I, 21 — stopped in Las Vegas. We just got in — my aunt Alice gave me the car and said, “Have a good time,” and we went west.

So, we stopped in the Flamingo, and I looked around, and I saw all of these well-dressed — they dressed better in those days — well-dressed people who had come, in some cases, from thousands of miles away. And this was before jets, so transportation wasn’t as good.

And they came to do something that every damn one of them knew was mathematically dumb. And I told Susie, I said, “We are going to make a lot of money.” (Laughter)

I mean, imagine people going to stick money on some roulette number with a zero and a double-zero there and knowing the percent. They all could do it, and they — they just do it. And I have to say, bitcoin has rejuvenated that feeling in me. (Laughter)

25. Berkshire will probably increase stakes above 10% if regulations are eased

WARREN BUFFETT: OK, Gregg?

GREGG WARREN: Warren and Charlie. While I understand Berkshire’s need to trim its stake in Wells Fargo and any other banks you hold, each year, in order to bring Berkshire’s ownership stake below the 10 percent threshold required by the Federal Reserve for bank holdings, given the ongoing share repurchase activity that’s taking place in the industry.

I was kind of surprised, though, to see you move to trim all of your holdings, where possible, on a regular basis to eliminate the regulatory requirements that come with ownership levels above 10 percent, which in my view limits the investment universe that Berkshire, or at least Warren, can meaningfully invest in longer term, given that Warren manages a large chunk of Berkshire’s $200 billion equity portfolio.

Could you elaborate more on the regulatory impact for Berkshire of holding more than 10 percent of any company’s stock, as well as how you feel about the Fed’s recent proposal to allow investors like Berkshire to own up to 25 percent shares of a bank without triggering more restrictive rules and oversight?

Basically, if that proposal were to come to fruition, would you be willing to forego that 10 percent threshold self-imposed that you’ve done, and put money to work in names that you’re already fairly comfortable with?

WARREN BUFFETT: Yeah, the 10 percent, there’s a couple reasons —

CHARLIE MUNGER: That’s the right answer. Yeah. (Laughter)

WARREN BUFFETT: We will — there’s two factors beyond in the case of banks. There’s the Federal Reserve requirement there. But many people probably don’t even — might not know about this, but if you own over 10 percent of a security — common stock — and you sell it within six months at a profit, you give the money over to the company, the short-swing profit that you give them.

And you match your — any sale against your lowest purchase. And I think if you sell it and then buy it within six months — I’m not as positive about that, because I haven’t reread the rule for a lot of years. But I think if you sell and then buy within six months, and the purchase is below the price at which you made the sale, you owe the money to the company.

There used to be lawyers that would scan that monthly SEC report that I used to get 30 or 40 years ago. They would scan it to find people that inadvertently had broken that rule, and they would get paid a fee for recovering it for the company.

So, it restricts enormous — it restricts significantly your ability to reverse a position or change your mind or something of the sort.

Secondly, I think you have to report within two or three business days every purchase you make once you’re in that over 10 percent factor. So, you’re advertising to the world, but the world tends to follow us some, so it really — it has a huge execution cost attached to it.

Nevertheless — and those are both significant minuses, and they’re both things that people generally don’t think about.

We did go over recently, for example, in Delta Airlines, that was actually an accident, but I don’t mind the fact at all that we did.

And if the Federal Reserve changes its approach, we won’t have to trim down below that. We don’t want to become a bank holding company and we don’t want to —

We went in many years ago and got permission with Wells, but then our permission expired, and we went in again a few — a couple years ago. And we spent a year or so, and there were just a million questions that Wells got asked about us and so on.

So, it’s been a deterrent. It’ll be less of a deterrent in the future, but it does have those two —

The short-swing thing is less onerous to us than it would be to most people who buy and sell stocks, because we don’t really think in terms of doing much.

CHARLIE MUNGER: But if we didn’t have all these damn rules, we would cheerfully buy more, wouldn’t we?

WARREN BUFFETT: Sure, sure. Well, any time we buy we do it cheerfully, but —

Yeah. And we will — you’ll probably see us at more than 10 percent in more things. And if the Fed should change its rules, there will be companies where we drift up over 10 percent simply because they’re repurchasing their shares. That’s been the case with Wells, and it’s been the case with an airline or two in the last year or so.

So, if we like 9.5 percent of a company, we’d like 15 percent better, and you may see us behave a little differently on that in the future.

CHARLIE MUNGER: Well, one more awkward disadvantage of being extremely rich.

WARREN BUFFETT: Yeah. (Laughter)

And it really is. Yeah, and people following you. I mean, the followers problem can be a real problem.

26. Money managers need to set expectations for their investors

WARREN BUFFETT: OK, station 6.

AUDIENCE MEMBER: Hi. I’m Jeff Malloy (PH) from San Francisco. And this is my first shareholders meeting.

Mr. Buffett and Mr. Munger, I’m 27 years old and aspire to be a great money manager like you two one day.

I’m considering starting my own investment fund, but I also recognize that I am young and have a lot to learn. My question to both of you is, how did you know you were ready to manage other people’s money? And what general advice would you give to someone in my shoes? Thank you.

WARREN BUFFETT: Well, that’s a very interesting question, because I’ve faced that. And I sold securities for a while, but in May of 1956, I had a number of members of my family — I’d come back from New York, and they wanted me to help them out with stocks as I had earlier before I’d taken a job in New York. And I said, I did not want to get in the stock sales business, but I wanted to — I enjoyed investing. I was glad to figure out a way to do it, which I did through a partnership form.

But I would not have done that, if I thought there was any chance, really, that I would lose the money.

And what I was worried about was not how I would behave, but how they would behave, because I needed people who were in sync with me. So, when we sat down for dinner in May of 1956 with seven people who either were related to me, or one was a roommate in college and his mother.

And I showed them the partnership agreement, and I said, “You don’t need to read this.” You know, there’s no way that I’m doing anything in the agreement that is any way that — you know, you don’t need a lawyer to read it or anything of the sort.

But I said, “Here are the ground rules as to what I think I can do and how I want to be judged, and if you’re in sync with me, I want to manage your money, because I won’t worry about the fact that you will panic if the market goes down or somebody tells you to do something different. So, we have to be on the same page.”

“And if we’re on the same page, then I’m not worried about managing your money. And if we aren’t on the same page, I don’t want to manage your money, because you may be disappointed when I think that things are even better to be investing and so on.”

So, I don’t you want to manage other people’s money until you have a vehicle and can reach the kind of people that will be in sync with you. I think you ought to have your own ground rules as to what your expectations are, when they should you roses and when they should throw bricks at you.

And you want to be on the same — and that’s one reason I never — we didn’t have a single institution in the partnership, because institutions meant committees, and committees meant that —

CHARLIE MUNGER: You had some aunts that trusted you.

WARREN BUFFETT: What’s that?

CHARLIE MUNGER: You had some aunts who trusted you.

WARREN BUFFETT: Yeah, well, and a father-in-law who gave me everything he had in the world, you know. And I didn’t mind taking everything he had in the world, as long as he would stick with me and wouldn’t get panicked by headlines and that sort of thing.

And so, it’s enormously important that you don’t take people that have expectations of you that you can’t meet. And that means you turn down a lot of people. It means you probably start very small, and you get an audited record.

And when you’ve got the confidence, where if your own parents came to you and they were going to give you all their money, and you were going to invest for them, I think that’s the kind of confidence that you’ll say, “I may not get the best record, but I’ll be sure that you get a decent record over time,” that’s when you’re ready to go on the —

CHARLIE MUNGER: Let me tell you story that I tell young lawyers who frequently come to me and say, “How can I quit practicing law and become a billionaire instead?” (Laughter)

So, I say, well, it reminds me of a story they tell about Mozart. A young man came to him, and he said, “I want to compose symphonies. I want to talk to you about that.”

And Mozart said, “How old are you?” And the man said, “Twenty-two.” And Mozart said, “You’re too young to do symphonies.” And the guy says, “But you were writing symphonies when you were ten years old.” He says, “Yes, but I wasn’t running around asking other people how to do it.” (Laughter)

WARREN BUFFETT: Carol?

We wish you well. (Laughter)

And we, and actually, we really do, because the fact you asked that sort of a question is to some extent indicative of the fact you got the right attitude going in.

CHARLIE MUNGER: It isn’t that easy to be a great investor. I don’t think we’d have made it.

27. Berkshire doesn’t have to disclose most foreign stock holdings, so it doesn’t

CAROL LOOMIS: This question is from Franz Traumburger (PH) of Austria and his son, Leon, who are both Berkshire shareholders. And it’s interesting to me that in the years we’ve been doing this, nobody has ever asked this question, as far as I know.

Their question is, “Mr. Buffett, I believe it is correct that in its SEC filings — that is the Securities and Exchange Commission — Berkshire does not have to give information about foreign stocks it holds.

“Assuming we hold foreign stocks, could you please tell us what our five largest positions are?”

WARREN BUFFETT: No, the fellow wants investment information. We really aren’t in the investment information business. We disclose what we have to disclose, but we could set up an investment advisory firm and probably take in a lot of money, but we haven’t done it. And we aren’t giving away what belongs to our shareholders for nothing.

But he’s correct that — I’m 99 percent sure he’s correct, and Marc Hamburg can correct me from our office — but we do not have to report foreign stocks.

And we do have — in certain important countries, there’s lower thresholds at which we have to report our holdings, as a percentage of the company stock outstanding — there’s lower thresholds than there are in the United States.

So, in a sense — in certain stocks. I think when we bought Munich Re stock or bought Tesco stock, or there are certain stocks we’ve had to report at — before we would have had to report in the United States.

But we will never unnecessarily advise if we plan to buy some land some place, if we plan to develop a business — we are not about giving business information that’s proprietary to Berkshire. We don’t give it unless we’re required by law.

And he is correct that, I’m virtually certain that we do not have to report our foreign stocks on the SEC filings. And he’ll have to find his own holdings in Austria.

But I think this Mozart story may have encouraged that particular question from Austria, what stocks we’re going to own in Austria. OK, Charlie, do you have any comments on that?

CHARLIE MUNGER: No.

WARREN BUFFETT: No, I didn’t think you would. (Laughs)

28. Buffett expects Precision Castparts earnings will “improve fairly significantly”

WARREN BUFFETT: Jonny?

JONATHAN BRANDT: Precision Castparts’ pre-tax profit margins, while perfectly fine relative to American industry as a whole, continue to be almost 10 percentage points below where they were in the years preceding the acquisition. And I’m guessing they’re lower than contemplated when the purchase price was determined.

The annual report hints that unplanned shutdowns, the learning curve on new plane models, and a shift of oil and gas capacity to aerospace, might all be temporarily depressing margins. But it’s unclear what a reasonable, long-term margin expectation is for this unit.

Now, I know you won’t want to issue a specific margin target or forecast, but I do have a question that I hope you can answer.

Is the downward trend in earning since 2015 mostly due to these transitory items, or have the competitive structure of the industry and Precision’s relationship with its customers changed to the point that meaningful increases from current margin levels are probably unlikely?

WARREN BUFFETT: Yeah. Your prelude is quite correct. I mean, they are below what we projected a few years ago. And my expectation — but I would have told you this a year ago — and they have improved somewhat.

My expectation is, based on the contracts we have and the fact that the initial years in anything in the aircraft industry, for example, tend to be less profitable as you go further down the learning curve and the volume curve, tend to be lower in the near-term. My expectation is that the earnings of Precision will improve fairly significantly.

And I think I mentioned maybe to you last year, in those earnings, there is about $400 million a year of purchase amortization, which are economic earnings in my viewpoint.

So — but even including that 400 million a year, which they would be reporting if they were independent, and we don’t report, because we bought them and there’s a purchase amortization charge. Even without that, they are below what I would anticipate by a fair margin within a year or two. That’s the present expectation on my part. Charlie?

CHARLIE MUNGER: No, I don’t have anything.

WARREN BUFFETT: You’ll have that question for me next year, and I think I’ll be giving you a different answer.

29. The older you get, the better you understand human behavior

WARREN BUFFETT: OK, station 7.

AUDIENCE MEMBER: Good morning Mr. Buffett, Mr. Munger. My name is JC. (PH) I am 11 years old, and I came from China. This is my second year at the meeting.

Mr. Munger, it’s great to see you again after the Daily Journal meeting in February.

Mr. Buffett, you mentioned that the older you get, the more you understood about human nature. Could you elaborate more about what you’ve learned, and how can the differences of human nature help you make a better investment? I would also like Mr. Munger to comment on that, please. Thank you very much. (Applause)

WARREN BUFFETT: You should wait for Charlie’s answer, because he’s even older. (Laughter)

He can tell you more about being old than I can even.

It’s absolutely true that virtually any yardstick you use, I’m going downhill. And, you know, if I would take an SAT test now, and you could compare it to a score of what I was in my early 20s, I think it’d be quite embarrassing. (Laughs)

And Charlie and I can give you a lot of examples, and there’s others we won’t tell you about how things decline as you get older.

But I would say this. It’s absolutely true in my view that you can and should understand human behavior better as you do get older. You just have more experience with it. And I don’t think you can read — Charlie and I read every book we could on every subject we were interested in, you know, when we were very young. And we learned an enormous amount just from studying the lives of other people.

And — but I don’t think you can get to be an expert on human behavior at all by reading books, no matter what your I.Q. is, no matter who the teacher is. And I think that you really do learn a lot about human behavior. Sometimes you have to learn it by having multiple experiences.

I actually think I, despite all the other shortcomings — and I can’t do mental arithmetic as fast as I used to, and I can’t read as fast as I used to.

But I do think that I know a lot more about human behavior than I did when I was 25 or 30 —

CHARLIE MUNGER: I’ll give you — do you want one mantra? It comes from a Chinese gentleman who just died, Lee Kuan Yew, who was the greatest nation builder probably that ever lived in the history of the world.

And he said one thing over and over and over again all his life. “Figure out what works, and do it.” If you just go at life with that simple philosophy from your own national group, you will find it works wonderfully well. Figure out what works, and do it.

WARREN BUFFETT: And figuring out what works means figuring out how other people —

CHARLIE MUNGER: Of course.

WARREN BUFFETT: — behave.

CHARLIE MUNGER: Of course.

WARREN BUFFETT: And Charlie and I have seen the extremes in human behavior, in so many unexpected ways.

CHARLIE MUNGER: Now we get it every night, extremes in human behavior. All you got to do is turn on the television.

WARREN BUFFETT: Yeah. I’m glad he used that example. (Laughter)

30. Ajit Jain on pricing unconventional insurance contracts

WARREN BUFFETT: OK, Becky?

BECKY QUICK: Warren, you mentioned, in response to an earlier question, that Ajit (Jain) and Greg (Abel) are both here to answer questions, and so I thought I’d ask this question that comes from Will in Seattle. He says, his question is for Mr. Ajit Jain and Mr. Warren Buffett.

“You have said that you communicate regularly about unconventional insurance contracts that expose the company to extremely unlikely but highly costly events. I’m curious about how you think about and safely price these unconventional insurance contracts. What analyses and mental checks do you run through your head, to make sure that Berkshire Hathaway will profit without being unduly exposed to catastrophic risk?

“Furthermore, Mr. Buffett, would you want a future CEO to continue a similarly close collaboration with the chief underwriter?”

WARREN BUFFETT: We will get a microphone to Ajit and a spotlight in just a second. And there he is.

Ajit, why don’t you answer first, if you’d like to?

AJIT JAIN: Hi. Obviously, the starting point, I mean, these situations where there’s not enough data to hang your hat on, it’s more of an art than a science.

We start off with as much science as we can use, looking at historical data that relates to the risk in particular, or something that comes close to relating to the risk that we’re looking at.

And then beyond that, if there’s not enough historical data we can look at, then clearly, we have to make a judgment in terms of, what are the odds of something like that happening?

We try — we absolutely, in situations like that, we absolutely make sure we cap our exposure. So, that if something bad happens or we’ve got something wrong, we absolutely know that how much money we can lose and whether we can absorb that loss without much pain to the income statement or the balance sheet.

In terms of art, it’s a difficult situation. More often than not, it’s impossible to have a point of view, and we end up passing on it.

But every now and then, we think we can get a price where the subjective odds we have of something like that happening has a significant margin of safety in it. So, we feel it’s a risk that’s worth taking.

Then finally, the absolute acid test is, I pick up the phone and call Warren. “Warren, here’s a deal. What do you think?” (Laughter) OK. Your turn, Warren.

WARREN BUFFETT: OK. (Applause)

CHARLIE MUNGER: It’s not easy, and you wouldn’t want just anybody doing it for you.

WARREN BUFFETT: No, no. In fact, the only one I would want doing it for us on the kind of things we have sometimes received is Ajit. I mean, it’s that simple. There isn’t anybody like him.

And as Ajit said, we’ll look at a worst case, but we are willing, if we like the odds, and like you say, there’s no way to look these up.

We can tell you how many 6.0 or greater earthquakes have happened in the last hundred years in Alaska or California or so on. And there’s a lot of things you can look up figures on. Sometimes those are useful, and sometimes they aren’t. But there’s a lot where you can get a lot of data.

And then there’s others that — well, after 9/11, you know, was that going to be the first of several other attacks that were going to happen very quickly? There were planes flying that couldn’t — well they couldn’t land in Hong Kong, as I remember. I think it was Cathay Pacific couldn’t land in Hong Kong the following Monday unless they had a big liability coverage placed with somebody.

I mean, the world had to go on. The people that held mortgages on the Sears Tower all of a sudden wanted coverage. —I think that actually was one — but they were just pouring in, of people that hadn’t been worried about something a week earlier, and now they were worried about things involving huge sums.

And there were really only a couple people in the world that would even listen and had the capacity to take on a lot of the deals we were proposed. And there’s no book to look up. So, you do — there’s a big element of judgment.

Ajit and I — I mean, Ajit’s a hundred times better at this than I am, but we do tend to think alike on this sort of thing. You don’t want to think too much alike, but we think alike. I’ve got a willingness to lose a lot of money.

And most, well, virtually every insurance company if they get up to higher limits, they’ve got treaties in place, and they can only take this much. So, the world was paralyzed on that.

We don’t get those, but now obviously. But we do occasionally get inquiries about doing things that really nobody else in the world can do. It’s a little like our investment situation, only transferred over to insurance. We don’t build a business around it, but we are ready when the time comes.

And Ajit is an asset that no other company in the world has. And we work him. And we actually enjoy a lot talking to each other about these kind of risks, because he’ll ask me to think about what the price should be. And he’ll think about — we don’t tell each other ahead of time. And then I’ll name it, and then he’ll say, “Have you lost your mind, Warren?” (Laughs)

And then he’ll point something out to me that I’ve overlooked. And it’s a lot of fun, and it’s made us a lot of money.

And the shareholders of Berkshire Hathaway are extraordinarily lucky. You can’t hire people like Ajit. I mean, you get them once in a lifetime. Charlie?

CHARLIE MUNGER: I don’t think we helped him very much. It’s really difficult.

WARREN BUFFETT: There will be a time when — I mean, I probably won’t be around then — but there will be a time occasionally, just like in financial markets, when things are happening in the insurance world, and basically, Berkshire will be the only one — virtually the only one — people turn to.

CHARLIE MUNGER: But in the past, Ajit, talking to you, has added more than $50 billion to the balance sheet at Berkshire, by making these oddball calls.

WARREN BUFFETT: And if he hadn’t talked to me, it’d be probably 49.9 billion, you know? (Laughs)

But you don’t want to try — don’t try this at home.

CHARLIE MUNGER: Yeah, that doesn’t mean it’s easy.

WARREN BUFFETT: No. And it’s not very teachable.

CHARLIE MUNGER: No, it isn’t very teachable, you’re right.

WARREN BUFFETT: No, it is not something that Berkshire has some secret formula someplace for it. It basically is a very unusual talent with Ajit, and —

CHARLIE MUNGER: We’re not holding anything back. It’s hard.

31. Despite Kraft Heinz problems, Berkshire could partner with 3G again

WARREN BUFFETT: OK, Jay? (Applause)

JAY GELB: This question is on Berkshire’s relationship with 3G Capital. Kraft Heinz’s recent challenges have raised questions about whether Berkshire’s partnership with 3G has become a weakness for Berkshire.

Warren, what are your thoughts on this? And would Berkshire be open to partnering again with 3G in a major acquisition?

WARREN BUFFETT: Yeah, they are our partners, and we joined them. We had a one-page agreement, which I haven’t even actually ever reread. I mean, Jorge Paulo, I mean, is a good friend of mine. I think he’s a marvelous human being. And I’m pleased that we are partners. It’s conceivable that something would come up.

They have more of a taste for leverage than we do, and they probably have more of a taste for paying up, but they also are, in certain types of situations, they’d be way better operators than we would.

I mean, they go into situations that need improvement, and they have improved them. But I think both they and we, I know we did underestimate, not what the consumer is doing so much, but what the retailer is.

And at See’s Candy, we sell directly to the consumer, but at Kraft Heinz, they’re intermediaries. And those intermediaries are trying to make money. We’re trying to make money.

And the brand is our protection against the intermediaries making all the money.

Costco tried to drop Coca-Cola back in, I think 2008, and you can’t drop Coca-Cola, you know, and not disappoint a lot of customers.

Snickers bars are the number one candy that Mars makes. And they’ve been number one for 30 or 40 years. And if you walk into a drugstore, and the guy says, “The Snickers are 75 cents or whatever it might be, and I’ve got this special little bar my wife and I make in the back of the store, and it’s only 50 cents, and it’s just as good,” you don’t buy it, you know. When you’re at some other place the next time, you buy the Snickers bar.

So, brands can be enormously valuable, but many of the brands are dependent, most of them — Geico is not, Geico goes directly to the consumer. If we save the consumer money on insurance, they’re going to buy it from us.

And our brand, you know — and we’ll spend well over a billion and a half on advertising this year, and you think, my God, we started this in 1936, and we were saying the same thing then about saving 15 percent in 15 minutes or something of the sort — not exactly the same — but that brand is huge, and we have to come through on the promise we give, which is to save people significant money on insurance — a great many people. That brand is huge, and we’re dealing directly with the consumer.

And when you’re selling Kool-Aid or ketchup or, you know, Heinz 57 sauce or something, you are going through a channel, and they would — the phrase was used earlier today. You know, our gross margin is their opportunity, and we think that the ultimate consumer is going to force them to have our product, and that we will get the gross margin.

And that fight, that tension, has increased in the last five years and I think is likely to increase the next five or ten years. And Charlie is a director of a company that has caused me to think a lot about that subject. Charlie?

CHARLIE MUNGER: Well. What I think is interesting about the 3G situation, it was a long series of transactions that worked very well, and finally there was one transaction at the end that didn’t work so well.

That is a very normal outcome of success in a big place with a lot of young men who want to get rich quick. And it just happens again and again. And you do want to be careful.

It’s so much easier to take the good ideas and push them to wretched excess.

WARREN BUFFETT: Yeah, that is — no idea is good at any price, and the price settlement is probably something that we worry more about generally than our partners, but we are their partners in Kraft Heinz. And it’s not at all inconceivable that we could be partners in some other transaction in the future.

32. Buffett’s not worried about strength of Kraft Heinz’s brands

WARREN BUFFETT: OK. Station 8.

AUDIENCE MEMBER: Hello Warren and Charlie. Consumer tastes are changing. I think if we asked how many people here in the arena have eaten Velveeta cheese in the last year or so, there’d be only a small handful, maybe more for Jell-O.

3G’s playbook of cutting R&D looks to have stifled new product development amidst changing preferences.

So, here’s my question. Why continue to hold when the moat appears to be dry? Or do you think it is filling back up?

CHARLIE MUNGER: Well, I don’t think the problem was that they cut research or something. I think the problem was, they paid a little too much for the last acquisition.

WARREN BUFFETT: That Jell-O — I can’t give you the exact figures. There are certain brands that may be declining 2 percent a year or 3 percent a year in unit sales, and there’s others that are growing 1 or 2 percent. There’s not dramatic changes taking place at all. I mean, Kraft Heinz is earning more money than Kraft and Heinz were earning six or seven years ago.

I mean, and the products are being used in a huge way. Now it’s true that certain — that there are always trends going to some degree, but they have not fallen apart, remotely. And they have widened the margin somewhat.

But it is tougher, in terms of the margin and the price negotiations, probably to go through to the actual consumer. It’s become a somewhat tougher passageway for all food companies, than it was ten years ago. It’s still a terrific business.

I mean, you know, you mentioned Jell-O or Velveeta. Charlie worked at my grandfather’s grocery store in 1940, I worked there in ’41. And they were buying those products then, and they buy the products now. The margins are still very good. They earn terrific returns on invested capital. But we paid too much in the case of Kraft.

You can pay too much for a growing brand. I mean, you can pay way too much for a growing brand, probably be easier to be sucked into that. So, I basically don’t worry about the brands.

A certain number are very strong, and a certain number are declining a bit. But that was the case 10 years ago. It’ll be the case 10 years from now. There’s nothing dramatic happening in that.

33. Buffett’s biggest problem with Apple is the stock keeps going up

WARREN BUFFETT: OK, we’ll take one more, and then we’ll break for lunch. Andrew.

ANDREW ROSS SORKIN: Thank you, Warren. Question on technology and the company’s biggest holding now.

“Given that Apple is now our largest holding, tell us more about your thinking. What do you think about the regulatory challenges the company faces, for example? Spotify has filed a complaint against Apple in Europe on antitrust grounds. Elizabeth Warren has proposed ending Apple’s control over the App Store, which would impact the company’s strategy to increase its services businesses. Are these criticisms fair?”

WARREN BUFFETT: Well, again, I will tell you that all of the points you’ve made I’m aware of, and I like our Apple holdings very much. I mean, it is our largest holdings.

And actually, what hurts, in the case of Apple, is that the stock has gone up. You know, we’d much rather have the stock — and I’m not proposing anything be done about it — but we’d much rather have the stock at a lower price so we could buy more stock.

And importantly, if Apple — I mean, they authorized another 75 billion the other day — but let’s say they’re going to spend a hundred billion dollars in buying in their stock in the next three years. You know, it’s very simple. If they buy it at 200, they’re going to get 500 million shares. They’ve got 4 billion, 600 million out now. And so they’ll end up with 4.1 billion under that circumstance.

If they’re buying at 150, they buy in 667 million shares. And instead of owning what we would own in the first case, we’d now — the divisor would be less than 4 billion, and we’d own a greater percentage of it.

So, in effect, a major portion of earnings — at least possibly, it’s at least been authorized — will be spent in terms of increasing our ownership without us paying out a dime, which I love for a wonderful business.

And the recent development, when the stock has moved up substantially, actually hurts Berkshire over time. We’ll still do — In my opinion, we’ll do fine, but we’re not going to dissect our expectations about Apple, you know, for people who may be buying it against us tomorrow or something of the sort. We don’t give away investment advice on that for nothing.

But we have — all the things you’ve mentioned, obviously we know about, and we’ve got a whole bunch of other variables that we crank into it. And we like the fact that it’s our largest holding. Charlie?

CHARLIE MUNGER: Well, in my family, the people who have Apple phones, it’s the last thing they’ll give up. (Laughter)

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fuckyeahsugaminyoongi-blog · 7 years

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lastmover · 6 years

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2018 Berkshire Hathaway Annual Meeting (Morning) Transcript

1. Buffett opens a box of peanut brittle for Munger

WARREN BUFFETT: Good morning.

VOICE: Warren and Charlie, we love you! (Applause)

WARREN BUFFETT: I’m Warren. He’s Charlie. Charlie does most things better than I do, but - (laughter) - you know, this one’s a little tough. Charlie, maybe you can chew on that a while. OK. (Laughter)

At the formal meeting that will begin at 3:45, we will elect 14 directors. Charlie and I are two of them, and I would like to introduce the other 12. I’ll do it in alphabetical order.

If they will stand as I announce their name. Withhold your applause. May be hard to do, but give it your best. And when we get all through, then you can let loose, but -

We’ll do this alphabetically beginning with Greg Abel, if you’ll stand and stay standing. Howard Buffett, Steve Burke, Sue Decker, Bill Gates, Sandy Gottesman, Charlotte Guyman, Ajit Jain, Tom Murphy, Ron Olson, Walter Scott, and Meryl Witmer. (Applause)

2. Accounting-rule net loss “not representative” of the business

WARREN BUFFETT: Let’s see. This morning, we posted both our earnings and our 10-Q. And if we can put up slide one, you can take a look at what was reported.

And as I warned you in the annual report, a new accounting rule was introduced at the beginning of this year. And it provides that our equity securities, whether we sell them or not, are marked to market every day.

So we can have a gain or loss of a couple billion dollars in our equity securities portfolio, and that day, according to the accounting principles now in effect, which are a change, will be recorded as making a couple billion dollars that day or losing a couple billion.

And I told you that would produce some very unusual effects from quarter to quarter. And it further explains why I like to release our earnings early Saturday morning and - as well as the 10-Q - to give people a chance to read through the explanation.

Because if you just were handed this with a TV monitor, you know, at 3:30 in the afternoon or whatever it might be, you would report the net earnings figure, understandably, very quickly. And it really is not representative of what’s going on in the business at all.

So, if you look at the figure of operating earnings, which is what we look at, we actually earned a record amount for any quarter we’ve ever had.

And that includes no realized gains or losses on securities, or on the few remaining derivatives we have.

You might leave that slide up there just a little longer. Maybe it is up -

The insurance underwriting - GEICO had a quite a good-sized turnaround in profitability and a good gain, although not as big a gain as last year, which was a record in terms of policies in force and, really, throughout most of our businesses.

And the details are in the 10-Q, which is up on our website now.

And as you can see, the railroad was up significantly, and we had - most of our businesses tended to be up.

Now we were aided in that, in a material way, by the reduction in the federal income tax rate from 35 percent to 21 percent. Our businesses were up significantly on a pretax basis, but the gain was further enhanced by the change in the income tax rate.

So that pretty well sums up the first quarter. We’ll probably get some - may well get some questions on it when we get into the question and answer section.

3. Master class: How to think about investments

WARREN BUFFETT: The questions we’ll be getting, we’ve got the press over here, and then we have the analysts on my left. And of course, we have our partners out in front of me. And we will rotate among you.

And the questions we get, as we go through the next six hours or so, will understandably relate to a lot of current events. You know, you will -

We may get asked, and we don’t know the questions, but we may get asked, you know, about Fed policy, or whether we’re seeing any inflation, or whether business is speeding up or down, or the threats we may face competitively in our businesses as we go along.

And you - anything goes on the questions, except we won’t tell you what we’re buying or selling. But it really can be a question sometimes of confusing the forest with the trees.

And I would like to just spend just a couple of minutes giving you a little perspective on how you might think about investments, as opposed to the tendency to focus on what’s happening today, or even this minute, as you go through.

And to help me in doing that, I’d like to go back through a little personal history.

And we will start - I have here a New York Times of March 12th, 1942. I’m a little behind on my reading. (Laughter)

And if you go back to that time, that - it was about, what? Just about three months since we got involved in a war which we were losing at that point.

The newspaper headlines were filled with bad news from the Pacific. And I’ve taken just a couple of the headlines from the days preceding March 11th, which I’ll explain was kind of a momentous day for me.

And so you can see these headlines. We’ve got slide two up there, I believe. And we were in trouble, big trouble, in the Pacific. It was only going to be a couple months later that the Philippines fell, but we were getting bad news.

We might go to slide three for March 9th. Hope you can read the headlines, anyway. The price of the paper’s three cents, incidentally.

The - and let’s see, we’ve got March 10th up there, as slide - I - when I get to where there’s advanced technology of slides, I want to make sure I’m showing you the same thing that I’m seeing in front of me.

So anyway, on March 10th, when again, the news was bad: “Foe Clearing Path to Australia.” And it was like it - the stock market had been reflecting this.

And I’d been watching a stock called Cities Service preferred stock, which had sold at $84 the previous year. It had sold at $55 the year - early in January, two months earlier - and now it was down to $40 on March 10th.

So that night, despite these headlines, I said to my dad - I said, “I think I’d like to pull the trigger, and I’d like you to buy me three shares of Cities Service preferred” the next day.

And that was all I had. I mean, that was my capital accumulated over the previous five years or thereabouts. And so my dad, the next morning, bought three shares.

Well, let’s take a look at what happened the next day. Let’s go to the next slide, please. And it was not a good day. The stock market, the Dow Jones Industrials, broke 100 on the downside.

Now they were down 2.28 percent as you see, but that was the equivalent of about a 500-point drop now. So I’m in school wondering what is going on, of course.

Incidentally, you’ll see on the left side of the chart, the New York Times put the Dow Jones Industrial Average below all the averages they calculated. They - they had their own averages, which have since disappeared, but the Dow Jones has continued.

So the next day - we can go to the next slide - and you will see what happened. The stock that was at 39 - my dad bought my stock right away in the morning because I’d asked him to, my three shares. And so I paid the high for the day.

That 38 1/4 was my tick, which was the high for the day. And by the end of the day, it was down to 37, which was really kind of characteristic of my timing in stocks that was going to appear in future years. (Laughs)

But it was on the - what was then called the New York Curb Exchange, then became the American Stock Exchange.

But things, even though the war, until the Battle of Midway, looked very bad and - and if you’ll turn to the next slide, please - you’ll see that the stock did rather well. I mean, you can see where I bought at 38 1/4.

And then the stock went on, actually, to eventually be called by the Cities Service Company for over $200 a share. But this is not a happy story because, if you go to the next page, you will see that I - (Laughter)

Well, as they always say, “It seemed like a good idea at the time,” you know. (Laughter)

So I sold - I made $5 on it. It was, again, typical - (laughs) - of my behavior. But when you watch it go down to 27, you know, it looked pretty good to get that profit.

Well, what’s the point of all this? Well, we can leave behind the Cities Service story, and I would like you to, again, imagine yourself back on March 11th of 1942.

And as I say, things were looking bad in the European theater as well as what was going on in the Pacific. But everybody in this country knew America was going to win the war. I mean, it was, you know, we’d gotten blindsided, but we were going to win the war. And we knew that the American system had been working well since 1776.

So, if you’ll turn to the next slide, I’d like you to imagine that at that time you had invested $10,000. And you put that money in an index fund - we didn’t have index funds then - but you, in effect, bought the S&P 500.

Now I would like you to think a while, and don’t - do not change the slide here for a minute.

I’d like you to think about how much that $10,000 would now be worth, if you just had one basic premise, just like in buying a farm you buy it to hold throughout your lifetime and depend - and you look to the output of the farm to determine whether you made a wise investment.

You look to the output of the apartment house to decide whether you made a wise investment if you buy an apartment - small apartment house - to hold for your life.

And let’s say, instead, you decided to put the $10,000 in and hold a piece of American business, and never look another stock quote, never listen to another person give you advice or anything of this sort.

I want you to think how much money you might have now. And now that you’ve got a number in your head, let’s go to the next slide, and we’ll get the answer.

You’d have $51 million. And you wouldn’t have had to do anything. You wouldn’t have to understand accounting. You wouldn’t have to look at your quotations every day like I did that first day - (laughs) - when I’d already lost $3.75 by the time I came home from school.

All you had to do was figure that America was going to do well over time, that we would overcome the current difficulties, and that if America did well, American business would do well.

You didn’t have to pick out winning stocks. You didn’t have to pick out a winning time or anything of the sort. You basically just had to make one investment decision in your life.

And that wasn’t the only time to do it. I mean, I can go back and pick other times that would work out to even greater gains.

But as you listen to the questions and answers we give today, just remember that the overriding question is, “How is American business going to do over your investing lifetime?”

I would like to make one other comment because it’s a little bit interesting. Let’s say you’d taken that $10,000 and you’d listened to the prophets of doom and gloom around you, and you’ll get that constantly throughout your life. And instead, you’d used the $10,000 to buy gold.

Now for your $10,000 you would have been able to buy about 300 ounces of gold. And while the businesses were reinvesting in more plants, and new inventions came along, you would go down every year in your - look in your safe deposit box - and you’d have your 300 ounces of gold.

And you could look at it, and you could fondle it, and you could - I mean, whatever you wanted to do with it. (Laughter)

But it didn’t produce anything. It was never going to produce anything.

And what would you have today? You would have 300 ounces of gold just like you had in March of 1942, and it would be worth approximately $400,000.

So if you decided to go with a nonproductive asset - gold - instead of a productive asset, which actually was earning more money and reinvesting and paying dividends and maybe purchasing stock - whatever it might be - you would now have over 100 times the value of what you would have had with a nonproductive asset.

In other words, for every dollar you had made in American business, you’d have less than a penny by - of gain - by buying in this store of value, which people tell you to run to every time you get scared by the headlines or something of the sort.

It’s just remarkable to me that we have operated in this country with the greatest tailwind at our back that you can imagine. It’s an investor’s haven - I mean, you can’t really fail at it unless you buy the wrong stock or just get excited at the wrong time.

But if you’d - if you owned a cross-section of America and you put your money in consistently over the years, there’s just - there’s no comparison against owning something that’s going to produce nothing.

And there - frankly - there’s no comparison with trying to jump in and out of stocks and pay investment advisors.

If you’d followed my advice, incidentally - or this retrospective advice - which is always so easy to give - (Laughs)

If you’d follow that, of course you - there’s one problem. Your friendly stock broker would have starved to death.

I mean, you know, and you could have gone to the funeral to atone for their fate. But the truth is, you would have been better off doing this than a very, very, very high percentage of investment professionals have done, or people have done that are active that - it’s very hard to move around successfully and beat, really, what can be done with a very relaxed philosophy.

And you do not have to be - you do not have to know as much about accounting or stock market terminology or whatever else it may be, or what the Fed is going to do next time and whether it’s going to raise three times or four times or two times.

None of that counts at all, really, in a lifetime of investing. What counts is having a philosophy that you’ve - that you stick with, that you understand why you’re in it, and then you forget about doing things that you don’t know how to do.

4. Nothing’s changed - Buffett’s still “semi-retired”

WARREN BUFFETT: So with all those happy words, we will move on and start the questioning, and we’ll start with Carol.

CAROL LOOMIS: Good morning. In choosing a first question to ask each year, I look for a question that is definitely Berkshire-related and is timely. And this question seemed to fill the bill. The question came from William Anderson (PH) of Salem, Oregon.

And he said, “Mr. Buffett, you have previously said that there are two parts to your job, overseeing the managers and capital allocation. Mr. [Greg] Abel and Mr. [Ajit] Jain now oversee the managers, which leaves you with capital allocation.

“However, you share capital allocation with Ted Weschler and Todd Combs. Question. Does all that mean you are semi-retired? Or if not, please explain.” (Laughter)

WARREN BUFFETT: I’ve been semi-retired for decades. (Laughter)

The answer is that I was probably - well, it’s hard to break down the percentage of the time that I was involved in but now - the jobs that are now done by Ajit and Greg, and in the case of investing, the sub part of the job that is done by Ted and Todd.

Ted and Todd each manage 12- or $13 billion, so in total, that’s 25 billion. And we have in equities 170-some billion, probably now, and 20 billion in longer-term bonds, and another hundred billion in cash and short-term.

So they’re managing 20 - 25 and doing a very good job. And I still have the responsibility, basically, for the other 300 billion. So - (Laughter and applause)

I think Charlie will tell you - in fact, I’d like him to comment - nothing’s really changed that much. We’ve got - clearly we’ve got two people in Ajit and Greg that are smarter, more energetic, just bring more to the job every day.

But they don’t bring too much, because the culture is that our managers are running their business. But there’s a lot - there’s a good bit to oversee. So they do a superb job.

And Ted and Todd not only do a great job with the 12 or 13 billion each - they started with a couple billion each - not that it’s all been the growth of the 2 billion - but they also do - have done a number of things for Berkshire that they do it cheerfully, but more important, very skillfully.

So there’s just - there’s one thing after another that I will have them looking into or working on. And sometimes I steal their ideas and -

But I think, actually, semi-retired is probably - catches me at my most active point. I think if -(laughter) - your questioner’s got a good point.

OK, Charlie?

CHARLIE MUNGER: Well, I’ve watched Warren for a long time, and he sits around reading most of the time and thinking. And every once in a while he talks on the phone or talks to somebody. I can’t see any great difference. A lot of people - (Laughter)

Part of the Berkshire secret is that when there’s nothing to do, Warren is very good at doing nothing. (Laughter)

WARREN BUFFETT: I’m still looking forward to being a mattress tester. (Laughter)

5. Precision Castparts is “a very good business”

WARREN BUFFETT: OK, Jonathan Brandt.

JONATHAN BRANDT: Hi Warren. Hi Charlie. Given the growth in airplane build rates, it seems surprising that Precision Castparts isn’t doing better on the top or bottom line.

I understand the issue with a bumpy transition from old to new programs, but I’ve also heard from industry sources that Precision’s market position is not as strong as it used to be amid intensifying competition and some technological disruption.

What does Precision need to do to solidify and strengthen its preeminent position with its aerospace customers so that it can deliver the growth you expected when Berkshire acquired it?

WARREN BUFFETT: Yeah -

JONATHAN BRANDT: More generally, two years after the acquisition, what is your outlook for that business?

WARREN BUFFETT: Give me the last part again. The outlook.

JONATHAN BRANDT: More generally, two years after the acquisition, what is your updated outlook for that business longer term?

WARREN BUFFETT: Oh, longer term, I think - and in the reasonably shorter term - it’s a very good business. I mean, you were -

You mentioned aircraft, but we get into other industries. But certainly aircraft’s the most important. You have manufacturers that are very dependent on both the quality of the parts and the promptness of delivery.

You do not want to have an aircraft with 75- or 100- or maybe $200 million and be waiting for a part or something of the sort. So it’s -

Reliability is, both in terms of quality and delivery times and all of that sort of thing, is enormously important. And we get contracts that extend out many years. And sometimes we - I mean, we will get them well before the plane even starts in production. So there’s very long lead times.

And we have found in the last year - found it earlier, but I know of some specific cases in the last year - where other suppliers have failed in their deliveries and then the manufacturers come to us and say, “We would like you to help us out.”

And we say, “Well, we’d be glad to help you out, but we’d like about a five-year contract, if we’re going to do it because we’re just not going to make up for these other guys’ shortfalls periodically.” But that sort of thing has a very long lead time.

The business is a very good business. One thing you will see their earnings charged with is about $400 million - little over $400 million a year - of intangible - nondeductible in that case - amortization of goodwill, which is really - is not an economic cost in my view.

We have a significant amount of that through Berkshire, but by far, the largest amount is related to the Precision acquisition. So whatever you see, you can add about 400 million that in my view is not an economic expense, but the accountants would argue otherwise. But it’s our money, so we’ll take my view. The - (Laughter)

Mark Donegan, who runs that operation, is incredible, and he has been not only - he’s a fabulous manager. I wouldn’t have bought it without him in charge. He also has been very helpful to us in other areas, and he loves to do it. So you can’t beat him, both as a manager in his own operation, but with his devotion to really doing everything that will help Berkshire.

It was - it’s a very good acquisition with very long tails to the products that are being developed.

Charlie?

CHARLIE MUNGER: Well, yeah, I think we’d buy another one just like it tomorrow if we had the chance.

WARREN BUFFETT: Yeah, that’s the answer. (Laughter)

Man of few words, but he gets the point. (Laughter)

6. Trade benefits are huge, so U.S. and China won’t do something “foolish”

WARREN BUFFETT: OK, now we will go to the shareholder in Station 1. I believe that’s probably up here to my right.

AUDIENCE MEMBER: Hello. This is Chao (PH) from Wuxi, China, (Inaudible) Capital. I’ve been to the meeting for 12 years. Wish you and Charlie good health, so we could see you both from meeting for 12 more years.

WARREN BUFFETT: Thank you. (Applause)

AUDIENCE MEMBER: Quick question. We know both you and China delegations - U.S. and China delegations - are in China for intense discussion, also called a trade war.

Let’s go one step beyond the trade war. Do you think there’s a win-win situation for both countries or the world is just too small for both to win and we have to revisit your 1942 chart again? Thank you.

WARREN BUFFETT: Thank you. I’d like to just mention one thing. In August, I’m going to be 88, and that will be the eighth month of the year, and it’s a year that ends with an eight.

And as you and I both know, eight is a very lucky number in China. So if you find anything over there for me, this is the time we should be acquiring something. All those eights.

AUDIENCE MEMBER: Will do. (Buffett laughs)

WARREN BUFFETT: The United States and China are going to be the two superpowers of the world, economically and in other ways, for a long, long, long time.

We have a lot of common interests, and like any two big economic entities, there are times when there’ll be tensions.

But it is a win-win situation when the world trades, basically. And China and the U.S. are the two big factors in that, but there’s plenty of other citizens of the world that are involved in how this comes out. And there is no question -

The nice thing about in this country I think is that both Democrats and Republicans basically, on balance, believe in the benefits of free trade.

And we will have disagreements with each other. We’ll have disagreements with other countries on trade.

But it’s just too big and too obvious for - that the benefits are huge, and the world’s dependent on it in a major way for its progress, that two intelligent countries will do something extremely foolish.

We both may do things that are mildly foolish from time to time, and there is some give and take, obviously, involved.

But U.S. exports in 1970 and U.S. imports in 1970 were both about 5 percent of GDP. I mean, here we we were, selling 5 percent of our GDP and buying up 5 percent of our GDP, basically.

Now people think we don’t export a lot of things. Our exports are 11 and a fraction percent of GDP. They’ve more than doubled as a share of this rising GDP. But the imports are about 14 1/2 percent, so there’s a gap of three percent or thereabouts.

And I would not like that gap to get too wide. But when you think about it, it’s really not the worst thing in the world to have somebody send you a lot of goods that you want and hand them little pieces of paper.

I mean, because the balancing item is, if you have a surplus or deficit in your trade, you’re going to have a surplus in investment.

And so the world is getting more claim checks on the United States, and they - to some extent they buy our government securities, they can buy businesses.

And over time, you don’t want the gap to get to be too wide because the amount of claim checks you are giving out to the rest of the world could get a little unpleasant under some circumstances.

But we’ve done remarkably well with trade. China’s done remarkably well with trade. The countries of the world have done remarkably well with trade. So it is a win-win situation.

And the only problem gets to be when one side or the other may want to win a little bit too much, and then you have a certain amount of tension.

But we will not sacrifice - the world, I mean - will not sacrifice world prosperity based on differences that arise in trade.

Charlie?

CHARLIE MUNGER: Yeah, well I think that both countries have been advancing. And of course China is advancing faster economically, because it started from a lower base and they’ve had a little more virtue than practically anybody else in the world in having a high savings rate.

And of course, a country that was mired in poverty for a long, long time, and that assimilates the advanced technology of the world, and has a big savings rate, is going to advance faster than some very mature company like Britain or the United States. And that’s what’s happened.

But I think we’re getting along fine, and I’m very optimistic that both nations will be smart enough to realize that the last thing they should do is have any ill will for the other.

7. Deals don’t depend on Buffett: “The reputation belongs to Berkshire now”

WARREN BUFFETT: OK, Becky Quick. (Applause)

BECKY QUICK: This question comes from Kirk Thompson.

He says, “Warren, in this year’s annual letter to shareholders, you referenced both cheap debt and a willingness by other companies to leverage themselves as competitive examples as to why it’s hard to get more acquisition deals done.

“It seems like the trust in - and prestige of doing a deal with Warren Buffett and Charlie Munger allow Berkshire to get a hometown discount and beat out other firms that might pay a little more to a prospective seller.

“Have you given thought to having other Berkshire managers have more public exposure, so future generations of successful business owners continue to bring deal opportunities to Berkshire like they have in prior decades?”

WARREN BUFFETT: Yeah, that sort of reminds me of - who was it? Tony O’Reilly remarked one time about the responsibility of a CEO.

That the very first job of the CEO was to search through his organization and find that person who had the initiative and the brains, the determination, all of the qualities to be his logical successor, and then fire the guy. (Laughter)

The - there’s no question. I think the reputation of Berkshire as being a very good home for companies - particularly private companies - but a good home for companies, I don’t think that reputation is dependent on me or Charlie.

It may take a little, you know, there’ll be a little testing period for whoever takes over, in that respect. But, you know, basically we’ve got the money to do the deals. We’ll have the money to do the deals subsequently. People can see how our subsidiaries operate in the future.

And the truth is that, I think some of the other executives are going - are getting better known. But there will be a - you know, I’ll tell you this, if things get bad enough, you don’t have to worry. They’ll be calling us no matter what. (Laughs)

So I do not worry about the so-called “deal flow,” which is a term I hate. But I don’t think there’s - I think that’s dependent on Berkshire and not dependent on me.

And, you know, as I’ve mentioned, my phone isn’t ringing off the hook with good deals. So apparently this big winning personality or something is not delivering for you. (Laughter)

So it may be the next person will be even more - get even more calls.

Berkshire - the reputation belongs to Berkshire now. And we are, for somebody that cares about a business that they and their parents and maybe their grandparents lovingly built over decades - if they care about where that business ends up being after, for one reason or another, they don’t want to keep it or can’t keep it in the family, we absolutely are the first call.

And we will continue to be the first call, whether Charlie or I answer the phone or somebody else does.

Charlie?

CHARLIE MUNGER: Well, a lot of the subsidiaries have for a long time already been making all kinds of acquisitions with people they know and we don’t. So it’s already happening. And, in fact, it’s happening more there than it is at headquarters, so -

WARREN BUFFETT: Don’t tell them, Charlie.

CHARLIE MUNGER: You’re getting your wish. (Laughter)

And it is weird that about 99 percent of the public companies that change hands, in terms of control, change hands in a sort of auction presided over by an investment banker.

And the people that buy are usually just leverage it to the gills, and when it starts doing a little better, they re-leverage it.

And that money is coming out of the charitable endowments and pension plans who are making these highly-leveraged investments in all these companies changing hands at very high prices. Sooner or later, this is not going to work perfectly.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: And it’s going to have an unpleasant episode. And I think we’ll be around and in good shape at that time.

WARREN BUFFETT: There was one fellow who came to me many years ago. And he had a wonderful business. And he had been worried because he had seen a friend of his die.

And the problems that arose later when the managers, to some extent, tried to take advantage of the widow. And it became a disaster.

So he said he thought about it a lot the previous year. And he decided he didn’t want to sell the business to a competitor, who would be a logical buyer, because they would fire all of his people. And the CFO that would remain, and, you know, all up and down the line, they’d all be the acquirer’s people. He didn’t want to do that to his people.

And then he thought, and he didn’t want to sell it to a private equity firm, because he thought they’d leverage it up. He never liked to leverage that much, and then they’d just resell it later on to somebody, so it would be totally out of control of what he wanted to do.

And he wanted to keep running it himself. So he said, “Warren,” he said, “It isn’t that you’re such a great guy,” he says, “It’s you’re the only one left.” So - (Laughter) -

Berkshire will continue to be the only one left in many cases.

8. “We don’t know what we’re doing” in cyber insurance

WARREN BUFFETT: Gary Ransom.

GARY RANSOM: Good morning. Warren, in your annual letter, you wrote about a potential for a $400 billion natural catastrophe event, something out in the tail of the loss distribution. I can think of another risk that could have a similar order of magnitude, and that would be cyberrisk.

I’m sure all your managers have taken steps against that potential, but in - out in the tail of the cyberrisk distribution, it could hit a lot of industries, a lot of your companies. So how do you think about and prepare for the big one in cyber?

WARREN BUFFETT: Yeah. Well, I include, incidentally, in my - that part I wrote in the annual report where I said that roughly - nobody knows the answer on this. I mean, I could stick down two, and somebody else much smarter in insurance would stick down a different figure.

But I think it’s about a 2 percent risk of what I call a 400 billion super-cat of all time. And -

But cyber is in that equation. I mean, that’s not just earthquakes and that sort of thing. And frankly, I don’t think we, or anybody else, really knows what they’re doing when writing cyber. I mean, we - it is just very, very, very early in the game.

And we don’t know what the interpretations of the policies, necessarily, will be. We don’t know the degree to which they’ll be what - there’ll be correlated incidents, which we don’t really think are correlated now or haven’t had the imagination to come up with.

We know that every year when I go and hear these people from the CIA or wherever it may be, they tell me that the offense is ahead of the defense, and will continue that way.

And I can dream of a lot of cyber incidents, which I’m not going to spell out here, because people that have twisted minds may be - they’ve probably got more - way more - ideas than I’ve got, but I don’t believe in feeding them any.

But it’s a business where we don’t - we have a pretty good idea of the probabilities of a quake in California, or the probabilities of a three or a four hurricane hitting Florida, or whatever it may be.

We don’t know what we’re doing in cyber, and we try to keep - we don’t want to be a pioneer on this. We do some business in that arena in Berkshire Hathaway Specialty.

But if you’re doing something for competitive reasons - which I’m OK with - but when I’m doing something where I - that people tell me is a competitive necessity, we are going to try not to have - we don’t want to be number one or number two or number three in exposures on it. And I don’t - and I am sure we are not in cyber. But I don’t -

I think anybody that tells you now that they think they know in some actuarial way, either what general experience is likely to be in the future, or what the worst case would be, I think, is kidding themselves.

And that’s one of the reasons that I say that a $400 billion event has a - I think has roughly a 2 percent probability per year of happening.

Cyber’s uncharted territory, and it’s going to get worse, not better. And then the question is whether, if we have a whole bunch of $25 billion commercial limits out there, whether there’s some aggregation that we didn’t foresee or that the courts interpret those policies differently, then you know - they are generally going to give the benefit of the doubt to the insured.

So you’re right in pointing that out as a very material risk, which didn’t exist 10 or 15 years ago and that - and will be much more intense as the years go along.

And all I can tell you, Gary, is that, that’s part of my 400 billion and my 2 percent. But if you’ve got a different guess, it’s just as likely that yours is right than mine on that.

Charlie?

CHARLIE MUNGER: Yeah, well, something that’s very much like cyberrisk is, you’ve got computers programmed to do your security trading and your computer goes a little wild from some error.

And that’s already happened at least once where somebody just was fine one morning and by the afternoon they were broke because some computer went crazy. We don’t have any computers we allot - we allow to do big, automatically trading securities.

I think, generally, Berkshire is less likely than most other places to be careless in some really stupid way.

WARREN BUFFETT: I do think if there’s a mega-cat from cyber, and let’s say it hits 400 billion, I do not think we’ll have more than a 3 percent -

CHARLIE MUNGER: No, no -

WARREN BUFFETT: - exposure.

CHARLIE MUNGER: No, no, we’ll get our share.

WARREN BUFFETT: And but it, you know, it will destroy - what will destroy a lot of companies - that we will actually, if we had a $12 billion loss, I would think, except for the new accounting rule, but I believe from what I call operating earnings, we would probably still have a reasonable profit that year.

I mean, we are in a different position than any insurance company I know of in the world, in our ability to handle the really - really super, super-cat.

OK, shareholder from station 2.

CHARLIE MUNGER: May I point out that the main shareholder to my right here has almost all his net worth in one security. That’s likely to be more carefully managed than some public place with people just passing through.

WARREN BUFFETT: Yeah, you don’t want a guy that’s 64 and is going to retire at 65. And a lot of decisions you really don’t want him or her to be making. (Laughter)

9. Capital allocation in the public sector

WARREN BUFFETT: Station 2?

AUDIENCE MEMBER: Wally Obermeyer, Obermeyer Wood Investment Counsel, Aspen, Colorado.

Warren and Charlie, you two have demonstrated great talent in private sector capital allocation and shown the world the power of excellence in this area.

Do you think there is a similar opportunity for outstanding capital allocation in the public sector, at both the state and federal levels? And if so, what approach and/or changes would you suggest for society to achieve these benefits?

CHARLIE MUNGER: That’s too tough. Why don’t we go on to a new question? (Laughter)

WARREN BUFFETT: I’m afraid I have nothing to add. (Laughter and applause)

I don’t mean to be unfair to somebody asking a question, but it - you know, it is unfortunately an entirely different game. And the electorate - the motivations are different, the terms, the reward system is different.

I mean, everything is different. And if we knew how to solve that, we wouldn’t - we can’t add anything to what you had in your view. I’m sorry on that.

10. Wells Fargo will emerge stronger after its “big mistake”

WARREN BUFFETT: OK, Andrew?

ANDREW ROSS SORKIN: Hi Warren. This question comes from Paul Spieker (PH) of Chicago, Illinois. I believe he may be here today.

He writes, “One of your more famous and perhaps most insightful quotes goes as follows:

″‘Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.’

“In light of the unauthorized accounting scandal at Wells Fargo, of its admission that it charged customers for duplicate auto insurance, of its admissions that it wrongly fined mortgage holders in relation to missing deadlines caused by delays that were its own fault, of its admission that it charged some customers improper fees to lock in mortgage interest rates, of the sanction placed upon it by the Federal Reserve prohibiting it from growing its balance sheet, and of the more than recent $1 billion penalty leveled by federal regulators for the aforementioned misbehavior, if Wells Fargo company is a chronically leaking boat, at what magnitude of leakage would Berkshire consider changing vessels?”

WARREN BUFFETT: Yeah, well, Wells Fargo (Applause) -

Wells Fargo is a company that proved the efficacy of incentives, and it’s just that they had the wrong incentives. And that was bad.

But then they committed a much greater error - and I don’t know exactly how or who did it or when, but - ignoring the fact that they had a faulty incentive system which was incenting people to do things that were kind of crazy, like opening nonexistent accounts, et cetera.

And, you know, that is a cardinal sin at Berkshire. We know people are doing something wrong, right as we sit here, at Berkshire.

You can’t have 377,000 employees and expect that everyone is behaving like Ben Franklin or something out there. They - we - I don’t know whether there are ten things being done wrong as we speak, or 20, or 50.

The important thing is, we don’t want to incent any of that if we can avoid it, and if we find - when we find it’s going on, we have to do something about it. And that is absolutely the key to it.

And Wells Fargo didn’t do it, but Salomon didn’t do it. And the truth is, we’ve made a couple of our greatest investments where people have made similar errors.

We bought our American Express stock - that was the best investment I ever made in my partnership years - we bought our American Express stock in 1964 because somebody was incented to do the wrong thing in something called the American Express Field Warehousing Company. We bought -

A very substantial amount of GEICO we bought that became half the - half of GEICO, for $40 million because somebody was incented to meet Wall Street estimates of earnings and growth. And they didn’t focus on having the proper reserves.

And that caused a lot of pain at American Express in 1964. It caused a lot of pain at GEICO in 1976. It caused a layoff of a significant portion of the workforce, all kinds of things. But they cleaned it up.

They cleaned it up, and look where American Express has moved since that time. Look at where GEICO has moved since that time.

So the fact that you are going to have problems at some very large institutions is not unique. In fact, almost every bank has - all the big banks have had troubles of one sort or another.

And I see no reason why Wells Fargo as a company, from both an investment standpoint and a moral standpoint going forward, is in any way inferior to the other big banks with which it competes on -

It - they made a big mistake. It cost - I mean, we still got - I mean we have a large, unrealized gain in it, but that doesn’t have anything to do with our decision-making. But the -

I like it as an investment. I like Tim Sloan as a manager, you know, and he is correcting mistakes made by other people.

I tried to correct mistakes at Salomon, and I had terrific help from Deryck Maughan as well as a number of the people at Munger, Tolles. And I mean, that is going to happen. You try to minimize it.

Charlie says that, “An ounce of prevention isn’t worth a pound of cure, it’s worth about a ton of cure.” And we ought to jump on everything. He’s pushed me all my life to make sure that I attack unpleasant problems that surface. And that’s sometimes not easy to do when everything else is going fine.

And at Wells, they clearly - and I don’t know exactly what - but they did what people at every organization have sometimes done, but it got accentuated to an extreme point.

But I see no reason to think that Wells Fargo, going forward, is other than a very, very large, well-run bank that had an episode in its history it wished it didn’t have.

But GEICO came out stronger, American Express came out stronger. The question is what you do when you find the problems.

Charlie?

CHARLIE MUNGER: Well, I agree with that. I think Wells Fargo is going to be better going forward than it would have been if these leaks had never been discovered.

WARREN BUFFETT: Or happened.

CHARLIE MUNGER: Yeah, so I think it’s - it - but I think Harvey Weinstein has done a lot for improving behavior, too. (Laughter)

It was clearly an error, and they’re acutely aware of it and acutely embarrassed, and they don’t want to have it happen again.

You know, if I had to say which bank is more likely to behave the best in the future, it might be Wells Fargo, of all of them.

WARREN BUFFETT: This New York Times that I have here from March 12th, 1942, if you go toward the back of it, in the classified section, you have one big section that says, “Help Wanted Male,” and another one that says, “Help Wanted Female.”

You know, was the New York Times doing the right thing in those days? You know, I think the New York Times is a terrific paper. But people make mistakes.

And you know, the idea of classifying between - taking ads and saying, “Well, we’ll take them and divide them up between men and women, what jobs we think are appropriate,” or that the advertiser thinks is appropriate.

We do a lot of dumb things in this world. And GEICO, as I say, in the early 1970s, they just ignored - and you can do it in the setting of proper reserves, which mean they charged the wrong price to new customers because they thought their losses were less than they were.

And I’m sure some of that may have been a desire to please Wall Street or just because they didn’t want to face how things were going. But it came out incredibly stronger. You know, and now it’s got 13 percent of the households in the United States insured.

And it came out with an attention to reserves and that sort of thing that was heightened by the difficulties that they’d found themselves in where they almost went bankrupt. Forty-two -

CHARLIE MUNGER: It was a lot more stupid than Wells Fargo. It was really stupid what they did way back, right?

WARREN BUFFETT: Yeah. They had the world by the tail, and then they quit looking at the reserve development. But - and American Express was just picking up a few dollars by having the field warehousing company in 1963. And, you know, they were worried whether it was going to sink the company.

And when some guy named Tino De Angelis in, I think it was Bayonne, New Jersey -

In fact, I went to the annual meeting in 1964 of American Express after the scandal developed, and somebody asked if the auditor would step forward.

And the auditor from one of the big firms, which I won’t mention, came up to the microphone, and somebody said, “How much did we pay you last year?”

And the auditor gave his answer, and then the questioner said, “Well, how much extra would you have charged us to go over to Bayonne, which was ten miles away, and check whether there’s any oil in the tanks?” (Laughs)

So it - you know, here was something - a tiny little operation - some guy was calling him from a bar in Bayonne and telling him this phony stuff was going on, and they didn’t want to hear it. They shut their ears to it.

And then what emerged was one great company after this kind of, what they thought was a near-death experience. So it’s - we’re going to make mistakes.

I will guarantee you that we will get some unpleasant news at Berkshire. I don’t know what it’ll be, you know - the most important thing is we do something about it.

And there have been times when I procrastinated, and Charlie has been the one that jabs me into action. And so he’s performed a lot of services you don’t know about. (Laughter)

11. “I like to think I’ll be missed a little bit, but you won’t notice it”

WARREN BUFFETT: OK. Gregg, Gregg Warren.

GREGG WARREN: Good morning, Warren. I have a little bit of a follow-up on Becky’s question.

At the 2014 annual meeting, as well as this morning, you noted that the power of Berkshire brand and its reputation, as well as the strength of Berkshire’s balance sheet, would allow the company’s next managers to replicate many of the advantages that have come with your being the face of the organization, one of which has been an ability to extract high rents from firms in exchange for a capital infusion and the Buffett seal of approval during times of financial distress.

I buy the argument about the strength of the balance sheet and believe that deals will continue to be done with sellers still lining up to become part of the Berkshire family, especially if the company’s next managers are allowed to keep a ton of cash on hand.

But I’m not entirely convinced that they’ll be able to garner the same 8, 9, 10 percent coupons, as well as other add-ons, that you’ve been able to extract from firms like Goldman Sachs and Bank of America in times of distress.

I’d expect those rents to be at least a few percentage points lower once you’re no longer running the show. That is, until those managers build up a reputation to warrant higher returns. Am I right to think about it that way?

WARREN BUFFETT: I’m not sure. The - when we, in two - you mentioned Goldman Sachs, and we also did with General Electric, in September or early October of 2008. We probably could actually have extracted better terms.

You know, I think it might have been counterproductive in the end, but I was - we would have done better, incidentally, financially, if we’d really waited until the panic developed further - because I didn’t know how far it would develop - but we could have made a lot better purchases three or four or five months later than we did at that time.

And we also did not want to do something that looked to be so high as to in - make the transaction disadvantageous to Goldman or to GE.

They were going to take the terms we offered, but we actually didn’t push it to the limit, because there really wasn’t anybody else around.

I think - and we’re working on something right now that probably won’t happen. It’s not huge.

But actually, in this case, both Todd [Combs] and Ted [Weschler] have brought deals to me. One of them brought something to me, and, you know, he was thinking in the same terms that I got - was thinking about - and he’s the one that returned the call that he had received about a transaction.

And I do not think the party on the other side is going to care about the fact that they had him on the phone rather than me on the phone. I -

You know, there may - there could be just a little bit at certain times in history. But, you know, we will continue to have our standards of what we think money is worth at any given time. And Ted and Todd think just as well about that as I do.

And there will be times, very occasionally, when our phone will ring a lot. And I don’t think they’ll hang up because I don’t answer it, if they need the money.

Charlie?

CHARLIE MUNGER: Well. The times he’s referring to, a lot of them, were like the worst in 50 years. So that’s a really rare kind of an occurrence. And we didn’t make all that many deals. So I think he’s right that it’ll be harder for us to make similar deals in the future.

WARREN BUFFETT: Yeah, the problem is the sums involved now, more than the problem of deciding what the proper terms should be. And sometimes we can get what we think is appropriate and sometimes we - most of the time, today, we can’t.

But you may see a transaction or two that - not in terms of buying business but in terms of securities - that strike you as perfectly decent ways to invest Berkshire’s money.

And they may well have come through Todd or Ted instead of directly to me.

I like to think I’ll be missed a little bit, but I - you won’t notice it. (Laughter)

12. Buffett talks to Ajit Jain about insurance pricing because it’s fun

WARREN BUFFETT: OK, Station 3.

AUDIENCE MEMBER: I’m Todd Lichter (PH) from Boulder, Colorado.

Mr. Buffett, are you still involved in pricing decisions at See’s Candies and The Buffalo News? And with what other Berkshire subsidiaries do you take more than a hands-off approach?

WARREN BUFFETT: Yeah, you’re correct that at one time I, and for some - for quite a while - both Charlie and I took part in the pricing decisions at See’s Candy.

And certainly, for some years, particularly with the question of the survival of The Buffalo News was really in question, I definitely took part in those decisions.

In both cases, we had good managers, but still we wanted to - we thought those decisions were important. But it’s been a long, long time - very long time - since we’ve participated in anything like that.

I can’t tell you what the per pound price is for See’s Candy, which is because people, and you’re invited to join this group, send me free candy from time to time. (Laughter)

And I can’t - I really, I can’t tell you the prices at The Buffalo News. All I know is it’s very, very, very hard to move up prices on advertising, generally. So no, we -

The only thing is, Ajit [Jain] and I talk frequently. And if there’s some very big risk, if somebody wants a $5 billion cover on a chemical plant some way excessive loss of over 3 billion or something - we have a certain amount of fun with him deciding on the price in his head. And I decide in my head, and then we compare notes.

It’s the kind of risk that you really can’t look up in a book and see, actuarially, what it’s fairly - the parameters - are fairly likely to be.

I enjoy thinking through the pricing of that, and I particularly enjoy comparing it with Ajit. So the -

These are just oddball situations, but we do that sort of thing, and we’ve done it for three decades. And it’s part of the fun of my job.

The candy prices, if you got to complain about those, you have to go to Charlie. (Laughter)

CHARLIE MUNGER: Well, the answer is, Warren is still doing it and talking to Ajit, and - but that’s because Ajit likes it that way.

WARREN BUFFETT: Yep.

CHARLIE MUNGER: We have a very peculiar place where the - where Warren’s contact with the various people elsewhere in the organization largely depends on what they want, not what he wants.

WARREN BUFFETT: The CEO of one of our -

CHARLIE MUNGER: It’s very unusual, and it’s worked beautifully.

WARREN BUFFETT: The CEO of one of our most successful subsidiaries, I may have talked to - unless I saw him here and just said hello - I probably talked to him three times in the last ten years.

And he does remarkably well. (Laughs)

He might have done even better if I hadn’t talked to him those three times. (Laughter)

And on the other hand, Ajit and I talk very, very frequently. And he’s got the kind of business, A, I do know - I know more about the insurance business than I know about a good many of the other businesses.

And it’s interesting. And we are evaluating things that you don’t look up in a book, you know. I mean, actuarial talent is not what’s important in the things that Ajit talks to me about. It’s plenty important throughout our insurance operation.

But in these particular cases, you know, we’re making judgments, and his judgment’s better than mine. But I like to - I just like to hear about them. They’re interesting propositions.

13. Putting business values in income account is “enormously deceptive”

WARREN BUFFETT: OK, Carol.

CAROL LOOMIS: ... shareholder named Jack Ciesielski . He’s a well-known accounting expert, who for many years has written “The Accounting Observer.”

“Mr. Buffett, in this year’s shareholder letter you have harsh words for the new accounting rule that requires companies to use market value accounting for their investment holdings.

″‘For analytical purposes,’ you said, ‘Berkshire’s bottom-line will be useless.’

“I’d like to argue with you about that. Shouldn’t a company’s earnings report cite everything that happened to, and within, a company during an accounting period?

“Shouldn’t the income statement be like an objectively written newspaper informing shareholders of what happened under the management for that period, showing what management did to increase shareholder value and how outside forces may have affected the firm?

“If securities increased in value, surely the company and the shareholders are better off. And surely they’re worse off if securities decreased in value.

“Those changes are most certainly real. In my opinion, ignoring changes in the way that some companies ignore restructuring costs, is censoring the shareholders’ newspaper.

“So my question is, how would you answer what I say?” (Laughter)

WARREN BUFFETT: Well, my answer to the question that asks what my answer would be to what he said - the - I would ask Jack, if we’ve got $170 billion of partly-owned companies, which we intend to own for decades, and which we expect to become worth more money over time, and where we reflect the market value in our balance sheet, does it make sense to, every quarter, mark those up and down through the income account, when at the same time we own businesses that have become worth far more money, in most cases, and become, you know, since we bought - you name the company - take GEICO, an extreme case - we bought half the company for $50 million, roughly - do we want to be marking that up every quarter to the value - and having it run through the income account?

That becomes an appraisal process. There’s nothing wrong with doing that, in terms of evaluation. But in terms of - and you can call it gain in net asset value or loss in net asset value - that’s what a closed-end investment fund, or an open-investment fund would do.

But to run that through an income account - if I looked at our 60 or 70 businesses, or whatever number there might be, and every quarter we marked those to market, we would have, obviously, a great many, in certain cases, where over time we’d have them at 10 times what we paid, but how quarter-by-quarter we should mark those up and run it through the income account, where 99 percent of investors probably look at net income as being meaningful, in terms of what has been produced from operations during the year, I think would be - well, I can say it would be enormously deceptive.

I mean, in the first quarter of this year - you saw the figures earlier - where we had the best what I would call operating earnings in our history, and our securities went - were down six billion, or whatever it was, to keep running that through the income account every day you would say that we might have made on Friday, we probably made 2 1/2 billion dollars. Well, if you have investors and commentators and analysts and everybody else working off those net income numbers and trying to project earnings for quarters, and earnings for future years, to the penny, I think you’re doing a great disservice by running those through the income account.

I think it’s fine to have marketable securities on the balance sheet - the information available as to their market value - but we have businesses there - if we - we never would do it - but if we were to sell half, we’ll say, of the BNSF railroad, we would receive more than we carried - carried for them - we would turn - we could turn it into a marketable security and it would look like we made a ton of money overnight. Or if we were to appraise it, you know, appraise it every three months and write it up and down, A, it could lead to all kinds of manipulation, but B, and it would just lead to the average - to any investor- being totally confused.

I don’t want to receive data in that manner and therefore I don’t want to send it out in that manner.

Charlie?

CHARLIE MUNGER: Well, to me it’s obvious that the change in valuation should be noted, and it is and always has been - it goes right into the net worth figures.

So the questioner doesn’t understand his own profession. (Laughter and applause)

I’m not supposed to talk that way but it slips out once in a while. (Laughter)

WARREN BUFFETT: Sometimes he even gives it a push. (Laughter)

14. McLane profits hurt by severe competitive pressure

WARREN BUFFETT: OK. Jonathan.

JONATHAN BRANDT: McLane’s core operating margins have dropped about 50 percent from where they’ve generally been since acquisition [from Walmart].

Could you elaborate on the competitive pressures in the grocery and convenience store distribution business that have caused the deterioration in profits? And do you expect the margin structure of that business to eventually get back to where it was, or is this the new normal?

WARREN BUFFETT: Well, I don’t know the answer to the second part about the future, but there’s no question that the margins have been squeezed. They were very, very narrow, as you know, they were about one cent on the dollar pretax, and they have been squeezed from that. Payment terms get squeezed.

In some cases we have fairly long-term contracts on that, so it will go on for five years (inaudible).

It’s a very, very tight margin business. And the situation is even worse than you portray because within McLane we have a liquor distribution business in a few states and that business has actually increased its earnings moderately, and we’ve added to that business, so within McLane’s figures there are about 70 million or so pretax from the liquor part that have nothing to do with the massive parts you’re talking about, in terms of food distribution.

So it’s even - the decline is even greater in what you’re referring to than you’ve (inaudible).

That’s just become very much more competitive. We have to decide - if you’ll look at our competitors, they’re not making much money either. And that’s capitalism.

I think, you know, there comes a point where the customer says, you know, “I’ll only pay X,” and you have to walk away.

And there’s a great temptation when you’re employing - particularly employing thousands of people -and you’ve built distribution facilities, and all of that sort of thing - take care of them - to meet what you’d like to term as “irrational competition,” but that is capitalism.

And - you’re right. We took - the earnings went up quite a bit from the time we bought it. And we’re still earning more than then. And we’ve earned a lot of money over time.

But, as I say, a fair amount of that is actually coming from liquor distribution, activities in about four states that we purchased - very well-run.

And - we will do our best to get the margins up. But I would not - I could not tell you - give you a really - your guess is almost as good as mine, or better than mine, maybe, as to what margins will be in that distribution business five years from now.

It’s a very essential service. We do $40-some billion. And we move more of the product of all kinds of companies that names are known to you, than anybody else. But - when you get - when you get - Kraft Heinz for that matter, or Philip Morris, or whomever it may be, on one side of the deal, and you get Walmart and some other - 7/11 - on the other side of the deal, sometimes they don’t leave you very much room in between.

Charlie?

CHARLIE MUNGER: I think you’ve described it very well. (Buffett laughs)

15. Health care costs partnership with Amazon and JPMorgan

WARREN BUFFETT: OK. (Laughter) Station 4.

AUDIENCE MEMBER: Good morning, Charlie and Warren. I know that seems a little bit out of order, but I’m a huge fan of yours, Charlie, mostly for your 25 Cognitive Biases.

I’m from Seattle, Washington. I run a one-person digital marketing firm that specializes in Facebook ads and email marketing. I use these a lot. I - your breakdown of Coca-Cola was really, really solid.

And I use that as reference when looking to how to understand the mechanics of my clients’ products and how to promote them. So I’m fairly certain that your cognitive biases work for internet-related companies.

Now that you’re partnering with Amazon [and JPMorgan] on health care, I’m curious, have you started to understand how to apply these biases to internet-related companies? Or is there another set of tools you use to decide if you understand a business? Because you guys talk a lot about not investing in businesses that you don’t understand.

WARREN BUFFETT: Well, health care is a - we don’t plan to start health care companies or, necessarily, insurers or anything. We simply have three organizations with leaders that I admire and trust. And we - mutually goes around all three.

And we hope to do something which Charlie correctly would probably say is almost impossible to change in some way a system which is - was taking 5 percent of GDP in 1960, and now is taking close to 18 percent.

And we have a hugely noncompetitive medical cost in American business, relating to any country in the world. The countries that - there were some countries that were around our 5 percent when we were at 5 percent. But we’ve managed to get to 18 without them going beyond 11 or so.

Literally, in 1960, we were spending $170 per capita on medical costs in the United States. And now we’re spending over 10,000.

And, you know, every dollar only has a hundred cents. So there is a cost problem. It is a tapeworm, in terms of American business and its competitiveness.

We don’t - we have fewer doctors per capita. We have fewer hospital beds per capita, fewer nurses per capita, than some of the other countries that are well below us.

And you’ve got a system that is delivering $3.3 trillion - that’s almost as much as the federal government raises - it’s delivering 3.3 trillion, or some number like that, to millions and millions and millions of people who are involved in the system. And every dollar has a constituency. It’s just like politics.

And whether we can find the chief executive, which we’re working on now, and which I would expect we would - we would be able to announce before too long - that - but that’s a key part of it.

And whether that person will have the imagination and support of people that will enable us to make any kinds of significant improvements in a system which everybody agrees is sort of out of control on cost, but what - but - but they all think it’s the other guy’s fault, generally - we’ll find out. It won’t be - it won’t be easy.

But it is not a - the motivations are not primarily profit-making. They’re - we want to deliver - we want our employees to get better medical service at a lower cost. We’re not going to - we’re certainly not going to come up with something where we think the service that they receive is inferior to what they’re getting now.

But we do think that there may be ways to make a real - significant changes - that could have an effect. And we know that the resistance will be unbelievable.

And if we fail, we’ve at least tried. And - but they - the idea is not that I will be able to contribute anything to, you know, in some breakthrough moment, by reading a few medical journals or something - (laughs) - changing something that is as embedded as the medical system.

But the idea is that maybe the three organizations, which employ over a million people and which, after we announced it, we had a flood of calls from people that wanted to join in, but there isn’t anything to join into now. But they will if we have - come up with any ideas that are useful.

Whether we can - bring the resources, bring the person. And the CEO is terribly important. And then bring the person, support that person. And somehow, figure out a better way for people to continue to receive better medical care in the United States without that 8 percent - 18 percent - going to 20 or 22 percent, you know, in the lifetime of, you know, our children or something of the sort - because there are only a hundred cents in the dollar.

And we will see what happens. It’s - you know - if you were Ajit [Jain], actuarially figuring, it would not - you would not bet on us. But - I think there is some chance we will do something.

There’s a chance - nobody can quantify it - that we can do something significant. And we are positioned better than most people to try. And we’ve certainly got the right partners. So, we will give it a shot and see what happens.

Charlie? (Applause)

CHARLIE MUNGER: There is some precedent for success in this public service activity. If you go back many decades, John B. Rockefeller I, using his own money, made an enormous improvement in American medical care. Perfectly enormous. In fact, there’s never been any similar improvement done by any one man since that rivals it.

So Warren, having imitated Rockefeller in one way, is just trying another. And maybe it’ll work.

WARREN BUFFETT: Rockefeller, incidentally, lived a very long time. So I actually am trying to imitate him three ways there. (Laughter)

We’ll see what happens. But we are - we’re making a lot of progress. And I think we’ll probably have a CEO within a couple of months. But if we don’t have one, then we’re not going to pick somebody just because we want to meet any deadline or anything like that. We’ve got these wonderful partners.

We don’t have a partnership agreement among us. Somebody started drawing up one in a legal department and the CEO just put a stop to it.

They - you do have places that have a lot of resources. And while we all have our share of bureaucracy, we can cut through it if we’ve got something that we really think makes sense.

And we will get the support - we’ll get - we’ll get a lot of resistance, too. But we will get the support of a lot of American business, if we come up with something that makes sense.

But if it was easy, it would’ve already been done. There’s no question about that.

CHARLIE MUNGER: It’s not easy.

WARREN BUFFETT: No. (Laughs) But it should be tried.

16. Weschler and Combs “slightly ahead” of S&P

WARREN BUFFETT: OK. Becky?

BECKY QUICK: This question comes from David Rolfe, who is with Wedgewood Partners, and has been - the company - has been shareholders in Berkshire since 1989. The stock is currently the largest holding in their stocks - 18 stocks.

He asks this question: “Over the past two years, you have listed the individual fund-of-funds performance from Protégé Partners. When will you start showing the annual performance on 25 billion that Ted [Weschler] and Todd [Combs] manage? Can you state if either Ted or Todd has beaten the S&P 500 index over the last five years?

WARREN BUFFETT: Yeah. Both - A, we’ll probably never report their individual performance.

But you can be sure that I have an enormous interest in - as does Charlie - in how much we think they contribute to Berkshire. And they have - they’ve been terrific. They’ve - they not only have the intellect, and the record, but they are exceptional human beings. And they -

Todd has done a tremendous amount of work, for example, on the medical project.

And - Ted is - I’ve given him several things, and he’s done them better than I could do them.

So the record, since inception - and I’m measuring it - Ted came later than Todd, a year or so later - but the record, since inception, is almost identical - both for the two managers - from their different inception and matching the S&P.

And they’ve received some incentive compensation, which they only get if they beat the S&P. And as I say, they’re just slightly ahead. That really hasn’t -

It’s been better than I’ve done, so naturally, I can’t criticize it. (Laughs)

They - they were the - they were two very, very, very good choices.

Charlie?

CHARLIE MUNGER: You did report it in a previous year. You just didn’t do it this year. And - but now you have your report. (Laughter)

WARREN BUFFETT: I would - the problem that all of us has is size. It’s actually - it’s harder to run even 12 or $13 billion, frankly, than it is to run a billion. And if you’re running a million dollars or something of the sort, it’s a whole different game. You’d agree with that, wouldn’t you, Charlie?

CHARLIE MUNGER: Of course.

WARREN BUFFETT: Yeah, OK. (Laughter)

Just like any good lawyer, you never ask him a question unless you think you know the answer they’re going to give. (Laughter)

17. GEICO is on a good growth and profit track

WARREN BUFFETT: OK. Gary?

GARY RANSOM: My question’s on GEICO. Last year, you promised growth and delivered. But along the way, the combined ratio was moving up, and it was the first time it was over a hundred in about 15 years.

Granted, some of that was catastrophes. But even excluding catastrophes, there was something going on in the loss trends that caused you to slow down that growth, at least at the - as we got to the latter part of the year.

And I wondered if you could tell us what was going on. And I did look this morning, too, so it looked like the first quarter has settled down a little bit, but I’d still like to know about the fourth quarter.

WARREN BUFFETT: Yeah, sure. It - the only thing I differ with the question on slightly - when you say it caused us to slow down - we didn’t want to slow down the growth. I mean, you’re looking at a guy here that has never wanted to slow down the growth of GEICO. The growth did slow down, but it wasn’t because we wanted it to.

Our prices that led to the underwriting loss - we actually - we’d have been slightly in the black without the catastrophes.

But, you know, if we hadn’t have paid our light bills, we might have been in the black, too. I mean, this “except for” stuff doesn’t mean much in insurance as far as I’m concerned.

The - if you’ll look at the first quarter - our margins were around 7 percent, which is actually a little more than we aimed for. And I received the unaudited - I mean, the preliminary - figures for April, and they’re similar.

So, the underwriting gain is - or margins - are perfectly satisfactory now. And we’d love to get all the growth we can. And we will gain market share this year. And we gained market share - Tony - when Tony [Nicely] took over the place, it was - in 1993 - it was two and a very small fraction percent. And it’ll be 13 percent of the - you know - 13 percent of the households in the country now. And we will keep gaining share. We will keep writing profitably - most of the time.

And every now and then, our rates will be slightly - modestly inaccurate - inadequate, I should say. And/or we’ll have, maybe, some big losses on hurricanes or something of the sort, or we’ll have a [Hurricane] Sandy in New York.

The - but GEICO is a jewel. And it’s - you know, it’s really a - we’ve got some others we feel awfully close to similarly about, but it’s an incredible company. It has a culture all of its own. It’s saving its customers probably 4 or $5 billion a year against which they would - against what they would otherwise be paying, based on the average in auto insurance. And it will be profitable on underwriting a very high percentage of the year. It contributed another $2 billion to float last year.

It is a terrific company. And like I say, the first four months are dramatically better.

Now, there’s some seasonal in auto insurance. So, the first quarter is usually the best of the four quarters. But it’s not a dramatic seasonal. So, I think when you read the 10-Q - and you can take my word for April - I think GEICO is on a good profit track as well as a good growth track. And the more it grows, the better I like it.

Charlie?

CHARLIE MUNGER: Well, I think you’ve said it perfectly.

WARREN BUFFETT: Huh.

CHARLIE MUNGER: It was never very bad, and it’s better now. (Buffett laughs)

18. Munger on steel tariffs: “Even Donald Trump can be right”

WARREN BUFFETT: OK. Station five.

AUDIENCE MEMBER: Good morning, Warren Buffett and Charlie Munger. My name is Ethan Mupposa (PH), and I am from Omaha, Nebraska.

My question is, how will Donald Trump’s tariffs affect the manufacturing business of Berkshire Hathaway?

WARREN BUFFETT: Well, to date - (applause) - steel costs - we’ve seen steel costs increase somewhat. But as I said earlier, I don’t think the United States or China - there’ll be some jockeying back and forth, and there will be something that leaves some people unhappy and - but I don’t think - I don’t think either country will dig themselves into something that precipitates and continues any kind of real trade war in this country.

We - we’ve had that in the past a few times. And I think we’ve learned a general lesson on it.

But there will - there will be some things about our trade policies that irritate others. And there will be some from others that irritate us. And there will be some back and forth. But in the end, I don’t think we’ll come out with a terrible answer on it.

Charlie, I’ll let you -

CHARLIE MUNGER: Well, steel has - it reached - the conditions in steel were almost unbelievably adverse to the American steel industry.

You know, even Donald Trump can be right on some of this stuff. (Laughter and applause)

WARREN BUFFETT: The - the thing about trade - you know, I’ve always said that the president, whether it’s president - any president - needs to be an educator-in-chief, which [Franklin] Roosevelt was in the Depression. That’s why he had those Fireside Chats, and it was very important that he communicated to the people what needed to be done and what was happening around them, and -

Trade is particularly difficult, because the benefits of trade are basically not visible, you know. You don’t know what you would be paying for the clothes you’re wearing today if we’d had a rule they all had to be manufactured in the United States, or what you’d be paying for your television set, or whatever it may be.

No one thinks about the benefits day-by-day as they walk around buying things and carrying on their own business.

The negatives, and there are negatives, are very apparent and very painful. And if you’re laid off - like happened in our shoe business [Dexter Shoes] in Maine - and you know you are - been a very, very, very good worker, and you were proud of what you did, and maybe your parents did it before you, and all of a sudden you find out that American shoes - shoes manufactured in America - are not competitive with shoes made outside the United States.

You know, you can talk all you want about Adam Smith or David Ricardo or something and explain the benefits of free trade and comparative advantage and all that sort of thing, and that doesn’t make any difference.

And if you’re 55 or 60 years old, to talk about retraining or something like that, you know, so what?

So, I - it is tough in politics where you have a hidden benefit and a very visible cost to a certain percentage of a - of your constituency.

And you need to do two things under those circumstances, if you have that situation. You know what’s good for the country. So, you have to be very good at explaining how it does really hurt, in a real way, somebody that works in a textile mill, like we had in New Bedford, where you only spoke Portuguese - half our workers only spoke Portuguese. And suddenly, they have no job. And they’ve been doing their job well for years.

You’ve got to do two things. You can - you’ll have to - you have to understand that that’s the price individuals pay for what’s good for the collective good.

And secondly, you’ve got to take care of the people that are - that - where retraining is a joke because of their age, or whatever it may be. And you’ve got to take care of the people that become the roadkill in something that is collectively good for us as a country. And -

That takes society acting through its representatives to develop the policies that will get us the right collective result, and not kill too many people economically in the process. And you know, we’ve done that in various arenas over the years.

The people in their productive years do help take care of the people that are too old, and too young. I mean, every time a baby is born in the United States, you know, we take on an obligation of educating them for 12 years. It’ll cost $150,000 now, you know? It -

We have a system that has a bond between the people in their productive years and the ones in the young and old. And it gets better over time. It’s far from perfect now. But it has gotten better over time.

And I believe that trade, properly explained, and with policies that take care of the people that are roadkill, is good for our country and can be explained.

But I think it’s a tough - it’s been a tough, tough sell to a guy that made shoes in Dexter, Maine or worked on a loom in New Bedford, Mass, or works in the steel mill in Youngstown, Ohio. (Applause)

19. Buffett won’t impose his political opinions on Berkshire

WARREN BUFFETT: Andrew?

ANDREW ROSS SORKIN: OK, Warren. This question comes from a Berkshire shareholder who says they’ve been a shareholder for ten years. I should say this may be one of the most pointed questions I’ve ever received for you. So -

WARREN BUFFETT: But you elected to give it, though.

ANDREW ROSS SORKIN: But I did. (Laughter)

The shareholder writes, “I have watched the movie every year at this meeting, when you testify in front of Congress on behalf of Salomon, as the symbol of what it means to have a moral compass. Investors are increasingly looking to invest in companies that are socially and morally responsible.

“So I was disturbed when you were asked on CNBC about the role that business could play in sensible policies around the sales of guns.

“You said you didn’t think business should have a role at all, and you wouldn’t impose your values on others. I was even more surprised when you said you’d be OK with Berkshire owning shares in gun manufacturers.

“At this meeting years ago, you said you wouldn’t buy a tobacco company because of the social issues. The idea that Berkshire would associate with any company as long as it isn’t illegal seems at odds with everything I think you stand for. Please tell us you misspoke.”

WARREN BUFFETT: Well - (applause) - let’s explore that a little. (Laughter)

Should it be just my view, or should it be the view of the owners of the company? So, if I decide to poll the owners of the company on a variety of political issues, and one of them being whether, you know, Berkshire Hathaway should support the NRA, I don’t - if a majority of the shareholders voted to do it, or if a majority of the board of directors voted to do it, I would - I wouldn’t - I would accept that.

I don’t think that the - my political views - I don’t think I put them in a blind trust at all when I take the job. And I - in the elections of 2016, I raised a lot of money. In my case, I raised it for Hillary [Clinton]. And I spoke out in various ways that were quite frank, but - (applause) - I don’t think that I speak -

When I do that, I don’t think I’m speaking for Berkshire. I’m speaking as a private citizen. And I don’t think I have any business speaking for Berkshire. We have never - at the parent company level - we have never made a political contribution, you know -

And I don’t go to our suppliers. I don’t do anything of that sort where I raise money either for the school I went to, or for a political candidate I went to, or anything else.

And I don’t think that we should have a question on the GEICO policyholder form, “Are you an NRA member?” you know, and if you are, you just aren’t good enough for us, or something. That - I think -

I do not believe in imposing my political opinions on the activities of our businesses.

And if you get to what companies are pure and which ones aren’t pure - (applause) - I think it is very difficult to make that call. Thank you.

I think with that response, I’m almost afraid to call on Charlie. But go ahead, Charlie. (Laughter)

CHARLIE MUNGER: Well, obviously, you do draw a limit, Warren -

WARREN BUFFETT: Yeah, we did.

CHARLIE MUNGER: - in all kinds of thing -

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: - which are beneath us, even though they’re legal. But we don’t necessarily draw it perfectly because we’ve got some sort of supreme knowledge. We just do the best we can.

And certainly, we’re not going to ban all guns, surrounded by wild turkeys in Omaha. (Laughter)

20. “Very unlikely” Berkshire would pay a special dividend

WARREN BUFFETT: OK, Gregg. (Laughter)

GREGG WARREN: Warren, this question’s also based on something you said more recently, so I can’t guarantee it’s going to be any easier. (Buffett laughs)

You recently noted that you prefer share repurchases over dividends as a means for returning capital to shareholders should Berkshire’s cash balances continue to rise and hit the $150 billion threshold you noted as being difficult to defend to shareholders at last year’s annual meeting.

While I understand the rationale for not establishing a regular dividend, a one-time special dividend could be a useful option for returning a larger chunk of Berkshire’s excess capital to shareholders without the implied promise to keep paying a regular dividend forever.

The drawback with the special dividend, though, is that it would lead to an immediate decline in book value and book value per share. Whereas a larger share repurchase effort, while depressing book value, would reduce Berkshire’s share count, limiting the impact on book value per share.

If we do happen to get a few years out and Berkshire does hit that $150 billion threshold, because valuations continue to be too high, both for acquisitions and for the repurchase of company stock, would you consider a one-time special dividend as a means for returning capital to shareholders?

WARREN BUFFETT: Well, if we thought we couldn’t use capital effectively, we would figure - we would try to figure out the most effective way of returning capital to shareholders. And - you could - I would have probably - I think it’d be unlikely we’d do it by a special dividend.

I think it’d be more likely we’d do it by a repurchase, if the repurchase didn’t result in us paying a price above intrinsic value per share. We’re never going to do anything that we think is harmful to continuing shareholders.

So if we think the stock is intrinsically worth X, and we would have to pay some modest multiple even above that to repurchase shares, we wouldn’t do it because we would be hurting continuing shareholders to the benefit of the people who are getting out.

But we will try and do whatever makes the most sense, but not with the idea that we have to do something every day because we simply can’t find something that day.

We had a vote as you know - I don’t know, a few years back - on whether people wanted a dividend. And - the B shares - so I’m not talking my shares or Charlie’s or anything - but the B shares voted 47 to one against it.

So I think through self-selection of who become shareholders - I don’t think shareholders world - or countrywide - on all stocks would vote 47 to one at all.

But we get self-selection in terms of who joins us. And I think they expect us to do whatever we think makes sense for all shareholders. And obviously, if we really thought we never could use the money effectively in the business, we should get it out, one way or another. And -

You’ve got a bunch of directors who own significant - very significant - amounts of stock themselves. And you can expect them to think like owners. It’s the reason they’re on the board.

And you can expect the management to think like owners and - owners will return money to all of the owners if they think it makes more sense than continuing to look for things to do.

But we invested in the first quarter, maybe - have to look it up on the - well, certainly through April - probably close to 15 billion or something like that, net, so -

And we won’t always be in a world of very low interest rates - or high private market prices.

So we will do what makes the most sense. But I can’t see us ever making a special - almost - it’s very unlikely we would just pay out a big, special dividend. I think that if we put that to the vote of the shareholders, and Charlie and I did not vote, I think we would get a big negative vote. And I’d be willing to - be willing to make a bet on that one.

Charlie?

CHARLIE MUNGER: Well, as long as the existing system continues to work as well as it has, why would we change it? We’ve got a whole lot of people that are accustomed to it, have done well under it. And if conditions change, why, we’re capable of changing our minds, if the facts change.

WARREN BUFFETT: Yeah, and we’ve done that several times.

CHARLIE MUNGER: Yes.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: Although, I must say, it’s a little hard. (Laughter)

WARREN BUFFETT: He always brings me back to earth.

21. Munger is more interested than Buffett in Chinese stocks

WARREN BUFFETT: OK. Station 6?

STEPHANIE YU: Hi, good morning, Mr. Buffett and Mr. Munger. My name is Stephie Yu from Horizon Insights, a China-focused research firm based in Shanghai. So I have a lot of mutual fund clients in China, who are very young - relatively younger - and they manage a smaller portion of funds.

So my question is, if you only have $1 billion in your portfolio today, how would you change your investments? Would you consider more investment opportunities in emerging markets such as China? Thank you.

WARREN BUFFETT: Yeah. I would say, if I were working with a billion, I would probably find - within a $30 trillion market in the United States, where I understood things better, generally, than I do around the world - I’d probably find opportunities there that would be better, incidentally, by some margin, than what we can find for hundreds of billions.

But I wouldn’t - there’s no way I’d rule out emerging markets. There was a time, 15 years ago or so, when just because it was kind of interesting and it took me back to my youth, I - on the weekend, I went through a directory of Korean stocks. And I bought - and these were small stocks - well, they weren’t small by standards of either Korean or American business. They were big, big companies.

But I found 15 or 20 in - that were statistically cheap and bought some of each one myself.

And there are opportunities with smaller amounts of money to do things that we just can’t do. And - but I - my first inclination always would be to comb through things in the United States. And -

But I’ve combed through - in other countries. I probably wouldn’t get into very, very small markets because there can be a lot of difficulties even in market execution and taxation, (inaudible).

You can find - if you can’t find it, you know, in America and China and Britain and a few other places - (laughs) - you probably aren’t going to find it someplace else. You may think you’ve found it. But that may be - it may be a different game than you know. Our problem is size, not geography.

Charlie?

CHARLIE MUNGER: Well, I already have more stocks in China than you do, as a percentage, so I’m with the young lady. (Laughter)

WARREN BUFFETT: OK. Well, you can - you want to name names? Do these stocks have names? Or - (Laughs)

CHARLIE MUNGER: No, I don’t. (Buffett laughs)

WARREN BUFFETT: Carol?

CAROL LOOMIS: This question is -

WARREN BUFFETT: I should just add one thing. You will find plenty of opportunities in China. Charlie would say you’ve got a better hunting ground than even a person with similar capital in the United States. Would you agree with -?

CHARLIE MUNGER: Yes, I do.

WARREN BUFFETT: Yeah, yeah. So - and in the sense they’re - it’s logical that should be the case because it’s a younger market, but still a large market. So that -

Markets probably work toward efficiency as they age. Japan had this very strange situation with warrants being priced out of line and all of that 30 years ago. And people notice after a while and it disappears. But there can be - some very strange things happen in markets as they develop. I think you’d agree with that, Charlie, wouldn’t you?

CHARLIE MUNGER: Absolutely.

WARREN BUFFETT: Yeah.

22. Munger: Keep the faith and don’t sell your stock when we’re gone

WARREN BUFFETT: Jonathan?

JONATHAN BRANDT: Hello -

CAROL LOOMIS: You skipped me.

WARREN BUFFETT: Did I skip -? I skipped Carol?

CAROL LOOMIS: Yup.

WARREN BUFFETT: Oh. I’m sorry.

CAROL LOOMIS: OK.

WARREN BUFFETT: OK.

CAROL LOOMIS: This question, and I would concede it is not a small one, comes from Gideon Pollack of Montreal.

He says, “The world knows generally how the looks of Berkshire Hathaway have changed since you began to run the company in 1965. Berkshire was then a tiny northeastern, textile company. And now it is the number-four company on the Fortune 500.

“What about the next 50 years? Could you give us your view of what Berkshire looks like in 2068?”

WARREN BUFFETT: I think it’ll look a long way away. (Laughter)

No, the answer is I don’t know. And I didn’t know, 50 years ago, what it would like now, I mean -

It will be based on certain principles. But where that leads, you know, we will find out and we’ll have people that are thinking about different things than I am. And we’ll have a world that’s different. But -

We will be - I very much hope and believe that we will be - that we’ll be as shareholder-oriented as any large company in the world. We will look at our shareholders as partners and we will be trying to do with their money exactly what we’d do with our own, not seeking to get an edge on them. And who knows what else will be happening then?

Charlie?

CHARLIE MUNGER: Well, I want to talk to the younger shareholders in the group. Those of you who, after we are gone, sell your Berkshire stock and do something else with it, helped by your many friends, I think are going to do worse. (Laughter)

So I would advise you to keep the faith. (Applause)

By the way, some of that has already happened in many families.

WARREN BUFFETT: I’ll give his answer next time now that I see it get all of that applause. (Laughter)

23. “Duracell should be earning more money than it is now”

WARREN BUFFETT: Jonathan.

JONATHAN BRANDT: Duracell’s $82 million of pretax profits in 2017 were still well below what it earned as a subsidiary of P&G. Can you clarify or quantify to what extent transition costs or purchase price accounting impacts at the segment level were still temporarily burdened last year? Or is it possible that the gap in earnings contribution simply reflects a commoditization of the category given the entry of Amazon into the battery market?

I did see that Duracell’s earnings were up in the first quarter. Is that a sign of a more meaningful contribution in 2018 and beyond, as you finish right-sizing the manufacturing footprint and acquisition-related charges fall away?

WARREN BUFFETT: Yeah. Duracell should be earning more money than it is now, and will be. And as you mentioned, it’s well on its way there. But it is not earning an appropriate amount now, based on the history of the company.

I was around when - I was on the board of Gillette when Gillette bought Duracell. And I’ve seen what it does when it is managed to its full extent. And I saw what Jim Kilts did with it at Gillette when he ran it. And there were a lot more transition problems in the purchase. For one thing, there’s a lot of rules connected with our swap of our stock in P&G for Duracell. There are a lot of things which you cannot do that made sense to do in that period of transition from P&G’s management to ours. But Duracell - the brand is strong. Very strong.

The product line is very strong. And we are making more money. And we should, and I believe we will earn, really, what the property is capable of earning. We should be earning that relatively soon.

But you’re absolutely right that it is - from a profit standpoint - is underperforming.

We’re making a lot of changes. And some of those are involved in jurisdictions - countries - where it is really expensive to change in terms of employment - payments that have to be made if a plant is changed or something of the sort.

But I like the Duracell deal absolutely as well as when we made it.

Charlie?

CHARLIE MUNGER: I like it better than you do. (Laughter)

WARREN BUFFETT: No. Duracell is a very, very - is our kind of business.

CHARLIE MUNGER: It is.

24. Long-term bonds are “almost ridiculous” at current rates

WARREN BUFFETT: OK. Station 7.

AUDIENCE MEMBER: Good morning. And I have a question related to the bond market - U.S. Treasury bond market. And my name is Ola Larsson (PH). I live in the San Francisco bay area.

And I never worked in the financial industry. I started out buying penny mining stocks on the Vancouver Stock Exchange. And then decades later, I got married. And my wife convinced me to buy Berkshire shares. That was probably a good decision. (Laughter)

So my question is, I read the newspapers about the Federal Reserve and the inflation numbers. And there must be an increase supply of Treasury bonds that must go to auction. And my question is how would - what do you expect that to impact yield or interest rate?

WARREN BUFFETT: Yeah. The answer is, I don’t know. And the good news is, nobody else knows, including members of the Federal Reserve and everyone -

There are a lot of variables in the picture. And the one thing we know is we think that long-term bonds are a terrible investment, and we - at current rates or anything close to current rates.

So basically all of our money that is waiting to be placed is in Treasury bills that, I think, have an average maturity of four months, or something like that, at most.

The rates on those have gone up lately, so that in 2018, my guess is we’ll have at least $500 million more of pretax income than we would’ve had in the bills last year.

But they still - it’s not because we want to hold them. We’re waiting to do something else.

But long-term bonds - they’re basically, at these rates - it’s almost ridiculous when you think about it. Because here the Federal Reserve Board is telling you we want 2 percent a year inflation. And the very long bond is not much more than 3 percent. And of course, if you’re an individual, then you pay tax on it. You’re going to have some income taxes to pay.

And let’s say it brings your after-tax return down to 2 1/2 percent. So the Federal Reserve is telling you that they’re going to do whatever’s in their power to make sure that you don’t get more than a half a percent a year of inflation-adjusted income.

And that seems to me, a very - I wouldn’t go back to penny stocks - but I think I would stick with productive businesses, or productive - certain other productive assets - by far.

But what the bond market does in the next year, you know - you’ve got trillions of dollars in the hands of people that are trying to guess which maturity would be the best to own and all that sort of thing. And we do not bring anything to that game that would allow us to think that we’ve got an edge.

Charlie?

CHARLIE MUNGER: Well, it really wasn’t fair for our monetary authorities to reduce the savings rates, paid mostly to our old people with savings accounts, as much as they did. But they probably had to do it to fight the Great Recession, appropriately.

But it clearly wasn’t fair. And the conditions were weird. In my whole lifetime, it’s only happened once that interest rates went down so low and stayed low for a long time.

And it was quite unfair to a lot of people. And it benefited the people in this room enormously because it drove asset prices up, including the price of Berkshire Hathaway stock. So we’re all a bunch of undeserving people - (laughter) - and I hope that we continue to be so. (Laughter)

WARREN BUFFETT: At the time this newspaper came out in 1942, it was - the government was appealing to the patriotism of everybody. As kids, we went to school and we bought Savings Stamps to put in - well, they first called them U.S. War Bonds, then they called them U.S. Defense Bonds, then they called them U.S. Savings Bonds. (Laughs) But they were called war bonds then.

And you put up $18.75 and you got back $25 in ten years. And that’s when I learned that that $4 for three - in ten years - was 2.9 percent compounded. They had to put it in small print then.

And even an 11-year-old could understand that 2.9 percent compounded for ten years was not a good investment. But we all bought them. It was - you know, it was part of the war effort, basically.

And the government knew - I mean, you knew that significant inflation was coming from what was taking place in finance, in World War II.

We actually were on a massive Keynesian-type behavior, not because we elected to follow Keynes, but because war forced us to have this huge deficit in our finances, which took our debt up to 120 percent of GDP. And it was the great Keynesian experiment of all time, and we backed into it, and it sent us on a wave of prosperity like we’ve never seen. So you get some accidental benefits sometimes.

But the United States government (inaudible) every citizen to put their money into a fixed-dollar investment at 2.9 percent compounded for ten years. And I think Treasury bonds have been unattractive ever since - (laughs) - with the exception of the early ’80s. That was something at that time.

I mean, you really had a chance to buy - you had a chance to invest your money by buying zero-coupon Treasury bonds, and in effect, guarantee yourself that for 30 years you would get a compounded return, you know, something like 14 percent for 30 years of your lifetime.

So every now and then, something really strange happens in markets and the trick is to not only be prepared but to take action when it happens.

Charlie, did you ever buy any war bonds?

CHARLIE MUNGER: No. No. I never bought war bonds.

WARREN BUFFETT: No. Used to be like take me -

CHARLIE MUNGER: I didn’t have any money when I was in the war. (Laughter)

WARREN BUFFETT: That’s a good reason not to buy. (Laughs)

25. “A bureaucracy is sort of like a cancer”

WARREN BUFFETT: OK, Becky?

BECKY QUICK: This question comes from Angus Hanton (PH), who - he and his wife are based in London, and he says they’ve been shareholders in Berkshire Hathaway for over 30 years.

He says, “We have all read about the zero-based budgeting that has been so effective with Kraft Heinz and other investments that you’ve done with 3G Partners. Can we expect these cost-reduction techniques to be used by your managers in other parts of the Berkshire Hathaway enterprise?”

WARREN BUFFETT: Well, in general, we do not expect the managers, generally, to get in the position where there would be a lot of change in terms of zero-based budgeting. In other words, why in the world aren’t you thinking that way all of the time?

The 3G people have gone into certain situations where there were - probably primarily in personnel, but in other expenses as well - a lot of expenses that were not delivering a dollar of value per dollar expended.

And so, they made changes very fast that - to a situation that probably shouldn’t have existed in the first place.

Whereas, we hope that our managers - take a GEICO. GEICO’s gone from, I think, 8,000 to 39,000 people since we bought control. But they’re all very productive. I mean, you would not find a way for a 3G operation to take thousands of people out of there.

On the other hand, I can think of some organizations where you could take a whole lot of people out, where it isn’t being done because the businesses are very profitable to start with.

That’s what happened with the tobacco companies, actually. They were so profitable that they had all kinds of people around that didn’t - weren’t really needed. But they - the money just flowed in.

So I - our managers have different techniques of keeping track of - or of - trying to maximize customer satisfaction at the same time that they don’t incur other than necessary costs.

And I think, probably, some of our managers may well use something that’s either zero-based budgeting or something akin to it. They do not submit budgets - never have - to me. I mean, they’ve never been required to. We’ve never had a budget at Berkshire.

We don’t consolidate our figures monthly. I mean, I get individual reports on every company. But there’s no reason to have some extra time spent, for example, by having consolidated figures at the end of April, or consolidated figures at the end of May.

We know where we stand. And - you know, I’m sure we’re the only company that - probably in the whole Fortune 500 - that doesn’t do it. But we don’t do unnecessary things around Berkshire. And a lot of stuff that’s done at big companies is unnecessary. And that’s why a 3G finds opportunities from time to time.

Charlie?

CHARLIE MUNGER: Well, if you’ve got 30 people at headquarters and half of those are internal auditors, that is not the normal way of running a big company in America.

And what’s interesting about it is, obviously, we lose some advantages from big size. But we also lose certain disadvantages from having a big bureaucracy with endless meeting after meeting after meeting around headquarters.

And net, I think we’ve been way ahead with our low overhead, diversified method. And also, it makes our company attractive to very able, honorable people who have companies.

So generally speaking, the existing system has worked wonderfully for us. I don’t think we have the employment that could be cut effectively that a lot of other places have. And I think our methods have worked so well that we’d be very unlikely to change them.

WARREN BUFFETT: Yeah. I think if some - at headquarters, you could say we have kind of subzero-based budgeting. (Laughter)

And we hope that the example of headquarters is, to a great extent, emulated by our -

CHARLIE MUNGER: But it isn’t just the cost reduction. I think the decisions get made better if you eliminate the bureaucracy.

WARREN BUFFETT: Oh yeah.

CHARLIE MUNGER: I think a bureaucracy is sort of like a cancer. And it functions sort of like a cancer. (Applause)

And so, we’re very anti-bureaucracy. And I think it’s done us a lot of good. In that case, we’re quite different from, say, Anheuser-Busch at its peak.

26. We’re experimenting with lower-cost commercial insurance

WARREN BUFFETT: OK. Gary.

GARY RANSOM: My question is on small commercial, and specifically, direct small commercial.

You seem to have some websites that enable buyers to purchase small commercial insurance directly; biBERK is one of them.

It’s a very competitive, fragmented market. But what is your strategy for that market? And then, can you ultimately GEICO-ize the small commercial market?

WARREN BUFFETT: Well, we’ll find out. I mean, it’s a very good question because that’s exactly the question we ask ourselves.

And we have this incredible company at GEICO, which has gone direct in the personal auto field, and was, you know, first started it in 1936.

And there’s no question in my mind that over a lot of years - and maybe not so many years - something like small commercial - anything that takes cost out of the system, you know, makes it easier for the customer, is going to work over time, if you’ve got a system that was based on something that had more layers of agency costs and that sort of thing.

So we are experimenting, and we’ll continue to experiment, on something like small commercial, workers’ comp, whatever it may be. We’ll try and figure out ways to take cost out of the system, offer the customer an equivalent product or better at lesser price, and we’ll find out what can be done and what can’t be done.

And we’re not the only ones doing it, as you know. But we are not going - we’ve got some managers that are going to be quite, I’m sure, enterprising on that. And we back them. And we expect some to fail and some - and if a few succeed - we’ll have some very good businesses. And the world is going in that direction. So - you could expect us to try and go with it.

Charlie?

CHARLIE MUNGER: Well, if it were easy, I think it would’ve happened more fast -

WARREN BUFFETT: Yeah -

CHARLIE MUNGER: - than it has.

WARREN BUFFETT: It will happen as we go along. I mean, it wasn’t easy in auto, I mean, when you think about it.

CHARLIE MUNGER: No, it wasn’t.

WARREN BUFFETT: No. I mean, it was a system with all kinds of extra costs that go back to the turn of the 19th century into the 20th. I mean, it was built on fire insurance and strong general agencies. And that slopped over into auto when the auto came along in 1903 from Ford or whenever. And - so it grew within a system that really wasn’t very efficient compared to what was available.

But it took State Farm initially to go to a direct, or a captive agency system. And then it took USAA, and then later, GEICO, and then later, Progressive, to go to direct systems that are even more efficient and consumer-friendly.

And the same thing is going to happen, to some degree, in all kinds of industries, and certainly small commercial - somebody will -

CHARLIE MUNGER: It could happen, but it will be slow.

WARREN BUFFETT: It takes an amazingly long time. I mean, it - but you know, the battle doesn’t always go to the strong and the race to the swift. But that’s the way to bet, you know, as they say. So - (Laughs)

27. Health care partnership is attacking a huge “industry moat”

WARREN BUFFETT: OK, station eight?

AUDIENCE MEMBER: Austin Merriam, from Jacksonville, Florida.

Mr. Buffett, with the recent news of the partnership between you, Mr. [Jeff] Bezos, and Mr. [Jamie] Dimon, to challenge the health care industry and the self-admitted difficulties you are running across, this would lead me to believe the industry has higher barriers to entry than may have originally been hypothesized; a larger moat, if you will.

Would that justify a higher earnings multiple for established players in the industries, such as PBMs, for example?

WARREN BUFFETT: Well, just - though the system may have a moat against intruders, it doesn’t mean that everybody operating within the system has individual moats, for one thing.

Now, I - we are - if this new triumvirate succeeds at all, we are attacking an industry moat. And I’m defining industry very broadly; health care, not just, you know, health care insurers or this or that.

We’re trying to figure out a better way of doing it and making sure that we’re not sacrificing care. And the goal is to improve care.

And like I say, that is a - that’s a lot bigger than a single company’s moat. It’s bigger than a component of the industry’s moat. The moat held by the whole system, since it interacts in so many ways, is actually - that’s the moat that essentially has to be attacked, and that’s a huge moat.

And like I say, we’ll do our best. But - I hope if we fail, I hope somebody else succeeds.

Charlie?

CHARLIE MUNGER: Well, I suspect that eventually when the Democrats control both houses of Congress and the White House, we will get single-payer medicine. And I don’t think it’s going to be very friendly to many of the current PBMs. (Applause)

And I won’t miss them. (Laughter)

28. Buffett vs Elon Musk on whether competitive moats are “lame”

WARREN BUFFETT: Andrew?

ANDREW ROSS SORKIN: This question comes from Kiwi (PH) and actually is directly about the issue of moats.

He notes that - “Elon Musk, this week, on his Tesla earnings call, said the following, quote, ‘I think moats are lame. They are, like, nice in a sort of quaint, vestigial way. And if your only defense against invading armies is a moat, you will not last long. What matters is the pace of innovation. That is the fundamental determinant of competitiveness,’ unquote.

“So, Warren, it seems the world has changed. Business is getting more competitive. Pace of innovation. Technology is impacting everything. Is Elon right?”

CHARLIE MUNGER: Let me answer that one, Warren.

Elon says a conventional mode is quaint. And that’s true of a puddle of water. And he says that the best moat would be to have a big competitive position. And that is also right. You know, it’s ridiculous. (Laughter)

Warren does not intend to build an actual moat. (Laughter)

Even though they’re quaint.

WARREN BUFFETT: Yeah. (Laughter)

There’s certainly a great number of businesses - this has always been true, but it does seem like it - the pace has accelerated and so on, in recent years. There’s been more moats that have been - become susceptible to invasion - than seemed to be the case, earlier. But there’s always been the attempt to do it.

And there - here and there, there are probably places where the moat is as strong as ever. But certainly - you could work at - certainly should be working at improving your own moat and defending your own moat all of the time. And then - Elon may turn things upside down in some areas.

I don’t think he’d want to take us on in candy. But - (Laughter)

And we’ve got some other businesses that wouldn’t be so easy to -

You can look at something like Garanimals out there in the other room. And - it won’t be technology that takes away the business in - (laughs) - Garanimals. Maybe something else that catches the young kid’s fantasy or something.

But - there are some pretty good moats around. Being the low-cost producer, for example, is a terribly important moat. And something like GEICO - technology has really not brought down the cost that much. I think our position as - there is a couple of companies that have costs as low as ours. But among big companies, we are a low-cost producer, and that is not bad when you’re selling an essential item.

29. Not surprised “if we find good uses” for Berkshire Hathaway Energy’s capital

WARREN BUFFETT: OK, Gregg?

GREGG WARREN: Warren, Berkshire Energy has benefited greatly from operating under the Berkshire umbrella. By not having to pay out 60 to 70 percent of earnings annually as a dividend, the company was able to amass 9 billion in capital the past five years, and closer to 12 billion in the past ten, money that can be allocated to acquisitions and capital spending, especially on renewables.

While tax credits for solar energy don’t run out until next year, we’ve already seen a dramatic reduction in Berkshire Energy’s capital commitment to solar projects. And even though spending on wind generation capacity is projected to be elevated this year and next, it does wind down in 2020 as the wind production tax credits are phased out.

Absent a major commitment to additional capital projects, it looks like Berkshire Energy’s expenditures in 2021 will be its lowest since 2012, leaving the firm with more cash on hand than it has had in some time.

Do you think it is likely at that point that Berkshire Energy starts funneling some of that cash up to the parent company? Or will it be earmarked for debt reduction, or just be left on the balance sheet as dry powder for acquisitions?

WARREN BUFFETT: Yeah. The - you’re right about when tax credits phase out and all of that. Although, as you know, they’ve extended that legislation in the past. Who knows exactly what the government’s position will be on incentivizing various forms of alternative energy?

But my guess is - I mean, if you take the logical expenditures that may be required in all aspects of the public - like regeneration and the utility business generally - I think there’ll be a lot of money spent.

And the question is whether we can spend it and get a reasonable return on it. There again, we’ll do what’s logical.

There are three shareholders, basically, of Berkshire Hathaway Energy. Berkshire Hathaway itself owns 90 percent of it. And Greg Abel and his family, perhaps, and Walter Scott and, again, family members - own the other 10 percent. And we all have an interest in employing as much capital as we can at good rates.

And we’ll know when it can be done and when it can’t be done. And we’ll do - there’s no tax consequences to Berkshire at all. So - but the three partners will figure out which makes the most sense.

But when you think of what might be done to improve the grid in the U.S. and the fact that we do have the capital, I wouldn’t be surprised if we find good uses for capital in Berkshire Hathaway Energy for a long time in the future.

Charlie?

CHARLIE MUNGER: Yeah. Well, I think there’ll be huge opportunities in Berkshire Energy as far ahead as you can see to deploy capital very intelligently. So I think the chances of a big dividend is approximately zero.

WARREN BUFFETT: Yeah. And we’ve not only got the money to an extent that virtually no utility company does - we’ve also got the talent, too. I mean, we’ve got a very, very talented organization there.

So it’s a big field and we’ve got shareholders that are capitalists. And we’ve got managers that are terrific. And you would think we’d find something intelligent to do over time in the field.

So far, we have. I mean, we’ve owned it now for close to 20 years. And we’ve deployed a lot of capital and so far, so good. I mean, it’s -

If you look at the improvements that can be made in our utility system in the United States, you’re talking hundreds and hundreds and hundreds of billions of dollars, if not trillions. So - you know, where else but Berkshire would you look for that kind of money? (Laughs)

30. “We do expect that normalized earning power to increase over time”

WARREN BUFFETT: OK, station 9.

AUDIENCE MEMBER: I’m Richard Sercer (PH) from Tucson, Arizona.

“At Berkshire what counts most are increases in our normalized per-share earning power.” That was in your last letter. What is our normalized per-share earning power, as you estimate it?

WARREN BUFFETT: Well, I would say that what you saw in the first quarter, under these tax rates, would probably be a reasonable guess. You know, obviously, it depends on the economy in any given year. I would say that would - is a reasonable estimate.

But we have firepower we haven’t used. And we’ll have more firepower as we go along. So we do expect that normalized earning power to increase over time. And if it doesn’t, you know, one way or another, we’re failing you because we’re retaining those earnings.

So - I don’t see anything abnormal in our earnings, figured now at a 21 percent federal rate. But as I look at the 5 1/4 billion in the first quarter - seasonally, insurance is better in the first quarter - but seasonally, most of our businesses, the first quarter is not the strongest quarter for us. I don’t see anything abnormal with it.

And then I think you can expect, you should expect, we expect, substantial capital gains over time in addition to what comes from the operating businesses.

So how much you figure in for that - I would say that the retained earnings beyond dividends of our 770 billion of equities - in other words, how much they’re keeping from us, but that our share of the earnings, which can be used by them, whether it’s Apple or American Express or Coca-Cola or Wells Fargo or whatever, our share, you know, is in many billions of dollars annually. And one way or another, we think that those dollars will benefit us as much as if they had been paid out.

Now, in certain cases, they won’t. But in certain cases, they’ll excel the amount, in terms of market value created.

So there’s many billions of dollars we are not showing in our earnings that is being retained by our investees. And one way or another, I think we’ll get value received out of those.

So you can take 20 or 21 billion under present tax rates, present economic conditions, and then we should get something from that and we should get more when we get 100 billion of cash invested. And we should get more as we retain the earnings. So we hope it adds up to a bigger number as we go along.

Charlie?

CHARLIE MUNGER: Well, I don’t think our shareholders are going to see another increase in net worth of $65 billion in a single year. They may have to wait a while for another. But I don’t think that - I think eventually there - another will come, and then another. Just be patient. (Laughter)

WARREN BUFFETT: We don’t regard the present situation as, you know, as disadvantageous, except we’d like to get more money out. But we like the businesses we have. We like the businesses that we own part of. We are not reflecting - in the way we look at earnings - the dividends we get from those partially-owned companies falls far short of what they’re going to contribute, in our view, to Berkshire’s overall earnings over time. We wouldn’t own those stocks otherwise. So -

CHARLIE MUNGER: And you also like the Apple and airline stocks you’ve recently purchased better than the cash you parted with.

WARREN BUFFETT: Absolutely. Yeah.

CHARLIE MUNGER: And that’s quite a lot.

WARREN BUFFETT: Yeah, yeah, yeah. OK. We won’t pursue that further. Carol? (Laughter)

31. No “unusual profits involved in being a real estate agent”

CAROL LOOMIS: This question is from Daniel Kane (PH) of Atlanta.

“Your annual letter this year pointed out that Berkshire has become a leader in real estate brokerage in the United States. Congratulations. That is a significant feat in less than 20 years.

“But let me mention a sticky point. If fees charged by stock market active managers are a drag on investor performance, I would argue that real estate commissions are no different, and perhaps more detrimental, especially when one considers the lifetime effects of large, forgone, upfront cash flows and the power of compounding interest. I would be pleased to hear your rejoinder on the points I’ve raised.”

WARREN BUFFETT: Well, the purchase of a home is the largest financial transaction, for a significant percentage of the population, that they make. And - people - a lot of people need a lot of attention. And you can show a lot of houses before you sell one.

I would say this. If you look at our close to 50,000 agents now, I think they make a good living - or a decent living. But I would say that that people who manage money make a whole lot more money with perhaps less contribution to the welfare of the person that they are dealing with.

So I don’t think that there are unusual profits involved in being a real estate agent. I don’t think there are unusual profits involved in the ownership. We like it because it’s fundamentally a good business.

But here we are, doing 3 percent of all the real estate transactions in the United States, and we’re making, maybe, $200 million a year - which - well, we won’t get into what the comparative efforts are in Wall Street to earn $200 million. But -

I think I have to tell them about Roy Tolles a little bit on this. Roy Tolles, for example - Charlie’s partner - many, many, many years ago, decided he was going to want to buy a house in San Marino. He’s going to have a number of kids.

So he sent his wonderful wife, Martha, out. And for six months, he had her look at houses in San Marino. And this was many years ago. And if they were priced at 150,000, she would offer (inaubible), or offer 75,000. And of course, the real estate agents were going crazy because they’re never going to get something listed at 150 sold at 75.

And then finally, when she found one that they both really liked, he had her offer something like 120 and the real estate was so happy to get a bid that was in the general area - (laughs) - of the offering price that he would work very hard on the seller to take that bid. Because he knew what - (laughs) - he did not want six more months of Roy bidding at the lower prices. So you don’t sell them on the first trip.

Incidentally, I had Roy buy a house for me, sight unseen, because this was a guy that - (laughs) - knew human nature.

You don’t get rich - real estate agency - you know, the people earn their money, and they earn it in a perfectly respectable and honorable manner in terms of what they get paid. And as in every single industry there is, you know, there can be excesses or mistakes or that sort of thing.

But we will continue to buy more brokers. In fact, we’ll probably have another couple to announce before long.

And we will feel that if we get to where we’re doing 10 percent of the real estate brokerage business in the country and we’re making 6- or $700 million a year, pretax, we will not think that’s a crazy amount of money to make for enabling 10 percent of 5 million people to change their homes every year in the United States.

Charlie?

CHARLIE MUNGER: Well, the commissions in real estate may get unreasonable if you’re talking about $20 million houses. It seems a little ridiculous to pay a 5 percent commission on a $20 million transaction.

But do any of us really care if the kind of people who pay $20 million for a house have a slightly higher commission? (Laughter)

The ordinary commission is pretty well-earned.

WARREN BUFFETT: Yeah. We have a number of brokerage firms. So the highest has their average transaction - in one section of the country - would be close to $600,000 a unit. But the - in terms of the sales price of the house. But the - in most of our real estate operations - the average price is more like $250,000 or something in that area. And you can show a lot of houses to make one $250,000 sale.

And of course, you split - the listing company and the selling company are usually two different companies. So it’s - it does not strike me as excessive.

And incidentally, it doesn’t strike the people in the industry that way either. It has not been particularly susceptible to online-type substitution or something of the sort. The real estate agent earns their commission in most cases.

But Charlie’s had more experience with $20 million houses. So he will comment on that area. (Laughter)

32. Some Kraft Heinz products “enjoy fairly healthy” growth

WARREN BUFFETT: OK, we’ll have one more question before we break. Jonathan?

JONATHAN BRANDT: Given the changes in consumer tastes in the food business, and Kraft Heinz’s already high margin structure, do you think the brands they own today, plus new product introductions, can together maintain or increase the current level of profits over the next ten years without the benefit of acquisitions? Is there anything in their portfolio besides ketchup that is enjoying growing demand?

WARREN BUFFETT: Well, in effect, you’re asking me whether Kraft Heinz is a good buy. And we don’t - (laughs) - we don’t want to give information on marketable securities in that manner.

But - yeah, there are a number of items besides ketchup that enjoy growing demand. And some vary quite a bit by geography. There’s enormous differences in the penetration of various products in the portfolio.

Consumer packaged goods are still a terrific business in terms of return on invested assets. And you know - but the population, worldwide, grows fairly smally and at - a fairly minor rate. And - people are going to eat about the same amount. And there is some more willingness to experiment, you know, or go for organic products of the sort.

It’s a very good business. And there are new products coming out constantly. It’s not one where you’re going to get terrific organic growth, but it never has been. And - you know, I like the business and we own 26 or so percent of it.

But there are a number of items within Kraft Heinz that enjoy pretty - fairly - healthy growth. And I think you’d find that at most food companies. And I think you’d find very good returns on invested - on tangible net assets - at those businesses.

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lastmover · 6 years

Text

2011 Berkshire Hathaway Annual Meeting (Morning) Transcript

1. Welcome

WARREN BUFFETT: Good morning. I’m Warren. He’s Charlie.

I can see, he can hear. That’s why we work together. (Laughter)

Have trouble remembering each other’s names from time to time. (Laughs)

We’re going to — we’re going to introduce the directors, we’re going to give you some information on the first quarter earnings.

We’re going to talk briefly about the David Sokol/Lubrizol situation, and then we’re going to open it up for your questions.

Anything as it relates to the Lubrizol matter is going to be transcribed and will be put up on the website — the Berkshire Hathaway website — just as promptly as we can, maybe this evening or this afternoon, maybe tomorrow morning, but very promptly, because we want to be sure that all shareholders hear — or get to read every word of what has been said here about the matter.

2. Board of directors introduced

WARREN BUFFETT: First thing I’d like to do is introduce the directors. And if they’d stand and remain standing, you can withhold your applause as they stand, but you can go crazy at the end, or you can continue to withhold your applause. That will be your call. (Laughter)

Charlie and I are up here, and we don’t like to stand up too often so we’ll skip our standing.

The — Howard Buffett, Stephen Burke, Susan Decker, Bill Gates, Sandy Gottesman, Charlotte Guyman, Don Keough, Tom Murphy, Ron Olson, and Walter Scott. (Applause)

3. Q1 earnings hurt by Asian catastrophes

WARREN BUFFETT: Now, we have a few slides that deal with the first quarter earnings.

I think Marc Hamburg would like me to emphasize that these are preliminary. This is about as early as we ever have a meeting, in relation to the quarter.

Normally it’s always the first Saturday in May, so they had to work a little harder than usual to get these numbers together.

And I will tell you as background that basically pretty much all of our businesses, with the exception of those that are related to residential housing, are getting better, and you can almost see it with most of them quarter by quarter.

We have a wide diversity of businesses. We have more than 70 companies we list, but then Marmon itself has over a hundred businesses. So we are a cross section of not only the American economy, but to some extent we see a fair amount about what’s going on internationally, too.

And in the first quarter, as has been the case, really, since the fall of 2009, both our nonresidential construction businesses, except for those nonresidential construction businesses, our other businesses have generally gotten better quarter by quarter, and there was no exception to that in the first quarter.

What was very different in the first quarter was that we had a — probably the second worst quarter for the insurance industry, in terms of catastrophes around the globe.

Normally, the third quarter of the year is the worst period because that’s when hurricanes tend to hit the U.S. with most of them — well, about 50 percent of them occurring in September and then sort of forming a normal curve on either side of September — so the third quarter usually is the record quarter, and the third quarter was the record quarter back at the time of Katrina.

But in the first quarter of this year, we had some major catastrophes in the Pacific Asian areas, and that hit the reinsurance industry particularly hard.

No one knows at this point. I mean it’s a wild guess, but probably those catastrophes cost the reinsurance industry on the order of $50 billion, and we usually participate to the extent of 3 to 5 percent.

First of all, I’ll give you our overall earnings the way we normally present them. And if we’ll put the first slide up.

You can see that our insurance underwriting suffered an after-tax loss of $821 million.

Now, when I wrote the annual report, I postulated normal earning power of Berkshire at about 17 billion pretax and about 12 billion after tax, assuming breakeven on insurance underwriting.

Our insurance underwriting has done better than breakeven. In fact, it’s made quite a bit of money for eight consecutive years.

But I would say with a start of these catastrophes in the first quarter — or the catastrophes experience we had in the first quarter — I would say that it’s unlikely that we would have an underwriting profit for 2011.

If it was remarkably catastrophe-free from this point forward, including hurricanes in the United States, it’s conceivable we would break even or make a tiny profit.

But that’s an improbable assumption, so I think for the first time in nine years we will likely have an insurance underwriting loss this year.

I think our record may very well be quite a bit better than, certainly, most other reinsurers and it does not change my expectation that over time, our insurance underwriting should at least break even. And if you have followed the — what I’ve written in the annual reports — if insurance breaks even, we get the free use of float, and that’s been enormously valuable in the past and I would expect it to be in the future.

And if you look at the other lines, insurance investment income is down a little. That will go down more because our Goldman Sachs preferred was called in April.

Our General Electric preferred is almost certain to be called in October. So we have lost — and we lost a — we had called a note from Swiss Re that was paying us 12 percent and came to something over $360 million a year when the Swiss franc went above par.

So we have lost, or are losing, at least three very high-yield investments, which we cannot replace with similar investments at present. So that line will go down.

On the other hand, at the end of the quarter we had 38 billion in cash, and that does not count the 5 1/2 billion that we were going to receive in April from our Goldman Sachs preferred. So that money is earning virtually nothing now, and I would not expect that to be part of the long-term picture, either.

So there would — you know, just a few percent on that would be many, many hundreds of millions of dollars.

So I think over time, our insurance investment income, even though it will dip throughout this year, I would expect that if we have a similar level of investments, to actually grow from the level we show here.

We had the full ownership of BNSF in the quarter this year. We only had it, I think, from February 12th last year, so that, in a significant way, accounts for the gain in that next line of railroad, utilities and energy.

But the BNSF also had a significant gain in earnings and the railroad business looks to me like it will have a very good year this year, not just our railroad but all railroads, and the competitive advantage of railroads is becoming more and more evident, almost by the day, particularly as fuel prices increase.

And in the remaining lines, we also had gains in most of our businesses.

So overall, we got hit very hard in the insurance business.

And if we’ll move to slide 2, we list the three major catastrophes that occurred, which in aggregate we estimate we have a total loss of a billion, 673 pretax, and that figure, as with all estimates — early estimates about major catastrophes — is subject to a lot of change. Nobody knows what the insured losses will be from the Japanese earthquake.

But this is our best estimate now. You’ll notice that over 40 percent of the underwriting loss comes from a contract we have with Swiss Re where we get 20 percent of their business.

That contract is in the fourth of its five years. They have indicated that they will not be interested in renewing it. I just wish they told us that a few months ago. (Laughs)

But we’ve enjoyed the relationship with Swiss Re, it’s just that we enjoy it some quarters more than others.

Our estimate — we’ve added a little something into their estimate because on balance we feel that most catastrophe losses develop upward. It’s sort of the nature of the business.

But that — incidentally, the tornadoes in April, just at GEICO, we expect — and all we’re talking about is automobiles here, cars, because we don’t insure homeowners. We act as agent in placing insurance for people, but we do not take the insurance risk.

We estimate that 25,000 cars will get automobile claims. That’s a lot of automobiles when you think about it, and our market share is about 9 percent, although it varies by state.

But it’s been an extraordinary tornado season, as you know. That does not hit — I do not believe that that hits the reinsurance business particularly hard, because there are multiple, multiple events but no one event is anything like, say, the New Zealand earthquake.

The New Zealand earthquake estimated at $12 billion of insured damage. Charlie, how many people are in New Zealand?

CHARLIE MUNGER: Well —

WARREN BUFFETT: We don’t practice these things, as will become evident here. (Laughter)

CHARLIE MUNGER: I’d guess —

WARREN BUFFETT: What, about four million? Three million?

CHARLIE MUNGER: I’d guess a little more than that.

WARREN BUFFETT: Four?

CHARLIE MUNGER: Five, maybe.

WARREN BUFFETT: Five, OK. Five million people. So that’s 1/60th of the population, we’ll say, of the

United States. And if you take 12 billion and multiply it by 60, you come up with 720 billion, which is 10 times Katrina, in terms of the impact on a place like that.

So those — there’s been some really extraordinary earthquakes. And as I say, the worst part of the season is, generally speaking, for reinsurers, is yet to come. So this may be a year that the reinsurers will remember, although they might prefer to forget it.

There’s some good news on the insurance front. On the next slide I show the growth in policies at GEICO month by month this year versus last year.

Now, if you’ll remember, in the annual report I gave an explanation, in talking about goodwill value, about how the goodwill of GEICO is carried on our books at about a billion dollars. And no matter how successful the business becomes, that goodwill value is never increased on the books, but it does grow.

And as I put in the annual report, I estimate its value currently, using the same sort of yardstick we used when we purchased the second half of the company back in 1995, I estimate that value has grown, maybe, to 14 billion.

I mean, every policyholder at GEICO, on average, has a value to us, the way I calculate it, of something on the order of $1,500.

And when we add 318,000 — and as of yesterday it was up to 381,000 — when we add that, we’ve added something approaching $500 million to the goodwill value.

That does not count the earnings from underwriting, which were substantial for GEICO. That does not count the investment income from the float, it does not count the investment income from the net worth we have attributed to it. That is added goodwill value, the same sort of goodwill value that a Coca-Cola has, or a Mars has, or any company like that.

And people think of it differently when they think of most consumer products. But a policyholder to Berkshire at GEICO has very, very significant value.

There’s a very significant percentage have been there for 10 years or more. And it’s something that we do not realize on our balance sheet or income account, but it’s an asset that’s every bit as real as the numbers that we do put on the balance sheet.

So there’s good news at GEICO. We are gaining market share every day.

As a matter of fact, if you think about it, we have some people in the adjacent room that will be glad to sell you GEICO policies, and if only 66 of you sign up, that’s a goodwill value of about $100,000, so it will take care of some of the expenses of this meeting. (Laughter)

Not that I care whether you do it or not but — (Laughs)

Now, there’s one more item I want to go through on the earnings picture, just because it illustrates to some extent the capriciousness of accounting and how we value our securities — or whether we take write-downs on them, I should say.

There’s something called “other than temporary impairment,” which is an accounting rule. It’s kind of a fuzzy accounting rule, but it says that if you own a security for a while, and you paid X for it, and it’s been selling at, say, 80 percent of X for quite a while, nobody knows exactly what quite a while means, and I’m sure they phrase it differently in the accounting textbooks, but anyway, if it sells there for quite a while, you’re supposed to mark it down to that new valuation and have that markdown go through your income account, through your profit and loss account.

Now we mark it down in any event for the balance sheet, and the balance sheet is what gives you the number for book value and is our reference point.

But only when it meets this other than temporary thing does the mark down actually get run through the profit and loss account.

Now, on March 31, as is shown, I believe, on the next slide, we owned some Wells Fargo stock, which had a cost of about 8 billion and the market value was 11.3 billion.

But some of the Wells Fargo stock we bought had been bought at higher prices than the March 31 figure, whereas, as you can see, a lot of the stock, which had a gain in it of 3.7 billion, had been bought at lower prices.

Well, under the rules, we were required to mark down the stock we bought at a higher price by 337 million, whereas we ignored, in the income account, the 3.7 billion of gain.

Now, interestingly enough, there’s two ways you can account for securities, as I understand it, both fully meeting GAAP accounting requirements. And if we had — if we had used the average cost method, we would not have had to mark down.

But we use what they call the specific identification method. Now the specific identification method is actually useful to us from a tax standpoint, because it means whenever we sell a security we can pick out the highest priced security and attribute the sale to that.

So it actually saves us money, or the time use of money, to get into specific identification.

But we could just as easily use the average cost method and then we would not have a write-down like we have and that’s why I — one of the reasons I emphasize that — the fact that you should ignore gains or losses in securities or derivatives on a quarterly basis, or even an annual basis.

The important thing is what the operating earnings of our businesses are doing and what the gain in book value, generally, has been.

And then on top of that, you have to make your own estimate for what intrinsic value is, which would include things like the goodwill value that has been developed at GEICO.

I apologize for taking you through the accounting lessons, but the headlines often just say what the final net income is, as if that’s the all-important figure. And sometimes it’s the all-deceptive figure.

I mean, it really bears — if you include gains and losses — it bears, really, no connection to the reality of whether a quarter has been satisfactory from our standpoint.

But it does get a lot of attention in the press and that’s why we spend, perhaps, an inordinate amount of time trying to explain what really takes place in our financials.

Now, I think we’re going to get to the questions and answers here in just a second. We’ll alternate between the press group on my right and 13 stations that — microphones that have been placed. I think a dozen of them in this room and maybe one in one of the overflow rooms.

4. David Sokol and Lubrizol: “inexcusable” and “inexplicable”

WARREN BUFFETT: I’d like to just comment for a few minutes — and this will be transcribed and up on the internet at our web page — I’d like to comment for just a few minutes, and I’d like to ask Charlie then to give his thoughts, on the matter of David Sokol and the purchase of Lubrizol stock.

You saw in the movie a clip from the Salomon situation, and that occurred almost 20 years ago. It will be 20 years ago this August.

And at the time, it was a Sunday, Charlie was there, and I was elected the chairman at — what, about 3:00 in the afternoon or so I think on a Sunday at Salomon, and I went down to address a press group.

And almost the first — somewhere in the early questions, somebody sort of asked me, you know, what happened?

Well, A) I’d just gotten to Salomon fairly recently, so I didn’t know too much about it, but the phrase that came out of my mind then — out of my mouth then — sometimes my mind and my mouth are coordinated — (laughter) — the phrase that came out of my mouth then was that what happened was inexplicable and inexcusable.

Now, it’s 20 years later, and looking back on Salomon, I still find what happened inexplicable and inexcusable. You know, I will never understand exactly why some of the events that transpired did transpire.

And to some extent, in looking at what happened a few months ago with Dave Sokol’s failure to notify me at all that he’d had any kind of contact with Citigroup. In fact, he directed my attention to the fact that they represented Lubrizol and never said a word about any contact with them.

And then the purchases of stock immediately prior to recommending Lubrizol to Berkshire, I think I — for reasons that are laid out in the audit committee report, which I urge you to read and which is on our website — I don’t think there’s any question about the inexcusable part that Dave violated, and that the code of ethics, he violated our insider trading rules, and he violated the principles I laid out — I lay out — every two years in a direct personal letter to all of our managers and which I’ve been doing for a long time. So I — you can read the audit committee report about that.

The inexplicable part is somewhat — well, it’s inexplicable, but I’d like to talk about it a little bit because I will tell you what goes through my mind in respect to it.

Certainly — well, one interesting point is that Dave, to my knowledge, at least, made no attempt to disguise the fact that he was buying the stock. I mean, you know, you read about insider trading cases and people set up trusts in Luxembourg, or they use neighbors who know neighbors, or they use third cousins — I mean, they have various ways of trying to buy the stock so that when it’s later — FINRA is a supervising organization — looks at the trading activity in the months prior to a deal, they do not see names that jump out at them as being associated with the deal.

To my knowledge, Dave did nothing like that, so he was leaving a total record as to his purchases.

Now, I think at least usually — and maybe always — we are queried after any deal. We are asked who knew about it when, and we supply a list of whether it’s people at the law firm or people that are in a secretarial position at our place or the law firm.

We give them a list of everybody that might have known or did know about the deal prior to the public announcement. And I don’t know whether they do that 100 percent of the time, but certainly it’s my experience that you get that.

And then a while later, you get a list of names of people that FINRA, again, has picked up as trading it, and they ask you whether any of those names ring a bell with you. So they’re trying to put together whether anybody did any inside trading ahead of time.

So the odds that if you’re trading in your own name, and you’re on that list of people who know of a deal ahead of time, the odds that it’s not going to get picked up seem to me are very much against you.

But, to my knowledge, Dave did not disguise the trading. Which, you know, that’s somewhat inexplicable that if he really felt he was engaging in insider trading and knew the penalties that could be attached to it, that he essentially did it right out in the open.

The second fact, which is less — perhaps less — puzzling, but Dave obviously has a net worth in very high numbers. He made, I think, close to $24 million. He earned it from Berkshire last year, and we got our money’s worth, but he did get $24 million, too.

So I would say that there are plenty of activities in this world that are unsavory that are committed by people with lots of money.

So I don’t regard that as, you know, totally puzzling. But I will give you one instance that does make it puzzling. It makes it very puzzling to me.

We bought MidAmerican at the end — Berkshire Hathaway bought MidAmerican — at the end of 1999. Berkshire Hathaway bought about 80 percent.

Walter Scott, who I just introduced, and his family was the second largest holder, I think something over 10 percent, and then two operating people, Dave Sokol the senior one, owned or had options on a big piece, and Greg Abel, a terrific partner of Dave’s, also had a piece.

And Walter Scott — and I’ve told this story privately a few times but not — I don’t think I’ve done it publicly.

Walter Scott came to me a year or two after we’d bought it, and Walter said, I think we ought to have some special compensation arrangement for Dave and Greg if they perform in a really outstanding manner. And he said — I think maybe he suggested something involving equity and he saw me turn white.

So he said, “Why don’t you design one and let me know.” So I just scribbled something out on a yellow pad. It didn’t take me five minutes.

And we call it, sort of in honor of Charlie, although he didn’t know about it, we called it the Lollapalooza.

And it provided for a very large cash payout, which I’ll get to in a second, based on the five-year compounded gain in earnings. And we were starting from a high base, in other words this was not from any depressed level, and we set a figure that no other utility company in the United States was going to come close to.

But if that figure were achieved, we were going to give $50 million to Dave and $25 million to Greg Abel.

And I had Dave come to the office and I said, “Here’s what Walter and I are thinking,” and, “What do you think of this plan?”

And it had these figures on per share that — that like I say, move forward at 16 percent compounded per year, and then I say, “Here’s the payout.”

And he looked at it for just a very short period of time and he said — he said, “Warren, this is more than generous.” But he said, “There’s just one change you should make.”

And I said, “What’s that?” And he said, “You should split it equally between me and Greg, instead of being 50 million for me and 25 for Greg. It should be 37 1/2 apiece.”

So I witnessed — and Walter witnessed, you can talk to him about it — we witnessed Dave voluntarily, without any — Greg had nothing to do with it, he wasn’t there — we saw Dave transfer over 12 1/2 million dollars — getting no fanfare, no credit whatsoever — to his, in effect, junior partner.

And I thought that was rather extraordinary, and what really makes it extraordinary is that $3 million, you know, 10 or so years later, would have led to the kind of troubles that it’s led to.

I find — that is really the fact that I find inexplicable, and I think I’ll probably — you know, it’s 20 years after Salomon — 20 years from now Charlie will be 107 — (laughter) — and we won’t mention what I’ll be — but I think 20 years from now, I will not understand what causes a man to voluntarily turn away 12 1/2 million dollars to an associate without getting any credit for it in the world, and then 10 or so years later, buy a significant amount of stock the week before he talked to me.

And when he talked to me about Lubrizol, it was either the 14th or 15th — he says it was 14th, I have no reason to disagree with that. The only reason I couldn’t say specifically was I had eight university groups, 160 students, in on that Friday. That’s the only thing that shows, and I spent most of the day with them.

And the 10K and the 10Q that got printed out on Saturday have that date on them, the 15th, when I looked at Lubrizol for the first time.

You might be interested in knowing, I’ve been looking up 10Ks and 10Qs for 20 or 30 years, but I don’t know how to print them out. So, fortunately, Tracy Britt was in the office, and I said, “Tracy, would you print this damn thing out? I don’t know how to do it yet.” (Laughter)

But that is why I don’t know whether it was the 14th or the 15th. The 10Q says the 15th.

But, at that time, when Dave called me on it, he said nothing about contact with Citigroup or anything of the sort and he — and I said, “I don’t know anything, really, about the company.” He said, “Well, take a look at it. It — you know, it might fit Berkshire.”

And I said, “How come?” And he said, well — he said, “I’ve owned it and it’s a good company. It’s a Berkshire-type company.”

And, you know, I obviously made a big mistake by not saying, “Well, when did you buy it?”

But I think if somebody says I’ve owned the stock, you know it sounds to me like they didn’t buy it the previous week.

So there we are with a situation, which is sad for Berkshire, sad for Dave, still inexplicable in my mind, and we will undoubtedly get more questions on that. We’ll be glad to answer them.

Charlie, do you have any thoughts on this?

CHARLIE MUNGER: Well, I think it’s generally a mistake to assume that rationality is going to be perfect, even in very able people. (Laughter)

We prove that pretty well, regularly.

WARREN BUFFETT: Do you have any explanation for the irrational?

CHARLIE MUNGER: Yeah. I think hubris contributes to it.

WARREN BUFFETT: Well, we’ve gotten quite a bit out of him, folks. (Laughter)

5. Journalists introduced

WARREN BUFFETT: OK. Let’s go to work.

We’ll start with Carol Loomis of Fortune Magazine. I might as well — I should introduce our group here.

Oh, we didn’t go alphabetical this time. We’ve got Carol, and then we’ve got Andrew Ross Sorkin of the New York Times, and we have Becky Quick of CNBC. (Applause)

In terms of my check-off system, I’m still going to go to Becky. That’s alphabetical.

So, Andrew, it didn’t do you any good to try to move over there into the center spot. (Laughs)

Carol, you’re on.

CAROL LOOMIS: Good morning from all of us, and I will make the small preamble that I’ve made before.

We’ve been getting questions for a couple of months, each of us on our e-mail.

Sometimes a question will be sent to all three of us and sometimes they’ll just send to one of us, therefore it becomes very hard to count how many we’ve had, but certainly it’s in the many hundreds and probably in the — up into a thousand, 2000.

And obviously we aren’t going to be able to ask every question — every good question. We have a lot of good questions we won’t be able to get to. But it’s just that you had to pick and choose.

And the other thing I should say is that whatever we do ask, Warren and Charlie have no idea of the question. None. No hint.

WARREN BUFFETT: Sometimes we have no idea of the answer either, but go ahead. (Laughter)

6. Buffett’s David Sokol timeline

CAROL LOOMIS: So I will begin. I don’t think that anybody will be surprised that it is a Sokol question.

And actually, the — this particular long-term shareholder believed, as Warren has believed, he says, “I do not see why he should have been expected to ask Sokol about his Lubrizol stock holdings when he said he owned the stock. That wouldn’t have been a natural question.

“But when you found out the details of his stock purchases a short time later, I do not understand your reaction.

“Surely you realized immediately that these facts were going to become known and that they were going to damage Berkshire’s reputation, something you had said repeatedly you would be ruthless in protecting.

“Being ruthless probably would have meant your firing Sokol on the spot, but you didn’t do that.

“And then you put out a press release that many Berkshire shareholders that I have talked to found totally inadequate.

“You have always been very direct in stating things. You were not direct in that press release, except in praising David Sokol. Otherwise you stated some facts and behavior that you said you didn’t believe was illegal.

“And then you ended the release, leaving us — now maybe you thought somehow we were going to read between the lines — without expressing any anger about what had happened. Why were you not incensed?

“If you were, why did you not express your anger? Why did you handle this matter in the inadequate way you did?”

WARREN BUFFETT: Yeah. The — (applause) — it wasn’t really immediately thereafter. I learned on March 14th, which was the day we announced it. Now bear in mind his first conversation when he said he owned the stock was January 14th.

In between January 14th and March 14th, Dave gave no indication that he’d had any contact with Citigroup of any kind, and as we learned later, I mean, he went — they met in, maybe, October or something like that where — and talked about possible acquisition candidates for Berkshire.

But none of that — he told me at one point, he said Evercore and Citi represent Lubrizol. One of them represents the directors and one of them represents the company, and not a word about any contact.

On March 14th, when the deal was announced in the morning, I got a call from John Freund. John Freund is probably here today. John Freund works for Citi in Chicago, and he handles — he’s handled the great majority of our business in equities for decades, and I’ve got a direct line to him. I talk to him frequently.

And he called and said congratulations and — you know and aren’t you proud of our — words to the effect. You can talk to John directly, although I’ve been told that the Citi lawyers have told him not to talk, but that — knowing the press, they probably can work something out of him.

The — he’s — essentially his words were that Citi’s team had worked with Dave on this acquisition, and they were proud to be part of it, et cetera, et cetera.

And this was all news to me, so that set up some yellow lights, at least. And the next day, I had Marc Hamburg, our CFO, call Dave, and Dave readily gave him the information about when he had bought the stock and how much.

Marc also asked him what the participation of Citi had been in reference to Berkshire’s side of the transaction, and Dave said that he thought he called a fellow there to get their phone number, which turned out to be somewhat of an understatement.

Now, during the period when we announced the deal on March 14th, Lubrizol is the one that needed to prepare a proxy statement. We were not issuing shares at Berkshire. So there was no proxy statement, no — nothing of this — that sort — on our part.

The Lubrizol legal team, Jones Day, went to work with Lubrizol management to start preparing the proxy statement.

We eagerly awaited to see the first draft of that because I was going to be leaving for Asia on Saturday, which, I guess, would be the 19th, and I wanted to see what Lubrizol had to say about this whole Citi matter or anything else.

The most interesting part of every proxy statement is something that says — it’s basically the history of the transaction, and it’s the first thing I read on any deal because it gives you a blow-by-blow of what has taken place.

And as Marc Hamburg can tell you, I kept — and our law firm can tell you — I kept urging them to get that to me before I took off for Asia.

We got that the afternoon of Friday the 18th, and it had a fair amount of material in it about Dave’s involvement with Citigroup.

Then at that point — I believe it was at that point — our law firm got involved, Munger Tolles got involved, in their input to the Lubrizol lawyers as to what we had seen that was different or what we had seen that they didn’t know about that we could add.

Ron Olson, the director of Berkshire and partner of Munger Tolles, was on the trip to Asia. So we got on the plane on Saturday the 19th and traveled over the next week until the 26th.

And we knew at that point that his partners at Munger Tolles were interviewing Dave, as — maybe some other people too, but certainly Dave — and I believe that he was interviewed at least three times about both the stock purchases, the history of things with — of his relationship with Citigroup, and they were assembling this information.

I don’t have a BlackBerry or whatever it may be. Ron does. So he would get some information as we were over there. And he was getting some input but — and we decided that when we got back we would need to have a prompt meeting of the Berkshire board about this matter.

And we would also learn what — the full details, at least — of what Bob Denham, and maybe other attorneys at Munger Tolles learned from their interviews with Dave.

And we back on — I guess it would be Saturday the 26th — and on the 28th we were going to bring Charlie into it before calling a board meeting.

But there would have been a board meeting that week. And then about five or so in the afternoon, a letter was delivered by Dave’s assistant, which really came out of the blue.

And I — he said to me he felt he was retiring on a high point and he gave the reasons why he was retiring, which I laid out and so on.

I don’t know whether the questioning the previous week had affected his attitude. He would say not.

But in any event, we had that resignation. That resignation as is — I believe it may have been put in the audit committee report — may have saved us some money.

If we’d fired him, the question would be whether it was with cause or not with cause, and we would have said it was with cause, but that might have very well gotten litigated, and a retirement did provide, in effect, the same non-level of severance payments that a firing with cause provided.

So I drafted up a press release, which has since been the subject of at least mild criticism — (laughs) — and I laid out the good things that Dave had done, which he had done for the company. He’d done many good things, some extraordinary things.

And then I laid out some actions which I said, based on what I knew then, did not seem to me to be unlawful, and incidentally, I talked with both Charlie and Ron about that.

Ron would have been more careful in that wording. I’m not sure Charlie would have been. I’ll let him speak for himself on that.

And we ran it by — I ran it by Dave Tuesday morning, just to be sure the facts were accurate, and he said — he objected very much to something I’d put in where I said that I thought that he was, in effect, had had his hopes dashed for succeeding me and that was part of the reason, and he said that was absolutely not true, that he had no hopes ever of succeeding me and that I — you know, basically he was telling me what was in his mind, and I shouldn’t be trying to second-guess what was in his mind.

So I took that part out. But he affirmed all of the other facts in that letter, and then I took it out, I sent it to him a second time to make sure that he was OK with the facts, and he said they were accurate.

Now, in there was included the fact that Dave had no indication that Lubrizol had any interest in an approach from Berkshire and that, at least according to the final Lubrizol proxy, is not the case.

I have not talked to anybody except John Freund at Citigroup, so I have no idea what took place with the investment bankers at Citigroup, except for what I read in the Lubrizol proxy. But the Lubrizol proxy now says that Dave did know that Lubrizol had an interest on December 17th.

But, both in the two chances he had to review it, and then when he went on CNBC on a Thursday and he talked for a half an hour, he made no attempt to correct any of the facts in it.

Now, on Wednesday, when we put out the report, we had to have a board meeting first. It was news to the board. They got the release a little bit ahead of time and then we had a board meeting.

We also delivered — well, through our law firm, we phoned the head of the enforcement division of the Securities and Exchange Commission and told him exactly the facts regarding the stock purchases and anything else that they might have cared to know.

So I think we acted in that case, very, very promptly, to make sure the Securities and Exchange Commission, and the top of the enforcement division, was well-versed on what had taken place, to our knowledge up to that point.

So, from our standpoint and my standpoint, Dave was gone, minimum severance costs, minimum chances for lawsuits about compensation due him, and we had turned over some very damning evidence, in my view, to both the public and to the SEC.

What I think bothers people is that there wasn’t some big sense of outrage or something in the release, and, you know, I plead guilty to that.

I — this fellow had done a lot of good things for us over 10 or 11 years, and I felt that if I’m laying out a whole bunch of facts that are going to create lots of problems for him for years to come, that I also list his side of the equation, in terms of what he’d done for Berkshire.

And I — and as I said a little bit earlier, you know, one thing I didn’t even lay out was this extraordinary act where, in effect, he turned over 12 1/2 million dollars to a fellow employee.

So that’s the history of my thinking on it.

Charlie, do you want to add anything? (Applause)

CHARLIE MUNGER: Yes. Well, I think we can concede that that press release was not the cleverest press release in the history of the world. (Laughter)

The facts were complicated, and we didn’t foresee, appropriately, the natural reaction.

But I would argue that you don’t want to make important decisions in anger. You want to display as much ruthlessness as your duty requires, and you do not want to add one single iota because you’re angry.

So, Tom Murphy, one of our best directors — (applause) — one of our best directors, always told the people at Cap Cities, you can always tell a man to go to hell tomorrow if it’s such a good idea. (Laughter)

So the anger part of it — and I don’t think it was wrong to remember the man’s virtues as well as his error. (Applause)

WARREN BUFFETT: I might add as an aside, Charlie and I have worked together for 52 years, and we have disagreed on a lot of things. We’ve never had an argument.

I need Tom Murphy’s advice to remind myself of it a lot of times on other things, but with Charlie it’s never even been necessary. It was long before I met Murph.

7. Market reaction when Fed ends stimulus

WARREN BUFFETT: OK. Let’s go to area 1.

AUDIENCE MEMBER: Mary Broderick, Berkeley, California. Good morning, Mr. Buffett. Good morning, Mr. Munger. And a big thank you. You probably aren’t aware of this, but you’ve been my personal financial and investment advisors for years.

I would like to know what you think the effect of the government ending the POMO program mid-July this year will have on the stock market and the economy in general.

WARREN BUFFETT: The government ending the — QE2 or —

AUDIENCE MEMBER: Permanent open market operation.

WARREN BUFFETT: Well, you’re one acronym ahead of me. (Laughter)

The — well, just as we’re discussing it now, it’s no secret what they’re going to do.

I mean, it’s sort of the most advertised open market purchase in history, and probably in terms of defining the amount per month and when it comes to an end, you know, what the balance sheet will look like at the end of the Fed.

So I don’t think — you know, if something is that well known by all participants in a market, I think any effect of it has been discounted by this point in time.

I mean, if you say you’re going to increase tax rates in a year, we’ll say, on corporations or decrease them or whatever it may be, and it’s really done and locked in stone, the market doesn’t wait until the date when the tax increases or decreases go through to build that into market prices. So I don’t — I see no reason — there may be some other things that happen then — but I see no reason why simply having that program come to an end will cause any significant change in stock or bond markets at that time.

You know, obviously, a huge market force will be withdrawn.

I mean you buy $600 billion worth of Treasurys and, you know, you probably leave a few traces along the way that you’ve done it. And it has been 100 billion or so a month, and that purchasing will not be in the market but the government issuances of debt will still be at a level that are consistent with what they are now.

So it will be a different market, but I think it’s a different market that’s already been anticipated.

Charlie?

CHARLIE MUNGER: I have nothing to add. (Laughter)

WARREN BUFFETT: Yep.

8. Role of Berkshire’s next chairman

WARREN BUFFETT: Becky?

BECKY QUICK: I’d like to ask a question that comes from Ron Taracant (PH) from Sugar Land, Texas.

He says, “Good morning, Mr. Buffett and Mr. Munger. You have always put great emphasis on hiring and retaining managers that not only have exceptional talent but also adhere to the higher standards of corporate ethics and behavior.

“Recent events surrounding Mr. Sokol’s actions have demonstrated that we were not very far from a situation where someone running Berkshire Hathaway had great talent, but lacked the other quality that has made Berkshire the envy of the business world.

In some ways, we are relieved these events happened when you were still at the helm.

But coming back to the succession plan that you have in place, how can you ensure that there are no more Sokols in the lineup of successional managers that you have.

WARREN BUFFETT: Yeah, he made an assumption there about Sokol being the next in line, which I’m not sure was warranted.

But he certainly was entitled to think that he was a candidate. And there are — that is, one of the reasons that I think it’s a good idea if my son, Howard Buffett, who would have no — get paid nothing, and have no activities in the company, be the chairman after I’m not around, because you can make a mistake in selecting a CEO.

I mean, I think the odds of us making a mistake are very, very low. And certainly the candidate that I think is the leading candidate now, I wouldn’t — I would lay a lot of money on the fact that he is straight as an arrow.

But mistakes can be made. You know, the — the Bible says the meek shall inherit the earth, but the question is, will they stay meek? (Laughter)

The idea of having an independent chairman, who would be voting a lot of stock — because even at my death, because of the concentration of A stock and so on, the executors would have a very significant block of stock — and if some mistake were made, it would be easier to change if not only a very large block of stock were available to express an opinion, but also if the chairmanship was not locked in with the CEO.

It’s gotten less tough to change CEOs at companies where either their moral or their intellectual qualities are found lacking, but it’s still difficult.

If — you know, it’s particularly difficult if they turn out to be a mediocre CEO. If the person is really bad, you know, people will rise up sometimes and — particularly if they have meetings without the CEO present.

But it’s not an easy job to displace a sitting CEO who also holds the chairman’s position and controls the agenda and all of that.

So I think an independent chairman, particularly one that represents a very large block of stock, and has no designs himself on taking over the place, is a safety measure for the possibility, however remote, that the wrong decision is made.

But I will tell you that the directors at Berkshire will be thinking every bit as much about the quality of the person as a human being as they will be thinking about their managerial skills, because it’s vital that you have somebody at Berkshire, in my view, that is running the place that really cares more about Berkshire than he does about himself, in terms of advancement.

And I think we have multiple candidates that fulfill that. And the idea of an independent chairmanship is a — is, you know, part of the belt and suspenders.

Charlie?

CHARLIE MUNGER: Well, you know, your idea about the Buffett family has a precedent.

The Rockefellers left the management of Standard Oil many, many decades ago, and they — but they did intervene once, and that was to throw out, what was it, the head of Standard of Indiana, and it was on moral grounds.

So that sort of thing can happen and you have put another string in our bow.

9. Picking tech stocks is difficult but could be profitable

WARREN BUFFETT: OK. We’ll go to area 2.

AUDIENCE MEMBER: Caroline Tile (PH), Boston, Massachusetts.

Mr. Buffett and Mr. Munger, if you were going to live another 50 years, and we sincerely hope you do, and could add one additional sector or asset class to your circle of competence, which sector would it be and why?

WARREN BUFFETT: Well, that’s a very good question, and I particularly like the preamble. (Laughter)

Well, you would — you would certainly pick a sector that’s large, because it isn’t going to make any difference to Berkshire if we get to be experts on some tiny little industry or business.

I would say that — that, you know, it would have to be something in the — this isn’t going to happen — but if I could really become expert — and I mean really expert, knowing more than most — almost anybody else about the subject — in the tech field, you know, I think that that would be terrific.

It isn’t going to happen, but it’s going to be a huge field.

There are likely to be, you know, a few enormous winners, a lot of disappointments. So that the ability to pick the winners, you know, is far disproportionate to the ability to pick the winners, we’ll say, among integrated major oil companies where they’re all equated in price.

You’re not going to have a big edge in trying to pick Chevron against Exxon against Continental and Occidental, and you name it.

But the degree of disparity in results among larger tech companies in the future is likely to be very, very dramatic. And if I had the skills where I could pick the winners there I would do a lot better than if I had the skills to pick the winners in the major integrated oil field.

You probably will have better luck with Charlie on this one because he knows a lot more about a lot of industries than I do. Charlie, what’s your answer?

CHARLIE MUNGER: Well, it would either be tech or energy. And I think that we’re the wrong people to develop the expertise. (Laughter)

I think if we were going to do it, it would have already happened.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: I do think we might identify someone else who has abilities that we lack. That’s been very hard for us but — (Laughter)

WARREN BUFFETT: We’re not going to tell you. (Laughs)

CHARLIE MUNGER: But we’ve done a little better lately.

WARREN BUFFETT: That’s a good question.

10. Why Buffett got past his skepticism about Lubrizol

WARREN BUFFETT: Andrew?

ANDREW ROSS SORKIN: This question comes from a shareholder named Ralph Coutant (PH) who asks, “In in your press release, your original press release, you noted that Dave ‘brought the idea of purchasing Lubrizol to me on either January 14th or 15th.’

“Initially you said, ‘I was unimpressed.’ You went on to note that on January 24th you sent another note to Dave indicating your, quote, ‘skepticism’ about making an offer for the company.

“However, in a very short period of time after Dave’s discussion with Lubrizol’s CEO, you, quote, ‘quickly warmed’ to the idea.

“Please clarify what caused you to, quote, ‘warm’ to the idea so quickly if this didn’t strike you as being a great business at first glance. What changed? And what was David Sokol’s role in convincing you?”

WARREN BUFFETT: Yeah, the — it wasn’t that it didn’t — it struck me as a business I didn’t know anything about, initially.

You know, you’re talking about petroleum additives. I never would understand the chemistry of it, but I — but that’s not necessarily vital.

What is important is that I understand the economic dynamics of the industry. Is there — are there competitive moats? Is there ease of entry? All of that sort of thing. I did not have any understanding of that at all, initially.

As a matter of fact, I suggested to Dave, I said, “Charlie is a lot smarter about oil than I am. Why don’t you give him a call because I don’t — you know, I just don’t know anything about that business?”

And I talked to Charlie a few days later, and I don’t remember whether I asked him whether Dave had called or anything, but I mentioned it to Charlie, and Charlie says, “I don’t understand it, either.”

So when I talked to Dave later he had not talked — he had not gotten ahold of Charlie. I told him, “Forget it. He’s as bad as I am.”

What Dave passed along to me after having that dinner with James Hambrick, and which I later confirmed in a lunch when James Hambrick came out here on February 8th, but it was the same thing.

I thought I — and I still feel — I thought I got a good understanding of industry dynamics and how the business had developed over time, what the role of oil companies was and would be, in relation to a chemical additive.

The oil companies are the biggest customers. They sell base oil to a Lubrizol, but they buy the — they are the big customers, and they have gotten out of the business to quite a degree, although there’s two of them left in it.

So this industry had consolidated over time. I looked at the question of ease of entry. You know, every time I look at a business — when we bought See’s Candy in 1972, I said to myself, if I had a hundred million dollars and I wanted to go in and take on See’s Candy, could I do it?

And I came to the conclusion, no, so we bought See’s Candy. If the answer had been yes, we wouldn’t have done it.

I asked myself that same question, you know, can I start a soft drink company and take on Coca-Cola if I have a hundred billion dollars, you know?

Richard Branson tried it some years ago in something called Virgin Cola. You know, the brand is supposed to be a promise. I’m not sure that’s the promise you want to get if you buy a soft drink but — laughter) — in any event, I felt after my conversation with Dave, subject to a second conversation with James Hambrick, but covering the same ground, that it’s not impossible at all for people to enter this business.

But in terms of the service that — and the relatively low cost of what Lubrizol brings to the party, and in terms of people trying to break into a market and take them on — and it’s not a huge market, it’s probably only about a $10 billion market overall, I decided that there was a pretty good-sized moat around this.

They’ve got lots and lots of patents, but more than that, they have a connection with customers. They work with customers when new engines come along to develop the right kind of additive.

So I felt that I had an understanding — didn’t understand one thing more about chemistry than when I started — but I felt that I had an understanding of the economics of the business, the same way I felt that when the ISCAR people talked to me — I mean, who would think you can take some tungsten out of the ground in China and put it in the little carbide tools and that you could have some durable competitive advantage? But I decided ISCAR had a durable competitive advantage after looking at it for a while.

That’s the conclusion — I have come to the conclusion that — and Charlie as well — that the Lubrizol position is the dominant — or the number one company, not dominant — but the number one company, in terms of market share, in that business — is sustainable and that it’s a very good business over time.

It helps — you know, they are helping engines run longer, run smoother, you know. You know, when metal is acting on metal, the lubricants are important, and they’re always going to be around. And I think Lubrizol will be the leading company for a very, very long time.

And that’s the conclusion I came to. And I did not have a fix on that, nor did Charlie, prior to Dave relaying on to me what he had learned at that dinner, which incidentally, Lubrizol had been telling the world — I mean they made investor presentations and all that quite extensively over the years.

I simply hadn’t paid any real attention to it. And when it was explained to me, I thought I understood it, and I still think I understand it.

I think Lubrizol will be a very, very good addition to Berkshire. And I saw James Hambrick just yesterday, and despite the turmoil around this, they are very enthused about becoming part of Berkshire, that they regard it as the ideal home.

Charlie?

CHARLIE MUNGER: Yeah, you know, ISCAR and Lubrizol, to some extent, are sisters under the skin.

You’ve got very small markets that aren’t really too attractive to anybody with any sense to enter, and fanaticism in service. So if you have any more like that why, please give Warren a call. (Laughter)

11. Using Berkshire’s stock for acquisitions

WARREN BUFFETT: OK. Area 3.

AUDIENCE MEMBER: This is Hsiang Hsiao Chu (PH) from Ottawa, Ontario. Warren, Charlie, I admire you guys tremendously.

I want to ask a question about the valuation of your company. You said, “Price is what you pay and value is what you get.”

In your letter to the shareholders this year, each Class A share owns about — investment about $95,000, and each share commands an earnings of $6,000.

So in my simplistic way of calculation, each share is worth $95,000 of investment plus the earnings discounted at 7 percent. That’s another about $90,000. So it adds up to about 185,000. Is that correct?

Does that mean the complexity of your empire is a value trap?

WARREN BUFFETT: We give those figures because we think they’re important, both the investments per share and the operating earnings per share, excluding earnings that come from the investments, and leaving out insurance underwriting profits or losses, because we think at worst they’ll break even, but they do bounce around from year to year.

Those figures are pretax on the operating earnings, so I’m not sure whether you’re applying your discount factor to pretax or after-tax.

But we think they’re important. And I would expect — well, the operating earnings, you know, are almost certain to increase. How much, you know, who knows? But that number is likely to go up.

The investments are still about the same as at year-end but that — they could go up or down based on whether we’re able to buy more operating businesses.

Our goal is to build both numbers to some extent, but our primary goal is to build the operating earnings figures.

We never — we — if Charlie and I had to stick a number in an envelope in front of us as to what we thought the intrinsic value of Berkshire was, well, neither one of us would stick a figure, we’d stick a range, because it would be ridiculous to come up with a single specific number, which encompasses not only the businesses we own, but what we’re going to do with the capital in the future.

But even our ranges would differ modestly, and they might differ tomorrow, in terms of how I would feel versus today, but not dramatically at all.

I would say this: I think — I certainly — well, you’ve received signals once or twice when we said we would buy in our stock, we obviously thought that it was selling below the bottom of a conservative range of intrinsic value, and we did that once some years ago.

And by saying so, of course, the stock went up, and so we never got any stock bought. So there’s sort of a self-defeating factor about taking the kind of approach to it that we do, in terms of really telling people that the only reason we’ll buy in stock is because we think it’s cheap. That is not standard practice in corporate America at all.

In fact, corporate America, to some extent, buys in their stock more aggressively when it’s high than when it’s low. But they may have some equation in their mind that escapes my reasoning power.

But the — I would — we do not regard Berkshire as overpriced. And I would say that we had, very recently, we had a very, very large international company that might well have been interested in doing something with Berkshire, and it’s a very nice company, but it’s bigger than we can handle unless we would use a lot of stock.

And we won’t use the stock. We just think our shareholders would come out behind. It would be a wonderful company and, you know, make a lot of headlines, but in the end our shareholders would be poorer because our stock is a currency, and unless it’s fully valued, it’s a big mistake to use it as a currency.

Now, we used some in the Burlington deal, but we used a whole lot more cash, and, in effect, we only used 30 percent for stock, and it was worth doing, but it was painful.

And if Lubrizol had wanted to do a deal involving stock, we would not have done it. I told James Hambrick that right off the bat.

So we had absolutely no interest in buying Lubrizol — we were perfectly willing to give, you know, close to $9 billion in cash, and in my view, we’re getting our money’s worth.

But we would not have given a significant portion of it in Berkshire stock, because we would be giving away part of the businesses we already own, and we like Burlington, and we like See’s Candy. We like ISCAR.

And to give away a portion of those, even to get another very good business, would not make financial sense for our shareholders.

So you can draw your own deductions about our calculations of intrinsic value from that statement.

Charlie?

CHARLIE MUNGER: Well, he’s obviously looking at two right factors. And I think that we have not permanently lost the ability to do some interesting things eventually with our enormous wealth in cash and marketable securities.

We won’t always be as inactive as we are now.

WARREN BUFFETT: We’re not that inactive, Charlie. (Laughter)

CHARLIE MUNGER: Well, I don’t know. You practically crawl out of your skin, sometimes.

WARREN BUFFETT: Nine billion is — you know, we say normal earning power is 12 billion. That uses up a good portion of one year’s quota.

Although we’d like to use more. I mean, there’s no question.

CHARLIE MUNGER: Now you’re talking.

WARREN BUFFETT: Can you see us using stock in the next few years?

CHARLIE MUNGER: If the business were good enough, of course.

Our trouble is — it’s a terrible trouble you people have — the businesses you already own are so good it’s not wise to part with them to get a business we don’t own. Ordinarily.

12. Buffett is always optimistic about American capitalism

WARREN BUFFETT: Carol?

CAROL LOOMIS: This is for Warren — and Charlie, too — from your longtime Omaha friend Dick Holland.

“Whenever you talk in a general way about America’s economic future, your remarks are invariably positive, even glowing, despite the severe problems of growing public and private debt, the huge budget imbalances that result, and no real policies to solve these problems.

“Some experts believe that we may reach the point where future bond offerings to cover the rising debt might fail. Many wonder if we are not entering a time of national decline.

“How can a lousy long-term U.S. economy make you so happy, and why do you see gold nuggets where others see salt?”

WARREN BUFFETT: That’s from Charlie’s good friend as well, Dick Holland, who we both have known for 60-plus years.

I don’t see how anybody can be other than enthused about this country.

If you look back to 1776 or 1789, whichever one you want to date it from, you know, it has been the most extraordinary economic period in the history of the world.

In fact, if you go back — I was born on August 30th, 1930.

Now, if somebody had come to me in the womb and said, “Let me tell you what it’s like outside now. The stock market has just crashed, but you haven’t seen anything yet. 4,000 banks are going to fail.

“The Dow Jones average is going to go down to 42. It was 381 back just a little bit before you were conceived, and it’s going to go to 42. They’re going to close the banks for a while. We’re going to have 25 percent unemployment. We’re going to have the dust bowl in the Midwest. The grasshoppers are going to take over.”

You know, it would be like in that Woody Allen movie where he says, “Go back, go back.”

All that’s happened since August 30th, 1930, is that the standard of living of the average American has increased six-for-one. Six-for-one.

You know, that’s absolutely incredible. I mean, you look at centuries where nothing happened for the average person. I mean, century after century. So we have a system that works magnificently.

It gets gummed up periodically. And it always has troubles. I mean, you know, I — my father was very anti-New Deal, so my sisters and I sat around a dinner table from the first we can remember hearing how things were going to go to hell.

As a matter of fact, my father-in-law told my wife-to-be and her mother that he wanted to have a talk with me before we got married.

And he was very much on my side, so I was not in a panic about this or anything, but I went down to his house shortly before the marriage and this wonderful man, Doc Thompson, sat in a chair for a couple of hours, and he said, “Warren,” he said. “I just want to tell you that you’re going to fail but it’s not your fault.” (Laughter)

And he said, “You and Susie, my daughter, if you starve, she would have starved anyway. I mean, it is not your fault. It’s because — you know, it’s because the Democrats are in, you know, and they’re going to take the country down the road to Communism and, you know, and just don’t worry about the fact you’re going to fail.”

And this went on for quite a while. And then he blessed me and we got married. It was a happy ending.

But ever since — when I got out of school in 1951, the two people I admired the most in the world, my dad and Ben Graham, both said, you know, you’ve got a good future but don’t start in stocks now because there’s never been a year when the Dow Jones average has not ended up below 200, and it’s above 200 now. It’s much too high, and if you start now selling stocks to people they’re going to have bad experiences. So why don’t you wait a while and go work in the Omaha National Bank or do something, park yourself on the sidelines.

There’s always negatives. The country always faces problems. I mean, this country went through, you know, it went through a civil war, you know. It — it’s gone through all kinds of things. But what happens?

You know, we have a few lousy years from time to time. We’ve had, probably, 15 recessions since the country started. And we will always have a list of 10 or 15 things at the start of the year that will tell you why this country can’t possibly work well.

But all I can tell you is that it doesn’t do it in a straight line, but the power of capitalism is incredible. I mean, you know, that’s what is bringing us out of this recession.

I mean, monetary and fiscal policy add some utility, and certainly in the fall of 2008 the government was needed in a huge, huge way. It could do what — it was the only one that could do what was needed.

But if you look at the history of the United States, you know, probably half of our recessions have occurred during — we’ll say in the 19th century — when people didn’t even know what fiscal or monetary policy was.

I mean, what happened was that excesses would come in and then the resuscitative power of capitalism would set the country back on the right — on a stronger growth pattern — and that’s happened time after time after time.

And the game isn’t over. I mean, it is not like the potential of America has been used up.

What has happened is the rest of the world has caught on, to some extent, so you’re seeing some state capitalism in places like China, and they are turning economies loose that have been dormant for centuries.

But it’s not because the people are smarter. It’s not because they work harder. It’s just because they have tapped into a system that works marvelously over time.

And I will tell you, in the next hundred years you’re going to have probably 15, maybe as many as 20 lousy years, but we will be so far ahead of where we are now that it will be unrecognizable.

Charlie? (Applause)

CHARLIE MUNGER: Well, I can go back a lot farther than that. You know, Europe survived the Black Death, where about a third of the people died. The world is going to go on.

WARREN BUFFETT: That’s wildly optimistic for Charlie. (Laughter)

Have you got anything more encouraging than that to say, Charlie? (Laughter)

CHARLIE MUNGER: I don’t know. I kind of — I understand a little bit of Dick Holland’s point of view.

And by the way, I’ve known him a long time. He aced me out of any hope of being the chief candle snuffer at the Unitarian church. (Laughter)

He was so damn good at it. (Laughter)

Anyway, what was the question? (Laughter)

WARREN BUFFETT: Can you bring yourself to say anything optimistic?

CHARLIE MUNGER: Well, I have a little bit of a twist on that. And so I would say that you can be cheerful even if things are slightly deteriorating, and that’s a very good quality to have.

I have a personal saying that has always amused me. I say, the politicians are never so bad you don’t live to want them back. (Laughter)

WARREN BUFFETT: Well, on that note of wisdom — (Laughter)

13. Best assets in an inflationary environment

WARREN BUFFETT: Let’s go to area 4.

AUDIENCE MEMBER: Good morning. Angie Janssen (PH) of Cambridge, Massachusetts.

My question is, aside from the need to put huge amounts of capital to work, do you still believe that a high return on tangible capital business, like See’s or Coke, is the best asset to hold in an inflationary environment, or do you now think an irreplaceable hard asset with pricing power, like a railroad or a hydroelectric dam, is superior?

WARREN BUFFETT: The first group is superior. I mean, if you can have a wonderful consumer product — doesn’t have to be a consumer product — a product that requires very little capital to grow, and to do more dollar volume, as will happen with inflation even if you don’t have unit growth, and it doesn’t take much capital to support that growth, that is a wonderful asset to have in inflation.

I mean, the ultimate test of that is your own earning ability. I mean, if you’re an outstanding doctor, lawyer, whatever it may be, teacher, the — you — as inflation goes along, your services will command more and more in dollar terms, and you don’t have to make any additional investment in yourself.

People think of that, you know, with a very long-lived real estate asset or something of the sort, or a farm, or anything where additional capital is not required to finance inflationary growth.

The worst kind of businesses are the businesses with tons of receivables and inventories and all of that.

And in dollar terms, if their volume stays flat but the price level doubles, and they need to come up with double the amount of money to do that same volume of business, that can be a very bad asset.

Now normally, we are not enthused about businesses that require heavy capital investment, just like utilities and the railroad.

We think that, on the other hand, particularly with the railroad, that where you do not have any guaranteed lower rate of return, that you should be entitled to earn returns on assets that are becoming more and more valuable to the economy as — whether it’s because of inflationary factors or because of just natural growth factors, or in the case of the United States, I think it will be both.

But the ideal business — See’s Candy is doing — it was doing $25 million of volume when we bought it, and it sold 16 million pounds of candy — a little more than — well, it retails $1.90, and we had some quantity discounts, so we were doing close to $30 million worth of business.

Now, we’re doing well over $300 million worth of business. It took $9 million of tangible assets to run it when it was doing 30, and it takes about 40 million of tangible assets at 300-and-some.

So we’ve only had to ploy back $30 million into a business which will make us — well, it’s made us, probably, a billion-and-a-half pretax during that period.

And if the price of candy doubles, we don’t have any receivables to speak of. Our inventory turns fast. We don’t store it or anything like that. We gear up seasonally and the fixed assets aren’t big, so that is a much better business to own than a utility business if you’re going to have a lot of inflation.

Charlie?

CHARLIE MUNGER: And what’s interesting about it is that we didn’t always know this. And so — (Laughter)

WARREN BUFFETT: And sometimes we forget it. (Laughter)

CHARLIE MUNGER: That’s true, too.

But it shows how continuous learning is absolutely required to have any significant achievement at all in the world.

WARREN BUFFETT: Yeah, and it does show — you know, I’ve said in the past that I’m a better businessman because I’m an investor and I’m a better investor because I’m a businessman.

There’s nothing like actually experiencing the necessity, particularly in the 1970s when inflation was gathering strength, and early ’80s, you would see this absolutely required capital investment on a very big scale that really wasn’t producing anything commensurate in the way of earnings.

I wrote an article for Fortune called “How Inflation Swindles the Equity Investor” back in 1977.

You really want — the ideal asset, you know, is a royalty on somebody else’s sales during inflation, where all you do is get a royalty check every month, and it’s based on their sales volume.

And you made — you came up with some product originally, licensed it to them, and you never have another bit of capital investment. You have no receivables, you have no inventory, and you have no fixed assets.

That kind of business is real inflation protection, assuming the product maintains its viability.

So even though we are going into some very capital-intensive businesses, part of that reflects the fact we can’t deploy the amount of capital we have in a whole bunch of See’s Candies. We just can’t find them. We would love to find them, but we can’t find them in that quantity.

So we are not doing as well with capital when we have to invest many billions a year, as we would if we were investing a few millions a year. There’s no question.

That’s true in investments. It’s true in operating businesses. There is a real disadvantage to size, and we just hope that problem grows.

CHARLIE MUNGER: Now you’re talking.

14. No dividend, so sell a slice of Berkshire if you need cash

WARREN BUFFETT: Becky?

BECKY QUICK: Aside from questions about Dave Sokol, the questions I’ve received most from shareholders have to do with dividends.

And Dave Corneal (PH), who is a shareholder who couldn’t be here this weekend because he’s at his daughter’s wedding, writes in, “I know that Berkshire is a great allocator of capital, but as an owner of stock and as I get closer to retirement, there will be a time when I will need income from my assets.

“Currently Berkshire does not pay dividends, yet it loves collecting on dividends on its investments. It also generates extensive cash flow in which it could pay dividends if it chooses to.

“Currently the only real option to get income from your Berkshire investment is to sell a share or two of the stock. Is there a point in the future where Berkshire shareholders may expect a dividend payment, or what conditions would be needed for Berkshire to consider paying a dividend?”

WARREN BUFFETT: Yeah, we will pay dividend — as a matter of fact, there may be an argument that when we pay dividends we should pay out almost 100 percent, because it does mean that we lost the ability to find ways to invest a dollar in a manner that creates more than a dollar of present value for the shareholders.

But let’s assume you had a savings account, and the savings account paid 5 percent. And you had your choice of taking $50 a year out, or letting the $50 stay in and somebody would pay you 120 percent of that savings account any time you wanted to sell a piece of it.

Now, would you want to take the $5 out or would you rather let it accumulate and have the ability to sell at 120 cents on the dollar, that account?

Every dollar that’s been reinvested in Berkshire has created more than a dollar of market value, so it’s much more intelligent, if you control the dividend policy of Berkshire, it’s much more intelligent for people to leave the dollar in, have it valued at $1.20 or $1.30 or whatever it may be valued, and then sell off a little piece if they want the income, or if they want to receive some cash.

And the logic of it, I think, is unquestionable. The execution of it is a problem. I mean, the question of whether we can keep investing dollars to create more than a dollar of present market value, you know, there’s an end to that at some point.

But so far, people, by leaving 160 billion at the end of third quarter in the business, have $200 billion that they can cash out for at any time they wish.

There will come a time and, you know, who knows how soon, because the numbers are getting big — there will come a time when we do not think we can lay out, you know, 15 or 20 billion a year and get something that’s immediately worth more than that for our shareholders.

And like I say, when the time comes where a dollar is only buying us 90 cents of value, we’ll quit spending the dollar. We’ll give it to the shareholders.

But I predict that the day that Berkshire declares a dividend, the stock will go down. I mean, it will — and it should go down — because it’s an admission, essentially, that a compounding machine has lost its ability to continue on that course.

Charlie?

CHARLIE MUNGER: Well, and there’s nothing wrong with selling a little Berkshire stock to buy jewelry if you do it in the right place. (Laughter)

WARREN BUFFETT: I would like to announce that my niece, Cynthia, visited Borsheims yesterday around — I guess around 3:00 — and she was there with her boyfriend, and he proposed, and they bought a ring. Congratulations. (Applause)

Her mother did the same thing a few years ago. And, you know, these things become family traditions, so go out there and who knows what will happen? (Laughter)

15. Still bullish on bank stocks Wells Fargo and U.S. Bancorp

WAREEN BUFFETT: OK. Number 5.

AUDIENCE MEMBER: Jeremy Pozen (PH), Newton, Massachusetts.

Mr. Buffett and Mr. Munger, Berkshire Hathaway has had large investments in Wells Fargo and U.S. Bank.

What are the revenue outlooks and business prospects for these two banks, given the backdrop of slow U.S. growth, an extended U.S. consumer, a tepid rebound in the U.S. housing market with foreclosures and write-downs lessening but still at historically high levels, and the potential for greater-than-expected inflation, or worse, possibly, deflation similar to Japan?

Thank you for your time and consideration.

WARREN BUFFETT: Yeah, Wells Fargo and U.S. Bancorp are both among the best large banks, if not the best, in the country and they’re different than what you think of in terms of some money center banks, but they’re very large. Wells is four times as large as USB.

Banking as a whole — U.S. banking — profitability will be considerably less, in my view, in the period ahead than it was, say, in the early part of this century.

And a very important reason is that the leverage will be reduced. And that’s probably a good thing for society.

It’s — it may be a bad thing for individual banks that could use leverage intelligently, but the trouble was that they all thought they could use leverage intelligently, and the actions of one, or more, that were unintelligent about it, you know, had consequences for everybody, which you can see if you view HBO on whatever it is — is it May 26?

The — so I would say that return on assets — even if return on assets were as good as it was some years ago, there will be less assets per dollar of common equity than before which means returns on common equity will be less.

We still think that Wells Fargo and U.S. Bank are very good operations. We think they’re very decent businesses. They’re not as attractive as when leverage ratios could be higher.

In terms of the troubles in banking, I think you’ve seen, by far, the worst in the past. And loan losses have been trending downward now for several quarters, and I think the expectation is that will continue, and I think banking is a very fundamental business.

But as John Stumpf said a few years ago at Wells Fargo, he said, “I don’t know why we keep thinking of new ways to lose money when the old ones were working so well.” (Laughter)

And banks periodically go crazy. It’s always on the asset side.

I mean, here you’ve got cheap money. You’ve got the federal government behind, although the federal government has never had to pay out anything on — in terms of the FDIC.

The FDIC has handled 3800 since it was established on January 1, 1934. The FDIC has paid out probably 3800, 3900 by now, institutions, 250 of them or so in the last couple years. And that has not cost the U.S. taxpayer a penny. I mean, that has all come from FDIC assessments on other banks. It’s been a mutual insurance company.

Banking, if you just keep out of trouble on the asset side, is a very good business because you get your money so cheap and, you know, because of the implicit federal guarantee, and you do get to leverage up to a fair extent, and America’s been a pretty good place to lend money.

So I like our positions in there. You will see that — if you looked at those totals — you’ll see we’ve added to Wells Fargo. And both those companies are very well run institutions, but they will not be able to earn — I don’t know what the figures were, but I think they were up 25 or — to 30 percent on tangible equity — and that’s not going to get repeated in the future, and it shouldn’t be.

Charlie?

CHARLIE MUNGER: Well, yeah, we might add that M&T Bank, which most people —

WARREN BUFFETT: Oh, yeah.

CHARLIE MUNGER: — never talk about, is headed by a really sensible fellow, and it’s been a wonderful investment for us.

WARREN BUFFETT: Yeah, as a matter of fact, if you get the M&T annual report, it’s written by Bob Wilmers, the letter, the first part of it is about M & T specifically, but the second part is about particularly the American financial economy, and I would really recommend you read that.

Bob is a very smart guy and he has a lot of good observations.

And, frankly, the other one I recommend you read is Jamie Dimon’s letter, at JPMorgan, is a tour de force, in terms of describing the banking scene, the economic scene. He has some real insights in there about some very important subjects.

We don’t own that stock, but it’s a letter that I think everybody could learn a lot from reading, as they could from reading Bob Wilmer’s letter at M&T.

CHARLIE MUNGER: And those people who like an element of morality in business, Wilmer sounds like an Old Testament prophet.

I mean, he really doesn’t like it that all the really big banks are making so much money out of trading, because he says you’re really trying to outsmart your own customers, and he’d rather serve them in a culture of deserved trust in both directions. It’s hard to think he’s totally wrong.

WARREN BUFFETT: He also expresses quite a dislike for the fact that a market system creates a reward system where money sort of disproportionally flows to people who work with money, and that that tends to attract a disproportional number of people that — of lots of ability that he thinks might be — at least some of them — might be better deployed elsewhere. It’s an interesting read.

CHARLIE MUNGER: It’s one of the best annual reports that’s ever came out of banking. Right out of Buffalo.

16. Productive assets will always beat gold

WARREN BUFFETT: Ok. Andrew?

ANDREW ROSS SORKIN: This question who comes from Neil Steinhoff (PH) who writes, “The commodity market, and particularly gold, have appreciated astronomically over the last few years.

“My Berkshire Hathaway stock is only slightly better — doing better — than it was in 2006. It’s barely kept up with inflation,” he says.

“Please explain why you have not invested more heavily in commodities. As long as Ben Bernanke continues to print money and there’s no indication he’s going to stop any time soon, isn’t it right that commodities, and particularly gold, will continue to appreciate?”

WARREN BUFFETT: Well, I would point out that when we started with Berkshire, it was about 3/4 of an ounce of gold, and gold was $20 an ounce then, and it was 15.

So gold, even at 1500, has a ways to go, and the — (Laughter and applause)

I think he’s right about inflation. But if you think about it, there are three major categories of investment. And you ought to think very hard about which category you want to be in before you start thinking about the choices available within that category.

Now, the first category is anything denominated in a currency. It could be bonds, it could be deposits in a bank, it can be a money market fund, it can be cash in your pocket.

And the — if you will reach in your pocket — I don’t like to do this, but — and pull out your wallet — you’re watching an historic event. (Laughter)

If you look at this — and I might point out this is a one. Charlie carries a — on the back of it, it says, “In God We Trust.” And that’s really false advertising.

The — if Elizabeth Warren were here, she would say, quite properly, it should say, “In Government We Trust,” because God isn’t going to do anything about that dollar bill, you know, if government does the wrong things, in terms of keeping it as valuable as it was when you parted with it to buy a bond or put it in a bank.

Any currency-related investment is a bet on how government now, and in the future, will behave. And if you happen to be unfortunate to live — fortunate to live in Zimbabwe and you decided to make currency-related investments, you know, you — family would have left you by now, and it was not a good decision.

Almost all currencies have declined in value over time. I mean, it may be built into almost any economic system that it will be easier to work with a value of currency that declines in value than a currency that appreciates in value, and the Japanese might reaffirm that here with their experience.

So as a class, currency-related investments, whether they are in the UK, or the United States, or anyplace else, unless we’re getting paid extremely well for having them, we do not think make much sense.

The second category of investments regard items that you buy that don’t produce anything but that you hope someone will pay you more for later on. And the classic case of that is gold.

And I’ve used this illustration before, but if you take all of the gold in the world — don’t get too excited now — and put it into a cube, it will be a cube that’s about 67 feet on a side. That would be 165,000 or 170,000 metric tons.

So you could have a cube — if you owned all the gold in the world — you could have a cube that would be 67 or 68 feet on a side, and you could get a ladder and you could climb up on top of it, and you could say, you know I’m sitting on top of the world, and think you’re king of the world.

You could, you know, you could fondle it, you could polish it, you could do all these things with it. Stare at it. But it isn’t going to do anything.

All you are doing when you buy that is that you’re hoping that somebody else a year from now, or five years from now, will pay you more to own something that, again, can’t do anything, but you’re hoping that the person then thinks that somebody else will buy something five years later from him.

In other words, you’re betting on not just how scared people are now of paper money, you’re betting on how much they think a year from now people will be scared two years from then on.

Keynes described all of this. I think it was in Chapter 12 of “The General Theory,” when he talked about this famous beauty contest where the game was not to pick out the most beautiful woman among the group, but the one that other people would think was the most beautiful woman, and then he carried it on to second and third degrees of reasoning.

Any time you buy an asset that can’t do anything, produce anything, you’re simply betting on whether somebody else will pay more for, again, an asset that can’t do anything.

And actually, we did that with silver, but silver had an industrial use, and we — about 13 years ago I bought a whole lot of silver. And if you’ll notice, silver has moved recently, so my timing was only about 13 years off, but, you know, who’s perfect?

The third category of asset is something that you value based on its — what it will produce, what it will deliver. You buy a farm because you expect a certain amount of corn or soybeans or cotton or whatever it may be, to come your way every year. And you decide how much you pay based on how much you think the asset itself will deliver over time. And those are the assets that appeal to me and Charlie.

Now, there’s some logical follow-on to that. If you buy that farm, and you really think about how many bushels of corn, how much bushels of soybeans will it produce, how much do I have to pay the tenant farmer, how much do I have to pay in taxes and so on, you can make a rational calculation, and the success of that investment will be determined in your own mind by whether it meets your expectations as to what it delivers.

Logically, you should not care whether you get a quote on that farm a day later, or a week later, or a month later, or a year later. We feel the same way about businesses.

When we buy ISCAR, or we buy Lubrizol, or whatever, we don’t run around getting a quote on it every week and say, you know, “Is it up or down or anything like that?” We look to the business.

We feel the same way about securities. When we buy a marketable security, we don’t care if the stock exchange closes for a few years.

So when we look at Berkshire, we are looking at what we think can be delivered from the productive assets that we own, and how we can utilize that capital in acquiring more productive assets.

And there will be times, you know, cotton doubled in price, much to our chagrin at Fruit of the Loom, but, you know, if you own cotton for the right six or eight months in the past year, you came close to doubling your money.

But if you go back a century and try to make money owning cotton over time, it has not been a very good investment.

So to pick a product, crude oil, cotton, gold, silver, anything that — and, of course, cotton has utility. Gold really doesn’t have utility.

I would bet on good-producing businesses to outperform something that doesn’t do anything over any period of time.

But there’s no question that rising prices create their own excitement. So when people see gold go up a lot — I mean, if your neighbor owns some gold, and you think you’re smarter than he is, and you didn’t own any, and your wife says to you, you know, “How come that jerk next door is making money, you know, and you’re just sitting here?” It can start affecting behavior.

And people like to get in on things that have been rising in price and all of that. But over time, that has not been the way to get rich.

Charlie?

CHARLIE MUNGER: Well, I certainly agree with that. And besides, something peculiar to buy an asset which only will really go up if the world really goes to hell. (Laughter)

It doesn’t strike to me as an entirely rational thing to do.

I think you can figure on leaving the country because the country is going to kill you. And all the countries you might go to will also be thoroughly screwed up.

I think all those people should buy a little gold, but I think the rest of us would be better off with Berkshire Hathaway stock. (Laughter and applause)

And, of course, there’s another class of people that think they can protect themselves by buying paintings of soup cans. (Laughter)

I don’t recommend that, either. (Laughter)

WARREN BUFFETT: One thing about gold, also, is that in addition to this 67-foot cube, more gold is being produced every year.

So you have to have buyers not only to offset sellers in the natural course of events, but you have to absorb something like a hundred billion dollars’ worth of added items of no utility.

I mean, it’s really interesting. I mean, they dig it up out of the ground in South Africa, and then they ship it to the Federal Reserve in New York and they put it back in the ground.

I mean, if you were watching this from Mars you might think it was a little peculiar. But think of how many people it makes happy.

I might mention that the value of that cube, all the gold in the world, is now about — valued at 1500-plus — it’s about $8 trillion. And there are a billion acres, roughly, of farmland in the United States. That’s a little a million-and-a-half square miles. And that’s valued at something over 2 trillion.

And if you take ten Exxon Mobils, you get up, maybe, another 4 trillion and — maybe not that much even — and so you could own all the farmland in the United States, every bit of it, and you could own ten Exxon Mobiles and you could stick a trillion or so in your pocket for walking around money, and you could have your choice of that or this 67-foot piece of gold that you could fondle and — (Laughter)

That may seem like a close choice to some people, but not to me. (Laughter)

CHARLIE MUNGER: Well, you would also need an army to defend the gold. And it’s really not a very good spot.

17. Buffett on getting his first investors

WARREN BUFFETT: OK. Number 6.

AUDIENCE MEMBER: — Millard, Dallas, Texas.

Mr. Buffett and Mr. Munger, when you were raising your first investment funds, how did you go about attracting investors, and once you had your first funds and your first investors, how did you go about growing them?

WARREN BUFFETT: Sounds to me like a man that’s about ready to start a hedge fund. (Laughter)

The — in my case, I’d moved back here from New York in March or so of 1956, and a few members of my family said we’d like you to manage our investments just like I did when I was selling securities out here before I went to New York. And I didn’t like being in the securities selling business, partly because if I sold somebody a stock at 20 and it went down to 10, I wanted to buy more, but I couldn’t face the idea of people that had bought at 20 and, based only on confidence in me not because they understood it, and now they were feeling depressed, and it was — it just wasn’t — it wasn’t very satisfactory.

I could not do as well managing money if people were watching every decision as I could if I did it in a room all by myself.

So I just told these seven members of the family — one of them, actually, was my roommate in college and his mother, they came in also — I said, you know, if you’d like to join up in a partnership, I’m not going to tell you what’s going on, but I will tell you that I will be doing with my own money what I’m doing with yours. Later on, I put all my own money in.

And it just was very slow.

A few months later, Graham-Newman, that I’d worked for, was liquidating, and a fellow named Homer Dodge asked Ben Graham what he should do with the money he was getting out of Graham-Newman. He said, “This kid used to work for me and he’s OK.” And so he came out and went in with me.

And another fellow, late in the fall, had seen the notice of partnership formed in some legal paper and he said, “What’s this?” and came in with me. It’s just — we just stumbled along.

And for almost six years, I operated out of my house, no employee. I kept all the books, I filed the tax returns, I, you know, went out and picked up the stocks personally and stuck them in a safe deposit box.

When Charlie came along, I kept chiding him about the fact — I met him in 1959 — and I said, “Law is OK as a hobby, but it’s no place for a man with your intellect to spend his time.” (Laughter)

And, well, I’ll let Charlie take it over from there. (Laughs)

CHARLIE MUNGER: It actually took me a long time to leave what was a family business.

And so any of you who are having a slow time accepting good ideas, why, you should be cheered by my example, because it was some years after you started working on me, and you pounded on me, and I slowly got the point.

WARREN BUFFETT: And he was actually asking about attracting money.

CHARLIE MUNGER: Well, of course, it helps if you conducted yourself in life so that other people trust you. (Laughter)

And then it helps even more if —

WARREN BUFFETT: You can see why I was so slow and he was so fast. (Laughter)

CHARLIE MUNGER: And then it helps even more if other people are right to trust you. So the formula is quite simple. First one, then the other.

WARREN BUFFETT: Unfortunately, with the present fee structure, just attracting money, rather than performing with it, can be enormously lucrative.

So the skill of attracting money may be — at least in the short run, and maybe the intermediate run — it may be a more important quality than the ability to manage money.

But we, neither one of us, ever charged any fixed fee of any kind.

Am I right on that, Charlie?

CHARLIE MUNGER: Well, we stopped taking any significant overrides on other people’s money at very young ages and at very small amounts of net worth.

I wish our example were more common. But I like our compensation practices, too, and they’re spreading slowly.

We get a new company every, what, five years?

WARREN BUFFETT: Yeah.

18. Berkshire isn’t a ’60s “Go-Go” conglomerate

WARREN BUFFETT: OK. Carol?

CAROL LOOMIS: This is from Jeff — sorry, Jeff Cunningham of Directorship.

“Berkshire’s corporate strategy resembles that of the go-go conglomerates of the 1960s: Geneen’s ITT, Teledyne, Textron.

“Small corporate team, tight financial controls, sector neutrality, and little involvement in subsidiary operations, and ultimately not fully valued for the sum of their parts. If you disagree with this, how does Berkshire differ?”

WARREN BUFFETT: Yeah, it — we are a conglomerate and, you know, people shy from that name, but that’s exactly what we are.

And I think I laid out in the annual report at least one of the advantages of being a conglomerate, namely the tax-efficient transfer of money from businesses that do not have good ways of using it to businesses that have better ways of using it, which is, if it’s carried out intelligently, is a very significant plus.

The conglomerates you mentioned — and I’m familiar with all of them — really became sort of stock issuance machines, where the idea was to get your stock to sell at a very high multiple, and then trade it for something else that was selling at a lower multiple, and voilà, you know, earnings per share went up, and then people said you’ll do it again.

So it was — it was really accepted and endorsed by Wall Street that if you had this sort of semi-Ponzi scheme of issuing shares constantly for things that had lower P/E ratios, everybody knew what the game was, but they thought the game would continue to succeed. And for a while it did.

And the Gulf and Westerns of the world, and the Littons of the world, and there were numbers of them, it was almost like an unspoken conspiracy that nobody will point out that this is kind of a perpetual motion machine, and if they don’t it will keep working.

But if something says anything about it, somebody says, “The emperor has no clothes,” it will all collapse.

The interesting thing, of course, you mentioned Teledyne in there. Teledyne played that game, and then it ended, and all of this stuff came back to Earth, but then Teledyne went into reverse and bought in stock like crazy when their stock got underpriced.

So they issued stock like crazy when it was overpriced, and they bought it in to an extraordinary degree when it was underpriced, and it created a sensational record.

Most of those companies, though, I think have very little relationship to Berkshire.

It’s true that, I think, some of them were pretty decentralized, although I remember — didn’t Harold Geneen have some famous room that he brought everybody in —

CHARLIE MUNGER: Yes.

WARREN BUFFETT: —chewed them out, you know, monthly for not making their projections, so they learned to make them whether they were actually really making them or not.

The managers were — if you took Charlie Bluhdorn at Gulf and Western, or, you know, take the group, they were primarily thinking about how — Jimmy Ling at LTV — they were primarily thinking about how they could pump the stock up to a level where they could buy big established businesses that were selling at lower P/E ratios and sort of have this perpetual motion game going. And it came to an end.

I don’t think there’s — you know, at Berkshire we are not in that game. We are in the game of trying to buy very good businesses that we’re going to keep forever and having them grow their earnings and have them also throw off cash that we can use to buy more similar businesses.

It is a conglomerate. Conglomerates, generally, are unpopular, and I don’t disagree with why they are. But I think it’s a very rational way of running the business as long as you keep it focused on running businesses and not as a stock-issuance machine.

Charlie?

CHARLIE MUNGER: Well, yes, and some of those companies got into really pretty heavy manipulation of the numbers.

One of them said, “I know what I’m going to report, I just don’t know how I’m going to do it.” (Laughter)

That’s not the attitude around this place.

WARREN BUFFETT: Yeah, we don’t know what we’re going to report. (Laughs)

CHARLIE MUNGER: No, no. And sometimes we don’t know how to do it, either. (Laughter)

19. Buffett’s preferred legacy: “teacher”

WARREN BUFFETT: OK. Number 7.

AUDIENCE MEMBER: Good morning, Warren and Charlie. John Norwood from West Des Moines, Iowa.

I have a question on legacy. A hundred years from now, Warren and Charlie, what would each of you like to be remembered for?

WARREN BUFFETT: Old age. (Laughter)

CHARLIE MUNGER: I’ve heard Warren say that what he wants said at his funeral is that’s the oldest looking corpse I ever saw. (Laughter)

I have a different saying that came down from one of my great grandfathers. And I think it — he wanted to be remembered for a fortune fairly won and wisely used. That’s a pretty good system.

WARREN BUFFETT: Yeah, I would — if you really ask me, I’d probably like “teacher.” I enjoy teaching a lot.

Some people think I do a little too much of the didactic stuff, but I like students coming. And, you know, I’ve benefited by some fabulous teachers, starting with my dad, but going on to Ben Graham, going on to Tom Murphy, I mean, lots of great teachers. So I would say that.

I might point out that on Wilt Chamberlain’s gravestone, I think it says, “At last, I sleep alone.” (Laughter)

Well, we have some people from Kansas here, anyway. (Laughs)

20. Dollar will decline, but inflation won’t destroy the economy

WARREN BUFFETT: OK. Becky?

BECKY QUICK: This question comes from Pierre Sorel. He’s a portfolio manager at Fidelity and he says that the U.S. dollar has been depreciating against major currencies.

“The Federal Reserve continues to run a zero interest rate policy in contrast to other major economies that are raising rates or have stepped back from quantitative easing.

“A few years ago, Berkshire had a short U.S. dollar position to preserve the company’s value from the devaluating dollar.

“So what’s the company’s management doing about the risk of further U.S. dollar weakness, given that most of the company’s assets and operating businesses are denominated in the U.S. dollar?”

WARREN BUFFETT: Yeah, we had a significance short position some years ago. Last year we had a small short position in two currencies, and we made about a hundred million dollars in them, but we have not been really active in the foreign exchange market.

We think — shouldn’t speak for Charlie here on this — but I think that there’s no question that the purchasing power of the U.S. dollar will decline over time. The only question is at what rate.

But I also think that the purchasing power of most currencies around the world — almost most currencies around the world — will decline.

And, of course, a short position is just a bet on which one declines at the faster rate, and I don’t have a strong conviction on that. I’ve got some mild feelings about it but not enough to where I want to back it up with a lot of money.

We do own some businesses — I mean, l take Coca-Cola.

Coca-Cola — I don’t have the exact figures — but my guess is that 80 percent or thereabouts of the earnings will be non-dollar. And we’ve got exposure in various other ways.

But we are not — we’re unlikely to make another big currency bet, although I — you know, I do think that the purchasing power of the U.S. dollar is destined to decrease. And I have fears, but I’ve long had some unwarranted fears, of it declining at a rapid rate.

Now, Charlie has pointed out to me that the dollar of 1930, when I was born, is worth 6 cents now. You know, 16-to-1 in terms of depreciation. And as he points out, we’ve both done pretty well.

So inflation has not destroyed us.

If somebody had said to me in 1930, In addition to this Great Depression you’re facing, and a World War where it looks like we’re even losing for a little while, and all these terrible things, on top of that that dollar that, you know, your grandfather is going to hand you when you’re born, is only going to be worth six cents in purchasing power, that might have been discouraging.

But overall, we’ve still done pretty well.

So, I hate inflation, but we’ve adapted pretty well to it over the years, and we have not had the total runaway-type inflation that really can be upsetting to a society, yet, but I think it’s something you always have to guard against.

Charlie?

CHARLIE MUNGER: No, but God knows where the world is headed. I just think that one way or another, the world muddles through.

Take a really god-awful culture, which is Greece, modern Greece.

I don’t mean there’s anything wrong with the Greeks, but — in their family life — but the way they manage their money and pay their taxes. The main industry in Greece — or one of the main industries — is tourist attractions, and they closed right — most of the time — during the tourist season.

It’s a pretty dysfunctional government. (Laughter)

And, of course, people don’t want to pay any taxes or do much work, and yet there it is. It’s — the people of Greece are surviving.

WARREN BUFFETT: It’s lasted a long time.

CHARLIE MUNGER: Yeah, yeah.

Adam Smith said it very well. He said, “A great civilization has a lot of ruin in it.”

It takes a long time, and there’s a lot left after you’ve been through a good deal of ruin.

In fact, it’s an easier game than the ordinary process of living and then dying.

WARREN BUFFETT: Well, I think we’ll see a lot of inflation, but if I had a choice, I would rather be born in the United States today than any other place, any other time in history, so — (Applause)

21. Buy Berkshire stock or a mutual fund?

WARREN BUFFETT: OK. Area 8.

AUDIENCE MEMBER: Good morning, Mr. Munger and Mr. Buffett. This is Mary Bundrick (PH) from Rochester, Minnesota.

I was wondering, what factors would you consider in deciding between investment in Berkshire Hathaway versus a no-load mutual fund?

WARREN BUFFETT: Well, I advise people to buy index funds, actually, if they’re not going to be active in investments.

I mean, if you just are going — if you’ve got a day job, and you want to just put money aside over time, I think the average individual will do better buying an index fund consistently over time than almost anything else available to them.

I think it will be a perfectly satisfactory investment. It won’t be — it’ll never be regarded as a great investment, but it will be a perfectly satisfactory investment.

If I personally had a choice between an index fund and Berkshire at present prices, I would rather own Berkshire. But I wouldn’t be unhappy if you told me I had to leave all my money in an index fund for the rest of my life and then — but I like Berkshire better. (Laughs)

Charlie?

CHARLIE MUNGER: Well, I like it a lot better, and I’d be very unhappy if I had to own an index fund. My ambitions are larger.

I don’t think the average return of a skilled investor over the next 50 years is going to be as good after all factors as it was over the last 50 years.

So I think reduced expectations are the best defense any investor has, and after that, I think Berkshire is a pretty good bet.

WARREN BUFFETT: Charlie’s big on lowering expectations.

CHARLIE MUNGER: Absolutely. (Laughter)

That’s the way I got married. (Laughter)

My wife lowered her expectations. (Laughter)

WARREN BUFFETT: And he lived up to them. (Laughter)

22. “Rules are not meant to be danced around”

WARREN BUFFETT: OK. Andrew?

ANDREW ROSS SORKIN: The question is, “Can you explain the company’s policy for your own personal investing outside of Berkshire and that of your other managers, and why aren’t all trades in investments first cleared through a compliance department like that of most other companies?”

WARREN BUFFETT: Well, I don’t think it is true of most other companies.

We have 260,000 employees, and we have one company that’s a subsidiary of General Re called New England Asset Management, but that’s the only company that advises other people on investments or operates in the investment field.

At Berkshire, there are presently three people that can execute trades, and then there are a few other clerical people that would see what was done.

But we are not an investment advisory firm. We’re not a mutual fund or anything of the sort.

So if we — we have some, I think, pretty clear rules that are going to be looked at, again, I can assure you, by the audit committee.

But in terms of the Code of Conduct, Code of Ethics, and insider trading rules, which go to the managers, I don’t think there’s anything ambiguous in those.

Now, to extend those beyond — I don’t know, Marc, how many people those go to but — whether 60 or 70 or something, I’m not sure of the number — but the problem with rules, you know, is, I mean, you’ve got to have them and we emphasize not only the letter of them, but the spirit. That’s why I write that letter every couple years.

I was on the audit committee, for example, of Coca-Cola. And Coca-Cola has about one-fifth as many employees — or did then — had about 50,000 — had about one-fifth as many employees as Berkshire. And each time the audit committee met we had eight or 10 code violations.

I mean, people — if you take Berkshire at 260,000 people, you know, that’s about the number of households in the greater metropolitan Omaha. And perfect as we like to think we are in Omaha, I will tell you there’s a lot of things going on in Omaha right as we sit here that, you know, do not match the rules. So it’s a real problem.

The problem, obviously, with the Sokol thing is it hit very, very high up, you know.

But we had a case sometime back where a fellow that was a friend of mine, vice president of one of our subsidiaries, and, like I say, a personal friend, and we supplied the evidence that sent him to jail.

You know, it has happened. We had a — as I remember some years ago, I think it was in Woodbury, New York, we may have had a woman arrested in the offices just because we want to make very clear, you know, what — that we mean business and as the — as the audit committee said that this is not public relations, this is reality.

Here’s a letter that went out from Johns Manville. I didn’t know anything about it until Todd Raba gave it to me the other day, but it describes what — dated April 27, and it said, “The audit committee clearly found that Mr. Sokol compromised the integrity-related values of both Berkshire and JM have worked so hard to ingrain in the fabric of both companies.

“This should serve as a tragic lesson learned for every employee in JM.” And then in boldface, “There are no gray areas when it comes to integrity.” And it goes on.

So we hope to get some value out of this experience that will help us reinforce, with not only the 60 or 70 managers, but with 260,000 people that we do mean business on this, and we’ve showed them we mean business when we have sent more than one person to jail.

But there will be, you know, we can have all the records in the world and if somebody wants to trade outside them or something, you know, I — they’re not going to tell us they’re trading in their cousin’s name. I mean, you know, it just doesn’t work that way.

We will have occasions in the future when people do wrong things.

Usually they get handled at the subsidiary level. I mean, it’s somebody doing something, whether it’s getting a kickback from a vendor or stealing out of a cash register, whatever it may be, and then, you know, we get the occasional mega one, which is very painful.

But we will — if there’s anything we can do in the rules that will make it even more explicit or get across further the idea that rules are not made to be danced around but rather that the spirit of them extends beyond them, we want to be sure we do it.

Charlie?

CHARLIE MUNGER: Yeah, all that said, if you look at the greatest institutions in the world, they select very trustworthy people, and they trust them a lot. And it’s so much fun to be trusted. And there’s so much self-respect you get from it when you are trusted and are worthy of the trust, that I think your best compliance cultures are the ones which have this attitude of trust, and some of the ones with the biggest compliance departments, like Wall Street, have the most scandals.

So it’s not so simple that you can make your behavior better automatically just by making the compliance department bigger and bigger and bigger.

This general culture of trust is what works. And, you know, Berkshire hasn’t had that many scandals of consequence, and I don’t think we’re going to get huge numbers, either.

23. Deficit spending is economic stimulus

WARREN BUFFETT: OK. Number 9. (Applause)

AUDIENCE MEMBER: Hi, Charlie and Warren. I’m Michelle from Decatur, Illinois.

Half the U.S. economy seems to be in a sluggish recovery while most foreign economies are showing solid growth numbers.

Are there any significant changes that you think can be made to either current U.S. economic policy or Federal Reserve policy or tax laws to get the economy healthy and growing in the U.S.?

WARREN BUFFETT: Yeah, we’ve really had our foot to the floor in both monetary and fiscal policy.

You know, you’ve seen it, obviously, on the monetary side, with extended period of effectively zero interest rates and actually with the chairman, just the other day saying this is going to go on for an extended period.

And then they asked him what an extended period meant, and he was — he said an extended period. (Laughter)

The — but we — it’s hard to imagine pushing harder on monetary policy than has occurred.

The interesting thing is people think of fiscal policy and they think, well, we had a stimulus bill.

Well, if you think about what stimulus really is, it’s not whether you call something a stimulus bill. If you had something that was called a stimulus bill and you didn’t run a deficit, it would not be, you know, it would not be a stimulus. You’d be —

And if you don’t have anything you call a stimulus bill at all, but you’re spending 10 percent more of your GDP than you’re taking in, you are applying an incredible stimulus — fiscal stimulus — to the economy.

We have a huge fiscal stimulus program going on now, and it’s called taking in 15 percent of GDP and spending 25 percent of GDP. That’s extraordinary.

So, I think that we have used those levers in a way that’s almost unprecedented. And I think it’s been wise, in general, to do what’s done, and I think it was particularly wise what was done in the fall of 2008.

But I think, generally, we have followed the right policies. I think they’re less important than most people think they are.

I think if you did the wrong policies it would really screw things up. But I don’t — I don’t — I think the natural resuscitative powers of capitalism are — will be the biggest factor in taking us out.

And I think you’ve seen that over the last two years and we’re seeing it month by month.

I would say this: residential construction is flatlined at, you know, 500,000 or so units per year.

I think when it comes back, and it will, but it will take — it takes working off a crazy excess inventory we had, and there’s no way to do that except through creating fewer residential units than you create households. That’s how you reduce the oversupply.

When that ends — when part comes back — I think you’re going to see much more of a pick-up in employment than you might think just by looking at construction workers.

I mean, we have Shaw Carpets. You know, I’m sure they’re not counted as construction jobs, but we have thousands fewer people working there because residential construction is where it is.

And we have people at the Furniture Mart and how much carpet they’re selling or houses, so I think there’s a lot of indirect, as well as direct, reservoir of jobs that will be drawn upon, or utilized, when residential construction comes back.

I don’t think I’d measure it just by the number of construction workers that are being employed currently versus, say, four or five years ago.

It will come back. I don’t know when. I said in the annual report I thought you’d be seeing it by the end of the year. I may or may not be right on that, but that would be my best guess, still.

We are creating households faster than we’re creating housing units. And, you know, we lose housing units just — you know, you look at the — with the tornadoes recently.

So there are — that problem will get cured. And I don’t think, when you mention we’re progressing more slowly than other places, certainly in terms of Asia, you know, there’s no question about it, or Brazil, but actually, I think our pace of coming out of this, while it’s been slow compared to the hit we took in 2008 — the American economy was paralyzed — it’s come back quite a distance, and we see that in our businesses.

Now, you know, our peak on railcar loadings were 219,000 one week, I believe, in 2006, but — and our bottom was 150- or 51-thousand. We’ll probably run 190,000, or thereabouts, currently, and that will pick up more as the year goes along.

So it’s come back a significant way. We have certain companies that are setting records that serve basic industries. If you look at TTI, which makes — which distributes — electronic components, has thousands and thousands of customers all over the world — it’s setting new records, and it’s way up in the first quarter and it set a record last year.

If you look at ISCAR, which supplies nothing but basic industry, I mean, nobody buys little carbon cutting tools, you know, to put in their recreation room or anything. This stuff is used, you know, for making big things, and their business is going up and up and up, you know, month by month.

So, the economy is coming back, and when residential construction finally gets this huge overhang largely eliminated I think — I think you’ll see a lot of improvement in the employment picture.

Charlie?

24. Munger tells how he’d take “an ax to our financial sector”

CHARLIE MUNGER: Yeah, the one place that I feel we’re making a huge mistake is not learning enough from the big mess that came from wretched excess in our financial system.

I don’t think we throttled the sin and folly out of that aspect of the economy nearly enough. And I think — if you look at all the panics and depressions in the United States, they all came from financial collapses, usually preceded by perfectly asinine and greedy behavior. And I think that would be a lot to be said for taking an ax to our financial sector and whittling it down to a more constructive size.

WARREN BUFFETT: Tell us more about how you use that ax. (Applause)

CHARLIE MUNGER: Well, Warren, I’ll make myself ridiculous, but I guess I’m so old I’m entitled to do that.

The — I would have the tax system discourage trading. I would have various kinds of Tobin taxes.

I would have securities trading more with the frequency of real estate than the trading by computer algorithms where one person’s computers outwit another person’s computers in what amounts to sort of legalized front running.

I don’t think we need any of that stuff. And I think making heroes out of the people who succeed at it is not good for the fiber of the country, either.

I hate the idea that 25 percent of our best engineers are going into the financial sector.

So, I think it’s crazy what we’ve allowed. (Applause)

And I think the lack of contrition in our financial sector, after the disgraceful stuff they got us into, is perfectly awesome. It makes Dave Sokol look like a hero. (Applause)

WARREN BUFFETT: He’s getting warmed up. (Laughter)

Just as a sidelight, how many of you know that if you trade an S & P future contract — 500 �� S&P 500 contract — and you hold it for 10 seconds and you have a profit, that 60 percent of the gain is long-term gain and 40 percent is short-term gain. So, essentially, our Congress has said that this activity should be more lightly taxed, you know, than cleaning washrooms or doing all the things that you people do every day. You get a special tax treatment.

Now that illustrates one of the problems with the tax code, in that there’s a few people that care intensely about having that in there, and the cost of it, in terms of less revenue for the U.S. government, is diffused among a large group, none of whom have enough interest to want to go out and write their Congressman or hire a lobbyist to fight the other way.

But it’s pretty extraordinary that we have decided that that particular form of activity should get 60 percent taxed at a 15 percent maximum rate, even though it may only take 10 or 20 seconds and be just a little flicker on a screen.

CHARLIE MUNGER: And the hedge fund operators of America get a much lower tax rate than the professors of physics or the drivers of taxis. This is demented. (Applause)

25. Update on Buffett’s bet against hedge funds

WARREN BUFFETT: Well, with that, we’re getting to our break at noon, and I promised — I made a bet three years ago with some fellows that run a fund of funds, and I promised to put the figures up every year as to how we’re doing.

It’s a 10-year deal, and if we can put up the slide — what number would that be? Probably five.

As you can see, these funds of funds — these are five funds of funds groups chosen by these people who I like, Ted Seides and his friends, and Ted couldn’t be with us today, but we will put these figures up annually.

He got off to a very good start with his group. Obviously, hedge funds should do better in a down market. And we haven’t caught them yet with the S&P 500, but it will give you all a reason to keep coming back over the next seven years as I report regularly on how we are doing in the S&P 500 versus the five funds of funds.

As [Fortune Magazine’s] Carol [Loomis] pointed out in an article recently or a — maybe it was on the web — in reporting on this, she looked at the bottom line where the investors in the S&P 500 are behind for the three years, and the investors in the funds of funds are behind, and the only people that are ahead so far are the investment managers. (Laughs)

They’re doing very well at this point. So we’ll keep you up to date on that.

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Text

2009 Berkshire Hathaway Annual Meeting (Morning) Transcript

1. Q&A sessions starts

WARREN BUFFETT: Good morning. I’m Warren. The hyperkinetic fellow here is Charlie. (Laughter)

And we’re going to go in just a minute to a question and answer section, at least a question section, that will be a little different than last year.

We have a panel — I can’t see very well here — over to the right, of journalists who will ask questions and alternate with the people in the audience.

And we’ll go back and forth. Got a little checklist here that we’ll use as we go back and forth. Here we are. And we should have a pen here someplace to check things off.

2. Board of directors introduced

WARREN BUFFETT: But first, even though we’ll have the formal meeting later on, I would like to introduce our directors. And if they would stand as I announce them and then remain standing until the end.

And if you’ll just hold your applause until the end or even later if you wish — (laughter) — we’ll recognize them. We’ll have a meeting later on to elect them. But if you’ll stand up. And like I say, you can’t see very well here with the lights, but —

There’s me and Charlie, we start off. And then Howard Buffett, Susan Decker, Bill Gates, Sandy Gottesman, Charlotte Guyman , Don Keough, Tom Murphy, Ron Olson, and Walter Scott. Those are the directors of Berkshire Hathaway. (Applause)

3. Money under your mattress beats Treasurys

WARREN BUFFETT: Now, we only have one slide, which actually is more than we would usually have. (Laughs)

And — but it does tell you something about what happened last year.

And it also acts as a commercial for our Nervous Nellie mattress with the famous night depository feature. (Laughter)

Last year — and have we got that up on the slide?

Last year, we wrote a ticket on December 19th. And we sold 5 million of Treasury bills. I hope you can see that. It’s — we’ve got the December 19th circled up there.

And those Treasury bills came due, or were to come due, on April 29th of this year. So they were going to come due over four months later.

And the remarkable thing is, and this tells you about what an extraordinary year it was, is that we sold those $5 million of Treasury bills, which were going to pay off at $5 million on April 29th of 2009, in December of 2008 we sold them for five million and ninety dollars and seven cents.

In other words, if the person who bought those from us and paid us five million and ninety dollars, instead had bought the Nervous Nellie mattress and had put their money under the mattress, they would’ve been $90 better off at the end of four months, than by buying Treasury bills.

If the U.S. Treasury had just sold 5 trillion of these, they could’ve made an easy $90 million and Tim Geithner could’ve put the money under a Nervous Nellie mattress and we all would’ve been better off.

Negative yields on U.S. Treasury bills are really an extraordinary thing. You’ve got less on — less for your money from the U.S. Treasury than you got from sticking it under a mattress.

I’m not sure you’ll see that again in your lifetime. But it’s been a very extraordinary year.

4. Panel of journalists introduced

WARREN BUFFETT: We have with us, the journalists. We have Carol Loomis of Fortune. We have Becky Quick of CNBC. And we have Andrew Ross Sorkin of the New York Times.

They have received questions from shareholders all over the country. Andrew told me that he received a couple hundred just this morning.

And they have selected what they think are — they’re all Berkshire Hathaway-related questions.

We were having a problem in recent annual meetings where we sort of drifted away from Berkshire, into the realm of what people’s children had done in school recently and that sort of thing. (Laughter)

So we wanted to bring it back a little bit to Berkshire.

So they have selected among the best of the Berkshire-related questions that they’ve received. And we will go from — we will start with Carol Loomis. And we will go then to the audience.

We have 13 sections, 12 in this room, one in an overflow room. And we have selected the people in each of the audience sections by a raffle system, half an hour to an hour ago. And we’ll go back and forth. And with that, we’ll start it off with Carol.

5. Carol Loomis comments

CAROL LOOMIS: Good morning. I come first because Loomis outrakes — outranks — the others alphabetically. But this gives me a chance to just have a few sentences to tell you that — about the questions that we received.

We conferred this morning. Andrew definitely got more than any, either Becky or me. We got almost 5,000 questions, which I think even will surprise Warren. Because I don’t think he knew that it’d run that high.

And the main thing I wanted to say is that an awfully lot of them were very good. And we had a real problem trying to get them down to the number that we’re probably going to be able to ask. We don’t even know what that is for sure.

But we want to apologize to anybody who sent us a Berkshire-related question, because we did have to cut out some because they weren’t that, and whose question we didn’t get asked. And maybe in another year, it will work.

6. Our stock index derivatives aren’t dangerous

CAROL LOOMIS: So, my first question, “Warren and Charlie, Warren particularly.

“You have referred to derivatives, this is famous, as weapons — financial weapons — of mass destruction.

“In the 1964 movie, ‘Dr. Strangelove,’ Major T.J. Kong, nicknamed ‘King’ Kong and played by Slim Pickens, rides a weapon of mass destruction out of the bomb bay of his B-52.

“As a long-term Berkshire shareholder, I’m feeling a little like Slim today. I understand that despite the dramatic decline in the stock market, there is a good probability we could make money on our derivatives, taking into account the return on our premiums.

“But given the amount of accounting equity and statutory capital, and, I would argue, market value —” this is the questioner saying this — “that these derivatives have destroyed, at least temporarily, do you think these large derivative positions are appropriate for a highly-rated insurance company?

“And if so, you do you think you will be adding to these positions?”

WARREN BUFFETT: Yeah. I would say this. The questioner to some extent answers his own question.

I don’t know whether he anticipates as strongly as I do that, net, these positions will make money.

But over — you know, our job is to make money over time at Berkshire Hathaway. It does not impinge on capital. We have arranged them so that the collateral posting requirements, which are one of the big dangers in the derivatives field, that we have very, very minimal exposure to that.

Even on March 31st, at a time when the market was down very substantially from when we entered into these transactions, we had posted collateral of a little less than 1 percent of our total marketable securities.

So they have no — they pose no — they pose problems to the world, generally. And that’s why I referred to them on a macro basis, in the 2002 report, as being financial weapons of mass destruction.

But I also said in that report, that we use them in our own business regularly when we think they’re mispriced.

And we think our shareholders are intelligent enough that if we explain the transactions, as we try to do in the annual report, and explain why we think we will make money — there’s no guarantee we’ll make money, but our expectancy is that we will make money — we think that as long as we explain them, that the financial consequences to our shareholders far outweigh any accounting consequences.

We explained in earlier reports that because of mark-to-market, that these things can swing billions of dollars as an accounting liability.

But the only cash that has taken place, for example, in our equity put options, we have received $4.9 billion roughly. And we hold that money. Originally, the terms of these were 15 to 20 years. So we have the use of $4.9 billion for 15 to 20 years.

And then markets have to be lower at that time than they were at the time of inception. So I personally think that the odds are extremely good that on the equity put options, we will make money.

I think on the high-yield index, credit default swaps we’ve written, I think that we will probably lose money before figuring the value of the money we’ve held.

Now, I told you a year ago, I thought we would make money on those. But we have run into far more bankruptcies in the last year than is normal.

We’ve, in effect, had a financial hurricane. We insure against natural hurricanes. And we insure against a financial hurricane. And we have been in a bit of a financial hurricane.

So I would expect those contracts, before investment income, would show a loss, and perhaps, after investment income. The bigger contracts are the equity put contracts. And I think the odds are very high that we make money on those.

Now, it would be nice if we were writing with current prices. But we probably couldn’t write them without getting into collateral posting requirements now. So we have a very favorable position on those.

In fact, in the last week, we modified two equity put contracts, one that had a strike price of 1514. That has been reduced to 994 on the S&P 500. Now, we shortened it up eight years. But it still has about 10 years to run.

So merely for reducing the term from 18 years to about 10 years, we still have the use of the money for 10 years, we reduced the strike price from 1514 to 994.

So I think those are going to be very advantageous contracts. I think our shareholders are intelligent enough to, if they’re explained properly, to realize how advantageous they are. And we’ll continue to hold them. And we’ll continue to explain them.

And they have no impact on our financial flexibility. And we are far more than an insurance company. I mean, we have earnings coming in from many areas. We have lots of cash sitting at the parent company. We have lots of cash in the subsidiaries. We have no significant debt maturities of any kind.

So we’re ideally suited to hold this sort of instrument.

And Charlie, what would you say?

CHARLIE MUNGER: Well, I would agree with the questioner that there is some limit to the amount of those things we should do. But I think we stayed well short of the limit.

7. Financial literacy problem could help Berkshire

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

AUDIENCE MEMBER: Hi. My name’s Scott Slaybee (PH). I’m from Denver, Colorado.

First off, I’d like to thank Mr. Buffett and Mr. Munger for having us out here today. I appreciate you bringing us out here so thank you very much.

WARREN BUFFETT: And thank you.

AUDIENCE MEMBER: And it’s great that you answer our questions.

I’m a former teacher. Or I’m a teacher. I shouldn’t say former. Being a former teacher yourself, I see a problem with financial literacy with our future generations.

And I’m curious what you think future generations should know and if there’s anything that needs to be in school curriculums to teach younger people financial literacy as we move forward?

WARREN BUFFETT: Yeah. I think there’s a problem with financial literacy with our current generation. (Laughter)

There’s a — Andy Heyward, who has helped us with the cartoon, has a — will have a — he sold his company last year, but he has a new company.

And he will have a program coming out that works on that question. And that I play a very small part in.

ABC has a program coming up with a number of well-known personalities in it that will deal with the question of financial literacy.

And it’s, you know, it is a tough sell in a world of credit cards and, you know, a world that depends on calculators rather than people sitting down and doing actual arithmetic and all of that, to teach people. But in the end, I think we make progress over time. I mean, I hope our annual reports contribute to that sort of thing.

But you’re going to have people doing very foolish things with money.

I remember on my honeymoon. I was 21 and my wife was 19. And we drove west. I’d never been west. And we went through Las Vegas. And it was 1952. And we stopped at the Flamingo. And people were better dressed in the casinos then.

And there were a bunch of Omaha fellows that actually owned part of the Flamingo at that time, terribly nice to us.

But I looked around at that casino and I saw all kinds of well-dressed people who had traveled thousands of miles to do something very dumb. And I thought this is a country where you’re going to get very rich. (Laughter)

If people are going to get on a plane in New York and fly a couple thousand miles to stand there and do things with a mathematical expectation that’s negative on every action they take, that is a world of opportunity. So — (Laughter)

I, you know, I recommend that you and — you work with your students. I started teaching at the University of Omaha, you know, when I was 21. And you work with your students to make them literate. And they will have a terrific advantage.

Charlie?

CHARLIE MUNGER: Well, a world where legalized gambling is now conducted by a great many states in the form of lotteries where people are encouraged to bet against the odds and a world where we have a vast overuse of high-cost credit card debt, it needs a lot more financial litery. I would argue — literacy.

I think we’ve been going in the wrong direction. So I don’t think you can teach people high finance who can’t use a credit card — (laughter) — intelligently.

WARREN BUFFETT: Yeah. If you’re — I talk to students about that. If you’re willing to pay 18 or 21 percent on a credit card —

And the credit cards companies need it, incidentally, currently, because you have losses running close to 10 percent. So with expenses, they may need that.

But there’s no way that you’re going to financially come out borrowing money at those kind of rates. And I wouldn’t know how to do it. And it’s too bad. On the other hand, it’s probably good for our business.

I mean, one of — you know — we are looking for things that are mispriced. And the more people think that borrowing money on credit cards is intelligent, they probably will not think that doing long-term equity put contracts is intelligent. And we’ll go our way and they’ll go their way.

8. Buffett “commends” DC’s response to credit crisis

WARREN BUFFETT: Becky?

BECKY QUICK: Warren, first of all, we’ve been asked to pass on a message that the attendance today is 35,000.

WARREN BUFFETT: Good. (Applause) Now —

BECKY QUICK: This —

WARREN BUFFETT: Now if they all just spend appropriately, it’ll be a big day. (Laughter)

BECKY QUICK: This question comes from James Lewis (PH) from Logan, Ohio, who said it was OK to use his name and city.

He says, “One of the substantial investments of Berkshire is Wells Fargo. The chairman of Wells Fargo supposedly indicated that he did not want to take TARP funds from the federal government.

“He, furthermore, recently said that some of the programs of the federal government to reinvigorate the banks were asinine.

“Mr. Munger, do you agree with the chairman of Wells Fargo? And please explain why you do or do not agree. And Mr. Buffett, do you agree with Mr. Munger?” (Laughter)

WARREN BUFFETT: Yes. (Laughter)

CHARLIE MUNGER: When a government is reacting to the biggest financial crisis in 70 years, which threatens important values in the whole world, and the decisions are being made hurriedly and under pressure and with good faith, I think it’s unreasonable to expect perfect agreement with all of one’s own ideas.

I think the government is entitled to be judged more leniently when it’s doing the best it can under trouble.

Of course, there’s going to be some reactions that are foolish. And I happen to share one of the troubles of some of the Wells Fargo executives, in that I’m pretty blunt.

I happen to think that the accounting principle that says your earnings go up as your credit is destroyed — because if you had any money left, you could buy your own debt back at a discount — I happen to think that’s insane accounting.

And I think the people who voted it into effect ought to be removed from the accounting board. So a man who talks like that has to have some sympathy with the people at Wells Fargo.

WARREN BUFFETT: He usually gets to hang them by their thumbs, but he held back this morning.

The government, in mid-September last year, really did — they were facing a situation that was as close to a total meltdown throughout the financial system as I think you can imagine.

You had a couple hundred billion dollars move out of money market funds in a couple of days. You had the commercial paper market freeze up, which meant that companies all over the country that had nothing to do with the financial world, basically, were going to have trouble meeting payrolls.

We were — we really were looking into the abyss at that time. And a lot of action was taken very promptly. And overall, I commend the actions that were taken.

So as Charlie says, to expect perfection out of people that are working 20-hour days and are getting hit from all sides by new information, bad information, that one weekend with Lehman going, AIG going, Merrill would’ve gone, in my view, unless the BofA had bought it.

I mean it was — when you’re getting punched from all sides and you have to make policy and you have to think about congressional reaction and the American people’s reaction, you know, you’re not going to do everything perfectly.

But I think overall, they did a very, very good job.

I’m sympathetic — that remark was made by Dick Kovacevich, who came in second last year to Charlie in the plain speaking contest around the world. (Laughter)

And it’s true that Dick Kovacevich was called on a Sunday at a little after noon, as I understand it, and told would be in Washington the next day at 1- or 2 o’clock, without being told what it was about.

And there were 11 bankers there and some officials. And they were told that they were going to take TARP money. And they were going to take loans from the government and preferred stock. And that they only had an hour or two to sign it and they didn’t get to consult with boards.

But that’s the nature of an emergency. You know, it — I think you — well, you’re going to have some decisions that later can be looked back at and somebody will say, “I could’ve done it a little bit better.” But, by and large, the authorities, in my view, did a very good job.

And all banks aren’t alike by a long shot. And in our opinion, Wells Fargo is a — among the large banks particularly — it’s a fabulous bank and has some advantages that the other banks don’t have.

But in a time like that, you’re not dealing in nuances.

Incidentally, I would recommend to all of you, that you go to the internet and read Jamie Dimon’s letter to his shareholders. Jamie Dimon of JPMorgan Chase. It’s a fabulous letter. It talks about a point that Charlie made there.

But it — Jamie did a great job of writing about what caused this and what might be done in the future. It’s as good a shareholders letter that I’ve ever seen. So by all means, look it up. It’s long, but it’s worth reading.

9. Higher mathematics can be dangerous for investing

WARREN BUFFETT: OK, we’ll go to area 2.

AUDIENCE MEMBER: Yeah, thank you, Mr. Buffett and Mr. Munger. My name’s Rick Franklin (PH). I’m from St. Louis, Missouri. I’d like to follow up on the microphone 1′s question on financial literacy. And my own question from two years ago on your discount rate.

But before I do that, I hope you’ll indulge me. Torstol’s (PH) wife, Rosemary Coons (PH), if you could come to section 222. I found your husband. (Laughter)

You can come to microphone 2, if that’s easier.

WARREN BUFFETT: You get a little of everything here. (Laughter)

AUDIENCE MEMBER: So my question is, free cash flow: sell-side analysts like to do a 10-year discounted cash flow analysis with a terminal value.

Even some of the books written about your style — “The Warren Buffett Way”, “Buffettology” — imply that you go through that exercise.

But I know you’re famous for not using computers or calculators. I’m wondering if those type of exercises fall into the “too hard” file, and you just do a simple free cash flow — normalized free cash flow — over a discount rate?

And if you care to augment the answer with your numerical analysis of Coke, I’d appreciate that. (Laughter)

WARREN BUFFETT: Well, the answer is that investing — all investing is, is laying out cash now to get more cash back at a later date. Now, the question is how much do you get back, how sure are you of getting it, when do you get it? It goes back to Aesop’s fables. You know, “A bird in the hand is worth two in the bush.”

Now, that was said by Aesop in 600 B.C. He was a very smart man. He didn’t know it was 600 B.C. But I mean, he couldn’t know everything. (Laughter)

But the — but that’s what’s being taught in the finance — you got a Ph.D. now and you do it more complicated, and you don’t say, “A bird in the hand is worth two in the bush,” because you can’t really impress the laity with that sort of thing.

But the real question is, how many birds are in the bush? You know you’re laying out a bird today, the dollar. And then how many birds are in the bush? How sure are you they’re in the bush? How many birds are in other bushes? What’s the discount rate?

In other words, if interest rates are 20 percent, you got to get those two birds faster than if interest rates are 5 percent and so on.

That’s what we do. I mean, we are looking at putting out cash now to get back more cash later on.

You mentioned that I don’t use a computer or a calculator. If you need to use a computer or a calculator to make the calculation, you shouldn’t buy it.

I mean, it should be so obvious that you don’t have to carry it out to tenths of a percent or hundredths of the percent. It should scream at you.

So if you really need a calculator to figure out that it’s — the discount rate is 9.6 percent instead of 9.8 percent — forget about the whole exercise. Just go onto something that shouts at you. And essentially, we look at every business that way.

But you’re right, we do not make — we do not sit down with spreadsheets and do all that sort of thing. We just see something that obviously is better than anything else around, that we understand. And then we act.

And Charlie, do you want to add to that?

CHARLIE MUNGER: Well, I’d go further. I’d say some of the worst business decisions I’ve ever seen are those that are done with a lot of formal projections and discounts back.

Shell Oil Company did that when they bought the Belridge Oil Company. And they had all these engineers make all these elaborate figures.

And the trouble is you get to believe the figures. And it seems that the higher mathematics, with more false precision, should help you. But it doesn’t.

The effects, averaged out, are negative when you try and formalize it to the degree you’re talking about. They do that in business schools because, well, they got to do something. (Laughter and applause)

WARREN BUFFETT: There’s a lot of truth to that. I mean, if you stand up in front of a class and you say, “A bird in the hand is worth two in the bush,” you know, you’re not going to get tenure. (Laughter)

It’s very important if you’re in the priesthood to look, at least, like you know a whole more lot more than the people you��re preaching to.

And if you come down and just — if you’re a priest, and you just hand down the 10 Commandments and you say, “This is it,” and we’ll all go home, you know, it just isn’t the way to progress in the world.

So, the false precision that goes into saying that this is a two standard deviation event or this is a three standard deviation event, and therefore we can afford to take this much risk and all that, it’s totally crazy.

I mean, you saw it with Long-Term Capital Management in 1998. You’ve seen it time and time and time again.

And it only happens to people with high IQs. You know, those of you who are — have 120 IQs are all safe. (Laughter)

But if you have a very high IQ, and you’ve learned all this stuff, you know, you feel you have to use it. And the markets are not that way.

The markets of mid-September last year, when people who ran huge institutions were wondering how they were going to get funding the next week, you know, that doesn’t appear on a — you can’t calculate the standard deviation with — that that arises at.

It’s going to arise much more often than people think, in markets that are made by people that get scared and get greedy. And they don’t observe the laws of flipping coins, it’s — in terms of the distribution of results.

And it’s a terrible mistake to think that mathematics will take you a long place in investing. You have to understand certain aspects of mathematics. But you don’t have to understand higher mathematics.

And higher mathematics may actually be dangerous and it will lead you down pathways that are better left untrod.

10. Moody’s wasn’t alone in making mistakes

WARREN BUFFETT: OK. Andrew, one of those 200 questions from this morning? Or what are —

ANDREW ROSS SORKIN: This one’s not from this morning, but it relates to Moody’s. And we’ve probably received about 300 questions, at least, on this topic.

This question, which is representative of many, comes from Aaron Goldsmeizer (PH). And the question is the following:

“Given the role of rating agencies in the current economic crisis — their conflict of interest, their reliance on, quote, ‘flawed history-based models,’ as you described in this year’s letter to shareholders, and the likelihood that a loss of credibility and/or regulatory reforms could force drastic changes in their business models or earning streams — why do you retain such a large holding in Moody’s?

“And more important, why didn’t you use your stake to try to do something to prevent conflicts of interest and reliance on these flawed history-based models?”

WARREN BUFFETT: Yeah, I don’t think the conflict of interest question was the — was the biggest —by anywhere close to the major cause of the shortcomings of the rating agencies in foreseeing what would happen with CDOs and CNBSs and all sorts of instruments like that.

Basically, five years ago, virtually everybody in the country had this model in their mind, formal or otherwise, that house prices could not fall significantly.

They were wrong. Congress was wrong. Bankers were wrong. People that bought the instruments were wrong. Lenders — the borrowers were wrong.

But people thought that if they were going to buy a house next year, they better buy it this year because it was going to be selling for more money the following year.

And people who lent them money said it doesn’t make any difference if they’re lying on their application or they don’t have the income because houses go up, and if we have to foreclose we won’t lose that much money. And besides, they can probably refinance next year and pay.

So there was an almost total belief — and there was always a few people that disagreed — but there was almost a total belief throughout the country that house prices would certainly not fall significantly, and that they would probably keep rising.

And the people at the rating agencies, one way or another, built that into their system.

And I don’t — I really don’t I think it was primarily the payment system that created the problem. I think they just didn’t understand the various possibilities of what could happen in a market— or in a bubble, really — where people leveraged up enormously on the biggest asset that most Americans possess, their house.

And so you had a $20 trillion asset class in a $50 trillion of total assets of American families that got leveraged up very high. And then once it started melting down, it had self-reinforcing aspects on the downside.

So I say that they made a major mistake in terms of analyzing the instruments. But they made a mistake that a great, great, great many people made.

And that probably if they had taken a different view of residential mortgages four or five years ago, they would’ve been answering to Congressional committees that would be saying, “How can you be so un-American as to deny all these people the right to buy houses simply because you won’t rate these securities higher?”

So I — they made a huge mistake. But the American people made a huge mistake. Congress made a huge mistake.

Congress presided over the two largest mortgage companies. And they were their creatures. And they were supervised by them. And, you know, they’re both in conservatorship now.

So I don’t think they were unique in their inability to spot what was coming.

In terms of us influencing their behavior, I don’t think I’ve ever made a call to Moody’s.

But it’s also true that I haven’t made it to, or made — maybe made one or two — to other companies in which we’re involved.

I mean, we don’t tell, you know, the Burlington Northern what safety procedures to put in.

We don’t tell American Express who to cut off on credit cards and, you know, what they’re — who they should lend to and who they shouldn’t.

We are — when we own stock, we are not there to try and change people.

Our luck in changing them is very low, anyway. In fact, Charlie and I have been on boards of directors where we’re the largest shareholders. And we’ve had very little luck in changing behavior.

So, we think that if you buy stock in a company, you know, you better not count on the fact that you’re going to change their course of action.

And in terms of selling the stock, the odds are that the rating agency business is probably still a good business. It is subject to attack. And who knows where that leads? And who knows what Congress does about it?

But it’s a business with very few people in it. It’s a business that affects a large segment of the economy. I mean, the capital markets are huge. I think there will probably be rating agencies in the future. And I think that it’s a business that doesn’t require capital. So it has the fundamentals of a pretty good business.

It won’t be doing the volume in the next — probably for a long time in certain areas of the capital markets. But capital markets are going to grow over time.

We have said in this meeting in the past, many times, that Charlie and I don’t pay any attention to ratings. I mean, we don’t believe in outsourcing investment decisions.

So we — if we buy a bond, the rating is immaterial to us, except to the extent if we think it’s rated more poorly than it should, it may help us buy it at an attractive price.

But we do not think that the people at Moody’s, or Standard and Poor’s, or Fitch, or anyplace else, should be telling us the credit rating of a company. We figure that out for ourselves. And sometimes we disagree with the market in a major way. And we’ve made some money that way.

Charlie?

CHARLIE MUNGER: Yeah, I think the rating agencies, being good at doing mathematical calculations, eagerly sought stupid assumptions that enabled them to do clever mathematics. It’s an example of being too smart for your own good.

There’s an old saying, “To a man with hammer, every problem looks pretty much like a nail.” And that’s — (laughter) — what happened in the rating agencies.

WARREN BUFFETT: Yeah, the interesting things about all those triple-As, is the people that created them ended up owning a lot of them. So they believed their own baloney, themselves. Every — the belief was enormous.

So you had these people stirring up the Kool-Aid and then they drank it themselves. And they — (laughter) — you know, they paid a big penalty for it. But I don’t think it was — I think it was stupidity and the fact that everybody else was doing it.

I send out a letter to our managers, only every couple of years. But the one reason you can’t give at Berkshire, as far as I’m concerned, for any action, is that everybody else is doing it.

You know, and just — if that’s the best you can come with, you know, something’s wrong. But that happens in security markets all the time.

And of course, it’s — when Charlie and I were at Salomon or someplace like that, it’s very difficult to tell a huge organization that you shouldn’t be doing something that people, well-regarded competitors, are doing. And particularly when there’s a lot of money in it.

And so it’s very hard to stop these things once you get sort of a industry acceptance of behavior. And you know, we were very unsuccessful, Charlie and I, at Salomon at saying, “Well, we just don’t want to do this sort of thing.”

We couldn’t even get them — initially, when we got in there at first, they were doing business with Marc Rich. And we said, “Let’s stop doing business with Marc Rich.”

You know, that’s like saying in the ’30s, “Let’s stop doing business with Al Capone,” or something. And they said, “But it’s good business. If he doesn’t do it with us, he’ll do it with somebody else.” And they felt that way. And I think we won that one. But it wasn’t easy.

You remember that, Charlie?

CHARLIE MUNGER: I certainly do.

11. Housing markets are beginning to improve

WARREN BUFFETT: OK, we’ll go to area 3. (Laughter)

OK, zone 3, are we on?

AUDIENCE MEMBER: I’m Laurie Gould (PH) from Berkeley, California.

Where do you see the residential real estate market headed nationally, particularly in California, over the next year or two?

WARREN BUFFETT: Well, we don’t know what real estate is going to do. We didn’t know what it was going to do a few years ago. We thought it was getting kind of dangerous in certain ways. But it’s very hard to tell.

I would say this. From what we’re — from what I’m seeing, and I do see a lot of data — there’s — and California, incidentally, is a very big — I mean, there are many markets within California. Stockton is going to be different than San Francisco and so on.

But, in the last few months, you’ve seen a real pickup in activity, although at much lower prices. But you’ve seen — I think you’ve seen something in the medium- to lower-priced houses. And medium means a different thing in California than it does in Nebraska.

But you’ve seen, in maybe $750,000 and under houses, you’ve seen a real pickup in activity, many more bidders. You haven’t seen it bounce back in price. Prices are down significantly and it varies by the area.

But it looks as if — you know, you had a foreclosure moratorium for a while. And so get into distortions because of that.

But what it looks like, looking at our real estate brokerage data — and we have the largest real estate brokerage firm in Southern California, in Orange County, Los Angeles County, and San Diego in Prudential of California that’s owned by MidAmerican — we see something close, I would say, to stability at these much-reduced prices in the medium to lower group.

If you’ve got a $5 million or $3 million house, that still looks like a very — erratic — it’s a market in which there still isn’t a lot of activity.

But in the lower levels, there’s plenty of activity now. Houses are moving. Interest rates, of course, are down so it’s much easier to make the payments.

The mortgages being put on the books every day in California, are much better than, you know, the mix that you had a few years earlier.

So it’s improving. And I don’t know what it’ll do next month or three months from now.

The housing situation is pretty much this way. You can look at it this way.

We create about 1,300,000 or so households a year. It bounces around some. But — and it tends to — in a recession, it tends to be fewer because people postpone matrimony and so on to some extent.

But if there’s 1,300,000 households created in a year and you create two million housing starts annually, you are going to run into trouble. And that’s what we did. We just created more houses than the demand was — the fundamental demand — was going to absorb.

So we created an excess of houses. How much excess is there now? Perhaps a million and a half units. We were building two million units a year. That’s down to 500,000 units a year.

Now, if you create 500,000 units a year and you have a 1,300,000 households created, you are going to absorb the excess supply.

It will be very uneven around the country. South Florida’s going to be tough for a long, long time. So it isn’t like you can move a house from one place to another if there’s demand in one place and not another.

But we are eating up an excess inventory now. And we’re probably eating it up at the rate of 7- or 800,000 units a year. And if we have a million and a half excess, that takes a couple of years. There’s no getting away from it.

You have three choices. You could blow up a million and a half houses, you know. And if they do that, I hope they blow up yours and not mine, but that’s a — (Laughter)

We could get rid of it. We could try to create more households. We could have 14-year-olds start getting married and having kids, and — (Laughter)

Or we can produce less than the natural demand increase. And that’s what we’re doing now.

And we’re going to eat up the inventory. And you can’t do it in a day. And you can’t do it in a week. But it will get done.

And when it gets done, then you’ll have a stabilization in pricings. And then you will create the demand for more housing starts. And then you go back up to a million and a quarter, and then our insulation business and our carpet business and our brick business will all get better.

Exactly when that happens nobody knows. But it will happen.

Charlie?

CHARLIE MUNGER: Oh, I think in a place like Omaha, which never had a really crazy boom in terms of housing prices, with interest rates so low if you’ve got good credit, that if I were a young person wanting a house in Omaha, I would buy it tomorrow. (Applause)

WARREN BUFFETT: We own the largest real estate brokerage firm in Omaha. So — (laughter) — Charlie will be — if he qualifies, we will give him a mortgage application.

If is true that 4 1/2 million houses will change hands. There’s about 80 million houses in the country. Twenty-five million of those do not have a mortgage. About a third of the houses in the country do not have a mortgage. You’ve got about 55 million, or a little less, that have a mortgage. And five or six million of those are in trouble one way or another.

But we’re selling 4 1/2 million houses every day. And by and large, they’re going into stronger hands. The mortgages are more affordable. The down payments are higher. We’re — the situation is getting corrected.

But it wasn’t created in a day or a week or a month. And it’s not going to get solved in a day or a week or a month. We are on the road to solution.

12. 2008 wasn’t great for investment manager candidates

WARREN BUFFETT: OK, Carol?

CAROL LOOMIS: Perhaps I should have said one other thing at the beginning. Those of you who read the annual report carefully know that Charlie and Warren were to be given no clue as to what any of the three of us were going to ask. So don’t think that they have gotten a little list. They have seen nothing.

This question, I got many versions of this question. This one happened to come from Jonathan Grant of New York City. It concerns the four investment managers you have said are in the wings as possible successors to you.

“Can you please tell us, without naming names, but preferably in both quantitative and qualitative terms, how each of the four did in 2008 with the money they are managing — they were managing — for their clients.

“You said you hoped to pick people who would be able to anticipate things that had never occurred before. While the world has seen credit crises before, there were a lot of things that happened in 2008, especially in the last few months of the year, that few were predicting and that you, yourself, have described as almost unprecedented.

“How would you rate the way that these managers — these four managers — did in managing against these low-probability risks? Are all four still on the list?

WARREN BUFFETT: Well, the answer is all four are still on the list. Let me just make one point first, though, because it got misreported a little bit.

We have three candidates for the CEO position. And this is always a major subject of discussion at our director’s meetings. All of them are internal candidates. You should know that.

That’s been said before. But it got misreported here once or twice. And it got confused, I think, because of the four possibilities for the investment job. And you could have all four come to work for us in that case.

We won’t have three CEOs or two CEOs. But we might have multiple investment managers after I’m not around. Or we might just have one. That would be up to the board at that time.

They are both inside and outside the organization. And we don’t preclude anything in terms of where they come from. So we could have a whole big list from outside the organization.

That will not be true about the CEO position. The person that follows me will come from within Berkshire Hathaway.

The four, I don’t have precise figures from them, although I’ve got a fair amount of information on some of them. I would say they did no better than match the S&P last year, which was minus 37 after adding back dividends.

So I would say that in terms of 2008, by itself, you would not say that they covered themselves with glory. But I didn’t cover myself with glory, either. So I’m very tolerant of that in 2008. (Laughter) They —

Charlie, you know some of the records pretty well. Wouldn’t you say that’s true?

CHARLIE MUNGER: Yeah. What’s interesting to me is that practically every investment manager that I know of in America, and regard as intelligent and disciplined and with a unusual record of past success, they all got creamed last year. (Scattered laughter)

WARREN BUFFETT: The group — I don’t hear a lot of laughter about that. (Laughter)

I think you’re hitting a nerve out there, Charlie.

The four have a better-than-average record over time. If you’d asked me at the start of the year, if you’d said, “There’s going to be a minus 37 percent year, will this group do better than average?” I would’ve said yes.

But I think I would’ve been wrong. And like I said, I haven’t got audit returns from every one of them. But I would say I would be wrong.

I would say that their record over 10 years has been, in each case, has been anywhere from modestly to significantly better than average. And I’d be willing to be that would be the case over the next 10 years.

But certainly, last year, you know, there were a lot of things that didn’t work. And our group was not exempt from them.

I have not changed the list. That doesn’t mean that we’re always looking with the idea of finding more people to add to it.

And as opposed to the CEO job, you know, if I dropped dead tonight, the board needs to put somebody in as a CEO tomorrow morning. And they will do so. And they know who it is. And they feel very good about it.

Not too good, I hope, but — (Laughter)

But on the investment officers — one or more, and it could easily be more — they don’t need to do something the next day or the next week.

I mean, the portfolio isn’t — everything doesn’t stop because of that. So that can be a somewhat more leisurely decision they’ll have. And it will be made, in an important way, in consultation and agreement with the new CEO.

So that is something that you shouldn’t expect the next day to hear an announcement on the investment managers. But you should expect to hear, you know, within a month or something like that.

CHARLIE MUNGER: I don’t think we would want a manager who thought he could just go to cash based on macroeconomic notions and then hop back in when it was no longer advantageous to be in cash. Since we can’t do that ourselves —

WARREN BUFFETT: Yeah, we think it’s impossible if we can’t do it ourselves.

CHARLIE MUNGER: Yeah, right. (Laughs)

So we’re not looking for a type who went to cash totally.

WARREN BUFFETT: Yeah, that would — in fact, we would leave out anybody that did that.

CHARLIE MUNGER: Yeah, we would exclude them.

WARREN BUFFETT: Yeah. That —

CHARLIE MUNGER: They’re not dumb enough for us. (Laughter)

13. Munger expects public/private hybrid health care system

WARREN BUFFETT: OK, let’s go to zone 4.

AUDIENCE MEMBER: Hi, Mr. Buffett, Mr. Munger. My name is Vern Cushenbery. I’m from Overland Park, Kansas.

I wonder if you might share your thoughts on the likelihood of a nationalized health care system, what that might look like and the effects on your portfolio?

WARREN BUFFETT: Well, I’m going to let Charlie answer that one since I don’t know how to. (Laughs)

CHARLIE MUNGER: Personally, I think something more like Europe will come to the United States in due course. And I think it’ll be supplemented by a private system, which is the equivalent of private school competition for public education.

And, although I’m a Republican, I’m not horrified by that probable development. Personally, I wish they’d put it off for a year while we solve the economic problems. (Applause)

WARREN BUFFETT: And I would say that in terms of its impact on Berkshire, you know, we have a broad cross section of companies — we have 246,000 people working for us — that we will adjust, like American business generally will adjust, to any developments along that line.

It won’t pose special problems for us. It won’t offer us special opportunities. We’ll see what the national sentiment is, as expressed through Congress. And we’ll behave accordingly.

14. Why we’re not training or naming our next CEO

WARREN BUFFETT: Becky?

BECKY QUICK: This is a question that follows up on the succession question. This one is a, in particularly, though, addressed to the three candidates for CEO. It comes from Irving Fenster who writes:

“Running Berkshire is very complex and complicated. Give us some insight for your reluctance to bring in your replacement to give him the benefit of your training, instead of his having to tackle the myriad of problems of the transition on his own.

“The benefits for Berkshire, your replacement, and you, are so compelling your reluctance is puzzling. Having him on board may relieve some of the stress on you and help add many, many more years of good health for you.”

WARREN BUFFETT: Irving is a friend of mine in Oklahoma. Went in in my partnership 40 years ago, Irving and Irene. And he’s been writing me on this for 30 or 40 years. And he’s had — (laughter) — he’s had no luck with me. So he decided to write Becky, apparently. (Laughter)

If we had a good way to inject somebody into some role that was — would make them a better CEO of Berkshire, we would try it.

But the truth is that the candidates we have are running businesses. They’re making capital allocation decisions. They’re doing things every day of an operating nature. And these are major businesses.

And to sit around headquarters while I’m sitting in there reading and on the phone and, you know, who knows what else, they — it — there just is — there wouldn’t be anything to do.

I mean, we could meet every hour. You know, I could say, “Here’s what I’m thinking about now. What do you think about this?” and — (Laughter)

It’d be a waste of talent. It’d be ridiculous.

And Irving has this notion that somehow, that they would be absorbing all these things that I’m doing. I just throw The Wall Street Journal to him after I’m done reading it, and I’d throw him The New York Times and I’d throw him the FT. (Laughs)

And these are people that know how to run big businesses. They run businesses that make many, many, many millions, or even billions, of dollars.

So, they are ready for the job right now. I wouldn’t be happy unless we have — they are 100 percent ready. They know how to allocate capital.

The biggest job they’ll have is the fact that they will have to develop relationships with potential sellers of businesses, with the world, generally, with you, the shareholders, with other managers. That takes some time, not an extraordinary time.

But that — you know, they will have to become acquainted with people. But — different constituencies. But that — there’s, you know, that is nothing that really needs to be hastened along. It’s nothing terribly important.

I mean, they know how to run businesses. And they would do many things much better than I would. The biggest — probably the biggest challenge, because we have all of those talented managers that you saw during the movie.

And those people have different styles. And they have different needs to some degree. They have different ways of operating. They’re all successes.

But you know, some of them bat left-handed. Some of them bat right-handed. Some of them stand deep in the box. You know, some of them crowd the plate. I mean, they all have a little bit of variation. But they all hit terrifically.

And for the CEO of Berkshire, it does require some knowledge of the individual personalities. And which ones like to run by themselves totally and which ones like to check in occasionally and all that.

But that is no reason to take a talent that’s now running a business very successfully and building value and to have them sit in an office next to me and have us chew over the day’s events.

I mean, Charlie and I worked together now for decades. And I’ve learned a lot from Charlie. But I haven’t done it by, you know, having him sit next door and have hourly meetings or anything of the sort.

What do you think, Charlie?

CHARLIE MUNGER: Well, I think, averaged out, you’re more likely to be qualified to be a CEO by running a subsidiary with an enormous amount of discretion than you are to being around headquarters watching somebody else do it his way.

A lot of the models that have worked well in the world, like Johnson & Johnson, are quite Berkshire-like, in that they’re decentralized and they let these people pop up from the subsidiaries. They don’t try and just create CEOs in a hothouse in headquarters.

WARREN BUFFETT: We have an unusual situation at Berkshire that most of the people at the top, virtually all of them, are doing what they want to do. I mean, they like running their businesses.

That’s what they came in expecting to do. And that’s what they’re doing, and we’re letting them do it the way they like to do it.

And so we don’t have 50 people that all think they’re on some pyramid to get to the top. And Irving would like me to name — he’s talked to me about it. He would like to me name who it would be. But that could change in the future. It could create some possible —

Well, we saw it at General Electric, I mean, when Jeff Immelt got appointed from among three, the other two left. And I don’t really see any advantage in having some crowned prince around. But Irving will keep writing me, I can promise you that. (Laughter)

15. Buffett’s business school: only two courses

WARREN BUFFETT: OK, zone 5.

AUDIENCE MEMBER: Hi, Warren. That’s a little loud, sorry. Hi. My name’s Sarah. And I’m from Omaha, Nebraska.

I’d like to know if you could explain your strategies, namely value investing, in regards to cultivating the next generation of investors. How will you teach this young group?

WARREN BUFFETT: Well, I had 49 — mostly universities, a few colleges — that came to Omaha this year. We do them in clumps of six. And then the last one, we had an added university. So we had eight sessions, full-day sessions.

And they asked me what — sometimes they asked me what I’d do if I was running a business school, teaching investments.

And I’d tell them I’d only have two courses. One would be how to value a business, and the second would be how to think about markets.

And there wouldn’t be anything about modern portfolio theory or beta or efficient markets or anything like that. We’d get rid of that in the first 10 minutes. The —

But if you know how to value a business — and you don’t have to know how to value all businesses. On the New York Stock Exchange, I don’t know, there’s 4- or 5,000, probably, businesses and a whole lot more on NASDAQ.

You don’t have to be right on 4,000 or 5,000. You don’t have to be right on 400. You don’t have to be right on 40.

You just have to stay within the circle of competence, the things that you can understand. And look for things that are selling for less than they’re worth, of the ones you can value.

And you can start out with a fairly small circle of competence and learn more about businesses as you go along.

But you’ll learn that there are a whole bunch of them that simply don’t lend themselves to valuations and you forget about those.

And I think if — accounting helps you in that, you need to understand accounting to know the language of business, but accounting also has enormous limitations. And you have to learn enough to know what accounting is meaningful and when you have to ignore certain aspects of accounting.

You have to understand when competitive advantages are durable and when they’re fleeting.

I mean, you have to learn the difference between a hula hoop company, you know, and Coca-Cola. But that isn’t too hard to do.

And then you have to know how to think about market fluctuations and really learn that the market is there to serve you rather than to instruct you.

And to a great extent, that is not a matter of IQ. If you have — if you’re in the investment business and you have a IQ of 150, sell 30 points to somebody else, ’cause you don’t need it.

I mean, it — (laughter) — you need to be reasonably intelligent. But you do not need to be a genius, you know. At all. In fact, it can hurt.

But you do have to have an emotional stability. You have to have sort of an inner peace about your decisions. Because it is a game where you get subjected to minute-by-minute stimuli, where people are offering opinions all the time.

You have to be able to think for yourself. And, I don’t know whether — I don’t know how much of that’s innate and how much can be taught.

But if you have that quality, you’ll do very well in investing if you spend some time at it. Learn something about valuing businesses.

It’s not a complicated game. As I say — said many times — it’s simple, but not easy.

It is not a complicated game. You don’t have to understand higher math. You don’t — you know, you don’t have to understand law. There’s all kinds of things that you don’t have to be good at. There’s all kinds of jobs in this world that are much tougher.

But you do have to have sort of an emotional stability that will take you through almost anything. And then you’ll make good investment decisions over time.

Charlie?

CHARLIE MUNGER: Yeah, you do have the basic problem that exactly half of the future investors of the world are going to be in the bottom 50 percent.

In other words — (laughter) — you’re always going to have more skill at the top than you have at the bottom. And you’re never going to be able to homogenize the investment expertise of the world.

There is so much that’s false and nutty in modern investment practice, and in modern investment banking, and in modern academia in the business schools, even in the Economics departments, that if you just reduce the nonsense, that’s all I think you should reasonably hope for.

WARREN BUFFETT: Beyond a certain basic level, though, of skill, wouldn’t you say your emotional make-up’s more important than the — than some super high degree of skill?

CHARLIE MUNGER: Absolutely. And if you think your talent — if you think your IQ is 160 and it’s 150, you’re a disaster. (Laughter)

You know, much better a guy with a 130 that’s operating well within himself.

WARREN BUFFETT: I get to see the students that come by. I loved a fellow from the University of Chicago, one of the students. And the first question that was asked of me was, “What are we learning that’s most wrong?” That’s the kind of — I mean, I wish they’d ask that sort of thing of the panel here.

CHARLIE MUNGER: How do you handle that in one session?

WARREN BUFFETT: Yeah. (Laughter)

But it was holy writ 25 years ago, efficient market theory. You know, I never understood how you could even teach it.

I mean, if you walked in in the first five minutes, you said to the students, “Everything is priced properly,” I mean, how do you kill the rest of the hour?

But — (Laughter) — they did it. And they got Ph.D.s for doing it well. You know, and the more Greek symbols they could work into their, you know, their writings, you know, the more they were revered.

It’s astounding to me and I — that may have even given me a jaundiced view of academia generally — is the degree to which ideas that are nutty take hold and get propagated.

And then I read a quote the other day that may have partially explained it. Max Planck was talking, the famous physicist.

Max Planck was talking about the resistance of the human mind, even the bright human mind, to new ideas. And particularly the ones that had been developed carefully over many years, and were blessed by others of stature, and so on.

And he said, “Science advances one funeral at a time.” And I think there’s a lot of truth to that. Certainly been true in the world of finance.

16. Ajit Jain’s successor won’t have the same broad authority

WARREN BUFFETT: OK, Andrew?

ANDREW ROSS SORKIN: OK. We have a succession question. However, this one has a twist, coming from Ben Knoll.

“You famously said, quote, ‘You should invest in businesses that a fool can run, because someday a fool will.’ (Laughter)

“Given your reinsurance company’s capacity and inclination for big financial bets, can you provide us more reassurance about the risk once Ajit is gone?

“Do you have a succession plan for him?”

Ben says, “The Titanic-like ending at AIG, once Greenberg was gone, has me spooked.”

WARREN BUFFETT: Yeah, I would say that it would be impossible to replace Ajit. And we wouldn’t try. And, therefore, we wouldn’t give the latitude, in terms of size of risk or that sort of thing, that we give to Ajit.

No, we’ve got a unique talent, in my view there, and I think in Charlie’s. And so, when you get somebody like that, you give enormous authority to them after you firmly establish in your mind that that’s who you’re dealing with.

But that doesn’t mean that the authority goes with the position. The authority goes with the individual. And we would not — giving your pen away in insurance, as they say, is extraordinary dangerous.

And we have in this town, we have Mutual of Omaha, which in the 1980s, had been built up carefully over, probably, 75 years by that time, and become the largest health and accident association in the world, I believe.

And they got the idea that they should be writing property-casualty reinsurance. So they gave a pen to somebody within the place. And probably nobody had even heard the guy’s name, you know.

And in just signing a few contracts, they lost half their net worth in a very short period of time. And they were worried that they might have lost more than that.

So you can do enormous damage in the insurance business with a pen. And you’d better — have to be very careful about who you give your pen to. And we’ve given our pen to Ajit in a way that we wouldn’t give it to anyone else.

Now, it just so happens that I enjoy hearing about the kind of things he does. So we talk daily. But we don’t talk daily because he needs my approval on anything. We talk daily because I find it very interesting.

When he says, “How much should we charge to insure Mike Tyson’s life for a couple of years?” I mean, that’s the kind of thing I can get kind of interested in. I — (Laughter)

I asked him whether there was an exclusion in case he got shot by a woman that felt unhappy about her treatment or something, but —

And it makes a difference in the price, but —

I enjoy that sort of thing. But I’m not needed. And Ajit is needed. And we won’t find a substitute for him. And you know, there’s some things that have to be faced that way.

Charlie?

CHARLIE MUNGER: Yeah. What that quotation indicates is sometimes, stated differently, you say if it won’t stand a little mismanagement it’s not much of a business. Of course, you prefer a business that will prosper pretty well, even if it’s not managed very well.

But that doesn’t mean you don’t like even better when you get such a business that’s managed magnificently. And both factors are quite important.

We’re not looking for mismanagement. We like the capacity to stand it, if we stumble into it. But we’re not looking for it.

WARREN BUFFETT: Yeah, we will not do things that we think are — we will not assign tasks to people that we think are beyond their capabilities. And it just so happens that Ajit has enormous capabilities.

So he gets assigned some very unusual things. But you don’t see that prevailing throughout our insurance operation. And our managers don’t expect to operate that way.

That’s a one-off situation with Ajit. And he’s in good health. And, you know, we send him all the Cherry Coke or fudge that he wants. (Laughter)

17. Berkshire was “cheaper” at the end of 2008

WARREN BUFFETT: OK, area 6. I recommend this fudge, incidentally. It’s terrific. I’m having a good time. (Laughter)

AUDIENCE MEMBER: Good morning. I’m Steve Fulton (PH) from Louisville, Kentucky. I gave up box tickets to the Kentucky Derby this afternoon to come out and ask you this question. Thank you for this opportunity.

My question relates to how you view, or what your view is of the market’s valuation of Berkshire’s shares.

You commonly comment that Berkshire has two primary components of value: the investments that they own — the stocks, the bonds, and similar — and the earnings from the non-insurance operating companies that you’ve got.

And when you compare 2007 to 2008, the investments were down about 13 percent. And the earnings were down about 4 percent. But the value that the market was placing on the shares was down about 31 percent. And I was curious as to your comments on that valuation.

WARREN BUFFETT: Yeah, well, I think you put your finger on something.

We do think that the — we think, obviously, the investments are worth what they’re carried for, or we wouldn’t own them.

In fact, we think they’re worth more money than they’re carried for at any given time because we think, on balance, they’re underpriced. So we have no problem with that number.

We define our earning power — we leave out insurance underwriting profit or loss, on the theory that insurance is — if it breaks even — will give us float, which we will invest. And on balance, I actually think that insurance probably will produce some underwriting profit. So I think we even understate it a little bit in that respect.

But we think the earning power of those businesses was not as good last year as normal. It won’t be as good this year as normal.

But we think those are pretty good businesses overall. A few of them have got problems. And — but most of them will do well. And I think a few of them will do sensationally.

So, I think it’s perfectly reasonable to look at Berkshire as the sum of two parts. A lot of liquid marketable securities — or maybe not so liquid, but at least fairly priced, or maybe even undervalued, securities — and a lot of earning power, which we are going to try and increase over time.

And if you look at it that way, you would come to the conclusion that Berkshire was cheaper in relation to its intrinsic value at the end of 2008 than it was at the end of 2007. But you would also come to the conclusion that was true of most securities. In other words, the whole level of securities.

And every stock is affected by what every other stock sells for. I mean, if the value of ABC stock goes down, XYZ, absent any other variables, but XYZ is worth less.

If you can buy stocks at eight times earnings, good companies, you know, or nine times earnings, you know, they — it reduces the value of Berkshire, as opposed to when stocks were selling, well, at 18 or 20 times earnings. I’m pulling those numbers out of the air.

But everything is affected by everything else in the financial world.

When you say a bird in the hand is worth two in the bush, you’re comparing it — you’ve got to compare that to every other bush that’s available.

So, you’re correct that Berkshire was cheaper in relation to intrinsic value at the end of 2008, than 2007, at least in my opinion.

And that that those two variables will count. We’ll report them to you regularly. And over time, we would hope that both increase.

And we particularly hope the operating earnings aspect increases, because that’s our major focus. We would like to move money into good operating businesses over time and build that number a lot.

Charlie?

CHARLIE MUNGER: Well, I would argue that last year was a bad year for a float business. It was naturally going to make the owner of the float appear, briefly, to be at a disadvantage.

But long-term, having a large float, which you’re getting at a cost of less than zero, is going to be a big advantage. And I wouldn’t get too excited about the fact that the stock goes down.

I happen to know that there was one buyer there who rather inartistically bought about 10,000 shares when Berkshire was driven to its absolute peak. And how much significance does that have in the big scheme of things over the long term?

What matters are things like this: our casualty insurance business is probably the best big casualty business in the world — our utility subsidiary, well, if there’s a better one, I don’t know it — and if I had to bet on one carbide cutting tool business in the world, I’d bet on ISCAR against any other comer.

And I could go down the list a long way. I think those things are going to matter greatly over the long term. And if you think that it’s easy to get in that kind of a position, the kind of position that Berkshire occupies, you are living in a different world from the one I inhabit. (Applause)

WARREN BUFFETT: Yeah, our insurance business now, it is a remarkable business. And it’s got some remarkable managers.

18. How GEICO benefited from the financial crisis

WARREN BUFFETT: There’s one interesting thing that’s happened. In September, when we had a financial meltdown and, really, almost the ultimate — it was almost the China Syndrome-type thing — Americans started behaving differently.

Probably people around the world, but I certainly know in terms of our businesses, it was like a bell had been rung. And one manifestation of it was kind of interesting.

Whereas it hurt very much our jewelry business, our carpet business, it hurt NetJets, it hurt all the businesses. Hurt American Express, for example. You know, the average ticket went down almost 10 percent.

I mean, it just was like that, that people’s behavior changed. But one of the things it did, was it also caused the phones to start ringing even more at GEICO.

And we didn’t change our advertising, particularly. Our price advantage, relative to other companies, didn’t change that much. But all of a sudden, just — it was remarkable. Thousands and thousands and thousands of more people came to our website or phoned us every week.

So, it — all of a sudden, saving $100 or $150 or whatever it might be, became important. Not only the people who were watching our ads that day, but just with the people that it was lurking in the back of their minds. They went to geico.com.

So in the first four months of this year — last year, we added about 665,000 policy holders. That’s a lot of people. It made us, by far, the fastest growing auto insurer among the big companies.

First four months of this year, we’ve added 505,000 in four months. It’s the behavioral changes. And that franchise, that competitive advantage, has been built up over decades.

And Tony Nicely has nurtured it like nobody else could, just day after day, office after office, associate after associate. But then it just pays off huge when the time comes.

Because we can — we are the low-cost producer among big auto insurance companies. That means we can offer the best value. And now people are value conscious.

So these things are going on all the time with our subsidiaries, with those managers. And it’s — it builds a lot of value over time.

I mean, every GEICO policy holder is a real asset to the company. I could give you an estimated value. But I don’t think it’d necessarily be smart. But they’re worth real money.

And, we are now the third largest auto insurer in the country. I think we’ll end up the year maybe at 8 1/2 percent of the market.

And it was 2 and a small fraction percent back in 1993 when Tony took charge of the business. And the fundamentals are in place — (applause) — to take us much higher.

19. 2008 was tough, but still no plans for dividend

WARREN BUFFETT: Carol?

CHARLIE MUNGER: (Quietly) Can you reach that peanut brittle?

CAROL LOOMIS: I promise you, this question did not come from Susan Lucci. However, it does concern dividend policy. It came from Peter Sargent of Yardley, Pennsylvania.

And to ask that, he quotes from principle number 9 of the “Owner’s Manual.” And Warren wrote there, quote:

“We feel noble intentions should be checked periodically against results. We test the wisdom of retaining earnings by assessing whether retention over time delivers shareholders at least $1 of market value for each $1 retained. To date, this test has been met.” Now, this was written some time ago.

“We will continue to apply it on a 5-year rolling basis. As our net worth grows, it more difficult to use retained earnings wisely.”

So I’m now quoting the questioner here:

“The recent annual report made me think about the performance of both the company and the stock price. Berkshire seems to have done quite well in the past few years. But the stock price seems to have not quite kept pace.

“So I looked at the last five years of earnings per share. They’re on page 26 of the annual report. And they add up, in total, to $29,207.

“As you probably know, the closing price of Berkshire on December 31st, 2008 was 84,250. If you add the 29,207 per share of retained earnings to this, you come up with a, quote, ‘minimum market value of 113,457.’

“Since Berkshire closed on 12/31/2008 at 96,600” — oh, wait, I have read something wrong here.

“The closing price of Berkshire on 12/31/2003 was 84,250.

“And since Berkshire closed on 12/31/2008 at 96,600, and it’s been lower than that since, and is now around that now, it would seem that the market value has not increased for each $1 retained.

“Assuming my analysis is correct, it raises the question of whether or not Berkshire will pay a dividend in the coming year or not.”

WARREN BUFFETT: Well, we’ll now have a short quiz on that program — (laughter) — on the question.

The earnings, incidentally, of the 5-year period would include gains from things that were listed in unrealized appreciation at the end of the period.

In other words, some of those were actually built into the asset value at the time, but then become realized.

But the truth is if you take all of the money we earned in the five years, and the stocks, bonds, businesses purchased, and you sold them for cash on December 31st, 2008, we would not have — we would’ve had a loss on that, I mean, under the conditions that existed on December 31st, 2008.

I think that’s probably true of almost all capital programs that were (inaudible) — if you really measured it by what you could’ve sold, the businesses we bought — we love those businesses.

But there was no market to speak of for many businesses at that time. And security values were down significantly.

So I would say that he’s absolutely right, that measured on the value on December 31st, 2008, that the reinvested earnings had not produced a dollar market value at that particular market point.

Now, I would say this, that we also say we measure our business performance against the S&P. And we use book value as a conservative proxy for intrinsic business value.

We think intrinsic business value is higher, but we use that as a proxy. And we’ve done that consistently throughout the history of Berkshire.

And during that 5-year period — or during any — we’ve never had a 5-year period when we’ve under-performed the S&P, in terms of the — what I would call the intrinsic value measure of Berkshire.

And, as I said a few years ago, it’s — as we get larger, it’s much harder to do that, and we’ll settle for a couple of points better.

But so far, that test has been made — been met. And it’s been met while we reinvested all earnings.

So I think that we still have got the burden of — we still should have to prove by the fact that Berkshire will sell above the earnings we’ve retained. Berkshire sells above it — every dollar that’s been retained at Berkshire translates even today into more than a dollar of market value.

But I would certainly say that if you took the five years and just sold all the things we bought during that period at that price, that there would be a loss.

Charlie?

CHARLIE MUNGER: Yeah, I don’t get too excited about these oddball things that happen once every 50 years.

If you’re reasonably prepared for them and you’re dented a little on the bottom tick, and other people are suffering a lot more, and unusual opportunities are coming to you that you don’t see under other conditions, I don’t think we deserve any salt tears.

20. Wells Fargo’s stock price plunge shouldn’t spark selling

CHARLIE MUNGER: Take Wells Fargo. I think Wells Fargo’s going to come out of this mess way stronger. The fact that the stock at the bottom tick scared a lot of people, I think will prove to be a very temporary phenomenon.

WARREN BUFFETT: Yeah. Wells Fargo got down below — actually, ticked below $9 a share at a time when spreads on business were never better, when depositing flows were never better, when their advantage in relation of costs of funds versus other large banks had never been better.

But you know, in a market that was terrified, it — literally, I had a class meeting that day, and it was the only time any of those classes have ever got me to name a stock. But they actually pushed me.

And somebody there with a BlackBerry, or whatever those instruments are that they carry around these days, checked the price and it was below $9. And I said, if I had to put all my net worth in one stock, that would’ve been the stock.

The — their business is — you know, the business model is fabulous.

And it, you know, when would you get a chance to buy something like Wachovia, which had the fourth largest deposit base in the United States, and bring that in? And then start getting the spread on assets versus liabilities that Wells gets and build the relationships they have. It’s a great business opportunity.

Wells Fargo will be better off — unless they have to issue a lot of shares, which they shouldn’t — Wells Fargo will be a lot better off a couple of years from now, than if none of this had happened.

And I think that’s true of some of other businesses as well. But you — you know, you have to be prepared. You can’t let somebody else get you in a position where you have to sell out your position.

Leverage is what causes people trouble in this world. So you don’t — you never want to be in a position where somebody can pull the rug out from under you. And you also never want to be emotionally in a position where you pull the rug out from under yourself.

I mean, you don’t want to have other people force you to sell and you don’t want to let your own fears or emotions to cause you to sell at the wrong time.

I mean, why anybody sells Wells Fargo at $9 a share when they owned it at $25 and the business is better off, is one of the strange things about the way markets behave. But people do it. And they get very affected by looking at prices.

If they own a farm like I do, you know, 30 miles from here, they don’t get a price on it every day. You know, they —

I bought that farm 25 years ago. And you look to the production of corn. You look to the production of soy beans and prices and cost of fertilizer and a few things. And you look to the asset itself to determine whether you made an intelligent investment. You have your expectations about what the asset will produce.

But people in stocks tend to look at the price. So they let the price tell them how they should feel or — that’s kind of crazy in our view.

We think you should look at the business just like you’d look at the apartment house that you bought or the farm you want. They let the fact that a quote is available every day turn into a liability rather than an asset.

And all I would say there is you better go back and read chapter 8 of “The Intelligent Investor,” where it tells you how to think about the market. And it will do you more good than learning what modern portfolio theory is all about.

21. Big stimulus spending bound to have some “slop”

WARREN BUFFETT: OK, number 7.

AUDIENCE MEMBER: My name is Jim Powers (PH). I’m from West Newton, Massachusetts. My question has to do with this stimulus bill by the federal government.

I’ve read that only 8 percent of the money is intended to go to infrastructure. When you invest money, you normally look at the asset you’re getting for the money.

With the country going into so much debt, don’t you think it would be better if a great percentage of the money invested by the federal government go to solid assets, as it did during the Great Depression with the Tennessee Valley Authority, Hoover Dam, other facilities, that are still making money today, and paying back the original investment by the government many times over, while putting numerous people to work?

CHARLIE MUNGER: Let me answer that one. Yes. (Laughter and applause)

WARREN BUFFETT: I would certainly agree. I mean the ’30s — a lot of really wonderful things were done with the money that was used to then to stimulate the economy. And that should be the goal and a model.

I can’t evaluate perfectly what the current stimulus bill will do. I know that I — I did get a notice the other day from the Social Security Administration telling me I’m getting $250 more. That ought to last me 6 or 7 months. (Laughter)

Charlie will make his last longer, I’m sure. (Laughter)

But you know, that’s the stimulus that the Buffett household has received at the present time.

Obviously, you want to use the money as intelligently as possible.

Obviously, also, anytime the federal government does anything on a massive scale — any time any big organization, a church or a business or anything, you know, throws all kinds of resources at something, usually there’s a fair amount of slop.

I think that the intent — but by the time it gets through Congress and everything, I can’t guarantee how the result comes out — but I think the intent is to get the money into action quickly and to end up having it utilized in intelligent ways.

But if the day after Pearl Harbor happened, you know, if you’d attached 5 or 6 thousand earmarks to the declaration of war, you know, it would not have been a pretty sight.

I mean, it — we have a system now where — that doesn’t seem to be perfectly effective, I would say, in detaching the interests of particular legislators away from the common goal.

I mean, I get distressed when I look at what gets attached to some of these bills. And that certainly was a case in point. So I’ll go along with Charlie on the answer.

But I think the intent of the administration is the right thing. When the American public pulls back like they have, government does need to step in.

It will have consequences. We are doing things on a scale — we’re doing the conventional things, but we’re doing them in unconventional amounts.

And we will see consequences from what we are doing now. I think we should be doing it. But I don’t think we should think it’s a free ride.

CHARLIE MUNGER: Yeah, we have one big no-brainer on the list of infrastructure investments that can be made. And that is a hugely improved nationwide electricity grid. The chances that that won’t help us are zero.

And that, when it happens, will enormously benefit Berkshire’s utility subsidiary. But that isn’t the reason I’m raising it. I would be making this argument if we didn’t have a utilities subsidiary.

WARREN BUFFETT: We might make it a little more strongly if we had the utilities subsidiary, however. (Laughter)

22. Hard to compete with government-guaranteed debt

WARREN BUFFETT: Becky?

BECKY QUICK: This question comes from Rita Addison (PH), who says, “How does Berkshire’s strong balance sheet and credit rating help take advantage of buying opportunities when even weak financial companies can now borrow more cheaply than Berkshire by using U.S. government guarantees of their debt?”

WARREN BUFFETT: Yeah, well, as I pointed out in the annual report, we are at a significant disadvantage in any financing-type business where we are competing against people who are getting their funding and their financing with a government guarantee.

Our raw material costs us a lot more money. And that’s particularly applicable at Clayton where we have 10- or $11 billion of, really, mortgage paper on mostly manufactured homes.

And it’s exceptionally good quality portfolio. Kevin Clayton and the people at Clayton Homes have done a great job in terms of lending responsibly. Our borrowers have behaved very well.

But the raw material to fund that portfolio — money — costs us a whole lot more than some bank that’s in trouble.

And that’s a real problem for us. And it’s forcing us to try to come up with various other sources of funding that portfolio where, one way or another, we get people with government guarantees involved in the program.

That’s just a fact of life with us now. There are the blessed who have government guarantees. And there’re the ones that aren’t.

And of course, you see that dramatically, in the case of some companies that have a government guarantee for part of their money and then sell other money — and then sell other bonds — that aren’t guaranteed.

I mean, just the other day, as I remember, I may be wrong on this, but I think Goldman Sachs sold something with a 400 basis point spread that wasn’t guaranteed. Whereas their guaranteed paper would be hundreds of basis points underneath that.

General Electric sold something earlier this year that wasn’t guaranteed. And the spread between the guaranteed and the un-guaranteed was huge.

We don’t have anything guaranteed to sell, so we are not in that favored class in any way. And we can’t become a bank holding company. So as long as the situation goes on, we have to figure out ways that we adjust.

We only really use borrowed money — we use it in our utility business. But other utilities are not in this favored class. I mean, the utility industry generally.

So our utility borrows money quite well, compared to most utilities. MidAmerican’s credit is regarded as very good.

And generally speaking, we’ve raised our money at a lower rate, which benefits our customers in the utility business.

We don’t use much money in the rest of our businesses, except for the financing at Clayton. And we won’t use much money.

So we get our money by float, basically. And our float is — it was $58 billion. I mentioned a little while ago, that Wells Fargo raises its money in the first quarter at, I think, 1.12 percent — 112 basis points — which is very cheap.

But our money’s cheaper. We can’t get as much of it as Wells does. But we do have 58 billion — in fact, we have more now — that you would think will cost us less than zero over time, although there will be given periods when we have a cost to it.

But we don’t have an answer for going head-to-head against a government-sponsored business that gets — can raise money with a government guarantee. We do not have a way of going head-to-head with them at any business, no matter how prudently we conduct our operations.

Charlie?

CHARLIE MUNGER: Well, of course we’re at a funding disadvantage. But on the other hand, we aren’t regulated like a bank or a bank holding company.

I think we’d be pretty ungrateful if we took this one disadvantage that has come to us and obsessed on it.

WARREN BUFFETT: I get those kind of lectures all the time. (Laughter)

23. Graham would probably agree with us on derivatives

WARREN BUFFETT: OK, number 8.

AUDIENCE MEMBER: Hi, Mr. Buffett. Hi, Mr. Munger. My name is Mary Kimble (PH) from New York City.

In getting back to basics, what do you think Ben Graham would have said about derivatives?

WARREN BUFFETT: He would not have liked them. I think he probably would’ve said pretty much what I said back in 2002, that they pose a real risk to the system.

They cause leverage to run wild. They cause counterparties to sign up for things that may be difficult to achieve under certain circumstances. That they place an already fragile economic system — added strains on them — which can pop up in unpredictable ways.

But he would probably also say if he saw some that were mispriced, he would act accordingly. But he wouldn’t get himself in a position where the problems of the people who didn’t act prudently could cause him any problems. And I think that probably would be the answer.

The — one of the — one basic problem on derivatives — well, there are several problems.

I mean, back in — after 1929, Congress met — there was a Pecora committee and so on— and they decided that it was very dangerous to let people borrow a lot of money against securities and that it contributed to the Great Depression.

And therefore, they said the Federal Reserve should regulate how much people could borrow against securities. And it was important for society.

And the Federal Reserve started requiring margin — they had margin requirements. Those requirements still exist. You are not supposed to be able to borrow more than 50 percent against your securities.

Actually, during one period, they went to where they didn’t — the Federal Reserve allowed no borrowing whatsoever. They went to a hundred percent margin.

But derivatives came along and just turned that into a — made those rules a laughingstock. You have what they call “total return swaps,” which means you can borrow a hundred percent against what you own. That goes way beyond anything that existed in 1929.

So derivatives became a way around regulation of leverage in markets, which like I say, Congress felt was important and the Federal Reserve still has a responsibility for enforcing.

Derivatives also meant that settlement dates got pushed out. One of the problems in securities markets comes about when you have a trade today, if you had — didn’t have to settle it for a year, you’d find it very hard sometimes to find the person on the other side.

And derivatives allow these very long settlement periods. Whereas security markets demand them in three days. There’s a reason they demand them in three days.

As you extend out periods, you get more and more defaults. So they’re a danger — they are a danger to the system. There’s no question about that.

We have a book in The Bookworm called “The Great Crash” by Galbraith. It’s one of the great books. You really ought to buy it. It tells the story of the ’29 and it gets into margin requirements, so…

Ben Graham would not like a system that used derivatives heavily. But he would — I don’t think he would have been above — if he saw something that looked way out of line and he knew he could handle it himself — I think he would have been quite willing to buy or sell one that was mispriced.

Charlie?

CHARLIE MUNGER: I think there’s been a deeper problem in the derivative business. The derivative dealer takes two advantages of the customer.

One, there’s croupier-style mathematical advantage equivalent to the house advantage in Las Vegas.

And two, the derivative dealer is playing in the same game with his own clients, with the advantage of being a better player. So —

WARREN BUFFETT: And having knowledge of what they’re doing.

CHARLIE MUNGER: — and having knowledge of what the clients are doing.

This is basically a dirty business. And you’re really selling things to your clients who trust you, that are bad for the clients.

We don’t need more of this kind of thing in America. We need less. (Applause)

24. Bailouts shouldn’t hurt senior debt holders

WARREN BUFFETT: Andrew?

ANDREW ROSS SORKIN: Well, this question came in this morning. And it’s a timely, philosophical one, given the results of the stress test that will coming out next week. And it relates to your stakes in Wells, U.S. Bancorp and Goldman Sachs. And the question is the following:

“The government’s proposed restructuring plans for Chrysler and GM require creditors, as well as common shareholders, to bear losses.

“Yet, with the banks, the government’s actions, to date, have not required concessions from holders of preferred stock and debt. The government has merely required the dilution of common stock holders.

“To what extent should holders of preferred stock and debt share losses in the bank rescue plans or in the resolution of a major bank holding company? And do you expect to be diluted in any of your holdings?”

WARREN BUFFETT: Yeah, I would say this. That’s very institution specific. With Freddy and Fannie, the preferred was gone. I mean, there was no equity. And the preferred got — in effect, it’s gotten wiped out along with the common stock.

With U.S. Bancorp or Wells, those are companies making lots of money. There’s lots of equity there. So there’s no reason to go up to senior securities and say that they should give up anything when there’s lots of common equity underneath.

It’d be like if I have a mortgage on my house and it’s 70 percent against its current value, saying, just because other people are having trouble in the neighborhood paying their mortgages because they got much higher mortgage or something, your saying my mortgage holder with 70 percent mortgage, that he should give up something and increase my equity even further.

There’s lots of equity there, which there is at Goldman, U.S. Bank, Wells Fargo. There’s lots of equity, lots of earning power. There’s really no reason for senior debt to give up anything.

You know, you could make an argument at Freddy and Fannie, about the subordinated debt, whether they should’ve suffered as well as the preferred stock and the common. But I don’t see it as applying to earning institutions with lots of future earning power.

I would love to buy all of U.S. Bancorp. You know, or I’d love to buy all of Wells if we could do it. You know, we’re not allowed to do it because it’d make us a bank holding company. But those businesses, there’s no reason for the creditors to suffer.

Now, you get into Chrysler or something of that sort, you know, there is no — I mean, they’re losing money all of time and they do not have a competitive advantage. You know, whether they’ve got a sustainable business model under any circumstances is open to question.

Whether there’s any common equity there is not open to question. You know, there isn’t any common equity. Nobody would pay a dollar, you know, if they had to take on Chrysler and all its debts.

Lots of people would pay billions of dollars to take on U.S. Bancorp or Goldman Sachs, you know, with all their debt. So those are different situations. I —

If you get into a situation where the common equity is wiped out, then you get into a question of — then you get into the proper allocation of things within the capital structure — who gives up so much, and the senior debt may give up something, and so on.

But I don’t see it as applying at all to businesses that are worth a lot of money, where the equity’s worth a lot money.

Charlie?

CHARLIE MUNGER: I have nothing to add. (Laughter)

25. Ignore original cost when reviewing your portfolio

WARREN BUFFETT: OK, number 9.

AUDIENCE MEMBER: Hello, Mr. Buffett. Sorry, about that. Mr. Buffett and Mr. Munger, my name’s Kelly Cardwell from Warrenville, Illinois.

Guys, if either of you were starting a smaller investment fund today, let’s say in Warrenville, Illinois, $26 million fund called Central Square Capital — hypothetically?

WARREN BUFFETT: What? You’ll get billed for a commercial later on. (Laughter)

AUDIENCE MEMBER: With this smaller asset base, what would you do differently, both in terms of the number of positions and frequency of turnover?

For example, if you owned a portfolio of 10 stocks and five of them doubled in a short time period, would it make sense to actively manage the portfolio and take profits in the five that had doubled and redeploy the proceeds into your positions, into the ones that had not moved higher, where, presumably, more upside exists and the odds are more dramatically stacked in your favor? Or would you favor the strategy of sitting on your hands in the name of long-term investing?

WARREN BUFFETT: We would own the half of dozen or so stocks we like best. Their — and it wouldn’t have anything to do with what our cost on them was.

It would only have to do with our evaluation of their price versus value. It doesn’t make any difference what the cost is.

And incidentally, if they went down 50 percent, we would say the same thing. I — you know, and using your illustration, I don’t know whether that fund has actually had something that went up or went down.

So, we would — our cost basis, except in rare cases — and we actually have a situation like this at Berkshire now, which I may explain a little later. But the cost basis doesn’t have anything to do the fund.

When Charlie and I ran funds, we didn’t worry about whether something was up or down. We worried about what it was worth compared to what it was selling for.

And we tried to have most of our money in a relatively few — very few — positions which we thought we knew very well. We do the same thing now. We’d do the same thing a hundred years from now.

Charlie?

CHARLIE MUNGER: Yes, he’s tactfully suggesting that you adopt a different way of thinking. (Laughter and applause)

26. Berkshire’s competitive advantage no longer requires us

WARREN BUFFETT: Carol?

CAROL LOOMIS: This question is from Michael Welter (PH) of Portland, Oregon.

“You’ve often said that two things you look for in an investment are a sustainable competitive advantage and a simple, easy to grasp business model. Berkshire’s sustainable competitive advantage is arguably you, Warren and Charlie. And that obviously is not sustainable over the long term.”

WARREN BUFFETT: I reject that. Defeatism. (Laughs)

CAROL LOOMIS: I knew you would.

“While at this point, Berkshire does not have a simple, easy to grasp business model. So if the two of you were outside investors, is it possible that, no matter what combination of intrinsic value and price Berkshire offered, you would not invest in it today?”

WARREN BUFFETT: No, our sustainable competitive advantage is we have a culture and a business model, which people are going to find very, very difficult to copy, even semi-copy.

We have an unusual group of shareholders. We have a business that’s owned by people where the turnover on our stock, even allowing for all the double-counting and everything like that, may be something like 20 percent a year, when virtually every stock in the S&P 500 turns over a hundred percent a year.

So we have a different shareholder base. We have people that understand their business differently.

And we have a business that can offer, to people who own private businesses, the chance to keep running their businesses as they have in the past and get rid of the problems of lawyers and bankers and all kinds of things like that.

And I don’t see any other company in the United States that has the ability to do that now, or probably the ability to adopt that model in any big way.

So I would say we have sort of an ultimate — and it’s not peculiar to me and Charlie. We may have helped create it. But it is a deeply embedded culture which any CEOs that follow are going to be well-versed in when they come into the job, and dedicated to, and able to continue in the future.

And you can’t — I don’t want to name names about other companies — but you can’t do that elsewhere.

So I think anybody wanting to copy Berkshire is going to have a very hard time. And I think the advantages we have are going to be very, very long lasting. And they’re not peculiar to the fact that Charlie and are I sitting up here anymore. They may have been, originally. But no longer.

Our culture, our managers join that culture. Our shareholders join that culture. It gets reinforced all the time. They see that it works.

You know, it’s something that I don’t know how I would copy it, if I were running, you know, some other company.

And it’s meaningful. Because there will be businesses, just as there was with ISCAR awhile back, just as the management at GEICO felt back in the mid-’90s in terms of what they wanted to do, there will be people that want to join up with us. And they really won’t have a good second choice. They’ll be plenty that don’t, too. But that’s OK.

We just need to have the right ones — some of the right ones — join us. And it can go on a long, long time.

Charlie?

CHARLIE MUNGER: Yes. I might state that a little differently. A lot of corporations in America are run stupidly from headquarters, as they try and force the divisions to come up with profits for every quarter that are better than the profits from the same quarter in the previous year.

And a lot of terrible decisions and terrible practices creep into those businesses. In the Berkshire model, that doesn’t happen.

So while Warren and Charlie will soon be gone — not too soon in my case, but I’m a little worried about Warren (laughter) — the stupidity of management practice in the rest of the corporate world will likely remain ample enough to give this company some comparative advantage way into the future. (Applause)

WARREN BUFFETT: OK. We’ll go to — it’s very important isn’t it, to watch what you eat, as you — (laughter) — in terms of preserving longevity. So we watch it for hours up here at a time. (Laughs)

27. We don’t keep every stock, but we do keep every business

WARREN BUFFETT: Number 10.

AUDIENCE MEMBER: Hello, Mr. Buffett, and Mr. Munger. My name is Aznar Midolf (PH). I’m from (Inaudible) organization, San Francisco.

And my question is from one of financial blogs. How do you justify holding stocks forever when the fundamentals have permanently changed?

WARREN BUFFETT: Well, the answer is we don’t. You know, and — if we lose confidence in the management, if we lose confidence in the durability of the competitive advantage, if we recognize we made a mistake when we went into it — we sell plenty of times. So it’s not unheard of.

On the other hand, if you really get a wonderful business with outstanding management — but mostly the wonderful business part of it — when in doubt, keep holding. But it’s no inviolable rule.

Now, among the businesses we own, not just securities we own, we have an attitude, which we express in our economic principles, that when we buy a business it’s for keeps.

And we make only two exceptions: when they promise to start losing money indefinitely or if we have major labor problems. But otherwise, we are not going to sell something just ’cause we get offered more money for it, even than it’s worth.

And that’s a peculiarity we have. And we want our partners to know about that.

We do think it probably helps us in terms of buying businesses over time. It’s also the way we want to run our business.

But with stocks, bonds, we sell them. But we’re more reluctant to sell them than most people. I mean, if we made the right decision going on, we like to ride that a very long time. And we’ve owned many — we’ve owned some stocks for decades.

But if the competitive advantage disappears, if we really lose faith in the management, if we were wrong in the original analysis — and that happens — we sell. Or if we find something more attractive —

Normally we have plenty of money around. But in September of last year, late September, we had committed to put 6.6 million — billion — in Wrigley. We — and then Goldman Sachs needed 5 billion, GE needed 3 billion.

I sold a couple billion dollars’ worth of J&J just because I didn’t like getting our cash level down below a certain point, under the circumstances that existed then.

That not was a negative decision on J&J. It just — it meant that I wanted a couple billion more around. And I saw an opportunity to do something that I probably wouldn’t see too much later. Whereas, I could always buy J&J back at a later date. But that’s an unusual situation.

28. We run Berkshire as if we owned all of it

WARREN BUFFETT: I’d like to go back to one point on the earlier question, too.

I always — I frequently ask CEOs of companies what they would do differently if they owned the whole place themselves.

You know, when I’m talking to, either companies where we’ve invested in, sometimes other companies, friends of mine run them. You know, “What would you do different if this was a hundred percent owned by you and your family?”

And they give me a list of things. There is no list at Berkshire. You know, we basically run this place the same way we’d run if we owned a hundred percent of it.

And that is a difference that — in terms of people joining in with us. They don’t have to adjust their lives to a bunch of rules that are kind of self-imposed, in terms of how people think about public companies, in terms of earnings, predictions, and all of that sort of thing.

And there are certain people that would prefer to be associated with an enterprise like that. And also —following through on this rule I just explained — know that they’ve made a one decision on where that business that they built up over decades and cherish and everything — they make one decision on where it’s going to go, and they’re not going to get surprised later on.

They’re not going to get some management consultant come in and say, “You ought to have a pure player, Wall Street’s saying, so you ought to spin this off or sell it,” or anything like that.

And they know we’re not going to leverage it up. So they know they’re really going to get to do what they love the most, which is to continue to run their business, not bothered by bankers or lawyers or public expectancies or anything of the sort.

And that is a — like I said earlier, that’s a real advantage.

Charlie?

CHARLIE MUNGER: Yeah, in the show business, they say the show has legs if it’s going to last a long time. I think Berkshire Hathaway’s system has legs.

29. Why the annual meeting isn’t webcast

WARREN BUFFETT: OK. With that, we’ll go to Becky. (Laughter)

BECKY QUICK: This is a question from Humin Timadin (PH) in Seattle, Washington. He’s got a two-part question. But he says, “From time to time, you purchase shares of public companies.

“Presumably, you feel that those shares are a better investment than Berkshire shares at the time, since you never buy back Berkshire shares.

“If Berkshire shareholders can purchase shares in the same companies for the same price as you, why shouldn’t they shell — sell their Berkshire shares and buy what you are buying?”

And secondly, he wants to know why, because he, “like thousands of other shareholders, is unable to attend the annual meeting, how come Berkshire does not webcast the meeting? I am aware of the irony that I will not hear your answer.” (Laughter)

WARREN BUFFETT: Well, our meeting does get written up, at least it gets written up a lot with various blogs and everything else. It gets written up pretty well in its entirety by Outstanding Investor Digest.

And there are others that prepare extensive reports. And they pop up on the internet. So he will, in all likelihood, find out the answer.

We could webcast. I get asked the same question about webcasting the meetings I have with students. You know, why not do that? It’s so much easier and everything.

I think there is something gained by personal contact. I certainly know that when I was studying and all of that, I gained a lot by personal contact.

Even though I’d read Ben Graham’s books, just going and being with him. And I follow that practice in teaching. And I think that —

I like the turnout we get. I like our partners to show up and see the products we sell and all of that. This is not something where we’re going to go and hide and hold our meeting, you know, in some hamlet, you know, in western Nebraska or something to discourage attendance.

We’ve got a different attitude. And I think that that — I hope that comes across. And I think that if we webcast it, you know, it was something like turning on a television show, I don’t think it would be quite the same.

30. No “quarrel” with copycats

WARREN BUFFETT: In terms of the first part of the question about buying the securities we buy, plenty of people do that. And some of them — but they — incidentally, they’re not buying it with free float that’s available from insurance.

So if they have $58 billion that they can get interest-free, they will be in the same position we are in buying those securities. But they are — on the other hand, they have some tax advantages we don’t have. So I don’t quarrel with people who do that.

We have to publicize to some extent what we own. Some things they wouldn’t be able to buy because we make direct purchases.

They wouldn’t be able to buy into the businesses we own. But they might very well do better piggybacking us in some way. And they’re certainly free to do it.

Charlie?

CHARLIE MUNGER: Yeah, generally, I think it’s quite smart to do what you’re talking about — is to identify some investors you regard as very skilled, and carefully examine everything they’re buying, and copy what you please. I think you have a very good idea. (Laughter)

WARREN BUFFETT: Yeah, I used — when I was 21 years old, I had to mail away to the SEC in those days — and you had these crummy copies about a week later and paid a lot per page to get them — but I used to get the semi-annual reports of Graham-Newman Corp before I went to work there.

And I would look at every security that was listed there. And I got some of my ideas that way. So it’s a — there’s nothing wrong with that.

31. Your best inflation protection

WARREN BUFFETT: Number 11.

AUDIENCE MEMBER: My name is Sam Alter (PH). I’m 11 years old and I’m from Westminster, New Jersey.

My question is, how will inflation affect my generation? And how is Berkshire investing to prepare for this time? (Applause)

WARREN BUFFETT: Well, that was about inflation, right? How inflation was going to affect him?

CHARLIE MUNGER: Yeah. How is inflation —?

WARREN BUFFETT: Well, inflation is going to affect you. You know, the — it’s certain we will have inflation over time.

Paul Volcker got very upset the other day and spoke out about three weeks ago, I guess, when he read that a majority of the Federal Open Market Committee had sort of targeted 2 percent inflation as the number.

And Volker, who came in when inflation was raging and saw the problems of stopping it when it got a momentum of its own, said, “You know, 2 percent sounds great, but in a generation it cuts away purchasing power by 50 percent.”

He was — kind of a long generation, there — but he was right in that once you start thinking about a couple percent, you are on something of a slippery slope.

And we are following policies in this country now to stimulate things, which — stimulate business — which are bound to have some inflationary consequences.

And to the extent that we borrow money from the rest of the world, it would be very human on the part of politicians in the future to decide that they would rather pay the rest of the world back in dollars that are worth far less than the dollars they borrowed.

I mean, it’s the classic way of reducing the impact and cost of external debt. And we’re building up a lot of external debt.

I always find it interesting when politicians now talk about using the taxpayer’s money to do this and the taxpayer’s money to do that and how the taxpayers are paying the bonuses at AIG.

We haven’t raised taxes at all in this country. You know, I mean, taxpayers are paying nothing beyond what they were paying a couple years ago.

Matter of fact, the federal revenues this year, which were close to 2.6 trillion a couple years ago, you know, maybe more like 2.3 trillion. So we are taking less money from the taxpayers.

The people who are really paying for the things we’re doing now will probably be the people who are buying fixed-dollar investments, much of it from the U.S. government, and who will find the purchasing power when they go to redeem those investments to be far less.

So you can — you might say that the AIG bonus is — probably the Chinese have — are the people that are ultimately paying the most in terms of the loss of purchasing power they will have with their holdings of government bonds, U.S. government bonds, many years down the road. But it sounds better to say the taxpayer than to say the Chinese are paying for it.

It’s an interesting situation. I read that comment everyday about how the taxpayers are doing this and that. And, you know, I haven’t had my taxes raised. You haven’t had your taxes raised. They’re giving me $250 bucks back here pretty soon.

The taxpayers haven’t paid anything so far. And my guess is that the ultimate price of much of this will be paid by a shrinkage in the value of — the real value — of fixed-dollar investments down the road.

And that will be the easiest thing to do. And if it’s the easiest thing to do, it’s the most likely thing to have happen.

So you will see plenty of inflation. Now, the best protection against inflation is your own earning power.

If you’re the best teacher, if you’re the best surgeon, if you’re the best lawyer, you know, whatever it may be, you will command a given part of other people’s production of goods and services no matter what the currency is, whether it’s seashells, or reichsmarks, or dollars.

So your own earning power is the best, by far. If you’re the best journalist, whatever it may be, you will get your share of the national economic pie, regardless of the value of whatever the currency may be, as measured against some earlier standard.

The second best protection is a wonderful business. You know, if you own the Coca-Cola, trademark, Company, you will get a given portion of people’s labor 20 years from now and 50 years from now for your product.

And it’s doesn’t make any difference what’s happened to the price level, generally. Because people will give up three minutes of labor, whatever it may be, to enjoy, you know, 12 ounces, you know, of a product they like.

So those are the — and — those are the great assets, your own earning power first, and then the earning power of a wonderful business that does not require heavy capital investment.

If it requires heavy capital investment, you get killed in inflation. And with those guidelines, I would tell you the best thing to do is invest in yourself.

Charlie?

CHARLIE MUNGER: Yes. The young man should become a brain surgeon and invest in Coca-Cola instead of government bonds. (Laughter)

WARREN BUFFETT: I get paid by the word. He doesn’t. (Laughter)

32. Newspapers are fading but we’re keeping the Buffalo News

WARREN BUFFETT: Andrew?

ANDREW ROSS SORKIN: OK. This question comes to us from Dennis Wallace (PH) in Waldorf, Maryland. We got a lot of these. And I’m selfishly interested in the answer.

Given the current economic conditions in the newspaper and publishing business, can you please provide some of your thoughts on its impact on Berkshire? Given that our investee, the Washington Post Company, has had a substantial decline in its stock value, is it still a good use of capital?

And given the, quote, “cheap trading prices of newspapers in the current climate,” would Berkshire considering — consider purchasing additional newspapers to add to the Buffalo News and Washington Post properties?

At what price does it become compelling to invest in the newspaper business? Or is there no price at which it becomes compelling in today’s environment?

WARREN BUFFETT: I would say, it isn’t today’s environment. I mean, it’s an evolutionary development.

But — so the current economic environment has accentuated the problems in newspapers. But it is not the basic cause.

Newspapers are, to the American public as a whole — Charlie and I — I read five a day. Charlie probably reads five a day. We’ll never give them up.

But we’ll also be the last guys reading a newspaper while having a landline phone, you know, by our side. (Laughter)

So, you don’t want to judge consumer preferences by what we do. The newspaper — no. The answer is, for most newspapers in the United States, we would not buy them at any price.

They have the possibility, and in certain places, they’ve already hit it, but they have the possibility of just going to unending losses.

And they were absolutely essential to a very high percentage of the American public, you know, 20, 30, 40 years ago. They were the ultimate business.

It was a business where only one person won, basically, in almost every town in the country. There were 1,700 papers in the United States. And about 50 of those, 20 years ago, existed in a city where there were multiple papers.

So they were a product that had pricing power, that was essential to the customer, essential to the advertiser. And they’ve lost that essential nature.

They were primary 30 years or 40 years ago if you wanted to learn sports scores or stock prices or even news about international affairs.

And then that nature, what Walter Annenberg used to call “essentiality,” I don’t know whether it’s in the dictionary or not, but it started eroding. And then the erosion has accelerated dramatically.

And they were only essential to the advertiser as long as they were essential to the reader. And you know, nobody liked buying ads in the paper. It was just that they worked.

And that has — that is changing. It’s changing every day. And I do not see anything on the horizon that causes that erosion to end.

We — you know, at the Buffalo News, Stan Lipsey would greet me 10 years ago. And he would say, “Warren, you should — on an economic basis — you should sell this paper.” And I said, “I agree 100 percent. But we’re not going to do it.”

And you know, we could’ve sold the Buffalo News for many hundreds of millions of dollars some years back. And we couldn’t sell it, you know, for remotely anything like that now.

And that’s one of the policies. We have a union that’s been very cooperative — unions, a bunch of unions — have been quite cooperative with us in recent months in trying to have an economic model that will at least keep us making a little money.

And as I put in the annual report, in our economic principles, that as long as we don’t think we face unending losses or have major union problems, we will stick with the businesses, even though it would be a mistake if you were acting as a trustee for, you know, a bunch of crippled children or something of the sort. And that’s just our policy at Berkshire.

The Post has a very good cable business. It has a very good education business. But it does not have answers on the newspaper business, as Don Graham wrote in the annual report. Nor does anyone else.

Now, we all keep looking around for somebody that will find the model. But there — I think there are about 1,400 daily papers now in the United States, and nobody yet has found the model.

We are as well-positioned in Buffalo, believe it or not, I think, to play out the game as anyone else. But whether we find something before the lines get so that we’re inexorably in the red, whether the situation gets so we’re inexorably in the red, I don’t know.

But we will play it out as long as we can. It’s not what they teach you in business school. But it’s the way we run Berkshire.

Charlie?

CHARLIE MUNGER: Well, I think that’s all 100 percent right. And it’s really a national tragedy. The — these monopoly daily newspapers have been an important sinew of our civilization.

And, by and large, they were impregnable from advertiser pressure. And by and large, they were desirable editorial influences. And by and large, they kept government more honest than it would otherwise be.

So as they disappear, I think what replaces it will not be as desirable as what we’re losing. But this is life.

33. Expect weak consumer spending for “quite a bit longer”

WARREN BUFFETT: Number 12.

AUDIENCE MEMBER: Good morning, Mr. Buffett and Mr. Munger. I’m Marc Rabinov, from Melbourne Australia.

I’m wondering if I could ask you how retailing, manufacturing, and service businesses have been severely impacted by the recession given the way consumer spending has changed. Is it likely the results will still be 20 percent below 2007 levels in three years’ time?

WARREN BUFFETT: I don’t know about three years’ time. Certainly those areas you named, to varying degrees, have been hit very hard.

Some of the manufacturing would tie in with residential construction. If we hold housing starts at 500,000 a year, you know, my guess is that in a couple of years at most, we would get something close to equilibrium in housing. Maybe quite a bit sooner. Nobody knows the figures with precision.

But if you keep forming households at a million-3, or something like that, a year, and you create 500,000 new units and a few of the old ones burn down, and a few — you will reach equilibrium at a point that’s not ridiculously far in the future.

And that will make a big difference in our carpet business, and brick business, and insulation business, and paint business, and so on.

Retailing has been hit very hard. The higher the end of it, generally speaking, the harder it’s been hit.

There’s been a big change in consumer behavior. And I think it will last quite a bit longer.

I think for years, government was telling people to save. And now that they’re saving, they’re unhappy about it.

But I think that — I think the experience of the last couple years, I don’t think will go away very fast. I think it could last quite a long time.

So I would not think our retailing businesses would do great for a considerable period of time.

And I would say that in retail real estate, I would think that that would be a tough field to be in for quite a period.

I think the shopping centers will be seeing vacancies that will be hard to fill. I think that the retailers will be struggling in many cases. And of course, the supply of real estate doesn’t go away.

So, that could be — the shopping center business, which was selling at, you know, these premiere cap rates of 5 percent or even less sometimes. I think that is going to look very silly before all of this is done. In fact, it already is looking that way. So I wouldn’t count — I wouldn’t —

The service businesses are generally the better businesses. They require less capital and they can be more specialized in the markets they serve, in general.

But I would not look for any quick rebound in the retail manufacturing service businesses. We’ve got a ways to go on that.

And we’ve got a ways to go on the ones that are construction related. But at least there, you can sort of see the math of when it’ll work out. And you can get a lot of information on what’s going on in real estate markets.

South Florida, I think, will be — for example, I think that’s going to be a problem for a long, long time.

I hope it isn’t. But I just think the math of it is pretty devastating, in terms of the number of units you have and net household formation down there. You’ve got a lot to wade through.

Charlie?

CHARLIE MUNGER: I’ve got nothing to add.

WARREN BUFFETT: OK.

34. We’ll never buy back Berkshire shares at a “silly” price

WARREN BUFFETT: Let’s go to Carol.

CAROL LOOMIS: I got lots of question sent in to me about the possibility of Berkshire buying its own shares. And here’s what one said:

“You recently described Berkshire’s policy regarding share repurchase as self-defeating, because before repurchase, you said, you would write a letter to shareholders explaining why we are going to do it.

“You said the letter would, by necessity, tell investors that the stock price was at a substantial discount to intrinsic value, which would cause the stock price to rise.

“The letter would be, in essence, a buy recommendation, though as a matter of policy, you don’t make those.

“In the past, you have emphatically endorsed share repurchase by other companies and criticized managers who would not buy when the price was right.

“You have said no alternative action can benefit shareholders as surely as repurchases. Your previous views suggest little patience for a manager with a self-defeating policy.

“You’ve said when you have a manager who consistently turns his back on repurchases when these are clearly in the interest of owners, he reveals more than he knows of his motivations. So — and the market correctly discounts assets lodged with him.

“Would it not be rational to conclude that the market will appropriately discount Berkshire’s share price unless and until you abandon your self-defeating policy and engage in repurchases of shares?”

WARREN BUFFETT: Yeah, incidentally, the — and this important, actually — the comments I made about repurchasing, overwhelmingly, those go back a lot of years when stocks generally were — frequently were — cheap in relation to intrinsic value. I did not make that —

You haven’t seen me writing about that in the last 10 years or so. Because I would say most of the repurchasing done in recent years, I’ve thought has been foolish, because people have been paying too much.

And companies got, in many cases — they would never acknowledge this — but they were buying because they were basically liked — they were trying to give out a buy recommendation when it wasn’t justified.

In the ’70s and early ’80s, Charlie and I would frequently urge people to repurchase shares because it was so much more attractive than other things they could do with their money.

The only time we felt strongly that Berkshire should repurchase its shares was in roughly 2000, whenever it was, that we thought it was demonstrably below intrinsic business value. And we wrote we would do it, and it did become self-defeating.

There’s clearly a point where if we thought it was demonstrably below — conservatively estimated — intrinsic business value and we notified the stock holders we were going to do it, we would do it. I think again, it would largely be self-defeating.

I don’t think that situation exists now. I think — I won’t give any buy or sell recommendations. But I think it ought to be quite compelling.

Like I say, I don’t — I think, probably 90 percent of the repurchase activity I’ve seen in the last five years, I did not think was serving the cause of the shareholder.

I thought it was being done because management thought it was the thing to do, and their investor relations department told them it was the thing to do, and they were actually buying stock at kind of silly prices.

And that was not the case when Charlie and I looked at Teledyne or the Washington Post or Cap Cities Broadcasting doing it many years ago. But I haven’t seen situations like that in recent years.

Charlie?

CHARLIE MUNGER: I’ve got nothing to add to that, either.

WARREN BUFFETT: Number — it’s interesting how many companies were buying in their stock at twice present prices that aren’t buying it now. I mean, there are lots of those.

We will never buy in our stock at a silly price. We may make a mistake by not buying it at a cheap price. But we’ll never make a mistake, I don’t think, by buying it at a silly price.

And we think a significant percentage of corporate America has done that in recent years, including a few stocks that we’ve owned ourselves.

35. Crisis made opportunity cost calculations difficult

WARREN BUFFETT: Number 13.

AUDIENCE MEMBER: Jack Benben (PH) from Haworth, New Jersey. First, I’d like to thank you. This is — I’ve been to about a dozen meetings. This is probably the best one.

So thank you very much for the new format. And thank you very much to the journalists who’ve really helped out a lot. (Applause)

WARREN BUFFETT: Yeah, thank you.

AUDIENCE MEMBER: At past meetings, you and Mr. Munger have talked at great length about opportunity cost. Excuse me. The past year has presented you with many unusual opportunities.

Can you discuss some of the more important opportunity cost decisions of the past year? And were those decisions at all affected by the macroeconomic picture? Thank you.

WARREN BUFFETT: Well, certainly opportunity cost has been much more in the forefront of mind in the last 18 months.

When things are moving very fast, when both prices are moving, and in certain cases, intrinsic business value is moving at a pace that’s far greater than we’ve seen for a long time, it means that in terms of calibrating A versus B, versus C, it’s tougher.

It’s more interesting. It’s more challenging. But it’s — and it can be way more profitable, too. But it’s a different task then when everything was moving at a more leisurely pace.

And I described earlier, you know, we face that problem. And it’s a good problem to have. We faced that problem in September and October. Because we want to always keep a lot of money around.

We have all kinds of levels — extra levels of safety — that we follow at Berkshire. And we will never get so we’re dependent on banks or other people’s money or anything else. We’re just not going to run the company that way.

So we were seeing things happen. I mean, we got a call — we got lots of calls. But, most of them, we ignored. But the calls that we got that we ignored helped us calibrate the calls that we paid attention to, too.

And if we got a call from a Goldman Sachs, I think it was on a Wednesday, maybe, you know, that was a transaction that couldn’t have been done the previous Wednesday and might not be done the next Wednesday.

And we’re talking real sums, 5 billion in that case. And we had certain commitments outstanding. We had a $3 billion commitment out on Dow Chemical. I think at that point, I could be wrong exactly on the day when we made it.

We had a $5 billion commitment out on Constellation Energy. We had 6 1/2 billion we were going to have to come up with in early October on the Wrigley-Mars deal. So we were faced with opportunity cost-type considerations.

And as I said earlier, we actually sold something that under normal circumstances we wouldn’t have thought about selling if it was 10 or 15 points higher, in Johnson & Johnson. But we just didn’t want to get uncomfortable.

So you are faced, in a chaotic market, particularly where people needs large sums — so you’re not talking about buying a hundred million dollars’ worth of something that, you know, one day and a hundred million the next day — but all of a sudden you’re called on for billions, if you’re going to play at all.

We faced that opportunity cost calculation frequently during that period. I mean, when we decided to commit to buy Constellation Energy, we had to be willing to come up with $5 billion seven or eight months down the line. And you didn’t know exactly when because it would be subject to public utility commission approval.

But if something chaotic happened in the market next week, we would get phone calls. Or we would see stocks selling or bonds selling at prices we liked. And if the relative values, against what we held, were interesting, we might sell things.

Now, it’s harder to sell things in huge quantities than it is to buy things in huge quantities during a period like that. So you have to measure whether you can actually get the offsetting transaction done to move from one to another.

We have a much — if we’re going to move billions from one to another, it’s much different than the problem you may have in moving hundreds of thousands or tens of thousands of dollars from one holding to another. We really can have big transactional costs unless we’re careful.

But that’s the kind of calculation we go through. And we love the fact we get the opportunity to make those calculations. It’s a sign of opportunity around.

And you know, we’ll — we haven’t had the flurry of activity like we had last year for a long time. So it was the first time we really faced the question, you know, can we raise a couple billion dollars in a hurry, to be sure that we’ve offset the cash needs of what we’re committing to on the purchase side.

On the Johnson & Johnson we sold, we actually made a deal where we got — I had a floor price on what we sell that for, just because the markets were so chaotic, that we wanted to be absolutely sure that we would not end up a couple billion dollars less than comfortable when we got all through.

Our definition of comfortable is really comfortable. We want to have billions and billions and billions around. And then we’ll think about what we do with the surplus.

Charlie?

CHARLIE MUNGER: Again, I’ve got nothing to add.

36. GEICO spends millions on advertising and will “never stop”

WARREN BUFFETT: Becky?

BECKY QUICK: This is a question from someone named Yem (PH) in Columbus, Ohio. It’s —

WARREN BUFFETT: That narrows it down.

BECKY QUICK: Yeah. Very company specific. It says, “GEICO has been spending around 400 to $600 million on media advertising a year in the last few years. What are the deciding factors into how much to spend? And how could one estimate the net return on such spending?”

WARREN BUFFETT: Well, that’s a question people have been asking themselves since the beginning of advertising.

And, you know, I’m not sure whether it was Marshall Field or John Dorrance at Campbell Soup, or something, one of those fellows said that, you know, when asked whether they didn’t waste a lot of money on advertising, he said, “Yeah, we waste half of it, but we don’t know which half.” (Laughter)

And that is the nature of advertising. Although, we can measure it better with GEICO than most companies.

We will spend about $800 million on advertising. We spend far more — even though we’re the third largest company — we’ve spent far more than State Farm or Allstate. And we will spend more and more and more. I mean, we will never stop.

We were spending $20 million a year, a little over that, when we bought control of it in 1995.

But we want everybody in the world to — well, everybody in the United States. We’re not going to be selling insurance in China or someplace very soon.

But we want everybody in the United States to have in their mind the fact that there’s a good chance they can save money by picking up the phone or going to geico.com and checking it out. And important money.

And when we get that message in people’s minds, you never know when it’s going to pay off later down the line. Because, as I mentioned earlier, starting in — around September 30th, we saw a big difference in the propensity of people to come to us to save $100 or $200, whereas they might not have cared about saving that before. So, we want —

Here’s auto insurance. Everybody has to buy it. Nobody likes to buy it. But they like to drive. And if you like to drive, you need auto insurance.

And so it’s going to sell. And you’re going to buy it from somebody. And if you care about saving money, you’re going to check with us. And we want to make sure everybody understands that.

And we won’t — you know, we will spend more money on it, I will guarantee you, three years from now.

Now, we’re getting more for our money in buying advertising this year. So 800 million this year buys more than 800 million would’ve bought a couple of years ago. So we’re getting more exposure for the money.

But we love spending money on advertising at GEICO. And we want to be in everybody’s mind.

Coca-Cola’s in everybody’s mind around the world. You know, he started in 1886. And they just kept associating Coca-Cola with moments of pleasure and happiness. And billions and billions of billions of people have that in their mind.

And they don’t have anything in their mind about RC Cola, you know. You know, or — they just — you say RC Cola to somebody around the globe and they give you a blank stare. You say Coca-Cola and it means something.

And a brand is a promise. We’re getting our — we’re getting that promise in people’s minds that there’s a good chance they can save money if they check with GEICO. And we’ll never stop.

Charlie?

CHARLIE MUNGER: Yeah, it’s interesting.

If GEICO would remain more or less the same size if we didn’t advertise so healthy, and if the new subscribers are worth more than the $800 million we’re spending advertising, then, in an important sense, GEICO is earning $800 million more pre-tax in a way that doesn’t even show.

That’s the kind of thing we like to see within Berkshire Hathaway.

WARREN BUFFETT: The value of GEICO goes up by far more than the earnings every year, if we keep adding these people, as Charlie says.

And we could maintain, I’m sure, we can maintain for a very long time our present policy holder count and probably spend $100 million a year, maybe less.

But we are getting more than our money’s worth for the — for what we spend. We probably waste some. But overall, we’re getting at terrific return on it.

And if I thought we could get anything like the same return by spending 2 billion next year, we’d spend 2 billion. I mean, it — it’s a very attractive business. And I don’t see how you create anything like it.

I mean, we are the low-cost producer. And if you’re the low-cost producer in something people have to buy and is roughly a $1,500 item, I mean, you’ve got a terrific, terrific business. And we have durable competitive advantage there.

37. Wells Fargo is better than many other banks

WARREN BUFFETT: OK, we’ll to go to number 1. And I think then we’ll break for lunch. Number 1?

AUDIENCE MEMBER: OK. Hello Warren, Charlie. Felton Jenkins from Savannah, Georgia, a long-time shareholder and partner.

Just want to make a quick comment about something that was a big deal the last couple of years about PacifiCorp. There was some controversy.

But I’m glad that PacifiCorp has agreed to work with the Native Americans and fishing communities on the West Coast to remove the uneconomic and harmful dams on the Klamath River.

So I want to encourage PacifiCorp management to move quickly, close the deal, and open the river soon. But thanks for their improved efforts over the last year.

My question is, you mentioned Wells Fargo got to $9. And that was a great deal, it looks like, at that price.

But what about Washington Mutual, AIG, Wachovia, Citigroup, Fannie Mae, even some Irish banks that I think you were involved with?

Those went through $9. And probably a lot of people thought they were still good deals or mispriced at $9.

And now you’ve got very expensive toilet paper, essentially, out of those stock certificates. So I mean, how would you know on the way down?

And looking at something like Bank of America, that was on the 13F sometime recently, what’s a likely outcome for a Bank of America and how would you analyze what might happen? Thanks.

WARREN BUFFETT: Well, there’s some you can’t analyze. And on the Irish banks, I couldn’t have been more wrong.

But it isn’t a matter of whether they go through $9 or anything like that. It’s really what their business model is and what kind of competitive advantage they have.

I would say that Wells, among the large banks, has, by far, the best competitive position, you know, of any — of the really large banks in the country.

And essentially, if you look at the four largest, they each have somewhat different models. But the model of Wells is more different from the other three than any one of the other three would be from the remaining group.

But I was wrong on the Irish banks in a very big way. I simply didn’t understand. And I should’ve understood.

It was available for me to understand, the incredible exposure they’d got into in more land development-type loans — not property loans, in terms of completed properties — but all kinds of land development loans.

It was extraordinary. For a country with 4 and a fraction million people, you know, they had money lent for developing properties, homes, that would extend just forever in the future.

It was the terrible mistake by me. Nobody lied to me, nobody gave me any bad information. I just plain wasn’t paying attention. The —

If you talk about the WaMus — I don’t want to go through all the names on them, because it’s specific to some companies.

But there were a lot of signs that they were doing things that a highly leveraged institution shouldn’t be doing. And that could cause trouble if this model of ever-rising housing prices turned out to be a false model.

You can get in a lot of trouble with leverage. I mean, it’s — you start creating $20 of assets, or something like that. You know, for every dollar of equity, you better be right.

And some of those big institutions did some very — what, in retrospect, for certain here — were foolish things, which, if they hadn’t been so highly leveraged, would not have hit them as badly.

And I would say most of them, if you read the 10-Ks and 10-Qs and did some checking, you could spot differences in them. Certainly, you can spot —

There’s no comparison, if you take Wells Fargo versus a WaMu or something like that. I mean, you don’t have to have an advanced level of sophistication about banking to compare those two.

They’re two different kinds of businesses. It’s like comparing a copper producer whose costs are $2.50 a pound with a copper producer whose costs are $1 a pound.

Those are two different kinds of businesses. One is going to go broke at a buck-fifty a pound. And the other one’s going to still be doing fine.

And banking has real difference in it. But people don’t — they don’t seem to look at them. The figures are available. And — but they don’t seem to look at them very carefully.

When Wells reported the other day, they have an item of expense of over $600 million in a quarter for the amortization of core deposits. That it not a real expense.

I mean, the core deposit figure will be up over time. And they are entitled under the tax law to put up, I don’t know, $15 billion or so, and they get to amortize that, which is an advantage.

But I didn’t see one newspaper article or any commentator that mentioned that that $600 million charge is in there, which is entirely different than looking at any other bank. But it just — it goes unnoticed.

So the figures are there. And the information’s there. And I think with Freddy and Fannie, for example, I think it was pretty clear what was going to happen.

Now, the interesting thing is, the government was telling them to go out and raise some more money for investors. And if those investors had put the money in, it would’ve been gone. It was already gone, actually, within a month or two, so —.

We had calls on that, people trying to — investment bankers — trying to place billions of dollars with us on something, on those two institutions. And you just could take one look at them and you could tell they were in big, big trouble.

You do have to know a little bit about — you have to know something about banking and what’s going on in the various kinds of lending and everything.

And I would say that generally speaking, for people that don’t spend a lot of time on their investments, they’re going to have trouble separating financial institutions.

I think it’s much easier to come to a conclusion on something like Coca-Cola or Procter & Gamble than it is for a person who is spending only a limited amount of time on investing to make a decision on whether to own bank A, or bank B, or bank C.

Charlie?

CHARLIE MUNGER: Yeah, there’s another problem. Generally accepted accounting principles allow a conservative, sensible bank to show vastly increased earnings if it changes its practices to make a lot of extremely dumb loans in large volumes.

Generally accepted accounting principles should not be constructed to allow this result. It’s — that what seduces so many of these bankers into this ghastly decision-making.

WARREN BUFFETT: Yeah, when we bought Gen Re, they had a financial products division. It was named similarly to the AIG one. It was called Gen Re Financial Products — AIG Financial Products.

And it produced numbers regularly that were always satisfactory numbers. But, you know, when we looked at that, you know, it looked like all kinds of trouble to us.

It cost us over 400 million to get out of. And a black box like that can produce — that’s why managements love them to some degree, they can produce numbers.

They don’t necessarily produce cash. And they sure as hell can produce all kinds of problems if you have to start posting collateral and doing things of that sort.

And I would say it is tough for, you might say, the passive investor, the one who’s not spending very much time on it. I would say it’s difficult for them to discern when that’s going on.

So I — it’s not a bad area to just say, “This one’s too tough,” and go onto something else that’s a lot easier.

I think you can analyze a utility operation easier or, you know, some premier consumer company or something of the sort.

I don’t think I would look for the tough situations to differentiate tough industries in which to differentiate things.

But there are huge differentiations. And again, I urge to read the JP Morgan Chase — Jamie Dimon’s letter. Because you’ll learn a lot by reading that.

CHARLIE MUNGER: But a lot of the new regulation that is coming wouldn’t have even been needed if accounting had done a better job, particularly in banking.

And yet, I have yet to meet an accountant from any of the big firms who has said, “I’m ashamed of my own profession.”

That’s a mistake in accounting. If they don’t have shame, they’re not thinking right.

WARREN BUFFETT: Well, with that happy thought, we will — (laughter) — we will go to lunch now.

We’ll reconvene about — let’s reconvene about a quarter of one. We’ll start at that time with Andrew and move onto section 2 when we come back.

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lastmover · 6 years

Text

2008 Berkshire Hathaway Annual Meeting (Morning) Transcript

1. TV soap star Susan Lucci trades jobs with Buffett

NEWS ANCHOR (CNBC’s Becky Quick, on tape): Folks, this just in. It appears that Warren Buffett has struck a deal to trade jobs with daytime soap opera diva Susan Lucci.

Buffett has reportedly negotiated a permanent spot on the cast of All My Children. Apparently, Ms. Lucci is en route to Omaha as the new CEO of Berkshire. (Applause.)

CHARLIE MUNGER: Where could he be? (Laughter and applause as actress Susan Lucci comes on stage)

SUSAN LUCCI: Do you mean Warren, Charlie? He’s been detained at the TV studio. (Laughter)

CHARLIE MUNGER: Really?

SUSAN LUCCI: Hi, Charlie. I’m Susan Lucci. Oh, haven’t you heard about the deal between Warren and me? He’s going to be a big star in All My Children, and I’m going to be taking over Berkshire Hathaway.

CHARLIE MUNGER: Well, you’ve certainly got some important qualities that Warren lacks. (Laughter)

SUSAN LUCCI: Well, thank you, Charlie. And you can relax now, you dear man. You just make yourself at home because I’ll take it from here, thank you.

I’ve been wanting to talk to our shareholders for quite some time now. There’s some changes I really think we need to make around here.

The first thing we need to look at is our dividend policy. (Laughter)

I have never heard of anything so cheap and so unfair to our wonderful shareholders. We need to change it. (Applause)

CHARLIE MUNGER: Sounds good to me. (Laughter)

SUSAN LUCCI: And, second, we need to look at giving guidance on earnings. And we need to do that every single week. (Laughter)

CHARLIE MUNGER: Sounds good to me. (Laughter)

SUSAN LUCCI: And, third, we need to pay our directors more than $900 a year. (Cheers and applause)

WARREN BUFFETT: Just one minute. (Applause.)

SUSAN LUCCI: Hi, Warren. Warren, I thought you were at the All My Children studio.

WARREN BUFFETT: What’s that talk about dividends that I hear?

SUSAN LUCCI: Oh, nothing important, Warren. You just concentrate on your role on the show.

WARREN BUFFETT: Susan, my show is Berkshire Hathaway. And my role is to run it. (Takes paper out of jacket pocket and rips it up)

SUSAN LUCCI: Warren, you can’t do that.

WARREN BUFFETT: I just did it. All My Children can’t do without you, and I can’t do without Berkshire. (Applause.)

SUSAN LUCCI: Oh, Warren. So you mean the deal is off?

WARREN BUFFETT: The deal is off. I really want to thank you. You’ve brought me to my senses. You can go back to All My Children. I’ll stay here at Berkshire.

But I am so grateful to you Susan, that I want you to go out to Berkshire — not to Berkshire — to Borsheims and I want you to pick out anything you would like, and charge it to Charlie. (Laughter)

SUSAN LUCCI: Oh, Warren, you are darling. Thank you. (Applause.)

SUSAN LUCCI (to MUNGER): And you’re a darling, too.

WARREN BUFFETT: Now, wait a second.

SUSAN LUCCI: Thank you. (Applause)

2. Welcome

WARREN BUFFETT: OK. Charlie, let’s get this show on the road. (Laughter)

The — she spent more time with him than she did with me, but — (Laughter)

The — we’re going to follow the usual procedure.

The business meeting will start at 3:15. But between now and then, with a break for lunch, we’re going to answer your questions. We don’t screen them ahead of time, as you know — based on who gets lined up at the microphone first.

And we’ll go around from sections to sections and then go to the overflow rooms. My understanding is that our best estimate is that we have about 31,000 people here today. (Applause.)

WARREN BUFFETT: Somewhere I have a map here. Marc, do we have that?

Pardon me? Can’t hear a thing up here. But in any event — on the yellow pad. OK. We’ll just mark them off as we go along.

The — I would like, before we start — I heard Ron Olson laughing there. I think he made it. I’m glad to hear it.

Let me introduce our directors. I really wasn’t sure whether to go through with this part of the show after they showed that rousing applause for things like dividends and raising their — but we have up here — we have Charlie Munger on my left. He’s the one that can hear; I can see. We work together for that reason. (Applause.)

WARREN BUFFETT: And if the rest of you will just stand as I give your name. And if you’ll hold your applause to the end — or even longer if you would like — (laughter) — I will introduce them.

It’s Howard Buffett, Susan Decker, Bill Gates, David Gottesman, Charlotte Guyman, Don Keough, Tom Murphy, Ron Olson, and Walter Scott. The best directors in America. (Applause.)

WARREN BUFFETT: Charlie and I will take a break at noon because we will probably, by that time, have finished all of the things we have up here to eat, and we’ll need to have lunch.

I’d appreciate it if you would limit your questions to one question, and that means not embodying a three-parter or a four-parter or something like that.

And there’s no need to make a long introductory statement because we’ll get more questions answered that way, and we want to cover as many people as we can.

3. How NOT to be a lemming

WARREN BUFFETT: So with that, we’ll go right over to post number 1 and start in with the first question.

AUDIENCE MEMBER: Very good morning to Mr. Buffett and Mr. Munger. My name is Rajesh Furor (PH) from Bombay, India.

I have been learning a lot from letters of yours. It’s been a great insight into investment philosophy that I haven’t learned from anywhere else. Great job.

That’s on the mind side. But on the heart side, what touches me the most is what you have achieved all these years is through a hundred percent honesty, and I salute to that. Thanks.

WARREN BUFFETT: Thank you.

AUDIENCE MEMBER: Now, my question is on what key steps would you recommend to correct the mind set of typical investor like me, which is what you noted as lemmings-like, the crowd mindset?

WARREN BUFFETT: What would we recommend — we got the question being repeated here — about the mindset of an investor? Is that —?

CHARLIE MUNGER: He wants you to advise him as to how he can become less like a lemming. (Laughter)

WARREN BUFFETT: Well, since you repeated the question, I’m going to let you give the first answer to that, Charlie. (Laughter)

Until he eats about a thousand calories, it — (Laughter)

CHARLIE MUNGER: He wants to invest less like a lemming.

WARREN BUFFETT: Oh, I understand that. I was giving you the first shot at it. Well, I will tell you what changed my own life on investing.

I started investing when I was 11. I first started reading about it — I believe in reading everything in sight. And I first started reading about it when I was probably six or seven years old.

But for about eight years I wandered around with technical analysis and doing all kinds of things, and then I read a book called “The Intelligent Investor.” And I did that when I was 19 down at the University of Nebraska.

And I would say that if you absorb the lessons of “The Intelligent Investor”, mainly in — I wrote a forward and I recommended particularly Chapters 8 and 20 — that you will not behave like a lemming and you may do very well compared to the lemmings.

We have here in the Bookworm, copies of “The Intelligent Investor”, and I think it’s as great a book now as I did when I read it early, I guess, in 1950.

You will never — you can’t get a bad result if you follow the lessons of — Ben Graham taught in that book.

I should mention that there’s a book out there also that I did not know it would be completed by this time.

My cousin, Bill Buffett, has written a book about our grandfather’s grocery store called “Foods You Will Enjoy.” And Bill will be out there. He’s signing books.

I just got my first copy a couple days ago. Read it, and I enjoyed it a lot.

Charlie worked at the same grocery store — how many years ago? Probably a good 70 years ago in Charlie’s case. Neither one of us was very good. (Laughter)

But my grandfather — you don’t want to pay much attention to his advice on stocks. He wrote a lot of letters, and he was very negative on the stock market and big on hard work at the grocery store.

So we quit listening to him. (Laughter)

Instead, read The Intelligent Investor. That’s the book that gave me the philosophy that has taken me now for a lot of years.

And there’s three big lessons in there which relate to your attitude towards stocks generally, which is that you think of them as parts of a business; and your attitude toward the market, which is that you use it to serve you and not to instruct you; and then the idea of a margin of safety, of always leaving some extra room and things.

But the people in this room, I think, have learned that important first lesson. I mean, I think most people that own Berkshire do not see themselves as owning something with a little ticker symbol or something that may have a favorable or unfavorable earnings surprise or something of the sort, but they’d rather think of themselves as owning a group of those businesses that are out there in the other room.

And that’s the way to look at stocks. You’ll never be a lemming if you do that.

4. Buffett will handle Cologne Re’s investment portfolio

WARREN BUFFETT: Let’s go to Number two.

AUDIENCE MEMBER: Good morning, Warren. Good morning, Charlie. My name is George Iscis (PH) from Cologne, Germany.

My question: how is the operational integration of the Cologne Re progressing? Thank you very much.

WARREN BUFFETT: Cologne Re, for those of you who are not familiar with it, is a 95 percent-owned subsidiary of General Re, of which Berkshire Hathaway owns 100 percent.

And Cologne Re, I believe, is the oldest reinsurance company in the world. It’s done a magnificent job for us as part of, first Gen Re, and then Berkshire Hathaway.

And we have a process in place that will, before too long, result in us owning a hundred percent of Cologne.

One difference, then — there won’t be any difference in operation. It runs magnificently the way it’s being run. But at that point — up until this point, they have run their own investment portfolio. That portfolio and the equity portfolio of GEICO are the only two that I don’t run.

But when we own a hundred percent of Cologne, then I will take the responsibility for Cologne’s investment portfolio. Otherwise it would be hard to improve on the operation of the management of Cologne.

So there will be — you will not see any other changes except we will consolidate in 100 percent of the earnings of Cologne rather than 95 percent.

5. “Forget about the word ‘stock’”

WARREN BUFFETT: Area 3.

AUDIENCE MEMBER: Good morning, Mr. Buffett, Mr. Munger. My name is Sam Reiner (PH) from Fort Lee, New Jersey, and my question concerns your comment this week about the recession, and the stock market going up so significantly in April.

Can you expand on where the market is going from here? (Laughter)

WARREN BUFFETT: Hah. Well, I can expand, but I couldn’t answer. (Laughter)

Charlie and I haven’t the faintest idea where the stock market is going to go next week, next month, or next year. We never talk about it. You know, it never comes up.

Our directors will tell you that they’ve never been to a directors meeting where the subject of the direction of the stock market is — we are not in that business. We don’t know how to be in that business.

Obviously, if we could guess successfully a high percentage of the time where the stock market was going to go, we would do nothing but play the S&P futures market. There wouldn’t be any reason to look at businesses and stocks. So it’s just not our game.

We don’t think — what we see when we look at the stock market is we see thousands and thousands and thousands of companies priced every day, and we ignore 99.9 percent of what we see, although we run our eyes over them.

And then every now and then we see something that looks like it’s attractively priced to us, as a business. Forget about the word “stock.”

So when we buy a stock, we would be happy with that stock if they told us the market was going to close for a couple years. We look to the business.

It’s exactly the same way as if you were going to buy a farm a few miles here outside of Omaha. You would not get a price on it every day, and you wouldn’t ask, you know, whether the yield was a little above expectation this year or down a little bit.

You’d look at what the farm was going to produce over time. You’d look at expected yields. You’d look at expected prices, the taxes, the cost of fertilizer, and you would evaluate the intelligence of your purchase based on what the farm produced relative to your purchase price.

Quotes would have nothing to do with it. That’s exactly the way we look at stocks. We look at them as businesses. We make judgments about what the future of those businesses will be. And if we’re right about — in those judgments, the stocks will take care of themselves.

Charlie?

CHARLIE MUNGER: Nothing to add. (Laughter)

WARREN BUFFETT: He’s been practicing for weeks. (Laughter)

6. We don’t cultivate great managers, we keep them

WARREN BUFFETT: Let’s go to area 4.

AUDIENCE MEMBER: Good morning, Mr. Buffett and Mr. Munger. My name is Chander Chavla (PH), and I am from Seattle, Washington.

Berkshire Hathaway has some of the best managers in the world, and I am very bad at hiring good managers. The — some of the decisions that I’ve made, which were without any phone calls from Jamie Lee Curtis, I look back and I see — you know, what was I thinking.

What can you advise on, how in one hour you can assess the capability of a person to be a good manager?

WARREN BUFFETT: Well, you have to understand that we cheat. (Laughs)

We buy businesses with good managers. So if you give me a hundred MBAs — and I have these classes come out all the time to Omaha. I’ve had about 30 schools this year, and usually there’s 75 or a hundred men and women in the classes.

I no more could take those hundred and spend a few hours and rank them from number one to a hundred in terms of their future achievements as managers, you know, than I could pick them — you know, it would be impossible for me.

But what we do is we buy businesses with great managers in place. We’ve seen those people perform for, in many cases, decades. We’ve seen their record, and they come with the business.

Now, our job is not so much to select great managers, because we do have this proven record that they come with. Our job is to retain them.

And many of the managers — a majority of the managers that work at Berkshire — are independently wealthy. We hand them checks, sometimes, in the billions, often in the hundreds of millions. So they do not have a monetary reason to work, in many cases.

So our job — we are dependent on them, incidentally. I mean, we have 19 or so people at headquarters, and we have 250,000 working for Berkshire around the world, and we can’t run their businesses.

And our job is to make sure that they have the same enthusiasm, excitement, passion, for their job after the stock certificate changes hands, than they had before.

Now, that requires some judgment on our part as to whether these people love the business or love the money. They all like money, but many of them — well, our managers in particular — they love their businesses. I mean, they’ve worked at them — they’re a work of art to them, and they’ve been in the family sometimes as many as four generations.

So we have to see the passion in their eyes, and if we see that, then we have to behave in a way that that passion remains.

Can’t be done by contract. We don’t have contracts. It won’t — that doesn’t work.

But we can try to create an environment — and Berkshire, frankly, is the ideal environment — it’s even an ideal environment because of events like this.

Our managers feel appreciated. And they are appreciated. They’re not just appreciated by me and Charlie; they’re appreciated by you. And we want to give you a chance to applaud them. (Applause.)

WARREN BUFFETT: So I can’t be of enormous help. And if you’re looking at a group of MBAs, you know, it’s not easy. I mean, they know — they sort of learn by that point in life how to fool you, in terms of what answers you want to hear and all of that sort of thing.

I would look for the person with passion for the job. I mean, the person that is always doing more than their share. You look for people that are goods communicators and all of that sort of thing.

But I like my way better. It’s a lot easier just to take somebody that’s been batting .400 in baseball and say, “I think I’ll stick them in the lineup.”

And the nice thing about our game is that, you know, in baseball, unless you’re Nolan Ryan or somebody, you have to hang up things at 40 or thereabouts, but in our game, they go on and on and on.

I mean, I use as an example — we had a famous Mrs. B from the Furniture Mart, and she worked for us until she was 103, and then she left and she died the next year. And that is a lesson to our managers that — (Laughter)

Charlie?

CHARLIE MUNGER: Well, that was very useful advice. It reminds me very much of the late Howard Ahmanson.

And a young and starving business student once asked him for advice as to how to get ahead, and Howard said, “Well, I always keep a few million dollars laying around in case a good opportunity suddenly turns up.” (Laughter)

7. Teaching option pricing is “totally nonsense”

WARREN BUFFETT: Well, let’s go to number 5. (Laughter)

AUDIENCE MEMBER: Good morning. I’m Joe Hutchin (PH), a shareholder from Culver, Indiana.

Could you please comment on how you use stock options when trying to enter or exit a position in a public company?

WARREN BUFFETT: Yeah. We’ve — I think there’s one time we sold a put on Coca-Cola with the idea that, if it got exercised, we were very happy to own more Coca-Cola. It didn’t get exercised. We would have been better off if we had just bought the stock.

Usually, if you want to buy or sell a stock, you should buy or sell the stock.

And using an option technique to buy a call on a stock instead of buying the stock outright with the idea that you get it a little cheaper that way means that about four times out of five you’ll be right and the fifth time the stock will have moved earlier and you’ll have missed, you know, the transaction you wanted to have.

And so we virtually have never used options as a way to enter a position or exit a position, and I would doubt very much if we do.

We’ve used — we’ve sold these equity — long-term equity put options that were described in the press release yesterday and were described in the annual report, but that’s a different sort of thing.

If we want to buy something, we’ll just start buying it. And if we want to get out of it, we’ll start selling it. And we won’t get involved in any fancy techniques.

Charlie?

CHARLIE MUNGER: Well, if I remember right, you wrote a letter when the public authorities were deciding whether we should have option exchanges for stocks. And Warren was all alone at that time, and he wrote a letter saying that he didn’t think it would do any good at all for the country to throw out the margin rules in this fashion.

I’ve always thought that Warren was totally right. We — it’s — the idea of turning financial markets into gambling parlors so the croupiers can make more money has never been very attractive to us.

WARREN BUFFETT: Yeah. (Applause.)

WARREN BUFFETT: Yeah. It’s very interesting to me when I talk to these MBA students. One of them from the University of Chicago, the very first question I got a few years ago, he says, “What are we being taught that’s wrong?”

I love questions like that. I have to plant them in the future.

The amount of time spent at business schools — maybe it’s a little less now — but teaching things like option pricing and that sort of thing, it’s totally nonsense.

I mean, you need two courses in a business school: one is how to value a business, and — from the standpoint of investments — how to value a business and how to think about stock market fluctuations.

But the idea that you would spend all of this time with formulas — but the problem, of course, is that the instructors know the formulas, and you don’t when they come, and so they’ve got something to fill the time explaining to you.

And, you know, it is no fun if you — I mean, if you were teaching Biblical studies, you know, and you could read three or four of the most important religious tomes forward and backward in five different languages, you would hate to tell somebody that it comes down to the Ten Commandments. I mean, any damn fool can do that.

So there’s a great desire of the priesthood in finance to want to teach the things that they know and you don’t know and that they spent a long time learning and that maybe requires a fair amount of mathematics.

And it really has nothing to do with investment success. Investment success depends on buying into the right businesses at the right price. And you have to know how to value businesses, and you have to have an attitude that divorces you from being influenced by the market.

You want the market there, not to influence you, you want it there to serve you. And that requires a mindset, which goes back to an earlier question, and it’s a mindset that’s described quite well in Chapter 8 of “The Intelligent Investor.”

8. Buffett praises sister Doris for her “retail” charity

WARREN BUFFETT: Let’s go to number 6.

AUDIENCE MEMBER: Hi. I’m Irene from Bonn, Germany. Both of you are very generous person. What is your joy of giving, and what are the potential pits when donating money — pitfalls when donating money? I’m sorry.

WARREN BUFFETT: The joys and giving and the pitfalls of donating money, huh. The — I know personally I’ve never given up anything in my life that made a difference in my life.

I mean, there are people that will go to church this Sunday and they will drop money in a collection plate, and it will make the difference about where they take their family, or whether they take their family, in terms of where they eat, whether they go to a movie, whether they get an extra present at Christmas, whatever it may be.

I mean, they are giving some money that makes a difference in their lives. I’ve never given a penny that way, and I never will.

I mean, I get to do everything I want to do in life. But because I’ve lived a long time — which gives you an enormous advantage in terms of accumulating money — and most of the things I want in life don’t come from the expenditure of money.

So it accumulates, and basically I’m giving away excess. I’m not giving away anything from necessity.

So I really — you know, I think what I’m doing is useful with the money, but I don’t think it’s on a par at all with the actions of somebody that’s giving money that really makes a difference in how they or their children live.

Those are really charitable people. I think my sister Doris is here. She has given away money that made a difference in her life. She gives away time, too. She gives away eight or ten hours a day, in terms of actually looking into the real needs of people, and giving them things beyond the money — giving them help and advice and somebody to talk to.

And, you know, that’s real giving. And I admire her for it. I’m not emulating her. I mean, she is in the retail business of giving; I like wholesale much better.

In terms of the pitfalls, you know, you can make mistakes in any area. But if you — you should give to things that you personally have an interest in and believe in, and that can be anything. I don’t — I’m not going to prioritize what should be done with gifts.

Something you’re involved in. Something you want to give your time to as well as money. But beyond that, I’ll let Charlie carry on.

CHARLIE MUNGER: Yeah. Regarding pitfalls, I would predict that, if you have an extreme political ideology, whether of the left or the right, you’re very likely to make a lot of dumb charitable gifts. (Laughter and applause)

WARREN BUFFETT: If you hang around Charlie like I do, you get the sunny side of life. I mean — (laughter)

We ought to have that playing, “The Sunny Side of the Street.”

9. We don’t “tell the world how to run their business”

WARREN BUFFETT: Let’s go to number 7.

AUDIENCE MEMBER: Good morning. My name is Okosh Vajay (PH), and I’m from India. I worship Mr. Buffett for his philanthropy, and I do hope to serve the Gates Foundation someday.

My question to Mr. Buffett is, what’s your level of involvement when one of your companies is faced with an ethical dilemma? For example, Fruit of the Loom’s competitors have sweatshops in Central America. So what do you do to ensure that you don’t fall into the same trap?

WARREN BUFFETT: Yeah. Well, we let our managers run their businesses. And we’ve got some terrific managers, not only in terms of ability, but I would say that what we have seen of the ethical standards of our managers has been extraordinary over the years.

That doesn’t mean there isn’t — there aren’t slip ups here or there. But taken as a group, over decades, I think that I’m very happy, in effect, turning over the keys, not only to the financial performance of the business, but in terms of how they behave.

And I would say that I think you’re quite wrong in terms of — Fruit of the Loom’s operations are conducted in absolutely terrific standards. John Holland is here. I’d be glad to have you meet with him later.

But we — we’re proud of our businesses and how they operate.

We do not give them elaborate guidelines. I write them a letter every two years, roughly, and I ask them to send me a letter telling who they think should be the successor if anything happened to them that night. I keep those letters around. Fortunately, they don’t come into play very often.

But I also tell them we’ve got all the money we need. It’s nice to have more money, but we’re not going to lack for money at Berkshire Hathaway.

We don’t have a shred of reputation more than we need, and we never want to trade away reputation for money.

So we give them that same message that was given in the movie, in terms of the Salomon situation, which is that not only do they behave in a way that conforms with the laws, but that they behave in a way where, if a story were written by an unfriendly but intelligent reporter, the next morning, in their local paper, they would have no problem with their neighbors, their family reading it.

And we run that in the movie every year, just because we like the managers to keep getting that message all of the time. There is no pressure from Berkshire’s corporate office to report X dollars per — of earnings in any quarter. They don’t give me budgets, so they don’t — there’s no feeling that they have to come through with given numbers or I’ll be embarrassed in public in terms of publishing earnings or anything of the sort.

We have no incentives to cause people to do anything that would go against their conscience or play games or cut corners or anything of the sort.

And, overall, I think it’s worked pretty well. It isn’t perfect. You can’t have 250,000 people in the city without having something going on at some point. And we do have 250,000 people working. But I’m not unhappy with our batting average.

Charlie?

CHARLIE MUNGER: Yeah. And, of course, Fruit of the Loom does have foreign plants, and we have no rule against that at all. We’ve got quite a few foreign plants now.

We don’t favor foreign plants. We just do whatever makes sense under the circumstances.

WARREN BUFFETT: Yeah, we had a shoe business I’ve written about in Maine, and we had wonderful, wonderful workers there. They were more productive than workers around the world.

But the United States was producing, 20 years ago, roughly a billion pairs of shoes a year, and we were a nation of Imelda Marcoses. I mean, it was wild.

And Brockton, Massachusetts, and you name the towns, revolved around the shoe business, as did a town called Dexter, Maine.

And we bought that business. And we tried to compete. We had a good brand name. We had great workmanship. And we found out that it just plain wouldn’t work against — competing against — shoes produced in China.

So now of the — it’s over a billion pairs of shoes a year used in this country. Basically they all come from outside the borders. And you’re going to see that.

And factories in China, factories in Central America — they do not have exactly the norms that we have in this country. And, you know, that’s going to be the situation.

We are — we will not — we are not going to tell the world how to run their business in any great way.

We — obviously we have some standards that have to be met, but we are not — they are not exactly the situation you are going to find in the United States.

10. Buffett dismisses higher raw material costs

WARREN BUFFETT: Number 8.

AUDIENCE MEMBER: Good morning. My name is Mike McGowan (PH). I’m from Pasadena, California. I’m a shareholder in both Berkshire and Wesco. I run a website called FinancialFoghorn.com, and I write about precious metals and things.

And I’ve asked you questions in the past about silver, and I didn’t really get them answered. So I thought I’d ask about a different commodity this time.

I read about the Chinese raising the price of tungsten, and I think about your comment last year in buying ISCAR.

Will commodity price increases in things like tungsten affect the profitability of ISCAR? And would that be the reason you’re locating a plant in China to build machine tools? Thanks.

WARREN BUFFETT: Yeah. The reason the plant was built in China was to serve the Chinese market, which is large and growing. And we opened in Dalian late last fall.

It’s nicer to be closer to the raw material, but it really had nothing to do with changes in the price of tungsten.

Generally speaking, if you’re creating a higher value-added product, as ISCAR is doing, from a raw material, there may be three months, six months, of adjustment to changes in raw material prices. And obviously, with some commodities, if it gets high enough you get into substitutes.

But there isn’t going to be any substitute for tungsten in the cutting tools, and there won’t be — you know, we tried some substitutes for crude oil in terms of gasoline or — not so — heating oil but then the substitutes like natural gas go up in price, too.

So I think largely, in our businesses, raw materials get passed through.

Now, we’re having a tough time, for example, in the carpet business in passing through the cost increases that we experience in oil-based raw materials. But we would be having trouble — we probably would be having trouble in the carpet business regardless now because of the slowdown in residential housing. It does make it tougher.

But over a period of time, our businesses are going to reflect raw material costs. You know, the candy here I have, this fudge, which I can hardly wait to get into, you know, it’s going to reflect sugar and cocoa and things like that over time.

And if you’re running an airline, it’s going to reflect the cost of fuel. So you can have little squeezes here and there, but it’s not a big deal, and it certainly isn’t the reason that we went to China to locate the ISCAR facility.

That facility — incidentally ISCAR — we have a number of people here from ISCAR, and families in some cases.

That is — I had very high expectations for that when we bought it. It’s exceeded it in every way. It’s exceeded in terms of financial performance. It’s exceeded in terms of the human relations we’ve developed with the people.

I mean, it was — I told you it was a terrific acquisition a few years ago. It’s been a dream acquisition, and I know Charlie wants to add to that. (Applause)

CHARLIE MUNGER: Yeah. I would say that the short answer is that, while we don’t like inflation because it’s bad for our country and our civilization, that we will probably make more money over time because there is inflation.

11. Lots of work to find a better buy than Berkshire

WARREN BUFFETT: Go to number 9.

AUDIENCE MEMBER: Good morning. My name is Marc Rabinov from Melbourne, Australia.

My question is, Berkshire has bought a lot of shares over the last 12 months in listed companies. Do you expect the return on these investments to be between 7 and 10 percent per annum over many years, which is, I would say, well below what Berkshire has achieved in the past?

WARREN BUFFETT: The answer to that is yes. (Laughs)

The — we would be very happy if we could buy common stocks where our expectation over a long period, pretax, from a combination of dividends and capital gains — we’d be very happy if we thought it was going to be 10 percent, and we would probably settle for a little less than that.

And there’s no question — absolutely no question — that returns from owning Berkshire will be less in the future than they have been in the past.

There’s no question that we will not do as well with the common stocks at Berkshire that we own in the future as we have over the last, really, 40 years or thereabouts.

We operate now in a universe of marketable stocks that — where we’re talking about companies with market caps of at least 10 billion but really, in most cases, to have a meaningful impact on Berkshire, we’re talking much bigger than that, maybe 50 billion and up.

Well, that universe is not as profitable a universe to operate in as if you have the entire universe of thousands and thousands of companies.

So we — if we — just take an example. If we find a company with a market cap of 10 billion and we can buy 5 percent of it — and usually that’s what we can buy without disturbing things — we can have a $500 million investment.

Let’s say it doubles over a period of time. That’s 500 million. You pay a 35 percent tax. You have 325 million. That’s less than two-tenths of 1 percent in terms of Berkshire performance.

So our universe has shrunk enormously, and we will not do as well in that universe — remotely as well — as we would if we were the operating in a much wider universe and could do all kinds of things.

We’ve found little things to do from time to time where we’ve made some money. I may refer to them a little later, a couple things. And they’re nice, but they don’t move the needle very much at Berkshire.

So anyone that expects us to come close to replicating the past should sell their stock. I mean, because it isn’t — it isn’t going to happen.

And, you know, I think we’re going to get decent results over time, but we’re not going to get indecent results. And in this field we prefer indecent, but we’re not going to get them.

Charlie?

CHARLIE MUNGER: I think you can take Warren’s promises to the bank.

We are very happy making money at a rate in the future that is way less than the rate at which we made money in the past. And I suggest that you adopt the same attitude. (Laughter)

WARREN BUFFETT: Well, I wouldn’t condemn them to that. I think if you’re working with small amounts of money — I’ve talked —

CHARLIE MUNGER: Oh, yeah.

WARREN BUFFETT: Yeah. Then you may have something very much better to do with your money than to buy Berkshire.

I mean, if you’re working with small amounts of money, and you want to put in significant amounts of time, and examine thousands of securities, you will find things that are more intelligent to buy than Berkshire.

You know, we still think Berkshire is an attractive investment over a long period of time. We think that it stacks up reasonably well with other very large companies.

We don’t think it’s the most attractive investment in the world, in terms of what you can find if you’re willing to go through those thousands of possibilities, which is what Charlie and I used to do many years ago. It’s not feasible for us to do it now and wouldn’t have any impact on Berkshire.

What we really like at Berkshire is buying good-sized to very large first-class businesses with first-class management and just sitting there. Because the nice thing about that is you don’t have go from flower to flower. You can just sit there and watch them produce more and more every year and give you capital and you can buy more businesses.

That’s a nice formula. It’s a formula that will work, I think, for us. It won’t produce returns like the past.

12. PacifiCorp will follow regulators on Klamath River dam

WARREN BUFFETT: Number 10.

AUDIENCE MEMBER: (Inaudible). My name is Chu Chu (Inaudible), and I come here from the Klamath River, and I come here with a heavy heart.

And I know this is a pretty light-hearted event, but I came here last year with a heavy heart, too. And I fasted for ten days driving over here to speak with you.

And, you know, we really were disrespected last year, because one of your subsidiaries, PacifiCorp, has dams on the Klamath River that are creating toxic algae blooms, along with multiple other things. I won’t go into it too far.

But I just come here today with a principle agreement between you and I, that you will sit down at the table and help us figure this out, help us make PacifiCorp accountable.

And being that I’m an indigenous American, and you’re a guest in my home as a European American, that you would do that in front of all your shareholders today in good faith, that you care, you know, as a philanthropist and you care about, you know, helping, you know, third-world countries, you know, fight poverty, disease, when you’re helping create it right here in the United States.

WARREN BUFFETT: You may not — you may not — last year we read the order under which we acquired PacifiCorp.

And, actually, as you may know, I’m prohibited from actually making decisions in that — in the area of PacifiCorp. That was part of the public utility commission ruling when we bought it.

But we have Dave Sokol here who can speak to that. I think the first dam was built in 1907, and we bought PacifiCorp a couple of years ago.

But David — if Dave could go to a microphone, I think that — I think he could address the issues that you brought up. I don’t think we meant in any way to be disrespectful last year.

Those of you who were here last year, we may have a difference of opinion on this, and incidentally there are strong differences of opinion, as I understand it, in your area about what should be done.

And — well, I think I should have Dave make the explanation on it. Dave? Somebody want to put a spotlight on the —

DAVE SOKOL: Thanks, Warren. As you stated first, it would be inappropriate for Mr. Buffett to respond in any detail on this issue, because it’s part of the acquisition in 2006 of PacifiCorp.

He specifically agreed in writing not to interfere with any decisions of our regulated assets within PacifiCorp. So having said that, these four dams that we operate on the Klamath River were built over the last 100 years.

There are a whole series of issues in the Federal Energy Regulatory Commission relicensing process as to what should occur.

These decisions, through that regulatory process, have been ongoing for eight years, and they won’t culminate for probably another six.

Having said that, there are 28 various parties from federal, state, and local agencies, Native Americans, fishery folks, local landowners, that are party to a discussion as to what should or should not happen with these assets — and I left out the irrigators.

Of those 28 parties, other than PacifiCorp, there are at least four different directions in which people think this process should go.

From our perspective, we will be pleased to find a resolution when the 28 parties agree as to how that resolution should go forward, how it would be funded, et cetera.

Fundamentally, it’s up to the Federal Energy Regulatory Commission, state and federal regulators, in addition to them, and then our specific regulators in each of the six states that PacifiCorp operates in.

So if public policy moves in a direction of dam removal, fish ladders, or maintaining the existing status quo, that would be the process in which we would go forward.

We are working constructively with each of the various parties. We’ve met numerous times with each of the four tribes. And it’s a complicated situation and one that hopefully, over time, a cooperative resolution can be met. (Applause.)

13. Eat what you want and love what you’re doing

WARREN BUFFETT: Area 11, please.

AUDIENCE MEMBER: Good morning. I’m (inaudible) from Walnut Creek, California. Well, we learned something from the comic movie, but could you please expand on how do you maintain your good mental and physical health? (Laughter)

WARREN BUFFETT: Well, you start with a balanced diet. (Laughter)

Some Wrigley’s, some Mars, some See’s, some Coke.

Basically it — if Charlie and I can’t have a decent mental attitude, who can? I mean, we get to do what we love doing every day. We do it with people that are not only cheerful about it and like us, but they do their jobs extraordinarily — they like their jobs too.

We’re forced to do virtually nothing we don’t want to. I have a trainer that comes three times a week. She — I think she’s probably here. And she may think I’m a little begrudging in that particular activity, but that’s only 45 minutes, three times a week.

The rest of the time I am doing almost — well, I’m doing whatever I love, you know, day by day by day by day. And I do it, you know, in air-conditioned offices and, you know, with all kinds of help and it — I mean, how could you be sour about life, you know, being blessed in so many ways?

And then the amazing thing is that Charlie is 84; I’m 77. And we’ve slowed down, I’m sure, in a lot of ways, but we pretend we haven’t, and it doesn’t seem to bother us. (Laughs) We get along fine.

Great partners, great managers, you know, great families. I — there’s just no reason to look at any minuses in life and to focus on that. It would be crazy.

So we really do count our blessings because they’ve been many and they continue to come forth, and we’ll enjoy it as long as we can. There’s not much more to it than that.

Charlie?

CHARLIE MUNGER: Well, I wish we were poster boys for the benefits of running marathons and maintaining a very slim bodily state and so forth.

But as nearly as I can tell, neither of us pays much attention to any health habits or dietary rules — (laughter) — and it seems to have worked pretty well so far. I don’t think we can recommend it to everybody, but I, for one, don’t plan to change. (Laughter and applause)

WARREN BUFFETT: Really, from the moment we get up to when we go to bed at night, we get to do all kinds of things.

We get to — associating with wonderful people is about as good as it gets. And, you know, we live — we’re biased, obviously — but we think we live in the best country in the world and have all kinds of good things. I mean, just imagine — (Applause.)

WARREN BUFFETT: We could have stayed in my grandfather’s grocery store, and it would have been hell. (Laughter)

CHARLIE MUNGER: By the way, this relates to the subject of corporate compensation.

You’re in a job which you would pay to have, if that were the only way to get it, and you’re supposed to be an exemplar from other people — for other people. There’s a lot to be said for not paying yourself very well. (Applause.)

WARREN BUFFETT: He points that out to me regularly. (Laughs)

Well, if you think about it, you know, the idea that CEO compensation represents a market system and that you have to pay some guy a $10 million retention bonus or something to stay around in the job that, you know, he’s been fighting to keep and stacking the board and everything so they keep him around.

I mean, it’s — I don’t know of a CEO in America — I’m sure there are a few — but I don’t know of any that wouldn’t gladly do the job at half the price or a quarter of the price.

And I’ve seen some that have left jobs paying them eight figures and nobody’s offered them anything, you know, a year later or two years later. I wonder where that wonderful market system is that is supposed to have all these bidders for their services. It’s really sort of ridiculous, I think. (Applause.)

14. Follow your passion and marry the right spouse

WARREN BUFFETT: Let’s go onto 12.

AUDIENCE MEMBER: Hi. I’m Richard Rentrop from Bonn, Germany.

At the moment I attend high school and would like your wisdom on how to approach the question of what to do with the rest of my life. So — (Laughter)

WARREN BUFFETT: We prefer things a little more difficult than that if you’re got a — (Laughter)

AUDIENCE MEMBER: So, Mr. Buffett and Mr. Munger, if you were about to start all over again, what profession would you choose and why?

WARREN BUFFETT: Well, I would choose what I do because, A, I have fun at it. I’m reasonably good at it. You know, I meet a lot of interesting people through it. No heavy lifting. You know, it — it’s — it fits me.

It doesn’t — but that — that’s not advice for you. I mean, you have to find out what really — what’s your passion in life?

You know, it’s a terrible mistake to kind of sleepwalk through your life, because unless Shirley MacLaine is right, you know, it’s the only one you’re going to have.

And the — so I’ve — I was very lucky in that I found my passion early. I mean, I — that’s not easy. You know, that takes some luck.

It just so happened my dad was in a business at a very small office and he had a bunch of books down there. And when I would go down there on Saturday or after school, I would start reading those books, and it turned me on.

And this was before Playboy actually existed. (Laughter)

And so, you know, that was just plain lucky, you know. If he’d been a minister, I’m not so sure I would have been quite so enthused about visiting the office. (Laughter)

But that’s the way to go. And I can’t prescribe that for you. But I can tell you that if you’re going through the motions in life, you’re doing something — now, obviously, if you need the job you have and you can’t make a change and your kids have to eat and all of that, you deal with realities like that.

But when you’re in a position to make choices, you know, I always tell the kids that come visit me, I tell them, “Go to work for an organization you admire or an individual you admire.”

That means many of them become self-employed, but they — (Laughter)

The idea — you know, you can’t get a bad result. I went to work for Ben Graham when I was 24. I only worked for him for less than two years, but I jumped out of bed every day in the morning.

I was excited about what I was going to do. I was learning things. I was with a man I admired. I never asked my salary when I took that job. I moved to New York City and found out what my salary was when I got the check.

So just be sure you — and be sure and get the right spouse. That’s enormously important.

You know, as Charlie says, the problem, you know, is that we talk about that fellow that spent 20 years looking for the perfect woman, and then he found her, and unfortunately she was looking for the perfect man. So you may have a problem in that respect. (Laughter)

But it’s enormously important who you marry. I mean, it’s a huge, huge, huge decision.

And, you know, if you’re lucky in a couple things like that, you’re going to have a happy life.

And you’re going to behave better as you go along. I mean, it’s a lot easier to behave well when things are going your way and you are enjoying your work and you like the — you’re thinking about things every day that are the kind of things that you like to think about.

And Charlie has a lot better advice than I have about it. Go to it.

CHARLIE MUNGER: Well, of course, you’ll do better if you develop a passion for something in which you have a considerable aptitude. I think if Warren had gone into the ballet — (laughter) - nobody would have ever heard of him.

WARREN BUFFETT: Oh, I think they’d have heard of me, just in a different way, Charlie. (Laughter)

Well, the chances are, if you find something that turns you on, you probably do have some talent for it. I mean, it — I never — I don’t think I could have gotten turned on by ballet. (Laughs)

15. How Buffett overcame his fear of public speaking

WARREN BUFFETT: Let’s go — we’re going to go now to 13, which is in an adjacent ballroom.

We have multiple overflow rooms, which is how we’re handling the 31,000. The grand ballroom is the only one we’ve got a microphone in. So let’s go to number 13. Somebody there?

AUDIENCE MEMBER: I’m Nancy Ancowitz. I’m from New York City, and I teach at New York University.

Mr. Buffett, I’d love to get your advice on something that’s a little off the investing path but that taps into your business experience and wisdom.

I’m writing a book to help people of a more introverted nature get the recognition they deserve.

What advice would you give to the quieter half of the population to help them raise their visibility in their careers?

WARREN BUFFETT: Well, that’s a very good question. And I sort of faced that at one time.

I was absolutely, throughout high school and college, terrified of public speaking.

And I would have — I avoided any classes, signing up for them, that would require it. I would get physically ill if I even thought about having to do it, let alone doing it.

And I took a Dale — well, I’ve — first of all, I signed up — I went down to a Dale Carnegie course when I was at Columbia, and signed up for it, gave him a check for a hundred dollars, went back to my room and stopped payment on the check. (Laughter)

This is a real man of courage you’re looking at up here. (Laughter)

And then I came out to Omaha, and I saw a similar ad. It was at the Rome Hotel, for you old-timers in Omaha, on 16th Street.

And I went down there, and this time I took a hundred dollars in cash and gave it to Wally Keenan, who some of you may know. He died some years ago. First time I’d met him.

And I took that course, and when I finished that course, I went right out to the University of Omaha and volunteered to start teaching, knowing that I had to get up in front of people.

I think the ability to communicate, both in writing and orally, is of enormous importance, under taught.

Most graduate business schools, they wouldn’t find an instructor to do it because it would sort of be beneath them to do something so supposedly simple.

But if you can communicate well, you have an enormous advantage. And to you, who are talking to the group of introverted people — and, believe me, I was in certain ways quite introverted — it — you know, it’s important to get out there and do it while you’re young.

If you wait until you’re 50 it’s probably too late. But if you do it while you’re young, just force yourself into situations where you have to develop those abilities.

And I think the best way to do that is to get in with a whole bunch of other people who are having equal problems, because then you find you’re not alone, and you don’t feel quite as silly.

And, of course, that’s what they did at the Dale Carnegie course. I mean, we would get up in front of 30 other people who could hardly give their own name, and after a while we’d find that we could actually pronounce our own name in front of a group.

But we would stand on tables and do all kinds of silly things, just to get outside of ourselves.

You may have thought — by this point you may think it went too far in my particular case, but that’s another problem. (Laughs)

But you’re doing something very worthwhile if you’re helping introverted people get outside of themselves. And working with them in groups, where they see other people have the same problem and they don’t feel quite as silly themselves, I think is — I think you’re doing a lot for some human beings when you help them do that.

Charlie?

CHARLIE MUNGER: Yeah. It’s a real pleasure to have an educator come who is working to do something simple and important instead of something foolish and unimportant. (Applause)

WARREN BUFFETT: I hope he’s not going to name names. (Laughter)

16. Klamath River dam economics

WARREN BUFFETT: OK. Let’s go back to number 1.

AUDIENCE MEMBER: Hi, Mr. Buffett. My name is Regina Chichizola, and I’m the Klamath Riverkeeper.

I came here today with many of the other people from the Klamath that came here, and I thank you for having us, and I thank the shareholders for being a lot nicer to us this year than they were last year.

So my question is, I’m sure you’re familiar with the severe pollution issues in the Klamath River, such as the toxic algae problem that is 4,000 times allowable recreation levels, and that the fish are also now toxic due to the Klamath dams.

I was wondering if you were familiar with the finances behind the Klamath dams? Many economic studies have shown that removing the Klamath dams would be up to hundreds of millions of dollars cheaper than relicensing them.

So my question is, what would you do if PacifiCorp decided to keep these dams, even though it would mean that your shareholders would lose money in the long run and that PacifiCorp’s ratepayers would also be losing money?

WARREN BUFFETT: Well, I think the question about the ratepayers will be addressed by the public utility commissions.

I mean, it is their job to represent the citizens of Oregon, and weigh a number of different considerations — for example, clean energy. Do you want to replace hydro energy with a — what you’re talking about — with coal, which emits carbons into the atmosphere? There are enormous tradeoffs.

Anytime the government gets involved in eminent domain — we have that with wind farms, for example, in Iowa — there’s some people that are unhappy with us using the land for wind farms. But, on the other hand, you get clean energy that way.

There are tradeoffs involved in government policy. You get into that with the question of eminent domain, all of that sort of thing.

But I think I’m going to let Dave talk to the more technical questions you get into.

But I would say, overall, you have people with widely different interests. Obviously, a big interest is the cost of electricity.

And to some extent, every public utility commission that makes a decision on gas versus coal versus wind versus solar is making a decision based partly on the economics to their ratepayers, partly on their feelings about what is the best for society, and those commissions are appointed state by state to make those decisions.

Now, in addition, in this case we have the FERC as it’s called, the Federal Energy Regulation Commission, that will also have to rule on it.

They will listen to everybody. They’ll listen to you. They’ll listen to the 28 others that Dave mentioned. In the end we will do exactly what they say.

I mean, as a public utility, if they tell us to put up — not put up coal, we will not put up coal. If they tell us to put up wind, assuming that there is a place where there is wind, we will put up wind. We follow the dictates of the regulatory bodies that tell us what to do.

And in the end they give us a fair return on the assets employed, and we will get that return whatever the assets may be. If they tell us to put in coal assets, we’ll get a return out of that.

So from our standpoint, from the standpoint of profitability, it’s neutral.

From the standpoint of society, weighing all these different things, that’s a decision society will make.

But, Dave, let’s — do you want to talk to the algae question?

DAVE SOKOL: Sure. First, it’s important, the Karuk tribe did do a study and found bioaccumulation of microcystins, or blue-green algae, in the perch and the fresh water mussels in the Klamath River.

What’s important to understand about that — and by the way, we disseminated that report immediately to state and federal health agencies because they should know about it.

Microcystin is not unique to the Klamath River. There are 27 other lakes in the state of Oregon that have blue-green algae, 70 different countries, every province in Canada, and 27 of the U.S. states have lakes that have blue-green algae.

It is created from lakes that have a high abundance of nutrients and naturally-forming algae. And at the head of the Klamath River is a lake known as Upper Klamath Lake, which is actually a Bureau of Reclamation reservoir — it’s a shallow, large reservoir, that is known as being hypereutrophic, which means a great abundance of algaes and various nutrients.

Those nutrients then flow down the river and do pass through or, in cases, get backed up by the four reservoirs down below the Bureau of Reclamation-linked dam.

The important issue is those things are, in fact, taken into account by the Federal Energy Regulatory Commission. They issued their environmental impact statement last November, which endorsed various fish passage methods on the dams but do not call for removal of the dams.

But, again, those are decisions that all the state, federal, agencies, and the various involved parties will either have to come to agreement with or let them run their course through the FERC process.

17. Long-short strategy wasn’t a big money maker

WARREN BUFFETT: Thank you. Number 2.

AUDIENCE MEMBER: Hi. My name is Henry Pattener (PH). I’m hailing from Singapore, most recently.

In one of your older letters, you — your older partnership letters in 1964 — you introduced a fourth investment method called “Generals — Relatively Undervalued.”

In your description you say, “We have recently begun to implement a technique which gives promise of very substantially reducing the risk from an overall change in valuation standards.

“We buy something at 12 times earnings when comparables or poor-quality companies sell at 20 times earnings, but then a major revaluation takes place so that the latter only sell at ten times.”

Is this technique pair trading and, if so, how did you think about and calculate the ratio of longs to shorts?

WARREN BUFFETT: Yeah. I didn’t remember we started as early as ’64, but certainly in the ’60s we did some of what, in a very general way, would be called pair trading now, which is a technique that’s used by a number of hedge funds, and perhaps others, that go long one security and short another, and often they try to keep them in the same industry or something.

They say that British Petroleum is relatively attractive compared to Chevron or vice versa, so they long one and short the other.

And actually that technique was employed first by Ben Graham in the mid-1920s when he had a hedge fund, oftentimes — I read articles all the time that credit A.W. Jones with originating the hedge fund concept in the late ’40s, but Ben Graham had one in the mid-1920s — and he actually engaged in pairs trading.

And he found out it worked modestly — very modestly — well because he was right about four times out of five but the time he was wrong tended to kill him on the other four.

We did — we shorted out the general market for about five years in the partnership, to a degree. We borrowed stocks directly from some major universities. I think we were probably quite early in that.

We went to Columbia and Harvard and Chicago and different places and actually arranged for direct borrowing. They weren’t — it wasn’t as easy to facilitate in those days as it is now.

And so we would take their portfolios and we would just say, “Give us any of the stocks you want, and then we’ll return them to you after a while and we’ll pay you a little fee.”

And then we went long things that we thought were attractive. We did not go short things that we thought were unattractive; we just shorted out the market generally.

It was always kind of interesting to me, when I would visit the treasurer of Columbia or something like and I’d say, “We’d like to borrow your stocks to short,” and, you know, he thought his stocks were pretty good at that point.

And he’d say, “Which ones do you want?” And I said, “Just give me any of them — (laughs) — I’m happy to short your whole damn portfolio.” (Laughter)

I needed the Dale Carnegie course to get me through that kind of thing, you know.

We didn’t have any specific ratios in mind. We were always limited by the number of institutions that would give us the stocks to short.

So it was not a big deal, but we probably made some extra money on it in the ’60s. It’s not something that would fit our — what we do these days at all.

And, generally speaking, I think if you’ve got some very good ideas on businesses that are undervalued, it’s really unnecessary to do any shorting out of the market.

There’s a — for those of you who are in the field — I mean, there’s a — kind of a popular proposal — money managers always have some popular proposal that’s being sold to the potential investors — and now there’s something called 130-30, where you’re long 130 percent long, short 30 percent.

That stuff is all basically a bunch of stuff just to try and sell you the idea of the day. It doesn’t really have any great statistical merit.

But the fish bite, as Charlie says. Charlie can elaborate on that.

CHARLIE MUNGER: Yeah. We made our money by being long some wonderful businesses. We didn’t make it by a long-short strategy.

18. Big opportunities often don’t last long

WARREN BUFFETT: Number 3.

AUDIENCE MEMBER: Dear Mr. Buffett, dear Mr. Munger. My name is Oliver Krautscheid from Frankfurt in Germany.

The subprime crisis has led to inconsistent pricing in capital markets. Credits are trading at large discounts, and at the same time, the equities do not reflect this.

My question is, when will this be over, and how do you take advantage of market dislocations?

WARREN BUFFETT: Well, when there are market dislocations, there are always ways to take advantage of it, but we’ll leave for you the joy of searching for those.

But there have been some really important dislocations. And I brought along, just for your amusement, a few figures on something that we’ve done recently. But it doesn’t have any big significance for Berkshire. I mean, Berkshire will make some extra money out of this.

It doesn’t take any time to think about. But it does illustrate just how dramatic the changes were. And the ones I brought along relate to the tax-exempt money market funds.

There were 330 billion of these. That’s a lot of money — 330 billion. And they relied on repricing of — really, in almost all cases — first-grade municipal bonds.

Every seven days they have these auctions, and it was all set up very elaborately so that people could have their money, more or less, in their minds, instantly available and something that was tax exempt, and they were marketed extensively.

And I brought along — for example, here’s one that related to the — they were backed by various municipal issues. This one happens to be one by the LA County Museum of Art. Just pulled that out.

And on January 24, it was marketed at 3.15 percent; January 31, 4.0; February 7, 3.5; February 14, 8 percent.

Now, how can a tax-exempt bond of short-term nature be selling at a 3 1/2 percent rate one week, and one week later on Valentine’s Day be at 8 percent, and one week after that be at 10 percent?

It’s now back to 4.2 percent. Now, those are huge dislocations in markets. That’s crazy.

It would be one thing to be some little obscure item, but this happened with billions and billions and billions of dollars of securities.

It even happened — we get these bid sheets every day, and this happens to be a bid sheet, I think, from Citigroup. And they were repricing these every seven days.

And what you would find on these — you’ll see there’s lots of issues involved — the same issue would appear on several different pages, because it would represent some different auction, although handled by the same broker at the same time.

On one page you would find an issue — we would bid all these — we happened to bid these at 11.3 percent.

On one page, we bought them at 11.3 percent. On another page, the same issue, we bid the 11.3 percent and somebody else bid 6 percent.

So you have the same issue with the same broker at the same time being sold at 11.3 percent and 6 percent. Those are marks of extreme dislocation, and you find those occasionally.

You found that after the Long-Term Capital Management crisis is 1998. You found the equivalent of it in the stock market in 1974, and so on.

And those are great times to make unusual amounts of money. And if you — there’s certain things we can’t figure out.

I see — in the Wall Street Journal — I see advertisements these days of auctions taking place in some esoteric mortgage securities. If you had enough time, you could probably figure out some of those that were very mispriced. We don’t fool around with that. We just don’t have the time.

We were able to do four — we have about 4 billion in this right now. When we get all through, we’ll have made some extra money for a couple of months.

It won’t be significant, in relation to Berkshire’s size, but it’s something that’s very easy to do.

You may be able to find — by working very, very hard on some smaller issues — you might be able to find in this mess in mortgages — and it’s gone beyond subprime. It’s gone into Alt-As and it’s gone into Option ARMs and that sort of thing.

There very well could be some great opportunities out there that Charlie and I will no longer spot because we just can’t be looking at that many things.

Charlie?

CHARLIE MUNGER: Yeah. What is interesting is that — how brief these opportunities to take advantage of dislocations frequently are.

Some idiot hedge fund bought unlimited municipal bonds at, you know, incredible margins. I think they bought 20 times more municipal bonds than they could afford with their own money, borrowing all the rest.

And when those things were dumped on margin calls, municipal bonds suddenly got mispriced in America. But the dislocation was very brief. So you —

WARREN BUFFETT: But very extreme.

CHARLIE MUNGER: But very extreme.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: So if you can’t think fast and act resolutely, it does you no good.

So you’re like a man standing by a stream trying to spear a fish and the fish just comes by once a week or once a month or once every ten years. And you’ve got to be there to throw that spear fast before the fish swims on. It’s a pretty demanding business if you do it right.

WARREN BUFFETT: But there have been times. I mean, in the junk bond market, there was a three- or four-month period in 2002 where some really incredible things happened and they happened on a large scale. So —

CHARLIE MUNGER: Yeah. It happens about twice a century.

WARREN BUFFETT: Yeah. (Laughter)

Which means he and I have only had four or five times when we could do it. (Laughter)

19. “Automatic formula for getting ahead”

WARREN BUFFETT: Let’s go to number 4.

AUDIENCE MEMBER: Hello, Mr. Buffett and Mr. Munger. My name is Svinneyvaz Canadival (PH). I’m from Fort Lauderdale, Florida.

I read all your letters and annual reports multiple times, and every time I get a different insight. So thanks for doing it.

My question is about converting the successful small businesses into large enterprise. I have a good and successful small business from the last few years, and I’m unable to grow it to the next level. It seems like there are some components are missing, so I wanted to take your advice on it.

WARREN BUFFETT: Well, Berkshire was a small business at one time. I mean, it just takes time. I mean, it’s the nature of compound interest. You know, you can’t build it in one day or one week.

So Charlie and I — you know, we’ve never tried to do in some master stroke — convert Berkshire into something four times as large. People have done that sometimes in business.

But we’ve sort of felt that if we kept doing what we understood, and did it consistently, and had fun while we were doing it, that it would be something quite large at some point.

But there’s nothing magic — it would be nice to attract a whole bunch of money into some great idea and have it — you know, multiply it manyfold in a few weeks or something of the sort. But that has really not been our approach.

We have just — we have done — in a general way, we’ve done the same thing. Now, we do little variations of it, but we kept doing the same thing for years and we’ll keep doing it.

You know, we will have more businesses a few years from now than we have now. And we’ll have all the ones we have presently. Most of them will do better. Some won’t. And we will have added something.

And that’s an automatic formula for getting ahead, but it’s not an automatic formula for galloping ahead.

But we don’t really feel — we’re not unhappy because we’re not galloping. We’re not happy if we’re not moving at all.

But, you know, we’ve got 76 or so, in most cases, pretty darn wonderful businesses. And, like I say, we’ll have more as we go along. So it’s a very simple formula.

Gypsy Rose Lee said once — she said, “I have everything I had five years ago. It’s all that it’s 2-inches lower,” you know.

Well, what we want to have five years from now is a whole bunch of businesses we had before that are 2-inches higher, plus some more businesses. And that’s the formula.

Charlie?

CHARLIE MUNGER: Yeah. You’ve got to remember that it’s the nature of things that most small businesses will never be big businesses.

It’s also in the nature of things that most small — most big businesses — eventually fall into mediocrity or worse. So it’s a tough game out there.

In addition, the players of the game all have to die, and that is — those are just the rule of the game, and you have to get used to it.

We’ve only created from scratch one small business that became a huge business that I can think of, and that’s the reinsurance department.

And there, Warren and Ajit and others have created a great and valuable business out of air. But can you think of anything other that’s large that we’ve done in all these decades?

WARREN BUFFETT: No. No.

CHARLIE MUNGER: We’ve only done it once, so we’re a one-trick pony.

WARREN BUFFETT: Yeah. We were lucky on that one, too. (Laughter)

Yeah, and incidentally, without Ajit we wouldn’t have done it at all.

CHARLIE MUNGER: Right, right.

WARREN BUFFETT: It isn’t that we did it. Ajit did it. We just sat there cheering.

CHARLIE MUNGER: Somebody asked us once what was the best investment we ever made, and I answered the fee we paid to the executive recruiter to find Ajit Jain. (Applause.)

20. Bond insurance business off to strong start

WARREN BUFFETT: In that connection, I’d like to give you a little report.

We went into the municipal bond insurance business a few months ago, and naturally, we did it through Ajit. And he got our companies up, licensed, and running.

And in the first quarter of 2008 — I don’t have the figures for all the other people — but our premium volume came to over $400 million.

And I think — now, that was overwhelmingly written in the secondary market, but I think our premium volume was not only larger than any other municipal bond insurer in the United States, I wouldn’t be surprised if it’s as large as all of the rest of them combined.

And this was from a standing start that Ajit accomplished this. And I have here a list of, what, 300 and — this is the end of the quarter — 278, I believe it is, transactions.

Now, that’s all done out of an office with 29 or 30 people who are doing a lot of other things, too. I mean, it’s a remarkable, remarkable place.

One of the interesting things about this is that almost all of this business — although not all the premium volume — all of — almost all of this business was — came from people who came to us with municipal bonds asking us to insure them, and in every case, except two or three, they already had insurance from the other bond insurance, most of whom are rated triple-A.

So they were paying us a fee which was higher to write insurance which would only be paid, not only if the municipality didn’t pay, but the original bond insurer didn’t pay.

So we were writing business at an average rate of two and a fraction percent for the quarter, and the original insurer had charged, perhaps, an average of 1 percent. And they had to pay and they — in fact, the only way we’re going to pay is if they went broke.

So it tells you something about the meaning of triple-A in the reinsurance — in the bond insurance — field in the first quarter of 2008.

Ajit has done a remarkable job in this arena. And Berkshire wrote a couple of primary policies for the Detroit Sewer District and the Detroit Water District that — each about 370 or 380 million — and people have found our insured bonds trading in the secondary market at a more attractive yield to the issuer. In other words, at lower yields than from any other bond insurer.

So this whole company has been built, just in a matter of a couple of months, by Ajit in his small office in Connecticut. It’s pretty remarkable, and I congratulate him for it. (Applause.)

21. We prefer “the business which drowns in cash”

WARREN BUFFETT: Let’s go to area 5, please.

AUDIENCE MEMBER: Hello. My name is Stuart Kaye, and I’m from New York City.

I wanted to know, if you could not talk with management, could not read an annual report, and did not know the stock price of a company, but were only allowed to look at the financial statements of a company, what metric would you look at to help you determine whether you should buy the company?

WARREN BUFFETT: Well, what we’re doing in investment, and what everybody is doing in investment, is they’re laying out money now to get more money back later on.

Now, let’s leave the market aspect of the asset out. I mean, when you buy a farm, you really aren’t thinking about what the market on it’s going to be tomorrow or next week or next month.

You’re thinking about how many — what the — how many bushels of beans per acre can you get or corn per acre and what the price is likely to be. You’re looking to the asset itself.

In the case you lay out, the first question you’d have to make is do I understand enough about this business so that the financial statements will tell me the information that’s useful to me in making a judgment about what the future financial statements are going to look like.

And in many cases, the answer would be no. Probably in a great majority of the cases it would be no.

But I’ve actually bought stocks the way you’re describing many times, and they were in businesses that I thought I understood where, if I knew enough about the financial past, it would tell me enough about the financial future that I could buy.

Now, I couldn’t say the stock was worth X or 105 percent of X or 95 percent of X, but if I could buy it at 40 percent of X, I would feel that I had this margin of safety that Graham would talk about, and I could make a decision.

Most times I wouldn’t be able to make it. I wouldn’t know — if you hand me a bunch of financial statements and you don’t tell me what the business is, there’s no way I could make a judgment as to what’s going to happen. It could have been a hula hoop business; it could have been a pet rock business. You know, on the other hand it could have been Microsoft early on.

So unless I know the nature of the business, the financial statements aren’t going to tell me much, you know. If I know the nature of the business and I see the financial statements, you know, if I see the financial statements on Wrigley, I know something about the business. Now I have to know something about the product before I can make that judgment.

But we’ve bought lots and lots of securities. The majority of the securities Charlie and I bought, we’ve never met the management and never talked to them, but we have primarily worked off financial statements, our general understanding of business, and some specific understanding of the industry in the business we’re buying.

Charlie?

CHARLIE MUNGER: Yeah. I think there’s one metric that catches a lot of people. We tend to prefer the business which drowns in cash. It just makes so much money that the main — one of the main — principles of owning it is you have all this cash coming in.

There are other businesses, like the construction equipment business of my old friend John Anderson. And he used to say about his business “You work hard all year, and at the end of the year there’s your profit sitting in the yard.”

There was never any cash. Just more used construction equipment.

We tend to hate businesses like that.

WARREN BUFFETT: Yeah. It’s a lot easier to understand a business that’s mailing you a check every month. But that’s what an apartment house — you know, if you own — you can probably value an apartment property pretty well if you know anything about, you know, the city in which it’s in.

And if you have the financial statements, you could make a reasonable guess as to what the future earnings are likely to be. But that’s because it is a business that gives you cash. Now, you can — there can be surprises in that arena as well.

But I’ve bought a lot of things off financial statements. There are a lot of things that I wouldn’t buy, you know, if I knew the — actually, there are a lot of businesses I wouldn’t buy if I thought the management was the most wonderful in the world because, if they were in the wrong business, it really doesn’t make much difference.

22. Pollution in Klamath River

WARREN BUFFETT: Number six?

AUDIENCE MEMBER: Good morning. My name is Mike Palmateer (PH), fisheries supervisor for Karuk Fisheries.

Mr. Buffett, you grew up and still live in the banks of the Missouri River. I, too, live on a river called the Klamath. My family has lived there since time immemorial.

In 2002, 68,000 fish died at the mouth of the Klamath River due to disease and bad water quality. These fish are also my relations.

If another company polluted your river and killed all the fish and made the river unswimable and unfishable, how would you approach this problem? Thank you.

WARREN BUFFETT: Well, I think society would — as a whole — should approach that problem by looking at the net benefits from whatever is taking place in that situation and what the costs of electricity would be and what the farmer’s situation would be if he went to a different form of water distribution.

I mean, there are a lot of competing ideas and desires in a large society, and it’s up to government, basically, to sort out those.

We’re sorting it out — right now, we’re building coal plants in the country. We’re building gas plants. We’re doing various things.

People are coming to different conclusions about what kind of tradeoffs they want to make, and generally these are being made at the state level, although you could have a national energy policy that would override individual states’ decisions.

We’re responsive to national policy on that. We’re responsive to local policy. The Oregon Public Utility Commission, I’m sure, is aware of exactly what you’ve discussed and they have to consider that, but they have to consider a lot of other things in determining what is the best way to generate the electricity required for the citizens of Oregon.

And, Dave, would you want to add anything to that?

DAVE SOKOL: Warren, just one comment. And not in any way to be disrespectful of the fishermen, but it — we are not polluting the river.

We’re not doing — adding — anything to the water that isn’t coming out of Upper Klamath River, and we do recognize the different views as to whether the irrigation is a good thing or a bad thing, whether renewable power such as hydro is better than returning the river to its prior 1907 date.

But the one thing that — just to be clear — is that PacifiCorp is not adding anything. The water is flowing through penstocks, creating electricity, and coming out the rear end, and it did so under a 50-year FERC license.

Again, we understand the varying concerns, and hopefully, over the next six years a societal answer that balances all those concerns will be reached.

WARREN BUFFETT: Thank you. (Applause.)

CHARLIE MUNGER: I’d like to — I’d like to point out how refreshing it is to have people addressing a pollution problem which has nothing to do with burning carbon. (Applause.)

23. Buffett’s advice to a 12-year-old

WARREN BUFFETT: Number 7.

AUDIENCE MEMBER: Hey. I’m Jack Range (PH). I’m from Philadelphia. I’m in seventh grade, and I’m 12-years-old.

I just wanted to ask, what kind of things should I be reading, like, in my grade? ’Cause I know there are a lot of things that they don’t teach you in school that you should know, but what things should I be looking into? (Applause.)

WARREN BUFFETT: Well, I would get in the habit, if you don’t have it already — but you sound like you very well may — of reading a daily newspaper, which is not the most popular thing in the world among younger people these days.

But you want to learn as much as you can about the world around you. And Bill Gates, I think, quit at the letter P in the World Book. Doesn’t seem to have hurt him too much to quit there.

But you can have a set of World Books. You can read the newspapers. You should just sop it up. And you’ll find out what’s the most interesting to you.

I mean, you know, there’s a certain point where the sports pages were most interesting to me, then the finance pages. I happen to be a political junkie. But you just can’t learn enough in life.

And I think the fact — what you’ll find is the more you learn, the more you want to learn. I mean, it is fun, and — but you sound to me like a young person that’s going to do a lot of that on their own.

Do you have any suggestions, Charlie? You’d probably suggest reading Ben Franklin.

CHARLIE MUNGER: My suggestion would be that the young person that just spoke has already figured out how to succeed in life. You’ve got it made. (Applause)

24. “We never urge people to sell good businesses”

WARREN BUFFETT: Number 8.

AUDIENCE MEMBER: Greetings to all of you from the Midwest of Europe, from Bonn, Germany, on the Rhine River. I’m Norman Rentrop. I’m a shareholder in Berkshire, Wesco, and Cologne Re.

I want to thank you and Eitan Wertheimer to take the initiative and the time to come to four cities in Europe, and potentially throughout the world, to tell owners of family businesses what great alternative Berkshire Hathaway is to selling their businesses to buyout funds.

Now, my question regarding the chocolate industry. I’m challenged since I cannot buy See’s Candy in my hometown, Bonn, Germany. You gave that great example of the great business, the good business, and the gruesome business.

See’s Candy, you cited, having sent, like, $1.3 billion in cash profits to Omaha. There’s another company called Lindt and Sprungli.

Now, while See’s Candy achieves more than 20 percent profit on sales, you describe that their growth has been “OK.” Lindt and Sprungli does only 14 percent on sales, but they did go almost global.

WARREN BUFFETT: Yeah. Could you get to the question, please, on this? (Laughs)

AUDIENCE MEMBER: Yeah. The question is in — whether you want to have a company with high profitability but OK growth versus a company going global but lower profits? What are your considerations?

WARREN BUFFETT: It really makes no difference to us. We evaluate all kinds of businesses.

And what we do want is we want a business with a durable competitive advantage, which both of the companies you named do.

And we want something we understand. And we want a management that we like and trust. And then we want a price that makes sense.

And we try to look at — we probably looked at every confectionary business, you know, for 20 years that was publicly owned where we got the figures. And sometimes we find something where we can take action, and most of the time we don’t.

When they’re private businesses, we don’t determine — a really good private business — I always tell the manager, the best thing to do if you’ve got a wonderful private business is just keep it. It’s going to be worth more next year and the year after.

So there’s no reason to sell a wonderful business except for kind of extraneous factors. It may be family situations. It may be taxes. It may be that there isn’t another potential heir or whatever it may be.

But there’s no need — if you’ve got a business worth a billion dollars, you don’t need the billion dollars — you’ve got a business that’s worth a billion dollars — any more than if you’ve got a farm that’s worth a million dollars. You’ve already got the million dollars. You just happen to have it in the farm. And if you like farming, you keep it.

So we never urge people to sell good businesses. We urge them to keep them.

But there comes times when they do want to sell for one reason or another — maybe once every 20 or 50 years — and we do think if they have a business that they’re enormously proud of — it’s a really fine business — that they can keep more of the attributes that they love in that business by selling it to Berkshire than they can, by far, selling it to anyone else.

So we are the logical buyer. As you mention, I’m going to Europe — Eitan, who’s been wonderful about setting this up — and we’re going to make presentations, not to try to get anybody to sell us their business now, because most people shouldn’t sell us their business now.

But we do want them to think of us when the time comes when an event occurs that does cause them to think about selling. And we want to be on their radar screen.

And we’re more on the radar screen in the United States than we are in Europe, and we’re going to try to correct that.

But if you take a firm like you name, a Lindt, you know, there’s a price at which we would buy stock in Lindt. There’s a price at which we’d buy the whole business. But it’s unlikely to be selling there.

You know, the — if you think about hundreds and hundreds of wonderful companies — I get all these managers that — just got a CEO yesterday who called me — and they want to tell me about their business, and they imply their businesses — or they think — their business is the most attractive investment in the world.

It isn’t the most attractive investment in the world. There are thousands of possible investments. And, you know, the idea that all these managers are saying “Our stock is the most wonderful in the world” is crazy.

But it’s our job to look at hundreds of things and, in terms of marketable securities, buy what we think are the most attractive ones, among the ones we understand and like as a businesses.

And then occasionally we get the chance to buy an entire business. We never do that at a bargain price. It just doesn’t happen. People don’t do that. The stock market gives you bargain prices; individual owners won’t. But when we get a chance to do that at a fair price, we like doing it.

We love building Berkshire with a bunch of businesses with favorable long-term economic characteristics.

But the chance that any one of them — you know, we aren’t going to look for a given confectionary company and say, “Regardless of price, we’re going to do this,” because we don’t do anything when the phrase “regardless of price” enters into the sentence.

Charlie?

CHARLIE MUNGER: Yeah. I watched a man build up a business in southern California, which was a wonderful business. And the time came to sell it — and he devoted his whole life to creating it — he sold it to a known crook who was obviously going to ruin the business just because he could get a slightly higher price.

I think that’s an insane way to live a life if you own a prosperous business. I think the better course is to sell to somebody you know is going to be a good steward of what you’ve created. (Applause.)

25. Dollar will probably weaken over time

WARREN BUFFETT: Let’s go to number 9, please.

AUDIENCE MEMBER: Hi. My name is Johann Freudenberg (Ph) from Germany.

How would you, as a European investor that invests in U.S. equities, hedge the U.S. dollar risk? Thank you.

WARREN BUFFETT: How would I what?

CHARLIE MUNGER: How do you hedge the U.S. dollar?

WARREN BUFFETT: Oh. Well, whether you’re thinking about starting in Germany and hedging the dollar risk of investing here or vice versa, we are happy to invest in businesses that earn their money in euros in Germany, or whether it’s there, or France, or Italy, or earn their money in sterling in the UK, because we do not have a feeling — at least I don’t have a feeling — that those currencies are likely to depreciate in a big way against the U.S. dollar.

That would be how we would get hurt. We could offset that by borrowing the money in those countries and borrowing in their currency to make the purchases.

But, overall, I think that the U.S. is going to continue to follow some policies that have made the dollar weaker in recent years.

So if I had to bet my life one way or another over 10 years, I would probably bet that the dollar would weaken against other major currencies, and, therefore, I feel no need — if we buy companies whose earnings primarily arise elsewhere in major countries — I feel no need to try and hedge those purchases.

I mean, if I landed from Mars today with a billion of Mars dollars or whatever they call them on Mars, and I was thinking about where to put my money, you know, I went to the local — wherever my UFO landed — and went to the bank and said, “I’ve got this billion of Mars currency,” and they said, “Well, what would you like to exchange here?” I don’t think I’d put all the billion in U.S. dollars.

So it doesn’t bother me to buy businesses around the world, unhedged in terms of their currency, and have a fair amount of our earnings coming from earnings that originate in other currencies and which I will convert at current rates to dollars at some time in the future.

If you take Coca-Cola — we own 200 million shares of Coca-Cola. And if their earnings are roughly $3 a share, that means our share of the earnings of Coca-Cola are $600 million a year.

And of those earnings of 600 million, you know, maybe close to 500 million will be from around the world — all different kinds of currencies.

Basically I like that. I think that that will be a net plus to us over time, and it certainly has been a net plus to us in recent years.

So we are not in the business of hedging currencies, basically. We do not have a lot of hedges set up.

Charlie?

CHARLIE MUNGER: Nothing to add.

26. Small stocks and mispriced bonds offer opportunities

WARREN BUFFETT: Number 10.

AUDIENCE MEMBER: Hey. How you doing? I’m Eric Schline (PH) from Larchmont, New York.

This is actually a follow-up question from a question that I asked last year at the meeting. I’d asked you guys, you know, what you would do with small sums of money since — you know, I run a small portfolio, under a million dollars.

And I asked you if you’d be doing things, you know, like the net-nets that Benjamin Graham used to talk about and, you know, liquidation arbitrage. You know, a lot of things you used to do at the Buffett Partnership.

And you acknowledged that you wouldn’t be just a buy-and-hold investor, that you — as you are today — but we would be doing a lot of those transactions.

And, Mr. Buffett, you also talked about how a lot of the investments you would do with under a million dollars would have nothing to do with stocks and would be with other types of securities, and you really don’t elaborate — neither of you really elaborated any more than that.

So I guess I was wondering if you could elaborate a little bit more on how your investment strategy, you know, back then, you know, in reference to non-stock investments, would be different than your buy- and-hold strategy today?

So what kind of stuff would you be doing? Maybe you could give me a past example that you did in the ’50s and the ’60s. That would be great. Thank you. Appreciate it.

WARREN BUFFETT: Well, if I work with small sums of money — and I’d be happy doing that — it would just open up thousands of possibilities to me.

And you might very well — certainly we found very mispriced bonds, where we could come nowhere near buying a position of enough size in Berkshire to make a difference, but where it would have made a difference if you were working with a million dollars.

But it would be bonds. It would be stocks of both in the United States and elsewhere. We found them in Korea a few years ago that were ridiculously cheap.

You know, you basically had to make very significant returns, but you couldn’t put big money on it.

So it could be in stocks. It could be in bonds. It wouldn’t be in currencies with small amounts.

But, you know, I had a friend who used to buy tax liens — you know, Tom Knapp, he’s got some relatives here. An enterprising person can find a lot of different ways to make money.

You’ll find most of them will be in small stocks. If you’re working with small money, they’ll be in small stocks or in some specialized bond situations. Wouldn’t you say that, Charlie?

CHARLIE MUNGER: Sure. (Laughter)

27. Pandering politicians behave better in office

WARREN BUFFETT: Number 11, please.

AUDIENCE MEMBER: Hi. I’m Dr. Silber from the Infertility Center of St. Louis. And we feel that by making many, many babies, we’re doing the best we can to help salvage the solvency of Social Security. (Laughs)

WARREN BUFFETT: We won’t pursue the logic of that too far. (Laughter)

AUDIENCE MEMBER: We need someone to pay into the system, and with the demographic implosion that we’re facing and the current anti-immigration feeling, that this is the real cause of the Social Security dilemma that we’re facing. And it’s true in most of the developed world.

But my question is, everybody is looking very closely at what you and Charlie are going to say at this meeting because there’s just a huge amount of confusion since the credit crisis, and I guess you’ve been through many, many years and decades of confusion.

But everybody really wants to know what you think, because we have three candidates, one of whom I like, which I won’t mention, but all three of whom seem to be pandering to voters and not really demonstrating a profound understanding of economics.

And we’re going to decrease interest rates to help the credit crisis, and we’re going to inject $180 billion as free gifts into the economy, and yet our dollar is down 50 percent, and we certainly don’t want a recession and all the misery that would bring.

But aren’t we going to eventually have a gigantic inflation here in the U.S.?

And so — in China, which is our major partner in this, the stock market has gone down and people are losing money because they’re worried about the U.S.

So I’m wondering if you could just shed some words of wisdom on, if you were the presidential candidate — which I would like to see happen — what would be your position or your policy?

WARREN BUFFETT: Well, I think it was Bill Buckley that ran for mayor of New York, you know, 40 years ago or something like that, and they asked him what the first thing he would do if he were elected. He said, “I’d ask for a recount.” (Laughter)

It’s not an easy game. I think we have — just personally— I think we have three pretty good candidates this time — quite good candidates.

But I think that your comments about the pandering and all that, I’m afraid that’s just part of — if you have a very long political process, and you have people only generally willing to listen to ideas in fairly short form, and you’re trying to make the other candidates look bad one way or another — I think that the truth is you do get a lot of pandering in the policies that are proposed.

I think you have candidates that are pretty smart about economics. I happen to think two of the three are maybe a little smarter about economics than the third, but the third may be just as smart, too. They may just be forced into a different position.

You know, a political process is something that doesn’t lend itself to Douglas-Lincoln debates on the fine points of policy, and it’s a tough game.

And I don’t — the one thing I think is I think they will behave better in office than on the stump. I think that’s true of all three of them, and I think — but I think that’s just built into the system.

We — you know, we have a country that works awfully well. You know, whether Warren Harding is in office or Franklin Pierce, or whatever it may be over the years.

And it gets back to that saying I’ve said many times that you want to buy stock in a business that’s so good that an idiot can run it because sooner or later one will. (Laughter)

And we live in a country, frankly, that is so good that your children and grandchildren will live a lot better than you live, even though an idiot or two runs it from time to time in between.

But we’ve got a lot better than idiots running. Believe me. I think we’ve got three very good candidates, and I wish — whichever one of them wins, I wish them well.

You know, it’s the toughest job in the world, the most important job in the world, and I think the motivations of the people running it are a lot better sometimes than their proclamations as they go along in the political process.

I think it’s very hard to run in Iowa without being for ethanol. You know, it may be — you may win some badge for courage or something in the end, but you won’t win the presidency.

Charlie?

CHARLIE MUNGER: Well, I’d like to address the recent turmoil and its relation to politics.

After Enron totally shocked the nation with the gross amount of folly and misbehavior, our politicians passed Sarbanes-Oxley, and it has now turned out that they were shooting at an elephant with a pea shooter.

And low and behold, we have a convulsion that makes Enron look like a tea party.

And I confidently predict that we will have changes in regulation and that they won’t work perfectly. (Laughter)

Human nature always has these incentives to rationalize and misbehave, and the learned professions very often fail in their basic responsibility to be learned. And we’re going to have this turmoil as far ahead as you can see.

WARREN BUFFETT: But look at it this way: I have a job here I love. You know, I’d gladly pay to have this job.

Now, I have enough stock so that I’m reasonably assured of keeping the job, but let’s just assume for the moment that there are three other candidates out there, and none of us had any stock, and we were all up here making a pitch to you.

My answers might have been a little different today, you know, in terms of what Berkshire’s prospects would be under me and all that sort of thing going forward. It’s a corrupting process.

Now, you know, it works pretty well, but the process itself has to be corrupting.

Just take the boom in commodity prices we’ve had. We’ve had a boom in the price of oil, but we’ve had a boom in the price of corn and soybeans.

Now, I’ve heard no political candidate say you’ve had this huge increase in the price of corn and soybeans. That means all these poor people throughout the country, they’ll be paying more for food, so we ought to put an excess profits tax on farmers. That is not something you’re going to hear.

On the other hand, when it happens in oil and it happens to be Exxon, you know, people will propose occasionally we ought to put a terrible tax on Exxon because the price of oil has gone up.

There’s a lot of situational ethics, or situational policymaking, that depends on how many voters there are in any given category and what state you happen to be in and all that. But I don’t think I’d behave any better.

If my ambition were to be President of the United States, you know, I would — I’m sure it would affect my — what I talked about and my behavior. You know, we’re all human beings.

So I don’t condemn the people for the fact that when they, you know, are working 18 hours a day and the other guy is shooting at them and they start exaggerating things a little, I just don’t think you should expect more of human beings than — and I think that they will tend — I think any one of the three candidates — will tend to behave quite well in the White House.

They’ll succumb to all the things that presidents do in terms of having to — certain groups that helped them get there and all that sort of thing. But I think, on balance, they will end up doing what they think is best for the country, and I think they’re all smart people.

28. “There will be no gap after my death”

WARREN BUFFETT: Number 12?

AUDIENCE MEMBER: My name is John Ebert (PH). I’m from Bremerton, Washington. I’m very pleased to see that both you and Charlie look so healthy, and I’m also glad to know that your goal is to work to at least 102 before you retire.

I think your secret must be the Cherry Coke and the See’s Candy by evidence of what you’re doing on the screen there.

My question, obviously, deals with succession. At last year’s meeting, you spoke about your plan for your chief financial officer. Could you please update us on where you stand on succession?

WARREN BUFFETT: Yeah. And we’ve said, on the CEO front, we have three that any one of which could step in and do a better job than I do in many respects.

And the board is unanimous, I believe, in terms of knowing which one it would be if it were tomorrow morning, but that might be different two or three years from now.

I think in any event, when the time comes, they’ll want to pick somebody reasonably young, because I think, on balance, it’s good idea to have a long run at this job, and I think it aids in acquisition and being able to make promises to people about how their businesses will be treated and so on.

In terms of the investment officer, the board has four names. We’ve discussed the four. Any one or all of the four would be good at doing my job, probably better in some ways, and — but they all have good jobs now. They’re happy where they are now.

They would — I think any one of the four would be here tomorrow if I died tonight and they were offered the job by the board. They’re all reasonably young. They’re all very well to do or rich, and compensation would not be a major factor with them.

I think any of the four would take the job at less money than they’re making now, but there’s no reason for them to come now.

I would still end up making the decisions, and they would probably chafe at the idea of not being able to make the decisions.

I actually worked for Ben Graham for a few years. And I loved the man enormously. I learned an amount from him. I named my older son, middle name, is after him.

But in the end, I wanted to make decisions, and I — if Ben Graham made them differently — you know, I actually prefer to make my own decisions. And anybody that manages money well is going to feel that way.

So it’s just better in this case. It can happen tomorrow. It could happen five years from now. But whenever I’m not around to make the decisions, the board will decide whether to have one, two, three, or four of these people.

They’ll decide — you know, they may decide to have four and divide it up four ways. They may decide to have only one. They will probably be heavily influenced by how the incoming CEO feels about exactly how he wants to work with a group or with one.

And they’ll come. So there will not — there will be no — there will be no gap after my death in terms of having somebody managing the money, and they’ll probably be a lot more energetic than I am now.

And they’ll — they could very easily have a much better record. Some of them have a much better recent record than I do.

Charlie?

CHARLIE MUNGER: Well, you know, we still have a rising young man here named Warren Buffett. And having — (Applause)

WARREN BUFFETT: That’s the advantage of working with a guy 84. You always look young. (Laughter)

CHARLIE MUNGER: And I think we want to encourage this rising young man to reach his full potential. (Laughter and applause)

WARREN BUFFETT: One thing I should point out, with our average age being 80, people talk about aging managements. We haven’t found a management that isn’t aging. If we ever find them, we want to start eating what they eat.

And what I can point out about your management, since our average age is 80, we’re only aging at the age of 1 1/4 percent a year, and that is the lowest rate of aging that I know of in corporate America.

I mean, some of these companies have 50-year-olds, and they’re aging at 2 percent a year, and just think how much riskier that is. (Laughter)

29. “Diversification is for the know-nothing investor”

WARREN BUFFETT: Let’s go to 13.

AUDIENCE MEMBER: I’m Isaac Dimitrovski (PH) from New York City. Mr. Buffett, it’s great to be here.

I’ve read that there were several times in your investing career when you were confident enough in one idea to put a lot of your money into it — say, 25 percent or more.

I believe a couple of those cases were American Express and the Washington Post in the ’70s. And I’ve heard you discuss your thinking on those.

But could you talk about any of the other times you’ve been confident enough to make such a big investment and what your thinking was in those cases?

WARREN BUFFETT: Charlie and I have been confident enough — if we were only running our own net worth — I’m certain a very significant number of times, if you go over 50 years, there have been a lot of times when you would have put at least 75 percent of your net worth into an idea. Wouldn’t there, Charlie?

CHARLIE MUNGER: Well, but 75 percent of your worth outside Berkshire has never been a very significant amount.

WARREN BUFFETT: No. Well, I’m going back — let’s just assume it was. (Laughter)

Let’s just assume you didn’t have Berkshire in the picture. There have been times — I mean, we’ve seen all kinds of ideas we would have put 75 percent of our net worth in.

CHARLIE MUNGER: Warren, there have been times in my life when I’ve had more than a hundred percent of my net worth invested in things.

WARREN BUFFETT: That’s because you had a friendly banker; I didn’t. (Laughter)

That — there have been times — well, initially, I had 70 — several times I had 75 percent of my net worth in one situation.

There are situations you will see over a long period of time. I mean, you will see things that it would be a mistake — if you’re working with smaller sums — it would be a mistake not to have half your net worth in.

I mean, there — you really do, sometimes in securities, see things that are lead-pipe cinches. And you’re not going to see them often and they’re not going to be talking about them on television or anything of the sort, but there will be some extraordinary things happen in a lifetime where you can put 75 percent of your net worth or something like that in a given situation.

The problem has been the guys that have put 500 percent of their net worth in. You know, I mean, if you look at — just take LTCM. Very smart guys. Very decent guys. Some friends of mine. High grade. Knew their business.

But they put, you know, maybe 25 times their net worth into things that were a cinch, if they hadn’t have gone in that heavily. I mean, they were in things that had to converge, but they didn’t get to play out the hand.

But if they’d have had a hundred percent of their net worth in them, it would have worked out fine. If they would have had 200 percent of their net worth in it, it would have worked out fine. But they instead went to, you know, maybe 2500 percent or something like that.

So there are stocks — I mean, actually, there’s quite a few people in this room that have close to a hundred percent of their net worth in Berkshire, and some of them have had it for 40 or more years.

Berkshire was not in a cinch category. It was in the strong probability category, I think.

But I saw things in 2002 in the junk bond field. I saw things in the equity markets.

If you could have bought Cap Cities with Tom Murphy running it in the early — in 1974, it was selling at a third or a fourth what the properties were worth and you had the best manager in the world running the place and you had a business that was pretty damn good even if the manager wasn’t.

You could have put a hundred percent of your net worth in there and not worry. You could put a hundred percent of your net worth in Coca-Cola, earlier than when we bought it, but certainly around the time we bought it, and that would not have been a dangerous position.

It would be far more dangerous to do a whole bunch of other things that brokers were recommending to people.

Charlie, do you want to —?

CHARLIE MUNGER: Yeah. If you — students of America go to these elite business schools and law schools and they learn corporate finance the way it’s now taught and investment management the way it’s now taught.

And some of these people write articles in the newspaper and other places and they say, “Well, the whole secret of investment is diversification.” That’s the mantra.

They’ve got it exactly back-ass-ward. The whole secret of investment is to find places where it’s safe and wise to non-diversify. It’s just that simple.

Diversification is for the know-nothing investor; it’s not for the professional.

WARREN BUFFETT: And there’s nothing wrong with the know-nothing investor practicing it. It’s exactly what they should practice. It’s exactly what a good professional investor should not practice. But that’s — you know, there’s no contradiction in that.

It — a know-nothing investor will get decent results as long as they know they’re a know-nothing investor, diversify as to time they purchase their equities, and as to the equities they purchase. That’s crazy for somebody that really knows what they’re doing.

And you will find opportunities that, if you put 20 percent of your net worth in it, you’ll have wasted the opportunity of a lifetime, you know, in terms of not really loading up.

And we’ve had the chance to do that, way, way in our past, when we were working with small sums of money. We’ll never get a chance to do that working with the kinds of money that Berkshire does.

We try to load up on things. And there will be markets when we get a chance to from time to time, but very seldom do we get to buy as much of any good idea as we would like to.

30. Parents Television Council and appropriate ads

WARREN BUFFETT: Go to number 1.

AUDIENCE MEMBER: Good morning, Mr. Chairman and Charlie. I’m Father Val Peter.

For 25 years I was lucky to be head of Boys Town. Expanded across the whole country. Warren was very kind to me, very helpful, over long periods of time.

What I represent today is Parents Television Council, where 1.2 million folks across the country, and our concern is to help keep toxicity off television programs — excessive violence, et cetera.

And I was very surprised, being on a parents television council board, when I read a report — I hope it’s not true, but it might be — that says that of the best and most troublesome advertisers, Berkshire Hathaway, is near the bottom at 444 out of 452. I hope that’s not true.

But my point is this: when I was head of Boys Town and somebody said something like that, I’d say, “Go find out. Correct it.” My question is would you be kind enough to say, “Go find out,” if it’s necessary, “Correct it.” Thank you.

WARREN BUFFETT: Yeah. I would say this: I don’t know where the rankings come from. I mean, I see the — certainly by far our biggest advertiser would be GEICO.

We spend over $700 million a year on advertising. I see their ads all over the place, and, you know, I don’t regard them as offensive or inducing antisocial behavior or anything like that.

But I would be glad for you to contact Tony Nicely because I can’t think of any other company at Berkshire that does, remotely, the amount of advertising. And Tony is an easy fellow — he’s here now, actually, but you could write him at GEICO or you could find him at the GEICO booth, probably, later in the day and just talk to him about that. I’d be glad to have you do that, Father Peter.

31. Diversification, IRAs, and brokerage accounts

WARREN BUFFETT: Number 2.

AUDIENCE MEMBER: Good morning Mr. Buffett, Mr. Munger. My name is Deb Caviello, (PH) and I’m from Windsor, New Jersey.

I’m 45-years-old and have achieved financial independence in that I’m able to manage the money of my spouse and myself full time. And that goes to marrying well, part of that. I was —

WARREN BUFFETT: That can be a big part of it. (Laughter)

AUDIENCE MEMBER: Marrying well in the sense that I received the encouragement and the confidence to pursue that.

WARREN BUFFETT: That’s terrific.

AUDIENCE MEMBER: I was going to ask you a question more along the lines of diversification, but I think I will put it this way. I’ll skew it a little differently.

Each of us has a traditional IRA, a Roth IRA, and together we have a brokerage account. Should the assets in those accounts be separated or better managed as a whole pile?

In other words, have overlapping securities in each account or different types of securities relegated to a specific account?

WARREN BUFFETT: Yeah. Well, I would say your marriage sounds like it’s going to last, so I think you should think of yourself and your husband as a unit.

And I would — you should — in my view, you should look at your overall financial condition and not worry about where the location of the assets will be.

So if you have a net worth of X and you have 20 percent of it in a 401(k) and 30 percent outright and so on like that, just look at the whole picture and decide what mix of assets, what type of assets you want, and don’t treat them as being in separate pots.

I mean, at Berkshire, you know, we own stocks in a whole bunch of different — our insurance companies own stocks in separate portfolios and we even have a portfolio in Cologne as mentioned earlier.

I don’t even think about what entity anything is in. You know, it’s all working for Berkshire, and I think you should — the way to think about your situation is to think about it all working for your family.

Now, if you’re — you strike me as having a very solid marriage, and I think your husband would be crazy if he split with you. But the — if you’re just starting out, you may want to keep your money separate for a while until you see how it plays out, because a significant percentage do end up in divorce.

Listen, I don’t get into marriage counseling very often. (Laughter)

But I can feel the ground sort of disappearing between my feet here. But I will turn it over, therefore, to our marital expert, Charlie Munger. (Laughter)

CHARLIE MUNGER: Yeah. Occasionally, you’ll find an investment that is going to produce a huge amount of taxable income. It’s a junk bond paying a high yield that’s taxable or something.

So some items are more suitable for those retirement accounts that get tax-deferral benefits. But apart from that, it’s all one pot. Sure.

32. Eventually power will have to come from the sun

WARREN BUFFETT: Number 3.

AUDIENCE MEMBER: Hi, Warren. I’m Doug Hicks (PH) from Akron, Ohio. And you hear on the news lately a lot of people say that oil will run out during this century.

Considering the U.S. policy is to do nothing until the very last second, how do you think the end of oil will play out?

For example, do you think that this would, unfortunately, result in World War III? Or do you think alternative energy will be available, the day that oil runs out, to take its place?

And maybe, do you think these oil companies’ value will go to zero when oil runs out?

WARREN BUFFETT: Yeah. Oil won’t run out. It doesn’t work that way.

What oil will do at some point — who knows when — people predict a lot of different things — oil at some point, daily productive capacity throughout the world will first level off and then start declining very gradually.

The nature of oil extraction is such that wells don’t — with rare exceptions — they don’t go to a given point producing a hundred barrels a day and then all of a sudden quit or anything like that. So you run into this depletion aspect and get into decline curves and that sort of thing.

So we won’t — we’re producing in the world, 86 or 87 million barrels a day of oil, which is more than we’ve ever produced before.

We are closer — by at least my calculations — we are very much closer to producing almost as much as our productive ability is in the world, with fields in their current stage of development, than we’ve ever been.

I mean, our surplus capacity, I think, is less than, well, any time I can remember. And it’s quite a bit less than most periods.

So we don’t have the ability to crank up, in any short period of time, the 86 or 7 to a hundred million barrels a day.

But whatever that peak will be, and whether we hit it five years from now or 50 years from now, and then it will just gradually taper down, and the world will adjust to it, and hopefully we’ll be thinking about it, you know, well before it happens, and various adjustments will be made in the world that will cause the demand to somewhat taper down as the available supply.

But we will be producing oil far beyond this century. It’s just — the question is whether we’re producing 50 million barrels a day, or 75 million, or 25 million barrels a day. I don’t know the answer to that.

There’s a lot of oil in place in the world. We’ve messed up the recovery of a lot of the oil. I mean, we never recovered the, you know, the total potential of fields. And some fields we’ve mis-engineered in ways so that we will recover a very small percentage. Now, maybe there will be better engineering, tertiary recovery, and that sort of thing in the future.

It’s nothing like an on and off switch, though, in terms of the world producing oil or adjusting to reduced capacity or anything like that.

You may still have enormous political considerations to — access to the available oil — because it’s going to be so darn important to our society for so long.

There’s nothing we can do, in any short period of time, that will wean the world off of oil. You know, that is a fact of life.

Charlie?

CHARLIE MUNGER: Well, if we get another 200 years of economic growth pretty well disbursed over the world, while the population of the world also goes up, all of the oil, coal, natural gas, and uranium reserves of the world are like nothing.

So eventually, of course, you have to use the sun. There is no other alternative. And I think we can confidently predict that there will be some pain in this process of adjusting to a different world.

Personally, I think it’s extremely stupid to use up the hydrocarbon reserves of the world as fast as we are.

I don’t think we’ve got any good substitutes for those things as chemical feed stocks, and I think it’s perfectly crazy to use up something so precious for which you have no alternative that’s sure to be available.

And if you look at it backwards, what should we have done? Hell, we should have bought all the oil in the ’30s in the Middle East and take it over here by tankers and put it in our own ground.

I mean, it’s obvious to see what should have been done in the past.

Even though that’s obvious, are we doing the equivalent of that now? And the answer is, basically, no.

So I think the governmental policy tends to be way behind in terms of rationality. And I think we’ll just have to soldier through. But eventually the — if we’re going to have a prosperous civilization — we have no other alternative than the sun.

WARREN BUFFETT: What’s your over-under figure for 25 years from now, world production oil per day?

CHARLIE MUNGER: Down.

WARREN BUFFETT: Yeah. (Laughter)

That’s not an insignificant prediction. I mean, it — believe me. If oil production is down 25 years from now, it will be a different world.

I mean, you — China’s going to sell over 10 million cars this year. I mean, the demand is going to keep — even at these prices — it’s hard for me to imagine demand falling off a lot. So if production falls off, you’ll have some interesting consequences.

33. Higher taxes for the superrich under Pres. Buffett

WARREN BUFFETT: Number 4.

AUDIENCE MEMBER: Mr. Buffett and Mr. Munger, my name is Guy Pope, and I’m from Portland, Oregon.

I enjoyed the cartoon this morning, and I’d like to expand on that.

I, too, like the idea of both of you serving as a single term as the President of the United States. During — hypothetically, let’s say, Mr. Buffett, you served the first term; Mr. Munger, you served a second term.

WARREN BUFFETT: I think the other way around is better, but go ahead. (Laughter)

AUDIENCE MEMBER: Each of you please name three difficult policy decisions you would implement during your term to better the country.

WARREN BUFFETT: Well, Charlie is going to serve the first term, so I’m going to let him name his three.

CHARLIE MUNGER: I think that one takes us so far afield that I think it’s asking too much. Three perfect solutions to the major problem of mankind from each of us in a few minutes?

We’ve just barely managed to stagger through life as well as we have, and I don’t think we’re quite up to it. (Laughter)

WARREN BUFFETT: We’d probably have a massive federal program for retirement homes, actually. (Laughter)

I would probably do something about the tax system that would change things so that the superrich paid a little more and the middle class paid a little less, but — (Applause.)

WARREN BUFFETT: That might be why you’d prefer to have Charlie serve first.

34. Munger: Ethanol is “monstrously dumb”

WARREN BUFFETT: Number 5.

AUDIENCE MEMBER: Hi. I’m Ryan Johnson (PH) from Arizona, and I wanted to ask what you think about the food shortages in the world and what trends you see in the next decade or two?

WARREN BUFFETT: Well, again, I’m no expert on that. Charlie?

CHARLIE MUNGER: Well, I said last year that I thought that the policy of turning American corn into motor fuel was one of the dumbest ideas, in terms of the future of the world — (applause) — that I’d ever seen.

I came out here with the head of an academic institution, and he called the idea stunningly stupid.

Now, I’m here in Nebraska where I like Nebraskans to prosper. But this idea was so monstrously dumb that I think it’s probably on its way out.

35. Amateurs should stick with low-cost index funds

WARREN BUFFETT: We’ve now — oh, no. We’ve got time for a couple more. Let’s go to number 6.

AUDIENCE MEMBER: Hi. My name is Timothy Ferriss. I am a guest lecturer at Princeton University twice a year. And I’d like to touch on an earlier question about investing with small sums of money.

I’d like to ask both of you, if you were 30-years-old again and had your first million in the bank, how would you invest it, assuming you’re not a full-time investor, you have another full-time job, you can cover your expenses with other savings for about 18 months, no dependents, and it would be really helpful for my students, for myself and others here, if you could be as specific as possible about asset classes, percentages, whatever you’re willing to offer. (Crowd noises)

WARREN BUFFETT: Well, I’ll be very simple: I — under the conditions you name, I’d probably have it all in a very low-cost index fund, and it would probably be — you know might be Vanguard — somebody I knew was reliable, somebody where the cost was low.

And because you postulated that you’re not going to become a professional investor, I would recognize the fact that I’m an amateur investor, and I would feel that a — unless bought during a strong bull market, which this hasn’t been — I would feel that that was going to outperform, to a degree, bonds, under current conditions over a long period of time, and then I’d forget it and go back to work.

Charlie?

CHARLIE MUNGER: Yeah. It’s in the nature of things that you aren’t going to have a whole lot of screamingly successful professional investors.

You’ve got a great horde of professionals taking croupiers profits out of the system, most of them by pretending to be professional investors, and that is in the nature of things, too.

But if you don’t have any rational prospects of being a very skilled professional investor, of course you should compromise on some simple thing like an index fund.

WARREN BUFFETT: Yeah. And that — you will not get that advice from anybody because nobody gets paid to give you that advice.

So you will have all kinds of people telling you how much better they can do for you than that, and how if you just give them a wrap fee, or give them commissions, or whatever it may be, that they will do better, but they won’t do better.

On average, you know, if a thousand other people like you do the same thing, that group of a thousand will do worse if they listen to the people that make pitches at them.

And in the end, why should you expect — I mean, you’ve got a very perfectly decent return over a 30- or 40-year period by doing what I suggest.

And why should you expect more than that when you don’t bring anything to the party? The salesman will tell you that you’ll get it, but you won’t.

CHARLIE MUNGER: I would give you another word of warning: do not judge stockbrokers generally by the ones you meet at this meeting. We attract some of the most honorable, intelligent stockbrokers in the world. They are not representative of the class.

WARREN BUFFETT: (Laughs) The politician in him just came out

36. No “extreme frugality” but don’t spend more than you make

WARREN BUFFETT: OK. We’ll do one more, and then we’ll break for lunch. Number 7.

AUDIENCE MEMBER: Good morning. My name is Tim Fam (PH). I’m from Austin, Texas.

For my children, I would like to hear from both of you as far as the temptation to keeping up with the Joneses.

And can you give them advice that they can live by with respect to frugality, debt, and work ethic?

WARREN BUFFETT: Yeah. Just tell them to keep up with the Buffetts. (Laughter)

Well, Charlie and I have always been big fans of living within your income, and if you do that, you’ll have a whole lot more income later on.

And, you know, it — I think they will, to a considerable extent, not a perfect extent, they will follow the example of their parents.

I mean, if their parents are coveting, you know, every possession of their neighbor, you know, or trying to figure out ways to increase their cost of living without necessarily their standard of living, the kids are likely to pick up on it.

But now you can get the reverse effect. If you get too tough with them, they go crazy later on. (Laughs)

But the — it’s — people make that election.

Incidentally, there are people — there are plenty of people that I don’t advise to save.

I mean, the real — if you’re struggling along and making a reasonable income and you have a job with a 401(k) being put aside for you, and you have Social Security, who’s to say whether it’s better to defer a dollar of expenditure on your family on a trip to Disneyland or something that they’ll get enormous enjoyment out of so that when you’re 75 you can have a, you know, 30-foot boat instead of a 20-foot boat?

I mean, there are choices and there are advantages to spending money in various forms for your family when it’s young, and giving them various forms of enjoyment or education or whatever it may be.

So I don’t — I don’t advocate — I may practice — but I don’t advocate extreme frugality.

The — and I don’t say that it’s always better to be saving 10 percent of your income instead of 5 percent of your income.

I think it’s crazy to be spending 105 percent of your income, and I think that leads to all kinds of problems, and I get letters from people every day that have experienced those problems.

But, you know, in the end you want to have an internal score card. I mean, you are not a better person or a worse person because you live a different kind of life than your neighbor. Live a life that, you know, is true to yourself.

Charlie?

CHARLIE MUNGER: Yeah. It’s obviously the best method to train your children to provide the proper example.

(A person in the audience is shouting)

WARREN BUFFETT: I think we’re hearing a child that didn’t get that advice. (Laughter)

CHARLIE MUNGER: But of course, even if you do provide the proper example, it’s likely not to work —

WARREN BUFFETT: It’s noon.

CHARLIE MUNGER: — some of the time anyway.

WARREN BUFFETT: It’s noon now. We’ll take about a 30 to 40-minute break. We’ll come back. Some of those who are in the other room — we always have some openings here after lunch so you might be able to move into the main room.

We’ll reconvene, we’ll say, at 12:45. We’ll go to 3 o’clock.

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lastmover · 6 years

Text

2006 Berkshire Hathaway Annual Meeting (Morning) Transcript

1. Welcome

WARREN BUFFETT: Good morning. I’m Warren; he’s Charlie.

There’s one thing I should probably clear up first because I know it’s puzzling you. In the movie, he always gets the girl.

Now, that’s hard to figure out, isn’t it? But I’ve — Charlie — but I finally understand what the — what’s happening.

It’s something called the “Anna Nicole Smith Rule.” That’s when choosing between two old rich guys, pick the older one. (Laughter)

Now, in a few minutes we’re going to open this up to your questions. We have a number of zones, and we’ll just proceed around zone by zone.

But before we do that, there are a few people I would like to thank, and then there’s a couple of short announcements I’d like to make.

First of all, if can we get the spotlight up there on Andy Heyward, Andy does that cartoon for us every year. He travels around. He gets the voices in there. Andy, where are you? (Applause)

He comes up with the ideas.

Andy is the — runs DiC Entertainment. DiC is the one I’ve told you about in the past that produced “Liberty’s Kids,” which I think is probably the best way not only for youngsters to learn American history, but for people my age as well.

I mean, it’s a terrific series of young kids — a couple of young ones in the time of the American Revolution. And I watched several of those episodes, and I’d forgotten a lot of American history since I was in school. It’s just a really — it’s a wonderful series.

It appeared on PBS over time. And if you’re looking to learn American history or have your children or grandchildren learn it, you couldn’t do better.

And in the months ahead, he’s working on the — what do we call it? — it’s the “Secret Millionaires Club.”

But it’s going to be a program that’s designed to teach young people some of the very basic lessons of — about money. How to avoid getting into trouble with it, how to use it effectively, and what your attitude should be toward it.

So, we’re looking forward to getting that out early next year. I’ll guarantee you that it will be a terrific program for teaching children and your grandchildren something about the subject of money.

I also want to thank Bob Iger. Bob is up there. Bob runs Disney. He’s doing a terrific job, and — (Applause)

I thought we could originally entice the “Desperate Housewives” into appearing simply by the chance to appear with Charlie. But after we made that appeal, we then went to Bob Iger and said, “See what you can do for us, Bob.” So thank you, Bob.

Also in that section, I’d like to have a special introduction for the man that first taught Charlie and me something about the value of franchises and the advisability of buying great businesses instead of cheap businesses.

Prior to the purchase of See’s Candies in 1972, I intended to look primarily at financial measures in buying businesses and buying things that were cheap in relation to book value, and we always tried to get a lot of tangible assets in relation to our money.

But we found out that the intangible assets, if properly nourished and if properly identified, you can make a whole lot more money with than buying a lot of tangible assets cheap.

And in 1972 — early in ’72, Charlie and I went to See’s Candy, which had been in the hands of the See family for many decades, and we bought it.

And, of course, Charlie and I didn’t know a thing about making candy — we were pretty good at eating it — and we needed someone to run the place.

We met a young fellow there. It was clear to both of us that he was the ideal person to run See’s Candy, and in just a few minutes we made a deal with him that’s lasted a lifetime.

And if Chuck Huggins and his wife, Donna, would stand up, I’d love to have you give them a real well-deserved round of applause. (Applause)

As you notice, my daughter Susie produced that movie. She does every year.

She works hard on it, and we don’t pay her anything, although she does remind me occasionally when I’m out at Borsheims that she worked very hard on the movie — (Laughter) — and I’ll see her there on Sunday.

And, Suz, if you would take a bow, please. (Applause)

And the impresario of this event, I just turn it over to her every year and forget about it.

But she puts on this show. She brings all the exhibitors in. She arranges everything. She moves into the hotel across the street a few days ahead of time, or a week ahead of time, and makes sure everything hums.

And Charlie and I just come down on the day of the meeting and take a bow. And that’s Kelly Muchmore-Broz.

Kelly, are you here? Where’s Kelly? There she is. Give her a big hand. (Applause)

We wouldn’t be having this without her.

2. Berkshire directors introduced

WARREN BUFFETT: Now I’d like to introduce our directors. We’re going to get to the business meeting at 3:15. We do the Q&A first, and we get to that later on.

But for those of you who won’t be around — and a lot of people tend to leave at lunchtime — I’d like to introduce the various directors. You’ve met Charlie and myself.

If you’ll just stand individually, we can withhold the applause, if any, until the end. (Laughter)

That way that embarrassing applause meter that we had on the Omaha Idol Show will not cause anyone distress.

Howard Buffett — Howie — Malcolm Chace, Bill Gates, David Gottesman, Charlotte Guyman, Don Keough, Tom Murphy, Ron Olson, and Walter Scott, Jr. It’s a terrific group of directors. (Applause)

I know of — I literally know of no directors of any large, publicly-owned companies that have, universally, as significant a percentage of their net worth in the company, purchased in the open market, as that group. Do you, Charlie?

CHARLIE MUNGER: None.

WARREN BUFFETT: None. OK. (Laughter)

That may be all you hear from him, folks — (Laughter) — so kind of savor a little bit.

3. Jamie Lee Curtis

WARREN BUFFETT: I also would particularly like to thank Jamie Lee Curtis, even though she came up with the wrong guy at the end.

Jamie cooperated on this. We’re going to have, as a thank you — Jamie is very interested in the Park Century School. One of her sons goes to that school. It’s for gifted, but learning-challenged students.

They’re having an auction tonight, but it will continue subsequently. And Bill Gates and I have autographed a Monopoly set, and we will personally inscribe it to whoever the winner of that auction is.

So if you want to go to eBay and check that out, we promise that we will not similarly autograph anything else. So I hope that Jamie Lee and the school have a big success on that.

4. Berkshire’s Q1 earnings

WARREN BUFFETT: We have two announcements, one relatively unimportant but, nevertheless, pleasant, and that is that we released our earnings yesterday after the close.

And I think we can put those up on the screen. Having any luck on that? Did we withdraw those earnings, Marc? Oh, they still have another six hours of audit or so.

And, as you can see, we don’t pay any attention to realized gains or losses. We had some gains this year; we had some losses in the first quarter of last year.

So — but that’s meaningless in the short term. Over time, obviously, it makes a difference.

But the — you know, we do not pick anything to buy or sell in any given quarter or any given year in the way of securities based on the effect it will have on our income account for that period. It’s totally immaterial.

In fact, we’d rather sell things that we have a loss in, just from a tax standpoint.

If we have some high-tax cost stocks and some low-tax cost stock, we’ll sell the high one and record the loss because we would get a better tax result that way for the short term. So we ignore that.

But if you look at the operating earnings, you’ll see that in those main divisions that I take in the annual report — I show our four major businesses and then investment income is aside of it — things worked out pretty well in the first quarter for all of them.

I would caution you that, in our insurance underwriting, our worst quarter would normally be expected to be our third quarter. You’re not going to have hurricanes in this hemisphere in the first quarter.

The real exposure — the worst exposure — is in the third quarter, and then there’s a lesser exposure in the fourth quarter.

We write a lot of catastrophe insurance business.

Earthquakes, as far as we know, don’t have any particular seasonal aspect to them, but hurricanes definitely do.

And the interesting thing is that under standard accounting, if we write a hurricane policy for the calendar year 2006 and we receive a million dollars of premium, we would earn a quarter of a million in the first quarter and a quarter of a million in the second quarter and so on.

We would earn a pro rata throughout the year. And that, in our view, actually is not proper accounting, but it’s required accounting.

The real exposure to loss is primarily in the third quarter.

So you can’t take our insurance underwriting results in any way for a rather benign quarter, like the first quarter, and extrapolate them for the year. But, nevertheless, it was a very good year — a very good quarter.

GEICO had excellent growth, I believe that our — well, I’m almost certain that our growth in the first quarter was better than any of our main competitors, and, actually, by — probably by some margin — the underwriting was very good. Our reinsurance underwriting was very good.

Gen Re had a good quarter. Our smaller companies had a good quarter.

So things, generally, have been working very well in all four sectors.

And that’s nice, but that’s not terribly important. I mean, five years from now, nobody will remember whether the first quarter or the second quarter was good at Berkshire Hathaway.

5. Acquisition of “really extraordinary” ISCAR

WARREN BUFFETT: But what did happen, and which we announced last night — which was very important — the acquisition of a large, extremely well-managed, profitable, really extraordinary company called ISCAR.

And up until October of last year, I knew nothing of ISCAR. I did not know about their extraordinary management.

But I got a letter, and I got a letter from Eitan Wertheimer, and — maybe a page and a half, page and a quarter — and he told me something about this business.

And sometimes character and talents sort of just jump off the page at me, and this was one of those letters, and it came from Israel. And I expressed an interest, after reading this letter, in getting together with Eitan.

And not long thereafter, I met not only Eitan, but his CEO and president, a remarkable man named Jacob Harpaz; Danny Goldman, the CFO. And we met in Omaha. They subsequently met Charlie.

And this all came to fruition yesterday when we signed a contract. Now we have — well, before I go on to this, maybe Charlie would like to say a word or two about ISCAR.

He’s the — hard as it is for you to believe, he is not only — he’s as enthusiastic about this as I am.

Now, have you ever seen that before, I’d ask you? Charlie likes this one extraordinarily well. Charlie?

CHARLIE MUNGER: Well, this is a company that, from very modest beginnings, grows to be the best company in its field in the world. It’s not yet the biggest, but that leaves them something to do.

The average quality of the people in this company is not only extraordinary, it’s off the chart. And the beauty of this, as you look at the two of us, is they’re all young.

No, this is a real quality enterprise, and these people know how to do some things that we don’t know how to do. A lot.

So, of course we’re enthusiastic about the company. I’m always enthusiastic when I get to deal with some of the best people in the world.

I would like if we could get the spotlight down there. They’re right down here in front. I would like, individually, three managers to stand up.

And then Eitan is going to talk to us a bit, and then we have a — I think we’ve got it arranged so that we can have a short movie that will tell you something about ISCAR.

But, first of all, if Eitan Wertheimer would stand up and we can get the spotlight on him? Over there. OK.

Eitan, let me introduce the other two, and then can we have you speak to the group?

Jacob Harpaz is the president and the CEO. (Applause)

Take a good look at these people because they’re going to make you — they’re going to do very, very well for you.

And Danny Goldman. Danny, would you stand up? (Applause)

Thank you. And if you’ll give the microphone to Eitan, I think Eitan would like to talk to the group just a bit.

EITAN WERTHEIMER: Good morning, everybody. It’s Omaha. It’s spring. The fields are green. The days get longer. And we bring a big family into a new home.

I’m standing here before you representing 5,869 people, not only the people, but the families, their past and their future.

It took us three years to look what to do next. We are successful. We still have a lot of mistakes ahead of us to do.

Until we found one day somebody came to us and asked, “Have you heard about Berkshire Hathaway and Mr. Buffett?” We said, “Yes, we heard, but we never thought about it.”

And when we started studying about the company, we understood that this is the right combination for us, a family company with a strong culture and a culture we’d love to keep, a young group of people that will love to work, maybe not for very long, but not less than 20, 25 years from today.

And we decided, let’s try it. And we had a very interesting lesson from Warren, we had a very interesting lesson from Charlie, and we survived both of them. (Laughter)

I’m very happy that I represent here, not only the people that make the products and go to the customers, I also in a way represent the big family of customers that make — manufacture things.

They make cars go faster and safer. They’ll make airplanes fly. They will make the mold to make the bottles for the Coca-Cola. They’ll make a washing machine. They’ll make the tools to make a carpet.

They’ll make many things. And many times the people that manufacture are a little bit in the shade.

And I’m very proud to stand as a manufacturing guy, and say I’m standing for all of them, all our customers, which I must thank them every morning, not only for buying, but also for trying new ideas that we bring and working very hard to stay competitive.

Whoever will stay competitive will be there long-term. And this is also our goal.

Here is Mr. Harpaz, Jacob. In reality, my job is not to disturb. He, in a very gentle way, fired me ten years ago.

He performed and did better things than I could do, and it didn’t make sense that I’ll disturb him; so I went on to do other things. We’ve been in the company only 34 years, and the real job is done by Jacob and many, many other people.

I’m sure that you have seen the film “In 80 Days Around the World.” And we prepared for you, “In 61 Companies Around the World.” And I hope you enjoy it.

We definitely have to fulfill a lot of expectations. We definitely have to work very hard to make everybody very proud that we joined the family, also our people and for sure everybody in this room.

So let’s hope we’ll all be successful, and let’s look into the future. And I’m looking forward to come every spring, to Omaha, where the fields are green and the days get longer. Thank you. (Applause)

ON TAPE, ANNOUNCER: IMC presents “Better Solutions for a Better World.”

In 1889, the appearance of the first automobiles brought with it the need for sophisticated solutions in metal processing. Such were the beginnings of a new company, launched by engineers in the U.S.: Ingersoll.

In the decades to follow, another plant was set up in Germany. Since its creation, Ingersoll has established strong ties with industry, which has placed it firmly in a leadership position.

For over a century, time after time, Ingersoll has proved that the best solutions begin with the best engineers.

In 1999, Ingersoll joined the IMC Group and discovered that the sky is not the limit but only the starting point.

Meantime, at the turn of the 20th century, another metal processing plant was established on the other side of the world in South Korea: TaeguTec. In joining the IMC Group in 1997, TaeguTec reinforced its position as the main supplier of cutting tools for industry in the Far East.

Today TaeguTec has achieved unparalleled success, penetrating new markets, streamlining production process, and showing that precise global thinking can cancel distances.

In the middle of the 20th century, in the north of Israel, Stef Wertheimer had predicted, from his little shack in Nahariya, the global need for more advanced cutting tools. “The new world demands better solutions,” said Wertheimer, and established ISCAR.

In a relatively short time, ISCAR has become the second largest cutting tool manufacturer in the world, a leader in the area of metal removal.

ISCAR has revolutionized every aspect of machining. Its mission: to apply innovation, quality, and automation on the highest technological level.

Among ISCAR’s groundbreaking achievements are the revolution in cutoff applications; development of SELF-GRIP in the ’70s; the pioneering triumphs in milling; the HELIMILL in the ‘80s; the CHAMDRILL; the revolution in drilling in the ’90s and tangential positive milling; the innovative TANGMILL.

These innovations and more have reinforced ISCAR’s position as the world’s leader in development of cutting tools.

The combination of Ingersoll, TaeguTec, and ISCAR has given rise to the IMC Group, taking the best of all worlds and creating the world’s best tools.

Today’s rapidly advancing world demands that we constantly elevate standards, apply ourselves more and more to provide ever-smarter and precise solutions, pushes us to advance to improve ourselves, to lead.

ON TAPE, EITAN WERTHEIMER: You have to be a full line supplier. To be a global company means to be local in many countries, in many places around the world.”

ON TAPE, ANNOUNCER: Other IMC Group companies:

IT.TE.DI Italy, designers and manufacturers of PCD diamond tools for high-precision aluminum machining in the automotive and aerospace industry;

UOP Italy, producers of high-quality solid carbide and high-speed steel standard tools and special tailor-made designs for applications in the aerospace and dye and mold industries;

Outiltec France, expert creative solutions in extra-long gun drills for deep drilling and applications that require unique geometries;

Unitac Japan, deep-drilling BTA-style tools with brazed and indexable heads;

And Wertec Italy, design and manufacturer of unique counterboring tools for deep and complicated boring applications.

ON TAPE, JACOB HARPAZ: If you look outside and you see some cars over there, be aware that in each car at least one part is manufactured by one of the IMC companies, for sure.

ON TAPE, ANNOUNCER: Automotive.

ON TAPE, EITAN WERTHEIMER: Before you have a product line, the geography spread, the people that understand the language, you cannot start thinking, “May I try or may I not try to become automotive supplier?”

ON TAPE, ANNOUNCER: We at IMC have made the automotive industry the foremost objective for all the factories of the group. All the Ingersoll vessels connect to contribute massively to the work of the automotive industry in North America.

At the same time, on the other side of the globe, TaeguTec cutting tools joins the momentum of the rapidly-developing Japanese and Korean automotive industries.

The alliance between ISCAR’s developments and the IMC Group has led to comprehensive solutions, which contribute to the efficiency of global automotive production and pave the way for production cost savings.

ON TAPE, JACOB HARPAZ: We’re not only selling tools, we are selling technology. We are selling the customer a better way to make profit. And we believe, by giving a solution, it can increase its productivity. And the bottom line for the productivity, making more profit for his company.

ON TAPE, ANNOUNCER: Heavy industry.

The power of IMC comes clearly to the fore in heavy industry. The unique combination of the three main manufacturing plants creates new opportunities.

The geographic location of Ingersoll and TaeguTec has led the companies to develop specific heavy industry specialization. The innovative geometries developed by ISCAR, together with the design and production of tools made to conform to the special requirements of this industry, places IMC at the forefront of this important industry.

Aerospace.

The blend and precision and inventiveness ought to go far.

If you want to reach far and high, you must be on top of the game in technology, in understanding materials, (inaudible).

The aerospace industry demands machining solutions for exotic and difficult-to-process materials, proficiency in lightweight materials, such as aluminum, and the ability to machine parts that require massive processing capabilities.

The grouping of the three plants and the profound understanding of cutting materials and complex cutting geometries, along with the expertise and building large-size tools, make IMC the strategic partner for the aerospace industry.

General engineering.

All this vast engineering experience accumulated in every field, in every industry, and in every corner of the world, has paved the way for the development of new, groundbreaking tools, which streamline production processes, shorten machining time, and reduce costs for every customer in the world of general engineering.

ON TAPE, JACOB HARPAZ: After releasing the product into the market, we put another team — our own team — and they’ll now compete against the release of the product.

ON TAPE, EITAN WERTHEIMER: In exhibitions, we are recognized as a very, very innovative company. Many times the sentence is, “Let’s go there because they must have something new. They always have something new.” That’s a big compliment, and innovation will make the difference.

ON TAPE, STEF WERTHEIMER: I believe that, in a way, industry is an art in itself. It’s art. It’s creation. You create something.

ON TAPE, ANNOUNCER: You can see it immediately upon entering an IMC branch or factory. The house of IMC is, first and foremost, a home for employees and customers as one. Years of experience have taught us that this is a vital element for success.

ON TAPE, EITAN WERTHEIMER: Many companies have buildings and machines and a lot of real estate, but it’s only people that have a chance to make any difference.

ON TAPE, JACOB HARPAZ: I believe with the ambition of the people, with the hard work of the people, we are going to reach the position of being number 1.

ON TAPE, ANNOUNCER: The world demands better solutions. That is why we’re here. IMC. (Applause)

WARREN BUFFETT: This is an important acquisition, as we paid $4 billion for 80 percent of the company. The family remains in partnership with us. They retained 20 percent.

It’s the first business we’ve purchased that is based outside the United States. We have others that have operations there.

I think you’ll look back on this in five or ten years as being a very significant event in Berkshire’s history.

And it’s interesting. In this world, in which many businesses get auctioned off, figures get dressed up before they sell them and leveraged up and so on, we continue to hear from people periodically who consider their business as too important to auction.

And we’ve never really bought one at auction — have we, Charlie — that I can remember?

CHARLIE MUNGER: I can’t remember one either.

WARREN BUFFETT: Yeah. So there’s a benefit in that.

Because, in effect, the people that pass through that filter of caring enough about their business that they don’t simply put it up like a piece of meat at an auction are also the people, in our view, that make the best managers and make the best partners over time.

There is something going on in their brain that says this business is so important, and the people that are here are so important, and the customers we take care of are so important, that we actually care about the home in which these businesses reside.

And I think that filter works very much to our benefit. We’ve bought a number of businesses in the last 15 or 18 months where people have felt that way, and I think the crowning one here is ISCAR.

So, I welcome our new friends from Israel. I’m going to go over there and visit in September to see if there are any more girls out there like you, see if we can drum up a little more business.

6. Questions and answers

WARREN BUFFETT: And with that, let’s go on to the question period.

And we will do this until noon, at which time we’ll break for 45 minutes or so and come back, and then we’ll continue until about 3 o’clock.

Then we’ll break for about 15 minutes, have the formal business meeting from 3:15 to 3:16. (Laughter)

And then at 4 o’clock, Charlie and I are meeting with all of the people who came from outside of North America.

This year we had about 550 requests for tickets from countries outside of North America, as opposed to about 380 last year. So we’re looking forward to meeting all of you that have come a long way to attend this meeting.

7. We can “easily handle” Social Security

WARREN BUFFET: Now, we’ve got a dozen zones in here, and we’ll start off with zone number 1.

AUDIENCE MEMBER: Yeah. My name is Edward Jannig (PH) from Denver, Colorado.

First, I want to thank Charlie and Peter Kaufman for their wonderful book. I think Benjamin Franklin would be very proud.

My question is, last year when asked about Social Security, you said that a country as rich as the U.S. should take care of their old people.

This year I read Pete Peterson’s book, “Running on Empty,” and I was wondering, from the standpoint that is the greatest benefit to society, where should you draw the line on entitlement spending?

And I was wondering if you gentlemen disagree on the subject at all.

WARREN BUFFETT: Now, you always have the question in every society — whether it’s formalized or not — you have the question of how you take care of the old and the young.

You know, you have people in their productive years turning out goods and services, and you have people that are too young to participate in the turning out of those goods and services but that, nevertheless, need them, and you have people that are old in the same position.

And starting in 1935, I believe, we statutorily formalized that idea. We’d always felt that way about the young, that school should be there for them when they couldn’t pay for them themselves, and that the society owed a duty to both classes. But in 1935, we took up the idea that the government would provide this base limit.

Now, I think there’s some merit to the argument that the 65 became outmoded as longevity improved. And that is now being changed, to some degree, and I think there’s probably some more change needed.

But this country has an output of almost $40,000 of GDP per person. And some people, like Charlie and myself, are very lucky to be wired in a way that in a market system we get enormously wealthy.

And other people are not so wired, and they come out and they, in a market system, do not necessarily do so well, and they’re fairly lucky if they provide for themselves during their working years and they do not have the ability to earn at a rate that takes care of them in later years.

And society has taken that on. Our country can easily handle the Social Security question.

I mean, it — and it’s kind of astounding to me that a government that is quite happy to run a 3- or $400 billion deficit now worries a lot about the fact they’re going to have a $100 billion deficit or something in Social Security 30 years from now. I mean, there’s a little bit of irony in that. (Applause)

It is true that, if we maintain the present age brackets, that eventually you have one person in the older years for every two that are producing in the younger years.

But we produce more every year as we go along. And there will always be a struggle in a representative society, in a democratic society, between how you divide up that pie.

But we have a huge pie. We have a growing pie. And we can very easily take care of people, in a manner at least as well as we take care of them now, in the future from that growing pie without the people in their productive years not — also having a gain in their standard of living.

CHARLIE MUNGER: Yeah. I think the world of Pete Peterson, but I don’t come to the same conclusion.

Of course, if we didn’t tinker with Social Security, it would eventually run low on funds.

But if the country is going to grow at 2 or 3 percent per annum for decades ahead, it’s child’s play to take a little larger share of the pie and divert it to the people who are older.

It would be crazy, I think, to think you would always freeze the share of money going to the old at exactly the same sum no matter how rich you got.

It’s a perfectly reasonable thing to do to pay a little more in the future to support what I regard as one of the most successful programs in the history of our country.

Social Security has a low overhead and does a world of good. It’s a very reasonable promise to make, and I wish my own party would wise up a little on how little an issue it is. (Applause)

WARREN BUFFETT: This is what happens when you ask a couple of guys our age how you feel about treating older people. (Laughter)

Incidentally, the — currently — and everybody likes to talk about the unified budget — you didn’t hear talk about the unified budget 30 years ago on the national level.

But the unified budget means that the Social Security surplus now gets counted toward reducing the overall budget. So they’re very happy at present to take the Social Security surplus and trumpet the number that is after that.

But then when they start talking about a Social Security deficit out 20 or 30 years, they tend to get — they want to separate that off and get very panicky about it. So I think there’s a lot of hypocrisy in the argument.

8. Different businesses, different compensation

WARREN BUFFETT: Let’s go to number 2.

AUDIENCE MEMBER: Good morning. My name is Phil Rafton (PH), shareholder from Orinda, California.

My question for you: How would you design a compensation system in a very cyclical industry that can swing from boom to bust?

You want to tie compensation to results in some way, but this can lead to huge swings in pay. And, for example, today in booming industries, like energy and mining, profits are large as a result of the boom in the industry and not necessarily the results of management skill.

Conversely, when the industry is down, profits are low due to no fault of management.

So, again, my question: How do you design a compensation package to best reward management performance?

WARREN BUFFETT: Yeah. That’s a terrific question. Because if you’re running a copper company now with copper at 3.50 a pound, you can coin money even if you happen to be the village idiot, you know.

And, similarly, when copper was 80 or 90 cents a pound, which has been most of our adult lifetime, in that general — there were fairly sparse times in mining much of the time.

And we design compensation systems at Berkshire. We have dozens and dozens of companies. Some of them are capital-intensive. Some of them are cyclical. Some of them don’t require much capital.

Some of them are terrific businesses if no one runs them. Some of them are very difficult businesses, even if the best of management comes.

And we have a wide variety of compensation systems. You’re wise when you say, “How do you design one for that kind of a situation?” Because so often people come in with, sort of, standardized systems or whatever the highest system they see is, and then apply it to their own benefits.

Most people, if left to select their own compensation systems, will come up with the appropriate, from their standpoint, comparable arrangement.

If we owned a copper mining company in its entirety, we would measure it, probably, more by cost of production than we would by whether copper was selling for $2.00 a pound or a dollar a pound.

I mean, they — the management has control — depending on the kind of ore bodies and everything — but they certainly have control over operating conditions. They do not have control over market prices.

And we would have something, I think, that would not fluctuate a lot in a business like that, the bonus available, but it would probably tie to what we thought was under the control of the individual who’s managing the business. That’s what we try to measure.

We try to understand the industry in which they operate, and we try to understand the things that the manager can have an impact on, and how well they’re doing in that.

We measure, at GEICO, for example, we measure by two unit measures: one is growth — unit growth — and one is the profitability of seasoned business.

New business costs money. We want new business; so we don’t charge that against the manager or the 20,000 other employees who share in it.

We do not want to pay for anything that is not under their control. We do not want to pay for the wrong things.

And I would say, in a cyclical business, that you — you know, if oil is $70 a barrel, I don’t think any particular management deserves credit for it. In fact, they all sort of deny that they’ve got anything to do with it when they get called before Congress.

But I would not give them credit for the fact that oil is $70 a barrel or $40 a barrel. I would give them credit for low finding costs for — over time.

I mean, what you really want to do, if you have a producing oil company, is you want a management that, over a five- or ten-year period, discovers and develops oil at lower-than-average unit cost.

There‘s been a huge difference in performance in that among even the major companies, and I would pay the people that did that well. I would pay them very well, because they’re creating wealth for me.

And I would not pay the guy a lot of money that simply is cashing in on $70 oil and that really has got a terrible record in finding it at reasonable prices. Charlie?

CHARLIE MUNGER: Yeah. It’s easy to have a fair compensation system like we have at Berkshire.

And a lot of other publicly-traded corporations also have fair compensation systems, but about half of them have grossly unfair systems in which the top people get paid too much.

We know how to fix Berkshire, but our ability to influence the half of American industry where the compensation systems are unfair has so far been about zero.

WARREN BUFFETT: Yeah. One thing you may find interesting, we have — I don’t know — 68 operating companies. We probably have — I probably have responsibility for the compensation system of, perhaps, 40 managers or thereabouts, because some of them have businesses grouped under them.

I can’t think — again, I can’t think of anyone we have lost over a 40-year period because of differences in views on compensation.

I also — we’ve never had a compensation consultant come into Berkshire. They may have had them at the subsidiaries, but they’re smart enough not to tell me. (Laughter)

They — it’s never happened. I mean, we do not — and we do not have lots of meetings. We don’t spend a lot of time on it. It is not rocket science.

It’s made more complicated than it needs to be, more confusing than it needs to be, because having a system that is complicated and confusing serves the needs of some who want to get paid a whole lot more than their worth.

And the system won’t change because it’s working to the advantage of the people that have their hand on the switch, the people that pick the human relations consultants and pick the people who are on the comp committee.

I was put on one comp committee, and Charlie can tell you what happened. (Laughter) He was there.

CHARLIE MUNGER: Yeah. We were the biggest shareholder at Solomon. Two of us were on the board, and Warren was on the comp committee.

And in that frenzy of envy, which characterizes compensation in investment banking, Warren remonstrated, softly, I thought, towards a slightly more rational result, and he was outvoted.

WARREN BUFFETT: Charlie used the term “envy” rather than “greed,” which is interesting, because that’s been our experience, is that envy is probably a bigger motivation, in terms of people wanting to be in that top quartile, or whatever it may be, than greed.

It’s a very interesting phenomenon that you can hand somebody a $2 million bonus, and they’re fine until they find out that the person next to them got 2-million-1, and then they’re sick for the next year. (Laughter)

Charlie has pointed out — you know, of the seven deadly sins — that envy is kind of the silliest because you don’t feel better. You know, I mean, if you get envious of somebody, you feel worse the whole time.

Now, you know, gluttony — you know, I’ve had some of my best times while being gluttonous. (Laughter)

There’s a real upside to gluttony. (Laughter)

We won’t get into lust. (Laughter)

But I’ve heard that there are upsides to that, occasionally.

But envy, you know, all you do is sit around and make yourself sick and can’t get to sleep. But that’s — it’s part of the human psyche, and you see it big time and you get this irony.

The SEC wants even more transparency on pay, which I think, you know, basically is a good idea except for the fact that it becomes a shopping list for every other CEO when they see that somebody is getting their haircuts paid for by the company.

They decide that they, too, need their haircuts paid for by the company, and they suddenly become big tippers.

9. Our managers are “trained” by our culture

WARREN BUFFETT: Let’s move on to number 3.

AUDIENCE MEMBER: Greetings to all of you from the Midwest of Europe. I’m Norman Wintrop (PH) from Bonn, Germany.

Thank you very much for writing your shareholder letter in such a way that we feel treated as partners.

Warren, in the shareholder letter, you ended with your thoughts on managing Berkshire Hathaway in the future.

May I ask you, how do you train your successors? What do you tell them? How do you summarize to them what is important to you?

And how, if you are able to do so, how would you measure whether or not they have lived up to your expectations?

WARREN BUFFETT: Well, that’s a good question.

And, I think, actually, in reading that letter — you know, that’s part of the — part of the reason it’s written — is to convey, not only to our partners, our shareholders, but also to our managers and anybody else in the public, you know, what Berkshire is all about.

This meeting, you know, in terms of what we do is intended to give a personality and a character to Berkshire. And we don’t say it’s better than anybody else’s, necessarily, but we do think it’s us.

And we think — we want managers to join us who believe in the sort of operation we have, a partnership with shareholders, a lifetime commitment to the businesses. We want those people to join us.

We want what they see after they join us to underscore the values we have. So everything we do we hope is consistent with what most people would call a “culture” at Berkshire.

So the written word, what they see, what they hear, what they observe. And that is training in itself.

It’s the same sort of training you get as a child. I mean, you — when you are in the home and you’re learning something every day by the behavior of these terribly important people, these big people that are around you.

And a home has a culture. A business has a culture. To some extent, a country can have a culture. And we try to do everything that’s consistent with that. We try to do nothing that is inconsistent with that.

And, believe me, if you’re a bright Berkshire manager — and they are bright — you know, they buy into it to start with, they see that it works, you know, and it doesn’t require formal lessons or mentoring or anything of the sort.

I mean, if you talk to our Berkshire managers, you would find that they think consistently with how, in effect, Charlie and I think.

There are plenty of people that don’t, and they don’t join us.

I mean, you know, we hear all the time from people — I’ve got one coming in a little while, actually, that, you know, nothing is going to come of it because this guy — I mean, his brain processes things different than mine does.

And I’m kind of interested in learning about his business, so we’ll get together, but it wouldn’t fit. You know, it would just not — it would be a mismatch.

And the nice thing about it is our culture is so well-defined that there aren’t many mistakes, in terms of people entering it or behaving in a way inconsistent with it. So I think that — I don’t think there’s any formal training necessary.

I mention in the annual report the fact that, if I die tonight, there are three obvious candidates to take my place.

Now, the board knows which one of them they would agree on tonight. Might be different three years from now, but any of those three would not miss a beat in terms of stepping into the culture that I hope we have here, because it’s theirs too.

Charlie?

CHARLIE MUNGER: Well, you know, if Warren has kept the faith until he’s 75 years old in maintaining a certain kind of culture and a certain way of thinking, do you really think he’s going to blow the job of passing the faith on?

What could be more important, in terms of his duties in life? You all have something — (Applause)

You all have something more important to do than worry about the fact that the candle is going to go out at Berkshire just because some people die.

This is a place where the faith is going to go on for a long time.

Of course, at headquarters, we aren’t training executives. We find them. And they’re not hard to find.

You know, if a mountain stands up like Everest, you don’t have to be genius to recognize that it’s a high mountain. (Laughter)

10. Irrational pricing of closed-end funds

WARREN BUFFETT: OK. Number 4?

AUDIENCE MEMBER: My name is Yuen Gunn (PH), and I’m from Whitehaven in England.

Actually, the last time I was this nervous asking a question, I’d just presented my wife with an engagement ring from Borsheims. (Laughter)

WARREN BUFFETT: Well, I hope you get nervous again. (Laughter)

AUDIENCE MEMBER: My question for you is, with the enthusiasm at the moment for emerging markets, many closed-end funds which contain emerging market stocks are trading at significant premiums to their net asset values, even when open-ended funds can be used to acquire similar portfolios of stocks for the net asset values.

This doesn’t seem very rational to me. Why do these premiums persist, and do you agree that it’s irrational?

WARREN BUFFETT: Yeah. I would say it would tend to be. I don’t know anything about the specifics that you’re referring to on emerging market funds. I haven’t looked at the size of the premiums.

But, history would certainly show that most closed-end funds — just about all closed-end funds — eventually go to discounts.

I actually worked — well, I’ll skip that analogy. But the — overwhelmingly, closed-end funds have gone to discounts.

You know, initially, if they’re sold with a 6 percent commission, of course, the initial people are getting 94 cents of net asset value by paying the dollar, but I know I — if I saw two — if I had an interest in buying into emerging markets through other people’s management and I could buy an open-end fund at X, or an asset value, and I had to pay 120 percent of X for some closed-end fund, you’d have to convince me very strongly that the management of the closed-end fund was better.

So I think you’re right. I don’t — again, I don’t know the — if the premium is a few percent, it doesn’t really make much difference.

But occasionally, Charlie and I have witnessed in the past closed-end funds that have sold even at 30 or 40 percent premiums over asset value.

Overseas Securities was a tiny fund that used to do that for years and baffled everybody. But eventually they will come back down to earth.

Charlie?

CHARLIE MUNGER: I’ve got nothing to add. (Laughter)

WARREN BUFFETT: He’s hitting his stride now. (Laughter)

11. Corporate boards should think like owners

WARREN BUFFETT: Number 5?

AUDIENCE MEMBER: Warren and Charlie, I want to thank you for putting a once obscure Midwestern city on the map last year with your acquisition of Pete Liegl’s company, Forest River.

I’m Frank Martin (PH) from Elkhart, Indiana, the RV capital of the world. I also want to thank —

WARREN BUFFETT: Glad to have you here, Frank.

Frank has just brought out a book, incidentally, that’s a history of some of his annual letters. It’s a good book, and I recommend you get it.

AUDIENCE MEMBER: Thank you, Warren.

I also want to thank you for your influence over Robin Williams and other Hollywood stars. Those of you who have seen the movie “RV” realize that Warren will go to no ends to promote the products of the companies he acquires. (Laughter)

WARREN BUFFETT: A few people have already noticed that, actually, Frank. (Laughter)

AUDIENCE MEMBER: On a more serious note, there’s a small but growing trend in American business governance to move from plurality voting for directors to majority voting, long the standard in Great Britain.

What do you see as the upside and downside of majority voting, as it relates to raising the standard of ethics in the corporate boardroom?

WARREN BUFFETT: Charlie, you want to take a swing at that?

CHARLIE MUNGER: I don’t think it’ll have any effect at all on ethics in the corporate boardroom.

There get to be fashions in the governance subject. I think that the troubles in American corporations are not going to be fixed by something like that.

All these reforms have to be considered in the light of the kind of people that are likely to be activist in using new powers, and that crowd is a mixed crowd, to put it gently.

WARREN BUFFETT: The question in the boardroom is to what extent — and you have to understand, it’s partly a business situation; it’s partly a social situation.

The question is to what extent do the people that are participating there think like owners, and whether they know enough about business so that even if they’re trying to think like owners, that their decisions will be any good.

And Charlie and I have been on boards of companies with dual voting. Berkshire has that, although it’s so minor that it doesn’t really make any difference. But we’ve been on other boards.

I have never really seen any difference in behavior based on the nature of the votes that got them into the boardroom.

But there’s an enormous difference — I think you’d be blown away if you watched boardrooms over the years — there’s just an enormous difference in terms of, really, the business savvy of the people in the room, the degree to which they are thinking like owners as they go along.

And I’ve seen no — I don’t know that dual voting or the lack of dual voting really is going to have very much to do with that.

The key — I’ve mentioned it in the past — there’s all these fashions, as Charlie says, in corporate governance.

But the job of the board is to get the right CEO, to prevent that CEO from overreaching. Because sometimes you have some people that are very able, but they still want to take it all for themselves.

But if they take nothing and they’re the wrong CEO, they’re still a disaster. So low pay itself is not the criteria.

So you want the right CEO. You do not want them overreaching.

And then I think the board needs to exercise independent judgment on important acquisitions, because I think CEOs — even smart CEOs — are motivated, frequently, in acquisitions by other than rational reasons.

And in those three areas, you know, American directors have — I don’t think they’ve given a tremendous account of themselves in recent years, whether at dual system places or otherwise.

The only cure to better corporate governance, in my view, is that the very large shareholders start really zeroing in on whether those questions I just mentioned are being addressed properly.

If they go on to all these peripheral issues, you know, they have a lot of fun and they get in the papers. You know, they have little checklists and they can issue grades and all that. It isn’t going to do anything in terms of making American business work any better.

But if the eight or ten largest shareholder groups, if the really large institutional investors say, you know, “This compensation plan doesn’t make any sense and we’re not voting for the directors, and here’s why we’re not voting for the directors,” you’d get change. But so far, they’ve been unwilling to do that.

It takes the big shareholders. It’s not going to be done by any coalition of small shareholders or people sticking things on ballots. But the big shareholders of this country, you know, basically they — some of them farmed out their voting, even.

I was amazed to find that out, that a number of very large institutional investors have actually just turned their voting process over to somebody else. They don’t want to think like owners. And, you know, they bear — we all bear — the penalty for that.

12. Tech is still in the “too hard” pile

WARREN BUFFET: Number 6?

AUDIENCE MEMBER: Hello. My name is Andy Pollen (PH) from Adrian, Michigan. Thank you, once again, for having me to Omaha.

My question is for Warren, but, Charlie, please add your thoughts as well.

Warren, I’ve heard you say many times that you don’t understand technology and that you rely on Bill for that, and that’s fine. And I see from this year’s movie that you’re learning, so that’s good.

WARREN BUFFETT: Slowly.

AUDIENCE MEMBER: I’m also curious to hear what you’ve learned so far about the other information technology companies, such as IBM, Sun Microsystems, Oracle, Dell, EMC, and Intel.

WARREN BUFFETT: I know — what I’ve learned is I know enough not — to know that I don’t know enough to make an investment decision.

The — Charlie and I have circles of competence that extend to evaluating a number of types of businesses, and there are a whole lot of businesses that we won’t be able to evaluate.

Some of them, I don’t think — I think very few people can evaluate.

I mean, you get outside of — you just get into businesses that — where the future is so likely to be different than the present that maybe there’s a few people that have great insights on it, but we sure don’t.

We are best at the businesses where we can come to a judgment that they’re going to look a good bit like they do now five years from now, ten years from now. They’ll be bigger. They’ll be doing different things, but the fundamentals will be the same.

ISCAR will be a bigger company five years from now. It may be a much bigger company, and we may get a chance to do interesting acquisitions.

But what you saw there, the fundamentals, won’t change. The way the people think won’t change.

I can name a number of businesses that are bound to change dramatically. I mean, when you think of how much the telecom business, for example, has changed over the last 15 or 20 years, it’s startling.

Even with hindsight, it’s a little hard to figure out, you know, who was going to make all the money and so on. There’s just — there’s just games that are too tough.

Charlie says, you know, “We’ve got three boxes at the company: in, out, and too hard.” (Laughter)

And a lot of things end up in the “too hard” pile, and it doesn’t bother us. You know, we don’t have to be able to do everything well.

If you go to the Olympics, you know, if you run the hundred meter well, you don’t have to throw the shotput. You know, some other guy can throw the shotput and you’ll still get a gold ribbon, you know, if you run the hundred meter fast enough.

So, we try to stay within the circle of competence.

Tom Watson, Sr. — I think it was Senior — yeah, Tom Watson, Sr. — many years ago said, “I’m no genius, but I’m smart in spots, and I stay around those spots.”

Well, that was pretty damn smart, you know. And we have found a lot of our managers who don’t think, you know, they can solve every problem in the world, but they run their businesses extraordinarily well.

You do not want to — Frank Martin mentioned Forest River. You do not want to go and compete with Pete Liegl and his business. He’s going to kill you. He’s very, very, very good.

But he doesn’t come around and try and tell us how to run the insurance business, because that’s not his game.

We look for people that are very good at things they understand. And we don’t get any inferiority complex at all about the fact that — well, I — you mentioned Intel, I believe.

I was virtually there at the birth of Intel because I was on the board of Grinnell, and Bob Noyce was the chairman of the board of Grinnell. And we bought — at Grinnell — we bought $300,000 worth of their original debentures.

And, you know, I knew Bob was always a very, very smart guy, but I wouldn’t have had the faintest idea how to evaluate the future of Intel then, and I really don’t have it now, you know.

And I think they probably had a few surprises themselves in the last few years with AMD and what’s been happening in their business.

But what that’s going to look like in five years, I don’t have any idea. And I’m not so sure, if you’re in the industry, you’d know exactly what it was going to look like in five years. Some businesses just are very, very hard to predict.

Charlie?

CHARLIE MUNGER: Yeah. One of the foreign correspondents last year, after looking at us carefully, said, in effect, “You guys don’t seem smart enough to do so much better than other people as you’re doing.” (Laughter)

WARREN BUFFETT: Were they looking at me or you, Charlie?

CHARLIE MUNGER: Both. (Laughter)

“Have you got an explanation?” And we said, “We know the edge of our competency better than most people do.”

It’s a very useful thing to know the edge of your competency. And I always say it’s not a competency if you don’t know the edge of it.

WARREN BUFFETT: I’ll have to think about that a little bit. (Laughter)

Bill will explain it to me later.

13. Too many tax breaks for the rich

WARREN BUFFET: Area 7, please.

AUDIENCE MEMBER: I am John Bailey (PH) from Boston, Massachusetts.

I wanted to ask, Warren and Charlie, if you could consider three hypothetical securities for a long-term investment.

The first would be, like, a share in median family income for the United States. The background there that, in real terms, median family income has been stagnant for approximately 30 years.

The second security would be a share in all corporate income in the United States. The background there that corporate income has been taking an ever larger slice of GDP for several years.

And, finally, a bit more abstract, a share in all capital assets in the United States, and I would like to include all intangible capital assets, if possible.

So would any of these be of interest for a long-term holding, perhaps 20 years or so? And, if not, why not?

WARREN BUFFETT: Well, I think I’d rather buy ISCAR. (Laughter)

The corporate profits, as you point out, have been close to their highs, except for a very few years post- World War II, as a percentage of GDP. It’s hard to imagine being much larger.

It’s interesting. While corporate profits is reported — you take S&Ps, percentage of book, percentage of sales, put on the line, they’re all on the high end.

Corporate income taxes, really, are not that high relative to the total revenues of the country. So you can see that there’s been a little disconnect there in some manner.

But median family income is something that Charlie and I have never even considered. We’re not shooting for that.

It is certainly true that, in the last five to ten years, that the disparity in income has widened significantly and that the tax breaks for the wealthy have been extraordinary.

I’ve pointed out in the past that most of the members of the Forbes 400, myself included, pay a lower percentage of their income to the U.S. government, counting Social Security taxes, than does the receptionist that works in their office.

That was not true 30 years ago, and I don’t think it’s something that should be true in a rich society, but it has happened.

And I just computed my 2005 return. In 2004 — and I have no tax shelters. I don’t have a tax adviser. I just do things, and at the end of the year I add it all up.

In 2004, my rate was the lowest of the 15 or 16 people in the office, and in 2005, my rate was even lower.

And that’s courtesy of the U.S. government. It’s not courtesy of a lot of tax write-offs or anything of the sort.

And I think that’s — I think it’s crazy, and I don’t think the American people understand it very well. And I think that if they did understand it, they should, and would, be quite unhappy about it.

So I think that — I think that the lower incomes, median — and the medium — people making medium amounts of income, have not shared in the prosperity of the last decade or so in a way that’s all proportional to the way the wealthy participate in it.

The last point you mentioned was too esoteric for me, so I’ll pass it over to Charlie.

CHARLIE MUNGER: Yeah. The main figure that matters to all of us, including the people at the median, is how does GDP per capita grow? And those figures have been very good.

And so, I wouldn’t get too wild on the subject of median income. It isn’t like we’re all permanently in some status from nobody moving from status A to status B.

There’s a huge flux, both up and down. And what’s really important is that the pie keep growing at a decent clip.

All that said, I think that Warren is right, that some of those tax changes were a little crazy. I mean, they caused more envy than we needed. But I don’t think it’s all that important.

WARREN BUFFETT: Yeah. We might think it was more important if we were working at the median income, Charlie. (Laughter)

14. Munger: Ethanol is “stupid”

WARREN BUFFET: Let’s go to Number 8.

AUDIENCE MEMBER: Good morning. I’m Diane Ryan (PH) from Kansas City.

My question is, what is your opinion on the economics of ethanol and as — just as a fuel additive?

And, as a potential investor, should I be looking at that industry?

WARREN BUFFETT: Well, I don’t know enough to answer the latter part. I know we don’t — Charlie and I would not know enough to evaluate ethanol projects.

We’ve been approached on them. And, of course, they’re quite popular now.

But in terms of figuring out what an ethanol plant is going to be earning on capital five or ten years from now, it’s far easier for us to figure out whether people will be drinking Coca-Cola, or even eating See’s Candy, which I highly recommend. (Laughter)

So, you know, it will depend on government policy. It will depend on a lot of variables that we’re not particularly good at predicting.

It’s easy to raise money for it now. I mean, it’s a popular item. You know, it’s hot.

And our general experience is that we don’t look at things very much that are hot at any given time.

I know nothing about the — you know, the biochemistry or anything of the sort.

I have a son who was a head of the ethanol board in Nebraska. And if I notice that he suddenly starts getting richer than I am, you know, I will suspect that I should start looking at ethanol very hard.

But so far, I haven’t seen tangible evidence of that.

There’s no question ethanol usage is going to grow. I mean, that we will see.

Generally speaking, ag processing — agriculture processing — businesses have not earned high returns on capital. I mean, if you look at Cargill, you look at ADM, you look at the big processers, that has not been a great business.

Ethanol could prove an exception, but I’m not sure how you gain a significant competitive advantage over time, you know, with any given ethanol plant.

And if you get too many of them around, you know, it will not be a good thing when you’re turning out a commodity.

Charlie?

CHARLIE MUNGER: Well, my attitude is even more hostile than Warren’s.

I have just enough glimmers of thermodynamics left in me to suspect that it takes more fossil fuel energy to create ethanol than you can get out of the ethanol you’ve created.

If so, that’s a very stupid way to try and solve an energy problem. (Applause)

WARREN BUFFETT: Well, considering my family situation, I would say I have friends who like ethanol, and I have friends who don’t like ethanol.

And I want my position to be perfectly clear: I’m for my friends. (Laughter)

15. Watch out for speculative commodity bubbles

WARREN BUFFETT: Let’s go to number 9.

AUDIENCE MEMBER: Hello. My name is Johann Freudenberg (PH) from Hanover, Germany.

Do you think we are in a commodity bubble? Thank you.

WARREN BUFFETT: Well, certainly — not in agriculture commodities, they haven’t done anything, if you’re talking about wheat or corn or soybeans or something.

But if you get into the metals, oil, there’s been a terrific move. The most extreme, probably, has been copper, I would say.

Oil, if you go back a few years to when it was $10 a barrel — it’s been more extreme than copper — but you were undoubtedly — it’s like most trends. At the beginning, it’s driven by fundamentals, and at some point, speculation takes over.

The very fact that — the fundamentals cause something that people looked at for years without getting excited about. Fundamentals change the picture in some way.

Copper does get a little short, you know, or people get a little worried about currency and, maybe, gold goes up or whatever it may be.

But, you know, it’s that old story of what the wise man does in the beginning, the fool does in the end.

And with any asset class that has a big move, that’s based initially on fundamentals, is going to attract speculative participation at some point, and that speculative participation can become dominant as time goes by.

And, you know, famous case always being tulip bulbs. I mean, tulips may have been more attractive than dandelions or something, so people paid a little more money for them.

But once a price history develops that causes people to start looking at an asset that they never looked at before and to get envious of the fact that their neighbor made a lot of money without any apparent effort because he saw this early and so on, that takes over.

And my guess is that we’re seeing some of that in the commodity area. And, of course, I think we’ve seen some of it in the housing area, too.

How far it goes, you never know. I mean, it just — some things go on to just unbelievable heights, and then, you know, silver went back and that was manipulation, to some extent, but it got up to $50 an ounce very briefly back in the early ’80s.

But the eyes of the world that never looked at silver when it was $1.60 or — or $1.30 back in the ’60s, you know, everybody in the world was looking at it. And some were shorting and some were buying, but it becomes a speculative football.

And my guess is that an awful lot of the activity in something like copper now is speculative on both sides of the market.

If — you know, if it goes to $5 a pound, who knows? But it — you are looking at a market that is responding more to speculative forces now than to fundamental forces, in my view.

Charlie?

CHARLIE MUNGER: Well, I think we’ve demonstrated how little we know about commodity prices by our very skillful operations in silver.

WARREN BUFFETT: I think you can change that from “our” to — it’s mine, actually.

I bought it very early. I sold it very early. Other than that, everything I did was perfect. (Laughter)

We managed to minimize things there with great efficiency, or I managed to. Charlie didn’t have anything to do with that. I was the silver king there for a while.

We did make a few dollars on it. But we’re not good at the game of, when it gets into the speculative area, figuring out how far a speculative boom will go.

If the fundamentals are attractive, we think we’re getting a lot for our money, buying equities or whatever it may be, we’ll make some money.

We will — we may not make as much money — remotely as much money — as somebody who is, you know, plays out the last 30 days or 30 weeks of a real wild orgy.

I mean, these things, they tend to be the wildest toward the end.

But that gets back to the question, you know, of Cinderella at the ball. I mean, you know, you’re there. You’re having a wonderful time. The punch bowl is flowing and the dance partners are getting prettier all the time.

And you know at midnight, it’s going to turn to pumpkins and mice.

And, you know, you look around the room and you think, “Just one more dance, one more good-looking guy,” you know, “one more glass of champagne.”

And you think you’re going to get out of there at midnight, and, of course, everybody else thinks they’re going to get out of there at midnight, too. And in the end, it does turn to pumpkins and mice.

And in this game, as I’ve said — you know, Adam Smith said it many years ago — a fellow named Jerry Goodman wrote under the pseudonym of Adam Smith — says the problem with that particular dance for Cinderella is that there are no clocks on the wall.

You know, and in the markets — if you’re talking copper now, if you’re talking Internet stocks in 1999, if you’re talking uranium stocks in the 1950s — there are no clocks on the wall.

And the party does get to be more fun, you know, minute after minute, hour after hour, and then it does turn to pumpkins and mice.

16. “Brazil would not be off limits”

WARREN BUFFETT: Number 10?

AUDIENCE MEMBER: My name is Luisa Loredo (PH). I’m a student at University of Kansas, and I’m originally from Brasilia, Brazil.

My question is for both Mr. Buffett and Mr. Munger.

The stock market in South America has been growing quickly in the last few years. What do you think about investment opportunities in South America, given the political environment and underlying risks?

WARREN BUFFETT: Yeah. We would — our problem in many markets is that we have to put a lot of money to work to move the needle at Berkshire. We’ve got a market value of 135 billion or something like that.

So we are looking to put out hundreds and hundreds of millions of dollars at a minimum when we look at marketable securities. And that really narrows the field in terms of countries or in terms of businesses within those countries.

But, you know, we made an investment about three years ago in PetroChina. Now, PetroChina is one — probably one of the — well, it is one of the five largest oil companies in the world — and, yet, we were only able to — even there — to get 400 and some million dollars into it, which fortunately is worth a couple of billion now.

But here it’s a country the size of China, largest company in that country, and even there we only got 400-and-some million dollars in, although we would have liked to have gotten more.

But we weren’t afraid to go into China. We wanted to get paid more for going into China, and we did, because we don’t know the game as well there. We would feel the same way in Brazil.

I mean, we — a great beer company down there that a friend of mine ran, and, you know, we should have been in that. We knew he was a great manager, and he was going to do a great job with it.

So, Brazil would not be off limits at all, but we’d have to be able to get a lot of money into a business we understood at an attractive price.

We would want it to be cheaper than if it were in the United States. We wouldn’t understand the tax laws as well, the nuances of governance, a whole bunch of things. But after allowing for that, at a price, we would do it.

We’re unlikely to put a lot of money into — Brazil is a big country, but we’re unlikely to put a lot of money into really small economies because we can’t get enough money into them. Charlie?

CHARLIE MUNGER: No more.

17. Outlook for Clayton and manufactured homes

WARREN BUFFETT: Number 11?

AUDIENCE MEMBER: My name is Jeff Bingham (PH). I’m from Chicago, Illinois.

I have a question regarding the manufactured housing industry. What is your outlook on demand for the industry? And, correspondingly, in your opinion, will lending increase in a meaningful way over the next few years?

And are the homes priced attractively relative to competitive products, like stick-built housing and apartments, in the face of continued site rent increases at the community level and, in some cases, lenders requiring shorter maturities on mortgages?

WARREN BUFFETT: It’s been kind of an interesting history on manufactured housing. If you go back — you have to go back 30 or 40 years — 40 years, I think, almost, to have — find volume as low as it’s been in the last couple of years. And the houses are better than — by far better — than they were then.

There have been years when 20 percent of the housing — the new housing product in the United States — was manufactured housing. One out of every five.

Last year, leaving out FEMA demand, you know, we were bumping along for the third year, I believe, just a tiny bit over the 130,000 level, you know, which is like 6 or 7 percent — probably 7 percent — of new housing starts.

So, the percentage of the total new housing stock that has been manufactured housing in recent years has really been very low, while the houses are better — considerably better — quality than in the earlier years.

You can look at the house. We’ve got two houses out there on the exhibition floor, around $45 a square foot. You know, that’s good value.

There’s a lot of resistance, through local zoning laws and that sort of thing by the local builders, to the influx of manufactured housing. We’ve made progress on that in some areas. We’re actually developing subdivisions in that business.

The houses were mis-sold four or five years ago in huge quantity because you had manufactured housing retailers selling the properties, getting any kind of a down payment, taking the loans — selling to people that shouldn’t be buying them — taking the loans, securitizing them, so somebody in some insurance company someplace lost significant sums of money.

So you had, really, an abuse of credit in the field. And there’s a hangover from that, and it’s taken a long time for that hangover to work its way through.

I think Clayton Homes, which we own, has done a terrific job in both the financing — they should be financed on shorter terms, incidentally.

I’m — if you put them on owned land, that’s one thing, but financing them for 30 years, in my view, was a mistake.

But the terms got very lax for a while, and, you know, we’re bearing the consequences of that now.

But I think the market will get bigger, but I do not think it will get bigger this year. I see a year that, counting some FEMA demand and some hurricane-induced demand, maybe 150,000 units, 145,000 units. And by industry standards, that’s down a lot.

Now, the number of plants is down a lot and the number of retailers are down a lot.

Clayton’s position is very strong. And their record is so much better than anybody in the industry that you have to look very hard to find number two.

Charlie?

CHARLIE MUNGER: Yeah. You asked about stick-built housing and how competitive it was. That’s been one of the troubles of the manufactured housing game is that the stick-built housing has gotten so efficient.

But there the system is aided greatly by Berkshire’s subsidiary MiTek. So — and stick-built housing is amazingly efficient when it’s done in big quantity with systems like MiTek provides.

And if it weren’t for that, there would be a lot more manufactured housing.

Personally, I think manufactured housing is going to get a lot better and take a lot more of the market. It may take a considerable period, but that is so logical that I think it will eventually happen.

WARREN BUFFETT: Yeah. Somewhere down the road, you would expect 200,000-plus units for the industry. But I don’t think you’ll see it in the next year or two.

The industry has to think through — and they have, they’ve made a lot of progress on this — but they have to think through what’s the logical way of financing these things, and what’s the way to make sure that the person who buys it really has an asset that’s in excess of their loan value five and ten years down the road.

And, really, very little consideration was given to that five years ago. It was just a question of put together the papers, sell it on Wall Street, and let somebody else worry about it later on.

Clayton did a way better job than other companies in that respect, but those were the industry conditions that existed then.

But I think Clayton will be — Clayton could easily be — the largest homebuilder in the United States in future years because we will be a big part of an industry that, as Charlie says, should be doing more volume.

CHARLIE MUNGER: I also think that some of the sin that was in the manufactured housing finance a few years ago has shifted into the finance of the stick-built houses.

There is a lot of ridiculous credit being extended in America in the housing field. And it had a horrible aftermath in the manufactured housing sector, and my guess is there will be some trouble in the stick-built sector in due course.

WARREN BUFFETT: Well, dumb lending always has its consequences and usually on a big scale, but you don’t see it for quite a while. So, therefore, it’s like a disease that doesn’t manifest itself for, you know, a few weeks.

And you can have an epidemic of something like that, and by the time you know you have an epidemic, you’re very well into it. Well, that’s what happens in dumb financing.

And you had that — you periodically — you certainly had it in commercial financing in the ’80s, and you had the RTC and the savings and loan crisis and all of that because, literally, one dumb project was put up after another.

A developer will develop anything he can borrow the money against. It’s that simple. And when the lending institutions pour the money out for something, it will get built.

And that happened in manufacturing housing. It happened in commercial real estate in the ’80s. I think it’s happened in conventional housing here in recent years.

And if you look at the 10-Qs that are getting filed for the first quarter of some lending institutions, and 10-Ks that were last year, and you look at the balances increasing on loans for interest that’s accrued but was not paid because people had adjustable mortgages, but they’re only adjustable so far, but the lending institutions are taking in the income as if it were paid, you’ll see some very interesting statistics.

CHARLIE MUNGER: Yes. And some of this dumb lending is being facilitated by contemptible accounting. The accounting profession has not stopped compromising its way into terrible behavior.

WARREN BUFFETT: Our auditing bill just went up.

18. No interest in investing in Russia

WARREN BUFFETT: Number 12? (Laughter)

AUDIENCE MEMBER: My name is Elliott Samuels (PH). I’m from New York City.

Thanks to high energy prices and other factors, Russia has been one of the best performing markets recently. The country’s financial condition has stabilized since the 1990s.

A fledging middle class is taking shape as personal incomes grow. And there are also risks — political, legal — risks to minority investors.

But there are also potentially great values among second tier companies there.

I was wondering, what needs to happen in Russia for you to invest there, whether for Berkshire or for yourself, and what kind of companies would interest you there?

WARREN BUFFETT: Sounds like you may own a few Russian stocks yourself. The — I would — as you know, in 1998, Walter Wriston said sovereign governments don’t default.

In 1998, in Russia, at least, he was proven wrong. And Charlie and I were — inherited a business at Salomon that was in the oil business big time-out in the — in Siberia.

And there came a time when — we got to dig the holes. We sent the money in. And as long as we were drilling, we were welcome. And then when we wanted to start taking the oil out, after our money had been used to drill the holes, they weren’t quite as friendly. In fact, it was really kind of extreme what took place with us.

So, having had a few experiences like that, it might take us quite a while before we wanted to sink a lot of money into Russia. It may be different now, but I don’t think it’s any certainty.

I had breakfast in Sun Valley three years ago this July, I believe it was, with [Mikhail] Khodorkovsky, and we had a translator there. And he talked to me about whether — he was thinking about listing Yukos on the New York Stock Exchange, but he said, you know, it would require registering with the SEC or something, and he wasn’t sure whether that would be too dangerous.

Well, I don’t think he listed it there, but he went back to Russia, and he’s been in jail now for — well, just about ever since.

And Yukos was put into bankruptcy with tax claims, and, you know, it — I don’t — I just think it’s a little hard to develop a lot of confidence that the world has changed permanently there in terms of its attitude toward capital, and particularly toward outside capital.

Charlie, what are your thoughts?

CHARLIE MUNGER: Yeah. The situation reminds me a little of POLY Petroleum, which, years ago, was much traded in Los Angeles.

The saying always was, “If they ever do find any oil, that old man will steal it.” And I’m afraid we have some of that problem in many of the countries in which we’re seeking for oil.

WARREN BUFFETT: Didn’t we really have the livelihood of our guys threatened over there, Charlie?

I think we sent in some people to get out the equipment, and they said if we sent in the people to get out the equipment, not only would the equipment not get out, but the people wouldn’t get out.

So we understood the situation. That was not that long ago.

CHARLIE MUNGER: No.

19. Hottest real estate markets are cooling off

WARREN BUFFETT: Number 1 again.

AUDIENCE MEMBER: I’m Lori Gold (PH) from San Francisco, California.

My question is, what are your thoughts about the residential real estate market in the U.S., where it’s headed? And how is California different, if so?

WARREN BUFFETT: Well, Charlie is our California expert. We’ve managed one time to develop a great piece of property in California. We spent about 20 years or so developing it, Charlie, or —

CHARLIE MUNGER: Yes. And we got our money back with interest.

WARREN BUFFETT: Barely. (Laughter)

CHARLIE MUNGER: Barely, yeah.

WARREN BUFFETT: We finished it at just the wrong time. We — the land value that we nurtured — that was a terrific piece of land. Charlie lives there. And I don’t think it’s an exaggeration to say we spent 20 years —

CHARLIE MUNGER: No.

WARREN BUFFETT: — working on developing the land. And the land value, which, in effect, we cashed out for, what, 5 or $6 million, now would have an — the implicit land value — would be what?

CHARLIE MUNGER: Maybe a hundred million dollars.

WARREN BUFFETT: Yeah. But we finished it at the wrong time.

So, you know, it’s a wonderful — the climate is wonderful. Everything is wonderful about this property.

It’s just that, from time to time, even in great localities — you’ve seen it happen in New York a couple of times, you know, in the last 30 years, where the swing in property values has just been huge.

And what we see in our residential brokerage business — and we’re in, I don’t know how many different states — is we see a slowdown every place.

Now, we see it most dramatically in some of the — what have been the hottest markets.

In the markets where you’re going to — in my view — you’re likely to see the greatest fall-off and where you’ve had the biggest bubble are the ones — they tend to be the high-end market, and they tend to be ones where people have bought for investment or speculation, rather than use.

People will pay $300,000 for a house and mortgage it for 270,000, and if the value goes to 250, if they have a job and everything, they won’t move out.

I mean, you don’t lose a lot of money even though the market value on a given day is less than the loan value when families stay together and employment is present and all that.

But when you have investment-type holdings, speculation-type holdings, when you, in effect, have had the day traders, you know, of the Internet move into the day trading of condos, then you — then you get — then you get a market that can move in a big way.

First it sort of stops, and then it kind of reopens. Real estate is different than stocks. If you own a hundred shares of General Motors, it’s going to trade on Monday and that’s what it’s worth and you can’t kid yourself about it.

But if you own real estate, you know, there’s a great tendency to think about the one that sold down the street a few months ago. And there’s a great tendency to think, you know, you only need one buyer who hasn’t gotten the word that things have slowed down and you’ll make your sale.

I can tell you that in Dade and Broward County, for example, in Florida, where the average condo is about 500,000, if you go back to December of 2004, there were less than 9,000 condos listed for sale, and I think 2,900 of them sold in the month so you were — turnover one every three months, less than that.

Now, the listings are up to 30,000, and the sales are down to under 2,000 a month. Well, 30,000 is $15 billion worth of properties. And you are — very likely, you can get real discontinuities in a market like that, where all of a sudden people realize that the whole supply-demand situation has changed.

So I think we’ve had a bubble, to some degree, and it’s very hard to measure that degree until after it’s all over.

But I would be surprised if there aren’t some significant downward adjustments from the peak, particularly in the higher-end properties.

CHARLIE MUNGER: Yeah. The man is right that the bubbles came in Manhattan and in certain places in California. In Omaha, housing prices are quite reasonable. So it’s — the country is not all the same, at all.

20. Attendance estimate and Furniture Mart sales

WARREN BUFFETT: We just got an estimate of the attendance at 24,000, which was about what it looked like from the tickets we had gotten. I thank you all for coming, on that note. (Applause)

Even better, the Furniture Mart, which had sales in 1997 of 5-and-a-fraction million, 2003 sales of 17 million, sales last year of 27 million, is up so far 2 1/2 million, with the best yet to come.

So we’re — I would say we’re likely to do over 30 million at the Furniture Mart. And that, incidentally, is about equal to a normal monthly volume for the store. So you’re doing your part. Thank you. (Applause)

21. Don’t like excess cash, but we hate dumb deals

WARREN BUFFETT: Number 2?

But you can do more. (Laughter)

AUDIENCE MEMBER: Good morning. My name is John Norwood (PH) from Des Moines, Iowa.

I have a two-year rule for my closet. If I don’t wear a particular pair of pants or a shirt within two years, I give it away to Goodwill so that someone else can put it to better use.

With 40 billion in cash, I’m wondering whether Berkshire Hathaway should have a similar closet rule for deployment of surplus shareholder cash.

WARREN BUFFETT: It won’t go to Goodwill, I promise you that. (Laughter)

AUDIENCE MEMBER: Thank you. And wouldn’t it be better if you had a smaller budget and fewer gifts you needed to — you and Charlie needed to shop for? Wouldn’t you have more time for the beach and a better chance of hitting some home runs?

WARREN BUFFETT: Yeah. I don’t think we’ll hit any home runs, under any circumstances. But the — you might consider a normal level of cash at Berkshire as being about 10 billion, although we — you know, there could be circumstances where we’d go below that.

But because of the catastrophe insurance business we’re in and all of that, we do not — you know, we do not scrape the bottom of the barrel, but we don’t need anything like 40 billion.

I think you’ll see in the 10-Q that we have — I think it was about 37 billion at the end of March — double check that — and I’m not counting the cash and the finance business — yeah, 37-something — and we’re spending 4 billion on ISCAR.

We’ve spent — we’re spending some money on some other things as well.

But we would be happier — much happier — if we had 10 billion of cash and all the balance in things that we liked very much.

And we work toward that end at all times. But there is nothing even about the way businesses come to us.

We’ve got one idea at present, low probability, but that would take — could take — as much as 15 billion or close to 15 billion of cash. And whether it comes to fruition or not, who knows, but we do work on them.

And, what we care more — we don’t like having excess cash around. We like even less doing dumb deals because we do them forever.

I mean, if we make a dumb deal, it just sits there. We don’t resell it three months later by having an IPO of it or something of the sort.

So you’re right to say that we should be very uncomfortable about the fact that we’ve got the cash. But it’s also important that we not be so uncomfortable that we go out and do something just to be doing something.

I would say it’s likely, but far from certain, that three years from now we have significantly less cash and, I hope, significantly more earning power. But the goal of that cash is to be translated into permanent earning power over time.

Like I say, with the 4 billion that we’ve just committed on ISCAR, you know, we love having that 4 billion employed there instead of sitting around in short-term securities.

And that’s our job. Charlie and I don’t do anything else, except appear in movies and that sort of thing.

But the — you know, you’re right to keep jabbing us on that because — but we jab ourselves. You know, we — neither one of us is — basically likes cash.

We always want to have adequate cash and we always will have adequate cash. And we are the biggest player in the world in cat insurance, and people come to us because they know we’re going to run a place that’s very strong financially. But it doesn’t have to be as liquid as we are now.

We spent 5 billion — well, we didn’t spend that much. At the Berkshire level, we spent about 3 1/2 billion on PacifiCorp.

You know, we contracted (inaudible) earlier, but we will get more chances, I think, in that field, but you never can tell when they’ll come.

So come back next year, and I hope we have less cash.

OK. We’ll go to 13 now.

OK. Charlie, would you like to add anything on that?

CHARLIE MUNGER: Yeah. I think you may get some perspective on what bothers you if you go back to the annual report of Berkshire ten years ago and then compare that report with the last one.

Despite the great difficulties of deploying cash, we managed to put an awful lot of wonderful stuff into Berkshire in the last ten years. So, we aren’t altogether gloomy about that process continuing. (Applause)

22. Should have sold Coca-Cola at “silly” price

WARREN BUFFETT: I neglected to go to the adjacent room, which has a number of people in it as well. So I’m going to go to No. 13 now, which will come from the ballroom.

AUDIENCE MEMBER: This is Phil McCaw (PH) from Connecticut.

I wonder — it’s been some time since you’ve commented on Coca-Cola. And now that you’re off the board, I wonder if you feel free to comment on it?

WARREN BUFFETT: Yeah. Well, I won’t make particularly different comments than from when I was on the board.

But Coca-Cola is a fabulous company. Coca-Cola will sell over 21 billion cases of various products — more Coke than anything else — around the world this year, and it goes up every year.

It’s interesting. The stock in, what, 1997 or ’98, whenever it was, sold over $80 a share when the earnings were — I don’t remember whether they were $1.50 a share, or something like that — and the earnings then were not as good quality as the earnings are now when, you know, they were $2.17 or something like that.

And every year the — you know, they have — they account for a little greater share of the liquids consumed by people in the world.

They make fabulous returns on invested capital. You know, it’s a business that has — exclude the bottling part of it — has 5 or 6 billion of tangible assets and makes a similar amount.

So, there are not lots of big businesses in the world that earn 100 percent pretax on tangible assets.

And it will be a great business, and it’s been a great business.

The stock got to what, in retrospect, clearly was a ridiculous level, but you can’t hold the present management, Neville Isdell, responsible for that.

And he — you know, if the company sells 4 or 5 percent more units this year than last year, and the population of the world goes up 2 percent, it just means that more people are putting that particular source of liquid down their throats than the year before, and that’s been going on ever since 1886.

So it strikes us as a really wonderful business that sold at a very silly price some years back.

And you can definitely fault me for not selling the stock. I always thought it was a wonderful business, but clearly, at 50 times earnings, it was a silly price on the stock.

So we like it. We’ll own it ten years from now, in my view. Charlie?

CHARLIE MUNGER: No more.

WARREN BUFFETT: This peanut brittle gets caught occasionally, but it’s worth it. It’s worth it, definitely.

CHARLIE MUNGER: Why don’t you share with me?

WARREN BUFFETT: What? Oh, you want some, huh? Get your own box next time. (Laughter)

23. Reinsurance rate variations

WARREN BUFFETT: Now, do you want us to go to 14 or not? Yes. OK. Number 14.

AUDIENCE MEMBER: My name is John Gosh (PH) from Key West.

Have insurance rates hardened as much as you anticipated, and have you seen a significant flight to quality in the last few years?

WARREN BUFFETT: Yeah. I think you’re probably asking more about reinsurance rates.

Actually, in auto insurance, you can figure it out. Our policies are up more than our premium volume. So the average premium in auto insurance, which, after all, is close to 40 percent of the whole market for insurance — the average premium in auto insurance is actually down a little bit.

But in reinsurance, in which we are a big player, you will — there’s great variances.

If you take insurance for marine risks in the Gulf Coast — drilling rigs and offshore platforms and that sort of thing — those prices are up very dramatically, but they should be.

I think in the last couple of years, there’s been, like, 2 1/2 billion of premium in the Gulf Coast and 15 billion in losses. So if you paid out 15 billion and took in 2 1/2 billion, the more astute of you would figure that you needed a little more money for that particular risk.

We have been, historically — at least in recent years — the largest writer of cat — catastrophe — mega catastrophe insurance in world, and I think we will be this year. In fact, I’m almost sure we will be this year.

Our mix has changed some. Prices are up a lot, but what we don’t know is whether exposures are up even more.

We don’t know whether the experience of the last two years, we’ll say, with hurricanes in this hemisphere, is more to be relied upon than the experience of the last hundred years.

You can take the hundred-year experience and it tells you one thing, and you can take the last couple years and it tells you something else. And which is more meaningful? We don’t know the answer to that.

We do know that it would be kind of silly to assume that the 100-year experience is the relevant criteria when conditions — we know certain atmospheric conditions have changed. We know water temperature’s changed.

But we do not know all of the variables that are into the propensity of hurricanes to occur and the degree to how intense they may be if they do occur. We don’t know the answer to that. We don’t think anybody else knows the answer to it, either.

So we are getting more money for hurricane insurance. We’re getting appreciably more money.

If the last two years are the relevant years, we’re not getting enough. If the last hundred years are the relevant years, we’re getting plenty. And we will know more as time unfolds.

The really scary possibility is that variables are changing in some way so that the change is continuous and that what we’ve seen the last two years is not a worst-case example at all.

And, of course, you get into chaos-type theory with some of these variables where the outcome is not a linear relationship to the input, and you can dream up some pretty scary scenarios on this.

I don’t know whether they’re true and nobody knows.

We are willing to write certain areas, certain coverages, because we believe the prices are adequate, and we can sustain the losses.

We’re willing to lose many billions of dollars in a given catastrophe if we think we’ve been paid appropriately for it.

But it is not like figuring out the odds on flipping coins or rolling dice or something like that. You are dealing with changing variables, and you — the worst thing you could have would be a 100-year history book in making those judgments.

The third quarter, we will have a lot of exposure for wind. We don’t have as much exposure now — well, we may. I’d say we’re getting there. But we don’t have as much — certainly as much as we had a couple of years ago.

Prices — question about prices hardening. Prices are getting — are hardening — in that particular area. And if they get to what the — where we really feel they’re appropriate — you know, we might take on a fair — we will take on — a fair amount more risk.

If they don’t get there, even though they’re higher than last year, we won’t write — you know, we’re not interested in writing it, because it’s a dangerous business.

And we don’t believe in modelers at all. I read all this stuff about modeling. I wrote about that a few years ago. It’s silly. You know, the modelers don’t know a thing, in my view, about what’s going to happen.

And we get paid for making guesses on it. If, over a lifetime, the guesses are decent, we will know that, you know, we were doing the right thing.

But if this year goes by and nothing happens, we still don’t know whether we were right on the prices.

Because if you get a 25 percent rate for something and it doesn’t happen in a year, that does not mean that you didn’t need 40 percent or 50 percent. It just means that if you do it enough times, you will find out whether, overall, your judgments are any good.

It’s still a business we like. We bring a lot to the party. Everybody knows we can pay. You get into the question of creditworthiness.

If there is some super, super catastrophe — and I regard, sort of, the outer limits of that being a $250 billion insured loss — for reference, Katrina was a — presently estimated — was about a $60 billion loss.

So, if something comes along that’s four times Katrina, which could happen, you know, we can pay, and we can comfortably pay. We would probably have about 4 percent of that, maybe 10 billion.

A very large percent of the industry would be in very, very serious trouble.

So, we can play bigger than others, and we can survive better than others if something bad comes along. And we will see, over a five- or ten-year period, how we do. You can’t judge it by any one year.

Charlie?

CHARLIE MUNGER: The record of the past, if you average it out, has been quite respectable.

And why shouldn’t we use our capital strength to get into volatile stuff that makes other people frightened?

24. NetJets losses and retroactive policies

WARREN BUFFETT: Do we go back to number — to here? One more. Number 15?

AUDIENCE MEMBER: Hello?

WARREN BUFFETT: Yeah.

AUDIENCE MEMBER: I’m Marc Rabinov from Melbourne, Australia. I had a two-part question on the 2005 annual report.

Firstly, NetJets is a substantial part of our operations. Unfortunately, its value is obscured by losses in recent years, and I can’t estimate its value from the report. I was hoping you might be able to help me on that.

The second thing, how do I value the Berkshire Hathaway reinsurance group in light of the deferred charges on retroactive policies? Thank you.

WARREN BUFFETT: The second question, that — about the — we have an item that’s about $2 billion on the asset side.

I think I’m addressing the question of deferred charges on retroactive policies. That reflects the fact that those retroactive policies, where we insure — we reinsure, in effect — the losses that somebody has already incurred, although they may not know how much they’ve incurred, and we have limits on these.

But we set up a factor that, essentially, recognizes the fact that we will have that money for a considerable period of time. We set up an asset, and that gets amortized over the length of time we have that asset.

That number, which I think has gotten as high as 3 billion over the years, since we haven’t done any of those — any big contracts recently, is down around 2 billion.

There’s nothing magic about that. It means that we’re going to amortize that 2 billion over the lifetime of the use of the funds, and we think we’ll make money, net, during that time.

But we misguessed on one a couple years ago and took a $100 million charge, for example, in the first quarter of — I think it was the year before last.

The other question was about NetJets, wasn’t it, Charlie?

CHARLIE MUNGER: Yeah.

WARREN BUFFETT: And I didn’t get it all. I love the Australian accent of our gecko, but I didn’t pick up the exact nuances of what you asked.

But my guess is you asked about the earnings and operation of NetJets.

And NetJets has grown rapidly, and so far, our expenses have grown faster than our revenue.

We’ve got the top service in the world. We’ve got, really, the only worldwide service. We have a very strong position, particularly in larger airplanes.

But I’d have to tell you that I did not anticipate — I thought we would have economies of scale, to some degree, and so far you can almost argue that we’ve had diseconomies of scale.

And our expenses, particularly last year, you know, basically got out of hand. And there are various reasons I could give you for that. All I can tell you is, it’s being addressed.

Rich Santulli, who runs that operation, you could not have a better operator. He loves NetJets. He works at it 16 hours a day. He’s — there’s nobody in the world I would have run that except for Rich.

I think it’s an important service. It’s tough to make money with airplanes. They’re capital-intensive. We’ve had fuel do what it has, although that’s a pass-through to people, but it still affects the business.

And I would — I had expected we would be profitable last year, and as I put in the annual report, I was dead wrong.

I think we will be profitable before long, but you should take my prediction there with — probably with — a certain amount of skepticism until it actually happens because I, like I say, I’ve been wrong.

We’ve got a good business in that almost anybody looking for a large plane on a fractional jet program comes to us. We are able to get full price for our service. But there were a variety of inefficiencies last year which added up to a lot of dollars.

And you know, you’re entitled to hold me accountable for the fact that we paid a lot of money for the business many years ago, and we haven’t earned any money since.

And we’ve got a much bigger business now, probably five times or so the size of the business we bought. That may be some solace to — I looked at Raytheon’s figures the other day. They lost a lot of money, and they have the second largest operation.

They sell their — they sell airplanes too, so they may not feel it the way I do.

But if I had to bet one way or the other, I would bet we will be making money before long, but I’ve lost that bet in the past.

Charlie?

CHARLIE MUNGER: Yeah. The product integrity is so extreme between flight safety and NetJets. The pilots are subjected to real oxygen withdrawal in the course of the safety training so they will recognize the subtle sensation that you get, and not everybody does that. It’s an expensive, difficult thing to do.

In place after place after place, that system is very obsessive about product integrity, and it’s my guess that that obsession, in due course, will be rewarded.

25. Why Buffett bought, and sold, silver

WARREN BUFFETT: OK. We’ll go to Number 3.

AUDIENCE MEMBER: Dear Warren and Charlie, I’m Oliver Couchet (PH) from Frankfurt in Germany.

Here’s a question to the Silver King: Some commodity investors give you as a reference as one of the largest owner of physical silver. Could you please clarify what kind of exposure you or Berkshire currently have in silver?

And, further, could you please help us to understand how you determine the value of a noninterest-bearing precious metal?

WARREN BUFFETT: Do you have any silver on you, Charlie? We had a lot of silver at one time, but we don’t have it now.

The original decision — my decision — was that the production of silver and the reclamation of silver — I don’t remember the numbers exactly now — but they were running, perhaps, 100 million ounces or thereabouts, less than the consumption.

And, now, a lot of consumption has gone down in photography, but that’s where the reclamation was, too, so that those tended more to balance each other out.

I haven’t looked at the figures for the last year or so, but silver was out of balance.

Now, on the other hand, there were enormous quantities of silver aboveground, and there were huge quantities of silver that could possibly be removed from other uses, perhaps, you know, in jewelry and all kinds of things, that could conceivably add to supply as they did in the early 1980s when the Hunt Brothers thing took place.

But, overall, silver was being produced and reclaimed at a lesser rate than it was being consumed.

And added to that was the fact that there are relatively few pure silver mines. Silver is largely produced as a by-product of copper and lead and zinc, and so that it was not easy to bring on added production.

So, all of that added up to the fact that I thought that silver would get tight at some point.

And, as I said, I was very — I was early in that conclusion, and I was early in selling.

So we have no silver now, and we did not make much money on it.

And you’re right that it doesn’t earn anything. So you sit with it. It’s not like sitting with a stock where, in most cases, earnings are piling up for you.

You have to hope that it — you have to hope that a commodity moves in price, because it is not producing anything as it sits there looking at you. And that’s one of the drawbacks of commodities.

Charlie?

CHARLIE MUNGER: We didn’t get where we are by owning noninterest-bearing commodities. I don’t think it’s a big issue around here.

WARREN BUFFETT: We actually owned oil at one time too, didn’t we? But we didn’t make much money on it. We made a little money.

CHARLIE MUNGER: No. You made quite a bit out of oil.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: But, you know, it’s a good habit to trumpet your failures and be quiet about your successes. (Laughter)

WARREN BUFFETT: Yeah. We have more to trumpet than we have to be quiet about. (Laughter)

26. “We don’t play big trends”

WARREN BUFFETT: How about number 4?

AUDIENCE MEMBER: Good morning. My name is Bill Gurn (PH). I’ve traveled from the United Kingdom.

And I would like to ask if you think it’s a good investment strategy to invest in regions of high resources per capita?

In particular, I should like to ask if you think that the analysis per capita should lead to higher growth for businesses in that region, plus the bonus of a relative exchange rate growth? Thank you.

WARREN BUFFETT: I’m not sure about the per capita part, Charlie.

CHARLIE MUNGER: My understanding is he was talking about investing in a region with high resources per capita. I think he means natural resources.

WARREN BUFFETT: Yeah. Are you thinking of places like Canada or something of the sort where the —

AUDIENCE MEMBER: I can clarify. Yes, high natural resources, but also good infrastructure. Thank you.

WARREN BUFFETT: And whether there would be relative currency strength in those as well and —

CHARLIE MUNGER: No. Whether it’s a good area for us to be operating in.

WARREN BUFFETT: Well, that would be a little macro for us. We really just zero in on, you know, whether people will keep eating candy and whether we can charge a little more for it next year.

We don’t play big trends. You know, we don’t think about demographic trends or anything of the sort. We think about our own age as getting older.

But other — big trends, they just don’t mean that much. There’s too much money to be made from year to year to think about things that take decades to manifest themselves.

So I can’t recall of a decision we’ve ever made on a purchase of a business or a stock or a junk bond or a currency or anything else based on a macro.

CHARLIE MUNGER: Not only that, we’ve recently failed to profit much from one of the biggest commodity booms in history.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: And we’ll probably continue to fail in the same way. (Laughter)

WARREN BUFFETT: But we’ll search for new ways to fail. I mean, we’re not trying to limit ourselves. (Laughter)

It’s probably true, incidentally, in a country like Canada, where you’ve got, probably, millions of barrels of oil of — millions of barrels a day — of oil production coming on and where there’s, you know, relatively few people and where there’s already a surplus.

When they’re running a significant current account surplus, that — you know, it’s not strange that their currency should be strong relative to a country like ours where we’re running a huge current account deficit and we don’t have that same natural — the gain in natural exports coming on that they do.

But that — there’s so many more important factors that are going to hit us immediately that that’s what we really think about day-to-day.

27. Nuclear threat is “ultimate problem of mankind”

WARREN BUFFETT: Number 5?

AUDIENCE MEMBER: Good morning. My name is Glen Strong (PH). I’m from Canton, Ohio.

I’m an optimistic person, and I’m sure it would be more enjoyable to discuss the Chicago Cubs’ march to the World Series.

WARREN BUFFETT: You are optimistic. (Laughter)

But everybody has a bad century now and then, as somebody said about the Cubs. (Laughter)

AUDIENCE MEMBER: However — (Laughter) — I have an information deficit on a certain topic that I hope you can fix. Please gaze into your crystal ball.

As an investor, I want to know how to address the risk of nuclear terrorism in the United States.

Consider a scenario where terrorists have detonated a nuclear device in a major U.S. city. I know there would be a terrible cost in human lives.

Gentlemen, what would happen to our economy? How would it respond? How resilient would it be? Thank you.

WARREN BUFFETT: Well, it would certainly depend on the extent of it.

But, if you’re asking how to profit from that, there’s probably some dealer that will sell you mortality derivatives. But I’m not sure that’s what we would be thinking about then.

No. I agree with you. I couldn’t agree with you more about that being the ultimate problem of mankind, not necessarily a terrorist-type usage, but a state-sponsored usage of weapons of mass destruction.

And it will happen someday. The extent to which it will happen, where it will happen, who knows. But we’ve always had evil people. We’ve always had people who wish evil on others.

And, you know, thousands of years ago, if you were psychotic or a religious fanatic or a malcontent and you wished evil on your neighbor, you picked up a rock and threw it at them, and that was about the damage you could do. But we went on to bows and arrows and cannons and a few things.

But since 1945, it’s — the potential for inflicting enormous harm on incredible numbers of people has increased, you know, at a geometric pace.

So it is the problem of mankind. It may happen here. It may happen someplace else.

People say it’s a — sometimes they say, “Well, you know, if we’d solve poverty, we’d solve this.” Well, I will just remind you that nuclear weapons have only been used twice, and those were by the richest country in the world, the United States, in 1945.

So, people will justify their use under some circumstances, if they feel threatened. They will justify them for religious reasons. They will do all kinds of crazy things.

And the — what holds it in check is the degree to which the lack of knowledge of how to do it is controlled, and the degree to which the materials are controlled, and which the deliverability is circumscribed.

And we’re losing ground on all of those fronts. The knowledge is more widespread. The possibility of getting your hands on materials — you know, the Dr. Khans [Pakistani nuclear scientist] of the world and so on, has increased.

And it will be a — it’s a real problem, but we won’t be thinking about what Berkshire did that day in the stock market.

And I don’t know how money attacks that. I mean, I’ve always saw that as the top priority, I think should be the top priority for philanthropy, in my particular case.

But it’s a difficult — it’s a very difficult — it’s a worst-case problem. You know, you have 6 billion people in the world, and you have a certain percentage of them who are, one way or another, a little crazy, or very crazy, and some of whom in that craziness would manifest itself by trying to do great harm to a lot of people.

And it’s — only one of them has to succeed.

I don’t know how many we’ve intercepted over the years. I’m sure we’ve intercepted a lot of incipient ones.

But it is a worst-case problem, and one will succeed at some point. And it may be state-sponsored; it may be terrorists.

But, you know, Berkshire is better set to survive than anybody else, but it won’t make much difference.

Charlie?

CHARLIE MUNGER: Well, I think that the chances we’ll have another 60 or 70 years with no nuclear devices used on purpose is pretty close to zero.

So, I think you’re right to worry about it, but I don’t, myself, think there’s much that any of us can do about it, except be as sensible as we can and take the consequences as they come.

WARREN BUFFETT: The only thing you can do about it — but you only have one vote — is to elect leaders who are terribly conscious of the product — problem — and who devote a significant part, you know, of their thought and energy into minimizing it.

You can’t eliminate it. You know, the genie is out of the bottle. And you would like to have the leading — the leaders — of the major countries of the world regarding it as their primary — as a primary — focus.

Actually, in the 2004 campaign, I think that both candidates said it was the major problem of our time. But, you know, they probably suffer from the same feeling that I do, that it’s very hard to address.

28. A Berkshire stock buyback won’t be a secret

WARREN BUFFETT: Number 6?

AUDIENCE MEMBER: Hello, Mr. Buffett, Mr. Munger. My name is William Schooler (PH), and I’m a shareholder visiting from Spicewood, Texas.

I would like to thank you both for being so generous to the public with your ideas.

Last year, I read “Poor Charlie’s Almanack” and came across a passage on share repurchases.

It reads, quote: “When Berkshire has gotten cheap, we’ve found other even cheaper stocks to buy. I’d always prefer this. It’s no fun to have the company so lacking in repute that we can make money for some shareholders by buying out others,” end quote.

Last year, you bought stock in some great businesses trading at fair prices, such as Walmart and Budweiser, but did not attempt to buy our own shares.

Would shareholders be correct to infer from this decision that you both felt Walmart and Budweiser were trading at a deeper discount to their intrinsic values than Berkshire was?

And would it be possible to buy as much Berkshire in the open market as you did Walmart without running up the share price?

WARREN BUFFETT: Most of the time, we would not be able to buy an amount that would be material, in terms of increasing the value of the remaining Berkshire shares. But that doesn’t mean it would never happen.

But it — if you look at the trading volume on Berkshire — and, [CFO] Marc [Hamburg], you might put that up, if we can, in a second — we probably have less opportunity than most companies if our stock is selling — should be selling — below intrinsic value to have anything meaningful happen.

We would also have — if we regarded some other company as worth X, a good business, and we could buy it at 90 percent of X, we might be doing that now, whereas we wouldn’t have done it many years ago.

But we might require a somewhat greater margin, in terms of buying Berkshire shares, simply because our view on that might be less — we probably have more knowledge on it, but we might be less objective than on some other things.

We think that when we buy — if we were to buy in Berkshire shares — and, if you remember, four or five years ago I announced we would if the price stayed the same — that the case ought to really be compelling, and if it’s compelling, we ought to do it. It was compelling at that time.

But simply the act of writing about it — you know, a little bit of a Heisenberg principle — the act of writing about it, in effect, eliminated the opportunity to do it, which is fine.

Because we do not — we are not looking to make money off of buying from shareholders at a depressed price.

On the other hand, if the price is sufficiently depressed, we will announce again that we intend to do it, and then we’ll see whether we actually get a chance to do it. Charlie?

CHARLIE MUNGER: Yeah. The whole climate in the country is different now.

It used to be that almost every company that bought in shares was buying them in at an obvious bargain price. Now I think a lot of share buying is designed to, sort of, prop the stock price.

In other words, it’s not bargain-seeking. It’s more like Sam Insull.

WARREN BUFFETT: Yeah. Forty years ago, 30 years ago, it was a very fertile field for making money to look at companies that were aggressively buying in their shares, the most extreme case probably being Teledyne.

But those people were buying overwhelmingly — Gurdon Wattles was doing it at the companies he controlled — those people were motivated simply by the fact they wanted to buy the stock below what it was really worth and — significantly below — and you could make money with that group, and we did a little of that at the time.

I would say in recent years, that motivation has been swamped by people who either think it’s fashionable to buy in shares, or by people who really like the idea of trying to prop their stock up somewhat.

And the SEC has certain rules, in terms of the way you conduct your repurchases to prevent daily, sort of, propping up.

But I think there’s a lot of motivation that our stock has got to be cheaper than other people’s stock, and we’ve got a wonderful company, and we’re just going to buy the stock come hell or high water, and that is not the way we would go about repurchasing shares.

We’ve got — well, we had up there, I think — some figures that showed the turnover of Berkshire shares compared — in a year — compared with a few others I picked out.

I think Berkshire has the lowest turnover, by some margin, of any major company in the United States.

And I put Walmart up there because the Walton family owns about the same — in fact, they own more — of Walmart than I do of Berkshire.

So, this is not a function of simply the fact that we’ve got concentrated holdings with the Buffett family.

This is a reflection of the fact that we’ve got a really unusual shareholder body in that they think of themselves as owners and not as people who are moving around with little pieces of paper every week or month.

We have the most — in my view — we have the most what I would call honest-to-God ownership attitude among our 400,000 or so shareholders of any company — of any big traded company — in the United States.

People buy Berkshire to own it, and hold it, and that’s reflected in our turnover. That does mean if, for some reason, the stock gets cheap — real cheap — that we would not be able to buy a lot of stock in.

But we don’t want — we are not looking to buy out our partners at a discount. If it sells there and we tell them we’re going to buy it, we’ll buy it. But that’s not a way that we’re trying to make money.

Charlie, any more?

CHARLIE MUNGER: No. I’ve said my piece.

29. Advice to young investment professionals

WARREN BUFFETT: Number 7?

AUDIENCE MEMBER: Good morning. My name is David Saber (PH), shareholder from Minneapolis, Minnesota. Looking for some advice you might give the young professionals here.

I could be classified as one of those helpers you describe in your annual report. In fact, most of my friends are helpers, and some could be classified as super helpers.

Most would love to step out and explore some of their more innovative ideas, innovative business models, strategies, and things of that nature.

But the risk of giving up a significant salary, health insurance, flights, other ridiculous corporate perks some of us young professionals earn.

What advice would you have for us in pursuing those dreams?

WARREN BUFFETT: Charlie, what do you think?

CHARLIE MUNGER: Well, there’s certainly a lot more helpers in the economy than there used to be, and the ones that come here tend to be the very best of the helper class.

So, I don’t think you should judge the helper class by those you meet here. We get the best of them.

And as to what the young helpers ought to do so that they’ll eventually be like Warren Buffett, I would say the best thing you can do is reduce your expectations. (Laughter and applause)

WARREN BUFFETT: I think I’ve heard that before.

Well, you know, as I wrote about — and I — trying to tweak the system a little bit — but it is an interesting business in that the activities of the professionals are self-neutralizing.

And if you’re going to — if your wife is going to have a baby — you’re going to be better off if you call an obstetrician, probably, than if you do it yourself. You know, and if your plumbing pipes are clogged or something, you’re probably better off calling a plumber.

Most professions have value added to them above what the laymen can accomplish themselves. In aggregate, the investment profession does not do that.

So you have a huge group of people making — I put the estimate as $140 billion a year — that, in aggregate, are, and can, only accomplish what somebody can do, you know, in ten minutes a year by themselves.

And it’s hard to think of another business like that, Charlie.

CHARLIE MUNGER: I can’t think of any.

WARREN BUFFETT: No.

But it’s become a bigger and bigger business.

And, as I’ve pointed out in the report, the main thing that’s been learned is that the more you charge, at least temporarily, the more money you bring in, that people have this idea that price equals value.

It’s useful to get into a business like that.

Sometimes, if I’m talking to the people at a business school and I ask them what the — what a great — to name me a great business — and, of course, one of the great businesses is a business school because, basically, the more you charge, the more your prestige is, to some extent.

And people think that a business school that charges 50,000 a year tuition is going to be better than one that charges 10,000 a year of tuition.

So there’s some of that that — well, there’s a lot of that that’s gotten into the investment field recently, and you now have large — certain large — portions of investment management that are charging fees that, in aggregate, cannot work out for investors.

Now, obviously some do, you know. But you cannot be paying people 2 percent and 20 percent where they get up it in the good years, and they fold their partnerships and start another one if they have a bad year and that sort of thing.

You can’t have that coming out of an economy that’s only going to produce, we’ll say, you know, 7 percent or something like that a year for investors, and have people net better off. It isn’t going to work.

And then the question that you will have is, “How do I pick out the few exceptions?” And everyone that calls upon you to sell you this will tell you that they are an exception.

And, I am willing to bet a significant sum of money, we’ll put it up, to anybody who wants to name ten partnerships that are $500 million or more of management and pit those, after fees, against the S&P over a ten-year period.

It — you know, it gets away from the survivorship bias and all that kind of a thing. And it isn’t going to happen.

But a few will do well. They’re bound to do well.

And, actually, I think I do know how to pick a few that will do well. I mean, I did it in the past.

When I wound up my own partnership in 1969, I told people to go to either Bill Ruane or Sandy Gottesman, and that would have been a very good decision, whichever place they went.

So, if you know enough about the person, know enough how they’ve done it in the past, know enough about their personality, honesty, and a whole bunch of things, I think that occasionally you can make a very intelligent choice in picking an investment manager.

But I don’t think you can do it if you’re sitting running a pension fund in some state and you have 50 people calling on you.

You’re going to go with the ones that are the best salespeople and not the ones that are the best investors. Charlie?

CHARLIE MUNGER: Yeah. On that state pension fund investment subject, I think it ought to be a crime to entertain, in any way, a state pension fund official, and I think it ought to be a crime, if you are a state pension fund official, to accept the entertainment.

It’s not a pretty scene, a lot of investment management, in America now. And, human nature being what it is and the amounts of money being what they are, I don’t think much is going to be improved.

30. Break for lunch

WARREN BUFFETT: Well, we wanted to leave you in a good mood for lunch. So — (laughter) — we will break now, and we’ll come back in about 45 minutes or so.

And those of you who are in the other rooms, by then the crowd thins, for some explainable reason, and you can all join us here in the main room. And we’ll be back in about 45 minutes.

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Text

2004 Berkshire Hathaway Annual Meeting (Morning) Transcript

1. Welcome

WARREN BUFFETT: (Applause) Thank you.

Good morning. Some of you may have noticed a stunt man was used in that [video shown before the meeting]. (Laughter)

Arnold [Schwarzenegger] just couldn’t handle some of those scenes. (Laughter)

Before we get started, I’d especially like to thank Andy Heyward, who’s here today and if we can — I don’t know whether we can find him out in the crowd, it’s a little hard to see from up here.

But Andy runs DiC Productions. He does that cartoon for us and let’s give him a big hand. (Applause)

Andy has produced a really extraordinary series telling the story of the beginning of this country called “Liberty’s Kids.” It’s been on public broadcasting the last couple of years. It’s great for kids but it’s great for adults, too. I’ve watched a number of sessions myself.

And this summer, in July, it will go on sale at Walmart, a very special celebration. And for those of you who want to pick out something good for your children or your grandchildren, I can’t think of a better series to have them watching. And thanks again Andy.

And thanks also to Kelly Muchemore who puts this whole production on. (Applause)

This is Kelly’s show.

She, along with that dog Dudley, who you saw in the movie — Dudley is a regular at Berkshire Hathaway. We don’t count him in the 15.8 [employees at headquarters], but she, along with Dudley, handle everything. I don’t even give a thought to what’s going to happen here, as might become evident during the meeting. (Laughter)

She is responsible for putting up that whole exhibition arrangement and really the whole thing. So, Kelly, I don’t know where you are exactly, but in any event, thank you very much. (Applause)

2. Formal business meeting begins

WARREN BUFFETT: Now, we’ll go through the business part of the meeting. And it may take a little longer than usual, but please be patient.

And I’d like to start out by calling the meeting to order. I’m Warren Buffett, chairman of the board of Berkshire Hathaway, and I welcome you to this meeting.

This hyperkinetic fellow next to me is Charlie Munger — (laughter) — the vice chairman. And we will have a good time, and I hope you do, too.

We work together because he can hear and I can see. I mean, it’s — (laughter) — there are times where we can’t remember each other’s name, but we have a lot of fun together.

Now, any shareholder who wishes to speak regarding the shareholder proposal expected to be presented by Human Life International, or any other matters germane to the shareholder’s meeting, should now go to microphone zone 1, which is in section 121 over on my right.

Or section 2, which is at section 221, I believe that’s higher up on my right. And — let me see if I have that right. Yeah, or go to section 7, which is — or section 105 — which is microphone 7 on my left. Or to section 205, which is microphone 8.

If you’ll go to — if you’re going to want to talk about anything concerning the business of the meeting, not the questions afterwards, but just that relates to the matters germane to the meeting, please go there now, because I’m not going to be able to spot people in a crowd this size.

And when it comes time to do the business, we’re going to ask anybody that cares to speak up on the business to be at those microphones. And that will be in just a couple of minutes.

Now after adjournment of the business meeting, I’ll respond to questions that you may have that relate to the businesses of Berkshire but that don’t call for any action at the meeting.

We had some complaints after last year that some people were asking six or seven-part questions. At least, that’s the reason I’m giving that we’re eliminating those.

The bigger reason is Charlie and I can’t remember the first part by the time you get to the fifth part. (Laughter)

So, we are asking you to ask only one question. And don’t try to get too clever about working three or four into a single question. And that will give more people a chance to get their questions asked. Only one question at a time and we will go around from microphone to microphone and get as many in as we can.

Now, we’re going to do this until noon and then we’ll take a break for lunch and we’ll come back about one and we’ll continue until 3:30. And anything goes on the questions. We’ll answer almost anything, except questions about what we may be buying or selling.

You’re free, of course, to wander around, go over and buy things. You know, we have a lot of things for sale over there.

It’s — as I’ve pointed out in the past, it’s better form to leave while Charlie is speaking than when I’m speaking, but you can — (laughter) — use your own judgment on that.

Now, I do want to remind you that any audio or video recording of this meeting is prohibited. That if anybody’s seen recording the proceedings, we will have to ask you to leave. So, if you see anybody doing that, we would appreciate it if you would just inform one of the staff personnel around.

Because there’s certain copyrighted material that we use and people, like Judge Judy, give us permission to use a segment like that. But it’s not intended to be used in any commercial way. So, we do ask that no recording take place.

3. Directors introduced

WARREN BUFFETT: Now, I’ll first introduce the Berkshire Hathaway directors that are present, in addition to myself and Charlie. Now, I’ll ask the directors to stand as their names are read and ask that you withhold applause, if any — (laughter) — until all are introduced.

We have — I don’t know whether we have anybody here from CalPERS, but they can register their own views as we go along. (Laughter)

And it is difficult to see from here, so if you’ll just stand as I mention your name and remain standing until the end, when we will see whether you get any applause.

Susan T. Buffett. Howard G. Buffett. Malcolm G. Chace. David S. Gottesman — Sandy had a conflict today. There’s a bat mitzvah, I believe, for a granddaughter, so he’s coming in tomorrow for our director’s meeting on Monday.

Charlotte Guyman. Donald R. Keough. Thomas S. Murphy. Ronald L. Olson, and Walter Scott Jr. And now you can go crazy. (Applause)

4. Four questions for the auditors

WARREN BUFFETT: 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.

In that regard, I wish to report that at Berkshire’s audit committee meeting held on March 2nd, 2004, Deloitte & Touche responded to the four questions I suggested be asked to the independent accountants by all audit committees. And we’re going to put these up in just a second.

With respect to Berkshire, the questions and the auditors’ responses will be shown on the following slides.

And I might mention that I really do think these questions should be asked of all auditors, at least annually, perhaps even quarterly.

And I really think that, if such a procedure had been followed over the years — don’t eat them all Charlie. (Laughter)

If such procedures had been followed over the years, there would have been a lot less trouble in corporate America.

I mean, for many years, particularly in the ’90s, I think there was a weakening, frankly, in auditor vigilance. And the trick, as I’ve said, is really to have the auditors more worried about the audit committee than they are worried about the management.

And it’s quite natural when they’re, essentially, hired by the management and when they see the management regularly and they only see the audit committee infrequently, that it’s tempting to listen a little bit more to management than the audit committee.

But these questions, if asked, in my view — and if the answers are put on the record — I think it would have a very helpful effect on behavior. Because once on the record, it means the auditors — it means they’re on the line.

And I’ve been on a lot of boards of directors and I’ve seen, in retrospect, things go by that I wish had been called to my attention by the auditors.

So we have these four questions. And if we’ll put up the first one — and I’d like to explain one item. Do we have those up? Yeah.

You can read the question and these are the responses, as we go along, that the auditors have given to these questions.

Now you’ll notice on the first one that there is one item that — and incidentally, we owe a shareholder, who I think is going to speak later — it was his suggestion that we actually present these at the meeting. And I think it’s a good suggestion. And I think if more companies did it, it would be a good idea. So I thank him for the suggestion.

The major item, which is not material, as auditors define it, but the major item in which we disagree and use a method which I will explain further — actually, it’s been changed — but concerns the purchase of life insurance policies, or the reinsurance of people who are purchasing life insurance policies, their so-called viatical settlements.

And we have had a business, of sorts, in that. And it’s likely to even be a larger business in the future.

And what takes place there is that somebody, usually elderly, has a life insurance policy and they’d rather have the money themselves than have their heirs get it later on. So, they want to cash out early.

And as you know, a life insurance policy typically has a cash surrender value. And sometimes those cash surrender values are quite low in relation to the actuarial value of the policy. So sometimes those people wish to sell a policy.

We had a case the other day where a 79-year-old woman had an insurance policy amounting to some $75 million. I’ve never met her, but she must be quite a woman, but — (Laughter)

The cash surrender value of that policy was $2 million. Clearly, for even a 79-year-old in the best of health, that was an inadequate sum for her to receive. But yet she wished to have the cash herself rather than eventually die and leave it to her heirs.

So, we paid — or we actually reinsured a transaction where somebody else did it, and we took only 50 percent of it, but I’m going to use a hundred percent figures.

We reinsured — we bought that policy for $10 million. And under accounting rules — GAAP accounting — we — it is recommended that we write that policy down immediately to the cash surrender value of 2 million. Well obviously, we think it’s worth 10 million or we wouldn’t have paid 10 million for it today.

But the rules, as they become more clear, say write it down immediately. I happen to think that rule is wrong. But last year, at the end of the year, there had been a total of $73 million applicable to such policies that reflected our purchase price as opposed to the cash surrender value.

In the first quarter of 2004, our activity has stepped up in this field some — the people we reinsure have stepped up their activities, so we get our 50 percent. And that amounts to — it’s going to amount in the first quarter to about 30 million.

So, we have adopted — even though we think it’s in incorrect — we have adopted the GAAP accounting. And you will see in the first quarter report of Berkshire the charge for the 73 million of last year plus the 30 million in the first quarter this year.

And that gets charged, believe it or not, to realized capital gains. And so, by buying these policies for X on one day and immediately writing them down substantially, that becomes a realized capital loss on our book. Now later on, we expect to get a perfectly satisfactory return from these policies. But that is the main item that is referred to in the auditor’s answer on question one.

Now, if we’ll go to number 2. You have time to read that.

I like the idea of this question being asked. I’ve read many reports where the footnotes are such that even if I reread them several times, I still don’t know what’s happened. And we try to write everything in plain English at Berkshire, and we try to explain things within the body of the letter that might give people the wrong impression if they simply looked at the figures, or that they might not be able to discern.

Because Berkshire’s gotten so large that we — there are all kinds of things that are lumped together in the consolidated statements, that I think it’s more helpful if we look at separately.

We’re going to work at — annually — at trying to disaggregate numbers and information in a way that makes it most useful without turning out something as long as the World Book.

Third item is very simple.

And the fourth item relates to something that became very prevalent in corporate America in the 1990s, which was moving around numbers from one quarter to another or moving them for one year to another.

And I have seen a lot of that. It’s deceptive. I like the statement that the two fellows at Google made the other day where they essentially said that if numbers are lumpy or peculiar when they get to them, they’re going to be lumpy or peculiar when they get to the public.

And if there’s some reason that requires explanation as to why they’re lumpy, that the management should explain them. But the one thing they shouldn’t do is start playing games from quarter to quarter or year to year in terms of moving numbers around.

And that became very fashionable. I hope it’s on the way to being moderated and we will continue to — each year, we will give you these questions at the meeting and we will report on the auditor’s answers.

5. Election of directors

WARREN BUFFETT: 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 the 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: Yes, I do. As indicated in the proxy statement that accompanied the notice of this meeting that was sent to all shareholders of record on March 3rd, 2004, being the record date for this meeting, there were 1,278,436 shares of Class A Berkshire Hathaway common stock outstanding with each share entitled to one vote on motions considered at the meeting, and 7,766,293 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, 1,121,231 Class A shares and 6,473,904 Class B shares are represented at this meeting by proxies returned through Thursday evening, April 29th.

WARREN BUFFETT: Thank you. That number represents a quorum and we will therefore directly proceed with the meeting.

First order of business will be a reading of the minutes of the last meeting of shareholders. I recognize Mr. Walter Scott, who will place a motion before the meeting.

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

WARREN BUFFETT: Do I hear a second?

VOICE: Seconded.

WARREN BUFFETTT: Motion has been moved and seconded. Are there any comments or questions?

We will vote on this motion by voice vote. All those in favor say “aye.”

VOICES: Aye.

WARREN BUFFETT: Opposed? Motion’s carried.

First item of business at 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 and she may do so. Also, if any shareholder that is present has not turned in a proxy and desires a ballot in order to vote in person, you may do so.

If you wish to do this, please identify yourself to meeting officials in the aisles who will furnish a ballot to you.

Would those persons desiring ballots please identify themselves so that we may distribute them? And I now recognize Mr. Walter Scott to place a motion before the meeting with a respect to election of directions.

WALTER SCOTT: I move that Warren E. Buffett, Charles T. Munger, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace, David S. Gottesman, Charlotte Guyman, Donald R. Keough, Thomas S. Murphy, Ronald L. Olson, and Walter Scott Jr. be elected directors.

WARREN BUFFETT: Is there a second?

It’s been moved and seconded that Warren E. Buffett, Charles T. Munger, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace, David S. Gottesman, Charlotte Guyman, Donald R. Keough, Thomas S. Murphy, Ronald L. Olson, and Walter Scott Jr. be elected as directors.

Are there any other nominations? Is there any discussion? Is there anybody that is at the microphones that would —

AUDIENCE MEMBER: Yes. Paul Tomasik, Thornton in Illinois.

I like the idea of inside directors. I think they’re necessary. However, I think we should have the best available. In particular, I’d like you to consider the CEOs of the Berkshire subsidiaries.

If you compare their qualifications to Susan Buffett’s and Howard Buffett’s, I think you’ll find that the CEOs have superior qualifications, particularly, business savvy and the ability to stand up to a forceful CEO.

I’d like to point out that we’ll hear how many of these CEOs are independently wealthy and could easily say, “Take this job and shove it.” So this is why I am withholding my votes for the directors. Thank you.

WARREN BUFFETT: Thank you. Charlie, do you have any thoughts on that?

CHARLIE MUNGER: I think we should go on to the next item. (Laughter and applause).

WARREN BUFFETT: The nominations are ready to be acted upon. If there are any shareholders voting in person, 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 inspectors of elections a ballot on the election of directors voting the proxies in accordance with the instructions they have received.

Miss Amick, when you are ready, you may give your report.

BECKI AMICK: My report is ready. The ballot of the proxy holders, in response to proxies that were received through last Thursday evening, cast not less than 1,123,189 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 the Delaware law of the precise count of the votes, including the additional votes to be cast by the proxy holders in response to the proxies delivered at this meeting, as well as any cast in person at this meeting, will be given to the secretary to be placed with the minutes of this meeting.

WARREN BUFFETT: Thank you, Miss Amick. Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chase, David S. Gottesman, Charlotte Guyman, Donald R. Keough, Thomas S. Murphy, Charles T. Munger, Ronald L. Olson, and Walter Scott, Jr. have been elected as directors.

6. Proposal to publish political contributions

WARREN BUFFETT: The next item is business is a proposal put forth by Berkshire shareholder Human Life International, the owner of one Class B share.

Human Life International’s motion is set forth in the proxy statement and provides that the company be required to publish annually a detailed statement of each contribution made by the company and its subsidiaries in various political causes.

The directors have recommended the shareholders vote against the proposal. We will now open the floor to recognize the appointed representative of Human Life International to present their proposal. Is someone here to present that?

TOM STROBHAR: Yes, Mr. Buffett. My name is Tom Strobhar and I do represent Human Life International. And I’m here to present the shareholder resolution regarding political contributions.

But before I do, I’d like to give you a little background. Some of you may remember, two years ago, there was a resolution asking the company to end its charitable giving program.

The resolution said corporate charitable contributions should help, not hinder, the company and suggested certain contributions, especially those related to abortion and population control, were doing just that.

This proposal was soundly defeated by the shareholders, receiving less than 3 percent of the vote. Oddly enough, a little over one year later, Mr. Buffett, in his wisdom, did terminate this program citing the adverse impact his philanthropic interests were having on the livelihoods of some employees at the Pampered Chefs division.

At the time of the resolution, we first learned that Mr. Buffett and Mr. Munger were directing their money to their personal foundations rather than more recognized public charities.

While previous chairman’s letters extolled the high participation levels among eligible shareholders, no mention was made that Mr. Buffett, who accounted for 31 percent of the equity of the company, was giving away almost 55 percent of the charitable gifts.

Why all of you B shareholders, who probably comprise a majority of the people in this audience, were excluded from giving, and whose vote on this proposal was dramatically diluted down to 1/200th of the value of an A share — which obviously is not quite democratic.

I refer you to the 1983 Chairman’s Letter. In addressing why he wouldn’t split the stock, Mr. Buffett describes something he calls “shareholder eugenics.”

Mr. Buffett laments how it’s impossible to screen entering members of the shareholder “club” for quotes, “intellectual capacity, emotional stability, moral sensibility, or acceptable dress.”

Splitting the stock and lowering the price of admission to the club — Class B shareholders take note — “would attract an entering class of buyers inferior to the existing class” and “downgrade the quality of our present shareholder group,” end quote.

All told, Mr. Buffett gave to his private foundation almost $100 million, much of it other shareholders’ money. This money, in turn, was devoted almost exclusively to population control seeking to lessen the number of people at a time when Western nations, especially those in Europe and Japan, face economic calamity from a baby bust.

How do charitable contributions relate to political contributions? It wasn’t until there was a resolution on charitable contributions that we received some disclosure. So too, with the resolution I’m about to present, did we find out the company gave a very modest $200,000 to various political candidates or causes.

While the charitable contributions may have been too much, the political contributions may be too little. Not necessarily from the company, but from other shareholders. If there are politicians or causes in which there is legitimate business interest in supporting, why not give the shareholders the opportunity to help them also?

By publishing the list, the word goes out to our thousands of shareholders who may wish to do the same with their own money. It costs little to publish, provides for transparency, checks any personal abuse, and sets an example to the rest of corporate America.

It also provides an opportunity for all the members of our shareholder club, even B shareholders, to get involved and help this company and help their investment.

And with that, I’d like to read the actual resolution, which I’m required to do.

“Within one month, after approval by the shareholders of this proposal, management shall publish in The Buffalo News a detailed statement of each contribution made by the company or of any of its subsidiaries, either directly or indirectly, within preceding fiscal year, in the respect of any political campaign, political party, referendum or citizen’s imitative, or attempts to influence legislation, specifying the date and amount of each contribution and the person or organization to whom the contribution was made.

“Subsequent to this initial disclosure, management shall cause like data to be included in each succeeding report to the shareholders. If no such disbursements were made, to have the facts so noted in the annual report.”

This proposal, if adopted, will require the management to advise its shareholders how many corporate dollars are being spent for political purposes, and to specify what politicians or political causes the management seeks to promote with these funds.

Political contributions are made with the dollars that belong to the shareholders of the group and they are entitled to know where their dollars are being spent. A vote for this proposal is a vote for full disclosure. Thank you.

WARREN BUFFETT: Is there anyone else that would care to speak on the motion?

Charlie, do you have any comment?

CHARLIE MUNGER: Well, I preferred our old charitable giving program to the way most corporations do it in America — (applause) — where the controlling officers decide. However, it’s a dead horse. It’s gone and there’s no point beating on the corpse. (Laughter)

WARREN BUFFETT: The dead horse will now speak. (Laughter)

I just want to add one point, because it a little different than occurs at many other corporations. To my knowledge or memory, I don’t believe Charlie and I have ever asked any employee or any vendor to Berkshire — any employee of Berkshire or a vendor to Berkshire — for either political contributions or charitable contributions.

There’s been no — there’s been no use of our positions to, in effect, extract money for our own personal causes, either in the charitable area or the political area. Is that correct, Charlie?

CHARLIE MUNGER: Yeah, but we don’t deserve too much credit for not asking other people for charitable contributions. (Buffett laughs)

Think what the reciprocity implications would be.

WARREN BUFFETT: Yeah. (Laughter)

But it’s a fairly common activity.

So here we are. We’ll — if any shareholder’s voting in person, they should now mark their ballots in the — on the motion and allow the ballots to be delivered to the inspector of elections.

Would the proxy holders please also submit to the inspector of elections a ballot on the proposal, voting of proxies in accordance with the instructions they have received? Miss Amick, when you are ready, you may give your report.

BECKI AMICK: My report is ready. The ballet of the proxy holders, in response to proxies that were received through last Thursday evening, cast 27,287.605 votes for the motion and 936,045.815 votes against the motion.

As the number of votes against the motion exceeds a majority of the number of votes related to all Class A and Class B shares outstanding, the motion has failed. The certification required by Delaware law of the precise count of the votes will be given to the secretary to be placed with the minutes of this meeting.

WARREN BUFFETT: Thank you, Miss Amick. The proposal fails.

7. Shareholder proposal to “tell us the rules” on motions

WARREN BUFFETT: Does anyone have any further business to come before this meeting before we adjourn? If so —

AUDIENCE MEMBER: Yes.

WARREN BUFFETT: —they should approach microphone 1 to be recognized. I believe we have someone.

AUDIENCE MEMBER: Yes. Paul Tomasik, Thornton in Illinois.

I have a proposal to put written rules for this meeting, the formal part, on the web, in order that this meeting can be conducted fairly and with good faith.

Would you like a little more comment?

WARREN BUFFETT: No.

CHARLIE MUNGER: No.

WARREN BUFFETT: The faster you can make it, the better. But go to it. (Applause)

AUDIENCE MEMBER: Well, that’s it —

WARREN BUFFETT: That’s it.

AUDIENCE MEMBER: — on that one.

WARREN BUFFETT: OK.

(To person sitting next to him) Is that a motion?

WARREN BUFFETT: Well, do you want to — would you place all — if you have more motions, would you place them, or is that it?

AUDIENCE MEMBER: No, certainly. The other three motions are to put the bylaws and the articles of incorporation up on the website, to write it into the bylaws how shareholders should present motions, and the fourth, to write it into the bylaws how shareholders can make director nominations.

To sum up, what these motions ask for is just tell us the rules. We’ll follow them. That’s it. Thank you.

WARREN BUFFETT: OK, thank you.

I actually think you came up with a very good suggestion on the audit committee report, which we’ve incorporated. I don’t really think this would add much, but if there are any shareholders voting in person, they should now mark their ballots in the motion — on the motion — and allow the ballots to be delivered to the inspector of elections.

Would the proxy holders please also submit to the inspector of elections a ballot on the proposal, voting the proxies in accordance with the instructions they’ve received.

Miss Amick, when you are ready, you may give your report.

BECKI AMICK: My report is ready. The ballot of the proxy holders cast 1,153,600.52 votes against the motion. As the number of votes against the motion exceeds a majority of the number of votes related to all Class A and Class B shares outstanding, the motion has failed. The certification required by Delaware law of the precise count of the votes will be given to the secretary to be placed with the minutes of this meeting.

WARREN BUFFETT: Thank, Miss Amick. The proposal fails.

I now recognize Mr. Walter Scott to place a motion before the meeting.

WALTER SCOTT: I move the meeting be adjourned.

WARREN BUFFETT: Is there a second?

VOICE: I second.

WARREN BUFFETT: 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 say “no.” The meeting’s adjourned. OK, now we’re — (Applause)

8. Rebuttal of calls for Buffett to leave Coca-Cola’s board

WARREN BUFFETT: Now we’re going to move into the questions and answers, at least questions. And just ask one as we spelled out before. And we will start with microphone 1, which is in section, what, 121 on my right. And we’ll keep moving 1 through 12 until we get till noon. Microphone 1.

AUDIENCE MEMBER: Jonathan Mills (PH) from London, England.

I wondered if you could comment on the views of those people who have stated that, because of so-called conflicts of interest, you should leave the board of Coca-Cola and whether you had any intention of doing so.

WARREN BUFFETT: That we should do what with the board?

AUDIENCE MEMBER: Leave the board. That you personally should leave the board of Coke.

WARREN BUFFETT: I would say that whoever suggested that should do 500 sit-ups. (Laughter)

Actually, Charlie and I — certainly I have — well, I’ll Charlie speak for himself — we like the idea and we’ve encouraged the idea of shareholders behaving like owners. I mean, shareholders have too often behaved like sheep in this country and they got shorn, in many cases.

And big institutional shareholders have sat on the sidelines while some things that might possibly have been corrected, had they gotten active, took place. So we have — we actually applaud the idea of shareholders behaving like owners.

The question is whether they, you know, can behave like intelligent owners. And I think that in the last year or two, as they’ve sort of woken up, they’ve searched for checklists of one sort or another to determine whether directors are appropriate in a given company or not.

And frankly, checklists are no substitute for thinking. The real job of the directors is to come up with the right CEO for a company and prevent him or her for overreaching. If they do that job well, the rest takes care of itself.

And you have to think some to determine whether that’s taking place. You can’t solve it by just running down a little checklist.

I think it was Bertrand Russell who said, “Most men would rather die than think. Many do.” (Laughter)

And I think we’ve seen a little bit of what he was thinking about in some of the voting. I think it’s absolutely silly, frankly, if Berkshire Hathaway owns 200 million shares of Coca-Cola, $10 billion worth, to not be able — it’s a little silly not to think that the interest that Berkshire Hathaway has in selling some hours of training at FlightSafety would cause me to do something counter to the interests of the shareholders, when we have $10 billion riding on that side of the table. I mean, it’s almost absurd, and somebody doesn’t understand proportionality at all when they come to that sort of conclusion.

I also think it’s absolutely foolish if — just to use Coca-Cola as an example. I think the directors of Coca-Cola haven’t even looked, but I think we probably received something like $100,000 a year.

And if we were to go out into the welfare line and pick somebody out who has no income and say, “We’d like you to become a director,” and that person would get $100,000 a year, which would be their entire income, and to say that person would be independent — you know, while they would be 100 percent dependent on their income — that person would be independent. Whereas Berkshire Hathaway, or myself representing Berkshire Hathaway with 10 billion of stock — and receiving the same $100,000 a year — is not regarded as independent.

So I encourage — I encourage institutional shareholders to — and large owners — to behave like owners. But I also encourage them to really think logically, as owners should think, in determining what causes they take on and how they vote.

Charlie? (Applause)

CHARLIE MUNGER: Yeah, I think that they, corporate America, needs a fair amount of reform. But the cause of reform is hurt, not helped, when an activist makes an idiotic suggestion — (laughter) — like the one that — (applause) — having Warren Buffett on the board of the Coca-Cola Company is contrary to the interest of the Coca-Cola Company. Nutty activities do not help the cause for which the person speaks.

WARREN BUFFETT: It’s a little bit like having a slicing machine in an orchard where you’re gathering together apples but you’re also picking up a lot of rocks in the process and sticks and stones. So you have a slicing machine with a conveyer belt. And the slicing machine is programmed so that every time something is red and round comes down the line, it slices and comes down, but it doesn’t come down on the rocks and everything and ruin the blades.

And, of course, that’s fine until a red balloon comes down the line and then you get a big pop and the machine has followed its little guidelines but it’s not slicing apples anymore.

And I think — I just — actually, institutions are coming new to really thinking about how they behave as owners. And you would hope that, in the evolutionary nature of learning — that not too many years distance — distant — they would actually think about what’s good for the shareholders of the company.

9. Surviving inflation

WARREN BUFFETT: Let’s go to microphone number 2, please.

AUDIENCE MEMBER: Mr. Buffett, Mr. Munger, good morning. My name is Zachys Sarris (PH) and I am from Athens, Greece.

There is a widespread perception that we’re heading towards an inflationary environment. What advice would you give to investors who need to preserve their capital and their purchasing power in such an environment?

WARREN BUFFETT: The best thing is to have a lot of earning power of your own. If you’re the best brain surgeon in town, or even the best lawyer in town, you will retain purchasing power, in terms of your income, no matter what happens, you know, whether people are using seashells for money, or whatever as time goes by.

In the investment world, it’s tougher. But Charlie and I think the best answer is to own fine businesses that will be able to price in inflationary terms and will not have huge capital investment that is required to handle the larger dollar volume of sales.

Some years ago, I used See’s Candy in our — in the annual report — as an example of the kind of business that, more or less, can handle an inflationary world and maintain investment and value, no matter what happens to the currency.

Unfortunately, most businesses will not come out well in real terms during inflation. Their earnings may go up a fair amount over time, but they’re compelled to put more and more dollars into the business just to stay in the same place.

You know, the worst kind of a business is one that’s — makes you put more money on the table all the time and doesn’t give you greater earnings. So you really want a business that can have pricing that reflects inflation and does not have very much capital investment that reflects inflation. But inflation is the enemy of the investor, in terms of real returns.

As you know, there are, in this country as well as a half a dozen other countries, there are what they call “inflation protected bonds” — we call them TIPS in the United States — where the income is adjusted — or, the principle amount is adjusted — to inflation. And that’s not a bad investment for people that have worries about inflation heating up. And I think, incidentally, we’re starting to see it heat up in this country.

Charlie?

CHARLIE MUNGER: Yeah, most people are going to get a very small real return from investment after considering inflation and taxes. I think that’s an iron law of the world and if, for a brief period, some of us do better than that, we ought to be very thankful.

One of the great defenses to being worried about inflation is not having a lot of silly needs in your life. In other words, if you haven’t created a lot of artificial demand to drown in consumer goods, why, you have a considerable defense against the vicissitudes of life.

WARREN BUFFETT: Charlie, we’re selling consumer goods in the other room. (Laughter)

It’s OK to talk that way at home, but — (Laughter)

CHARLIE MUNGER: It doesn’t do any good there. (Laughter)

WARREN BUFFETT: I know the feeling. (Laughter)

10. Reluctance to hold special meetings for analysts

WARREN BUFFETT: Let’s go to microphone 3.

AUDIENCE MEMBER: Good morning, gentleman. My name is Larry Coats, from Durham, North Carolina.

Mr. Buffett, after last year’s meeting, my longtime friend and business partner George Brumley [III] sent you a letter addressing several issues. Having participated in the preparation of that letter and on his behalf, I thank you for your response.

WARREN BUFFETT: Thank you.

AUDIENCE MEMBER: In such, you suggested that many of those issues would be appropriately addressed in this forum. In his honor, I’d ask you to address just one of those, and that is the ultimate generational transfer of Berkshire away from its current base of long-term, self-selected, and well-informed shareholders, and the potential of instituting a series of analyst meetings to address the relative lack of interest in, and ownership, and understanding of, Berkshire by institutional shareholders and investors. Thank you and good morning.

WARREN BUFFETT: Well, thank you. I mean, George was a wonderful man. A great analyst and a friend.

I have some problem with having meetings with subgroups of investors, such as institutional investors. If we had something like that, I think we would want it to be open to everybody. And, you know, that gets to be quite a production.

But I can understand, you know, why A) you’d like to see our managers and hear what they have to say about their businesses. We try to convey a lot about the businesses in the report, but —

Charlie, do you have any thoughts on that?

CHARLIE MUNGER: I don’t think it fits our temperament at all well. Many corporations have a huge amount of effort spent in talking to groups of analysts. One of Berkshire’s strengths has been that we don’t spend time in that way.

That’s a very time-consuming process. And it does give some shareholders some advantage over others. We try and be more egalitarian in events like this and the way we write the annual report, et cetera.

WARREN BUFFETT: Yeah, we really like the group of shareholders we have. I mean, we’re not about enticing new people into it. But I know your point also is that the present shareholders could better understand Berkshire if they would listen to Bob Shaw talk about Shaw Carpet or Rich Santulli talk about NetJets. And the truth is, it is fun to listen to those people.

But one of the things we promise managers when they join up with us, too, is they that they don’t have to listen to bankers, they don’t have listen to investment analysts. They just get to run their businesses. They can devote a hundred percent of their time to it. And people like that, and they’re more productive because of it.

I mean, we really place no impediments in the way of our managers doing what they do best and what they like to do best, which is run their businesses.

And frankly, a number of them have expressed to me that they’re very happy because they existed in a different mode before. And in that mode, they would spend maybe 25 percent of their time on activities that they didn’t enjoy and they didn’t feel were very productive.

So we want to get across the information about our businesses to you. And believe me, when I write the report and Charlie looks at it, we say to ourselves, “Are we telling you what we would want to know about if our positions were reversed, if we were on the receiving end?” And we really try to put in the report everything that’s germane to evaluation.

Now, if you have a market cap of 130 billion, you know, it’s really not too important to get keen insights into some business that’s making a relative small amount of money. But anything that counts — and really, you have to look at them in aggregates — we want to get across to you.

So, you know, it’s — I’m very respectful of your suggestion. It’s conceivable to do it.

The Washington Post has a shareholder day, because their annual meeting is turned into a farce often because it’s largely dominated by people who are complaining about this story or that story. But the shareholder day is very useful and they do have their managers there and talk about it.

But I really think if we spend six hours here answering your questions about the business and we do a half-way decent job of writing the annual report, we should get across the essential information.

And we’re really not trying to get across — we’re not trying to talk to an audience that is trying to get some special insight into what next quarter or next year is going to look like.

We’re really looking for owners who join us in what we regard as kind of a lifelong investment. And I would say that certainly analysts, like your group, have exactly the same objective we do and want to understand the business that way.

But my experience, you know, in talking to hundreds of them, is that there are relatively few that are actually thinking about, “What do we buy and put away forever?” Like, we’d buy a farm or an apartment house or something. So we’ll consider it, but I don’t want to make any promises.

11. Compensation plans: specific to the business, simple, and generous

WARREN BUFFETT: Go to number 4, please.

AUDIENCE MEMBER: Good morning, gentleman. My name is Matt Sauer and I’m from Durham, North Carolina.

Regarding compensation, you have commented along the lines of people willing to bet big on their (inaudible) usually have a lot of bet on.

A MidAmerican regulatory filing indicated some attractive prospective compensation possibilities for its senior executive team, subject, of course, to meeting profitability milestones.

Perhaps you might provide some details on the thought process that went into crafting that compensation structure, and in doing so, use this specific example as a reminder about Berkshire’s compensation philosophy, related to pay for performance versus the more popular approaches.

If it’s easier to figure out and administer, better for owners, and can still attract talented people, why don’t more companies adopt such practices?

WARREN BUFFETT: Yeah, we — you could make a lot of money working for Berkshire. Not if you’re chairman or vice chairman, but there’s a chance to make a lot of money. But it will relate to performance. No one is going to make lots of money at Berkshire for average performance.

And you mentioned the MidAmerican situation. We’ve got some extraordinary management at MidAmerican. And it’s — in terms of how that compensation arrangement was worked out, I was thinking one day about what would be appropriate for the two individuals who are key to the success of MidAmerican. And I took a yellow pad and I spent about three minutes sketching out a proposal.

And I went to Walter Scott, who is our partner in the business and now actually heads the comp committee. And I said, “Walter this is an idea I have, what do you think of it?” And he looked at it and he said, “It looks fine to me.”

And we talked to the two managers about it and actually, as we presented it, we had it so that something over 50 percent went to the CEO, Dave Sokol and something under 50 percent went to the number two man, Greg Abel, who’s enormously well named.

And when we gave it to David, he said, “Let’s just” — he said, “I like it fine, but let’s make it 50/50.” That’s the extent of it.

As you have commented, that’s wildly different than the approach at companies. I mean, most companies go through very elaborate procedures in working out executive compensation. I don’t think that Charlie and I have spent ever, maybe five minutes, on thinking about any.

We have an arrangement at See’s Candy with Chuck Huggins. We worked it out in 1972. It’s still in force now.

John Holland took over Fruit of the Loom a couple of years ago. I met with him for a couple of minutes, suggested something, takes up a paragraph or two. And that’s what we’ll have with John the rest of his life.

It’s not highly complex. You have to understand the businesses. There is no one formula we could use at Berkshire that would fit across our businesses, that’s asinine.

You don’t want them complicated. We don’t have anything that goes on for pages and pages. It’s not needed. It establishes a relationship between us and the manager that’s not good.

So all of our stuff is very, very simple.

At GEICO we have two variables and they’re what count, you know. So we make — from Tony Nicely on down, we have everybody participating based on that. We worked that out whenever we took over at GEICO and it’s worked fine since and it’ll keep working.

But we do not bring in compensation consultants. We don’t have a human relations department. We don’t have — at the headquarters, as you could see, we don’t have any human relations department. We don’t have a legal department. We don’t have a public relations department. We don’t have an investor relations department.

We don’t have those things because they make life way more complicated and everybody gets a vested interest in going to conferences and calling on other consultants and it takes on a life of its own.

In the typical large corporation, there’s a comp committee. And, as I pointed out in the past, they don’t put Dobermans on the comp committees, usually. They — they look for Chihuahuas that have been sedated and — (Laughter)

I’ve been on 19 boards. They put me on one committee once, and I was chairman and I got outvoted. Do you remember that, Charlie? (Laughs)

CHARLIE MUNGER: I certainly do.

WARREN BUFFETT: Yeah. The —

CHARLIE MUNGER: By two very fine guys.

WARREN BUFFETT: Yeah, terrific guys, actually. And they — you know, the nature of it is that now, particularly with Sarbanes-Oxley, there’s lot of committee meetings. The directors meetings are filled up with process.

And you have on one side of the table, some people that usually are spending an hour or two and getting presented with a bunch of material by the human relations department and some outside consultants.

And I’ve never seen the head of a human relations department or a consultant come in and say, “This bozo you’ve got is only worth about half what you’ve been paying him.” This just isn’t going to happen.

So it’s, you know — it’s a situation where the intensity of interest on both sides is seldom equal. The directors are often dealing with something my friend Tom Murphy in the past has called, “play money,” and the CEO is dealing with something very dear to his heart.

So you’ve got to expect a situation like that to get gamed over time. Not over time, promptly, actually.

And there is some change in that that’s taking place. But it’s not being — in large part, it’s not being led by CEOs and it’s difficult for directors to do — to get a lot done.

They get handed a sheet of paper that shows them comparables elsewhere, and everybody thinks their CEO is in the top 25 percent or something. And so there’s a ratcheting effect that takes place.

And now stock options are coming out of favor, so restricted stock comes in. But the idea is to keep the pie very large for CEOs. And if I needed the money, I’d probably be doing the same thing.

Charlie?

CHARLIE MUNGER: Well, I would rather throw a viper down my shirtfront than hire a compensation consultant. (Laughter and applause)

WARREN BUFFETT: Tell me which kind of consultants you actually like, Charlie? (Laughter)

He’s not going to answer that.

12. We don’t think about investing “categories”

WARREN BUFFETT: We’ll go to number 5. (Laughter)

AUDIENCE MEMBER: Warren and Charlie, good morning. My name is Mo Spence from Waterloo, Nebraska.

Years ago, you listed the four or five investment vehicles you considered appropriate for Berkshire, including, I believe, common stocks, long-term debt, and arbitrage opportunities.

In light of your comments in this year’s annual report, I was wondering if you could review that list, in order of preference, and specifically comment on them, including the current environment for arbitrage.

WARREN BUFFETT: Yeah. Well, the items you name — and you could break that down by high-grade bonds, you know, versus junk bonds.

The items you mention are all alternatives. You know, Charlie and I sit around and think about what’s the best thing to do with Berkshire’s money. It’s a fairly simple proposition.

And we have a number of things that we feel competent to make judgments on, and we have a number of things that we’re not competent to make judgments on. So we narrow — we hope to narrow the field to investments that we think we can understand. And there are a reasonable number of those, although there are a lot that we can’t understand.

Anything I would say today, you know, can change tomorrow. We don’t think about the categories by themselves.

Now, in a period like summer to mid-fall of 2002, when junk bonds became very attractive, we bought a lot of them. But we didn’t make some great decision to buy junk bonds, we just started seeing things, individual items, that started screaming at us, you know, “buy, buy, buy.” And then that came to an end.

And so we don’t go to the office in the morning thinking what category — how do we prioritize our categories. You know, we have an open mind and whatever we see that day that overcomes, or that crosses the threshold to where we take money out of short-term cash and move into it.

It could be arbitrage — it’s unlikely to be arbitrage now, because that’s a game that, to play on a scale that would have a meaningful effect at Berkshire, is hard to do.

I mean, take very big deals, and it’s something we’ve done successfully in the past. We’ve made a lot of money over the years in arbitrage and quite consistently sometimes in the past.

But we don’t — Charlie and I do not have a checklist that we talk about every day, or every month, or every year, in terms of prioritizing categories.

We just hope — I hope he gets a good idea, he hopes I get a good idea. And when we get one, we move in a big way.

They have to be big now and that’s a limiting factor in terms of what’s available for us.

As you know, if you read the annual report, you know, we took a significant position in currencies. We’re buying viatical settlements, in terms of the transaction I mentioned a little earlier.

We’re open to anything we can understand. Charlie?

CHARLIE MUNGER: Yeah, you really asked us to determine an order of precedency among two or three activities we don’t have much interest in at the moment. And that’s not something we spend a lot of time at.

In other words, we have all this cash because we don’t much like any of those fields at the moment. And spending all the time thinking about orders of precedency among things you clearly are not going to do is pretty fruitless for us.

WARREN BUFFETT: Yeah, I thought I had a slide here but I don’t. But it — when we were buying junk bonds in the summer to fall of 2002, we were literally buying securities — and we limited it to the kind of junk bonds we can understand, which is far from the whole universe — but we were literally buying things on a 30, 35, 40 percent yield to maturity basis.

Now, we buy those with a mental attitude of buying common stocks.

Interestingly enough, within 12 months, some of those same securities that were yielding 30 or 35 percent went to prices where they yielded only 6 percent. I mean, that is truly remarkable when you think about that happening in a country that was not in the throes of depression or anything.

I mean, prices do amazing things in securities markets. And when they do something that strikes us as amazing in our direction, you know, we will act.

But we do not know today what we’re going to be doing tomorrow. We have — you know, we have some things — a few things we may be doing. They’re likely — It’s likely we’re doing them tomorrow, but there’s — we don’t hold any committee meetings on this.

And there’s, you know, this business where somebody says, “You should have 50 percent of your money in bonds and 35 percent, you know, in equities, and 15 —.” We don’t go through anything like that. I mean, we regard that as nonsense.

Any further thoughts, Charlie?

No further thoughts, evidently. (Laughter)

13. “Very dangerous to project out high growth rates”

WARREN BUFFETT: Microphone 6.

AUDIENCE MEMBER: Good morning, gentleman. My name is Tony Ado (PH) and I come from New Jersey.

Mr. Buffett, my question is on business valuation and growth. In one of your letters, you mentioned the discounting formula on earnings divided by the difference between the discount and the growth rate.

But if the growth rate is larger than the discount rate and if we use this formula, then we get a negative number. And one way around this — let’s call it method A — is to have two growth stages, one with a high growth and the second stage with a low growth.

And the second way, method B, would be to estimate how much the earnings is on the third year for the company and then multiply this by the average price-to-earning ratio to get the price in the tenth year.

I don’t know if you use the method A or method B, but if not, I would like to ask, Mr. Buffett, how do you estimate how much a company is worth if the growth rate is larger than the discount rate?

WARREN BUFFETT: Well, you put your finger on an interesting mathematical relationship. Because if you’re using a present value discount formula and you put in a growth rate that is higher than the discount rate, as you have postulated, the answer, of course, will be infinity.

And there are a lot of managements around who like to think their stocks are worth infinity, but we — (laughs) — haven’t found one yet.

That precise subject was covered in a paper called “The St. Petersburg Paradox” by a fellow named [David] Durand probably 30 years ago. And somewhere, we probably have a copy at our office. My guess, if you go to Google and you put in the name Durand and you put in St. Petersburg, you may be able to call up that article, although they aren’t necessarily terrific on old articles.

So if you’d like it, we would — if you’ll let somebody know in our office, we’ll look around a little and see if we can find that.

It gets very dangerous to project out high growth rates because you get into this paradox. If you say the growth rate of a company is going to be 9 percent between now and judgment day and you use a 7 percent discount rate, it goes off, you know, you get into infinity. And that’s where people get in a lot of trouble.

The idea of projecting out extremely high growth rates for very long periods of time has caused investors to lose, you know, very, very large sums of money.

There aren’t many companies — just take a look at the Fortune 500, go back 50 years — they’re commemorating that — and look at the companies that were there and how many have really maintained rates much above 10 percent. It’s not an easy hurdle. And when you get up to 15, you know, you’re in the atmosphere and rarified atmosphere.

So that’s — there’s a real danger in projecting out high growth rates. And Charlie and I will very seldom — virtually never — get up into high digits. You can lose a lot of money doing that.

You may miss an opportunity some time, but I haven’t seen people who have been consistently successful doing that. And you do run into this paradox you mentioned.

Charlie?

CHARLIE MUNGER: Well, you’re obviously right, when you get a mathematical result that is infinity, to back off and realize that can’t happen. And, of course, what people do is they project that the growth rate will reduce and, indeed, eventually stop. And then you get more realistic numbers. What else could anyone do?

14. NYSE specialist system has “worked pretty well”

WARREN BUFFETT: OK, we’ll go to microphone 7. I believe that’s over here.

AUDIENCE MEMBER: Yes, My name is Jack Oneil (PH). I’m from New Brighton, Minnesota. Thank you for the opportunity to ask questions here and for the opportunity to learn from you and Charlie.

I had a two-part question and I’m striking the first part, which dealt with my concern over how long the country can continue with this ballooning national debt.

My second — my question then is, what is your opinion of the need for specialists on the New York Stock Exchange? Thank you.

WARREN BUFFETT: Charlie, you want to tackle that one? (Laughs)

CHARLIE MUNGER: Well, thank you, Warren. (Laughter)

Generally speaking, I think the specialist system has worked pretty well over the years. There may have been a few troubles lately, but averaged out, it’s worked pretty well for a long time. And I’m not all that horrified that some people who stand there all day make a fair amount of money.

WARREN BUFFETT: Charlie actually had a specialist firm, you should know that. That’s why I turned the question over to him, despite his snide remark. (Laughter)

How long were you and Jack [Wheeler] the specialists in General Motors on the Pacific Coast Stock Exchange?

CHARLIE MUNGER: About 13 years.

WARREN BUFFETT: Yeah —

CHARLIE MUNGER: Yeah.

WARREN BUFFETT: You’re looking at an experienced specialist.

15. Buffett predicts “big problems” from derivatives

WARREN BUFFETT: Let’s go to number 8.

AUDIENCE MEMBER: Good morning, gentleman. I’m Neil Steinhoff from Phoenix, Arizona.

Thanks for the tips on TIPS. Also thanks for the information in the newsletter — your annual letter — about the books. I particularly enjoyed “Bull!” by Maggie Mahar, I think it was.

I’m concerned about the future for a number of different reasons, in America. The debt, both accumulated by the government and personally, the stock buybacks, which are benefiting the top five executives, continues. The insanity of derivatives and the overpriced market with a P/E, which is also insane. Any comments?

WARREN BUFFETT: Well, which one do you want us to comment on? You only get one question. (Laughter)

AUDIENCE MEMBER: Derivatives.

WARREN BUFFETT: Derivatives.

Well, Charlie and I have expressed ourselves on derivatives. You know, we don’t think the probability, in any given year, is necessarily very high, that derivatives will either lead to or greatly accentuate some financial trauma. But we think it’s there.

And I think it’s fascinating to look at something like Freddie Mac, where you had an institution that perhaps even hundreds of financial analysts were looking at — certainly many, many dozens of financial analysts were looking at. You had an oversight office. You had a creature that was created by Congress, presumably with committees that would be interested in their activities.

You had on the board two of the smartest and highest-grade people that you could have, in terms of fixed income markets, in Marty Leibowitz and Henry Kaufman, and you had a bunch of other very good directors, too.

And, with an auditor present, they managed to misstate earnings by some $6 billion in a fairly short period of time.

Now, all of that wasn’t accounted for by derivatives, but a very large portion of it — 6 billion, that, you know, that is real money even — well, in any place. A large part of that was facilitated by activities and derivative instruments.

Now you can look at the Freddie Mac annual report for 2000, whatever it is, ’2 or 2001. And you can read the footnotes and you can read the auditor’s certificate. And you can look at bunch of high-class, very smart directors.

And you can be comforted by the fact that dozens of people in Wall Street, who are paid just to follow relatively few stocks, were studying this, and that they had conference calls all of the time.

And in the end, what happened? It was 6 billion. It probably could have been 12 billion if they’d wanted.

A lot of mischief can happen with derivatives. And as we’ve pointed out, Charlie and I have seen it happen.

When there’s a derivative transaction, particularly a complicated one — the plain vanilla ones, probably people will not get in big trouble on — but when you have a complicated derivative transaction, and the trader at investment house A is on one side and a trader on investment house B is on the other side, and they record a transaction — which has to be a zero-sum game between the two of them — and both put on the books a profit that day — I’ve never seen one where they both put on a loss that day — it lends itself to mischief. And the scale is absolutely huge and getting larger all the time.

And I will tell you that I know the managements of some of the companies that have big derivative activities, and they do not have their minds around what is happening.

We didn’t have our mind around what was happening at Gen Re Securities. We couldn’t. We tried to get our mind around it. We couldn’t do it. And that was far from, you know, the most extensive or complicated derivative operation around.

We had the same experience at Salomon. But whatever the figures were at Salomon, they would be a great multiple today. And there was a Sunday in 1991 when we were preparing — or we had the lawyers preparing — bankruptcy papers at Salomon.

And if the Treasury hadn’t reversed itself, we would have found a judge some place in Manhattan. He probably would have been watching baseball, eating popcorn. And we would’ve walked up to his door and said, “You know, here is a situation with Salomon. There’s these 1.2 trillion of derivative contracts that the guy on the other side thinks is good and they’re not going to be any good,” and a lot of other things, and, you know, “It’s your baby.”

A lot of things correlate in the securities world that people don’t expect to correlate. And there are people following similar strategies all over the world, as happened when Long-Term Capital had its problems.

And the world — the financial world — operates on a hair trigger, to some extent. People want to jump the gun and move just ahead of the other fellow.

And when you get huge amounts of transactions, which many people only vaguely understand, you are creating a potential huge problem that may come about because of some other exogenous event that triggers defaults on a huge scale. And that can be very disruptive to financial markets.

So we think they’re dangerous as used in society. We use them ourselves, incidentally. You know, we get them collaterized. We’ve made money off of them.

But I would predict that sometime, in the next 10 years, that you will have some very big problems that will either be caused by, or accentuated in a big way, by people’s activities in derivatives.

Charlie?

CHARLIE MUNGER: Yeah, I think part of the trouble in — you were talking about — came because people didn’t think enough about the consequences of the consequences.

That’s a common error. You start trying to hedge against interest rate changes, which is a very complicated thing to do when you’ve got a mortgage portfolio where people have options to pay the mortgages off early.

And then, under the accounting conventions, the hedges started making the quarterly results lumpy instead of nice and regular, the way all the institutional analysts like them. So then they gave us another bunch of derivatives to smooth out the returns. Well, now you’ve morphed into lying.

Well, it’s complicated enough to start with. But when you add lying to the process, it’s a Mad Hatter’s Tea-Party.

And yet, this happens with eminent directors of vast financial sophistication sitting on the board. It shows that the sophistication won’t save you. Somebody has to have the common sense to say, “We’re just not going there.” It’s too tough.

WARREN BUFFETT: Charlie was on the audit committee at Salomon and changed it into, you know, six and seven hours meetings. I think you found mismarks that were in the tens of millions of dollars on a single contract with a place with many — you know, tens of thousands of contracts. Isn’t that correct?

CHARLIE MUNGER: I think it’s fair to say that it was bonkers and that the accountants sold out.

WARREN BUFFETT: Uh-huh. (Laughter)

It’s interesting stuff. You might — if you feel in kind of a nasty mood, you might go to a shareholders meeting of some company that has very large positions in derivatives and grill the CEO a little bit about some of the more esoteric transactions.

They get very, very complicated. They get mind-boggling, in terms of trying to figure out the consequences.

And the one thing you can be sure of is that the trader that puts them on will certainly want to mark them at a profit, either immediately or within a year or two, because he gets his bonus too often based on the figures for that year, and will be done in 20 years, because some of these are very long-dated. Will be gone — when the consequences fall to the firm.

Anytime you have incentives, with people who are quite smart, to mismark things, you’re going to get mismarks, or temptations to take on risk in an inappropriate manner.

Originally with derivatives, the argument was made that it would disperse risk. That, you know, the Coca-Cola Company faced foreign exchange risk, or some bank faced, you know, interest rate risk.

And the theory was that you would use these derivatives to spread risk around the system. And indeed, there are many people that make that argument now.

I would say that that may work in that manner a great percentage of the time. But the time that counts is when the system has intensified risk and placed enormous credit risk on very, very few institutions.

Believe me, the Coca-Cola Company is in a better position to accept foreign exchange or interest rate risk in a year than some derivatives dealer who has tons of positions on.

And I think, actually, there is much more risk in the system because of derivatives than the proponents of derivatives would say has been dispersed because of the activities.

16. Bill Gates as next Berkshire chairman?

WARREN BUFFETT: Microphone 9, please?

AUDIENCE MEMBER: Good morning. Robert Piton (PH) from Chicago, Illinois. Thank you very much for your countless insights about investing, and life, for that matter.

My question has to do with Bill Gates. You’ve gone on record stating that Bill Gates is the smartest person you’ve probably met in your life. Charlie, sorry to break it to you.

WARREN BUFFETT: No, and I haven’t said that quite — but you’re close. (Laughs)

AUDIENCE MEMBER: I’m close. And you’ve also mentioned that he can do your job, but you probably could not do his.

WARREN BUFFETT: That’s entirely correct.

AUDIENCE MEMBER: OK. So that being the case, given his aptitude, his accomplishments, his ability to keep great people together within Microsoft, would you consider having him become the future chairman of Berkshire in one of two ways.

Either a merger — and if a merger doesn’t make sense because it’s a technology company and you don’t understand it, so you don’t want anything to do with Microsoft.

With the second being he resign his post as chairman of Microsoft in order to keep the masterpiece that you’ve assembled together, as well as keep these very talented managers of all the Berkshire Hathaway companies together, with a leader that you so respect because of his accomplishments and aptitude.

WARREN BUFFETT: Did Bill put you up to this? (Laughter)

AUDIENCE MEMBER: He did not.

WARREN BUFFETT: No, I know that.

You know, it’s not a crazy suggestion, but we’ve got a better answer.

Bill could do my job very well. And I could not do his job. But we also have at least four people within the Berkshire organization that, in many respects, could do my job better than I do. And probably in one or two respects, they might not be as good at certain parts of it. But they would be terrific successors.

We’re more blessed in that situation than we’ve ever been in the history of Berkshire. If you go back 15 years, we did not have four.

And as we add businesses, it’s not inconceivable that more potential future leaders come with those businesses. So we’re well-equipped.

And we would — we will — barring something terribly unusual — we will have a leader that succeeds me that comes from within Berkshire and has been around for a long time.

One advantage of that — and this would not be necessarily a disadvantage if it were Bill — but one advantage to that is that we really like the culture at Berkshire. And having someone that has operated in that culture for a number of years, I think, is a plus.

Plus, you know, we’ve seen how they work and we know their pluses and minuses. We are very well-equipped now.

And Bill, I think — to the extent that he spends less time at Microsoft and he will probably be — you know, the Gates foundation will take up, perhaps, more of his time — I don’t really think he is looking for my job, although he may salivate at the pay level that’s available. (Laughter)

Charlie?

CHARLIE MUNGER: I’ve got nothing to add.

17. Reading list for improving investment knowledge

WARREN BUFFETT: OK, we’ll go to number 10.

AUDIENCE MEMBER: My name is Oliver Graussa (PH) and I’m Vienna, Austria.

I have studied economics and I’ve read about 40 books about investing and want to be such a successful investor as you have been.

Mr. Buffett and Mr. Munger, when both of you were younger and had much less capital for investing, how many — which publications were the best to get a few excellent investment ideas to be so successful? And how many hours per week, on average, did you spend with reading about companies? Thank you.

WARREN BUFFETT: Well, when we were younger, we spent — probably Charlie, compared to now, spent a lot more time — I spent a fair amount more time — looking at companies.

But we would — if we were doing it over again, we would do it over again pretty much the same way.

We would look at everything in sight that we thought we could understand. And it — the world hasn’t changed in that respect. There may be some more people doing it, but there are a lot more companies to look at now.

And we would — we would read everything in sight about the businesses and the industries we thought we could understand.

We would look for things that jumped out at us as being very cheap in relation to the value. And we would have one enormous advantage because we would be working with far less capital, which means the universe of potential ideas would be far greater.

But there’s no — there’s nothing different, in my view, about analyzing securities now than there was 50 years ago.

Charlie?

CHARLIE MUNGER: Yeah, we read a lot and we thought a lot. I don’t know anybody who is wise who doesn’t read a lot.

On the other hand, that alone won’t do it. You have to have a temperament, really, which grabs the correct ideas and does something with those ideas. And I think most people who read a lot don’t have the necessary temperament, and they grab the ideas or they’re simply confused by the mass of material. And, of course, that won’t work.

WARREN BUFFETT: Yeah, there’s probably something — Phil Carret used to talk about having a “money mind,” and I would call it a “business mind.” And, you know, there are people that are better with, you know, identical IQs, that are better adapted for one than the other. And the temperament is all important.

I mean, if you can’t control yourself, no matter what the intellect you bring to the process, you know, you’re going to have disasters. And Charlie and have seen one after another that —

It’s not a business that requires extraordinary intellect. It does require extraordinary discipline.

That shouldn’t be so difficult. But as I look around the world sometimes, apparently it is quite difficult. I mean, the whole world went a little mad a few years back in terms of investments.

And you say to yourself, “How could that happen? Don’t they learn anything for the earlier ones?” But, you know, what we learn from history is that people don’t learn from history. And you certainly see that in financial markets all the time.

Incidentally, you mentioned books. Charlie, you didn’t recommend any books this year?

CHARLIE MUNGER: Well, one book I really like I couldn’t buy because it’s published only in England. But it’ll get here in due course. And that’s called “Deep Simplicity” by John Gribbin. It’s a perfectly marvelous book. And of course, that’s a great title: “Deep Simplicity.” That’s what we’re all looking for.

WARREN BUFFETT: I’ve been reading “A Short History of Nearly Everything.” It’s very impressive to — you know, to read about people pondering how to figure out the weight of the Earth or something in the 18th century.

And you would think that minds that would do that would do very well in financial matters. But, you know, if you remember, Isaac Newton spent a significant part of his life trying to turn lead into gold. And he might have made a good stockbroker. (Laughter)

But it didn’t do much for him financially. Charlie knows more about Isaac than I do, so —

CHARLIE MUNGER: Well, and he lost an enormous —

WARREN BUFFETT: Yeah, in the bubble —

CHARLIE MUNGER: —chunk of his net worth in the South Sea Bubble. So he invested in an absolute crooked mania. And here was the smartest man in the world. So just IQ points alone won’t do it.

18. Admiration for Treasury’s crack down on tax shelters

WARREN BUFFETT: Microphone 11, please.

AUDIENCE MEMBER: My name is Martin Wiegand from Bethesda, Maryland. Thank you for hosting this wonderful, educational, and fun weekend. We —

WARREN BUFFETT: Well, thanks for coming —

AUDIENCE MEMBER: —appreciate it.

WARREN BUFFETT: —Martin, yeah. (Applause)

AUDIENCE MEMBER: In this year’s annual report, you defended Berkshire’s tax payment record against criticism from certain newspaper columnists and Assistant Secretary [for Tax Policy at the U.S. Treasury] Pamela Olson.

Compared to other large corporations, particularly insurance companies, does Berkshire pay its fair share so we can our Berkshire Activewear with the American flag on it with pride?

WARREN BUFFETT: Incidentally, Pamela Olson is here today. I don’t know whether she can stand up. But I owe her an apology.

She’s done a great job as a public servant and I teased her a little bit in the annual report. But she actually has worked actively at the Treasury in cracking down on tax shelters and some things that Charlie and I think shouldn’t exist. So Pamela has my admiration. And, like I say, if she’s here and can stand up, we’ll give her hand. (Applause).

Some of the tax shelter proposals — I met with her yesterday — and she told me of some things that I’ve sort of seen myself. But some of the things that have been done and, in some cases, sponsored by the most prominent auditing firms, you know, are absolutely disgusting, and are the reason why, in my view at least, the middle class probably pays a lot more than they should be in terms of raising the total funds that are needed to sustain the government.

Berkshire, as we noted in the report, is a heavy contributor to the Treasury. As I mentioned, if only 540 entities in the country paid what we pay in income tax, no one else would have to pay anything, no Social Security, no nothing.

We have not — I mean, we may own tax-exempt bonds. We own dividends, which receive a dividend receive credit. But we pay on a very, very high percentage of our income — including capital gains — we pay at the full 34 percent corporate rate.

So go out and buy the Fruit of the Loom underwear with the flag on it, you’re entitled to wear it. (Laughs)

Charlie?

CHARLIE MUNGER: I’ve got nothing to add. But you understate the evil that crept into our leading accounts — accounting firms — when they started selling these fraudulent tax shelters in exchange for contingent fees.

One of them actually explained to me that they were an ethical seller of fraudulent tax shelters. (Laughter)

He said, “The other firms just sold these to anybody. And we just sold them to our 20 most important clients so they were more likely to stay secret.”

WARREN BUFFETT: Yeah. And of course, the lawyers would write the opinions so that, if they did get caught with these things that they hoped that no one even picked up because they were so obscure, convoluted, the lawyers wrote the opinions so that the — they could walk — you know, when the IRS came around, they could wave that letter and say, “Well, gee, we’re sorry we made a mistake, but we did it on the advice of counsel and therefore you shouldn’t assess fraud penalties or anything.” I mean, they would — we don’t want to leave the lawyers out of this, Charlie. (Laughs)

We had people come to our office. Not the auditing firm that we use, I want to make that clear. But we had people come to our office from the top auditing firms with these propositions which they said we had to sign away a given percentage of the amount we saved. And then they would give us these proprietary methods, you know, which would usually involve about 20 off-shore trusts and partnerships around the world and all kinds of things.

Many of — part of the design being to have so many entities involved so that the numbers that popped up here or there on the return, that no agent could figure out what the totality of the transaction was.

You know, it’s — those are — the people who don’t pay taxes because of that, increase the taxes of the people in this room. So we — I applaud Pamela for her efforts on that and a lot more are needed.

19. “If you’re innumerate, you’re going to be a klutz”

WARREN BUFFETT: We will go to number 12, please.

AUDIENCE MEMBER: Good morning. My name is Johann Freudenberg (PH) from Germany.

Mr. Munger, you said in a speech that scientific reality is often only revealed by math, as if math, it’s a language of God. Could you elaborate on that, and especially tell us the reason why math often reflects reality? Thank you.

CHARLIE MUNGER: It’s just the way it is. (Laughter)

If you — it’s as though God made the world so that only people fluent in math could understand it.

I think you can handle an ordinary human activity pretty well. But if you want to understand, say, science, you can’t do it without math. That’s just the way it is. And in business, if you’re innumerate, you’re going to be a klutz.

WARREN BUFFETT: Keep talking, I’m chewing. (Laughter) We’ll go back — go ahead.

CHARLIE MUNGER: The good thing about business is you don’t have to know any high math.

WARREN BUFFETT: It may be a disadvantage to know high math, Charlie.

CHARLIE MUNGER: Yes, I think it is. Because you look for opportunities to use this marvelous, complicated tool. And by and large, that doesn’t work nearly as well as just using the simple math.

WARREN BUFFETT: Yeah. When my mother sang me songs about compound interest, there really wasn’t any need to go further. (Laughter)

20. Buffett’s $10 billion Walmart mistake

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

AUDIENCE MEMBER: My name is David Farlow (PH) from Minnesota, Minneapolis. Thank you, Warren and Charlie.

A few minutes ago you mentioned the importance of learning from history. What have you learned from the investments you did not make over the last few years that you now regret refraining from?

WARREN BUFFETT: Well, the mistakes we made, and we made them — some of them big time — are of two kinds. One is when we didn’t invest at all in something that we understood that was cheap, maybe because we weren’t even working hard enough at looking at the whole list, or because, for one reason or another, we just didn’t — we didn’t take action.

And the second was starting in on something that could have been a very large investment and not maximizing it.

Charlie is a huge believer in the idea that you don’t sit around sucking your thumb when you can — when something comes along that should be done that you pour into it.

And that’s generally what we’ve tried to do. But there have been times — and it’s usually happened when I’ve started buying something at X and it went up to X plus an eighth or some intolerable amount like that — and I quit or waited for it to come back. And we’ve missed, in some cases, billions of dollars of profit because of the fact that I’d gotten anchored, in effect, to some initial price when I could have paid more subsequently and it really was inconsequential.

CHARLIE MUNGER: Do you have anything worse to confess than Walmart?

WARREN BUFFETT: No, Walmart — I cost us about — it’s up to 10 billion now. (Laughter)

I cost us about 10 billion. I set out to buy 100 million shares of Walmart, pre-split, at about 23. And Charlie said it didn’t sound like the worst idea ever came up with, which is — from him, I mean, it was just ungodly praise. (Laughter)

And then, you know, we bought a little and then it moved up a little bit. And I thought, “Well, you know, maybe it will come back” or what —

Who knows what I thought? I mean, you know, only my psychiatrist can tell me. And that thumb sucking, reluctance to pay a little more — the current cost is in the area of 10 billion.

And there have been other examples, too. And there will probably be more examples in the future, unfortunately.

But that is — that’s — on the other hand, it doesn’t bother us. I mean, you know, it’s maybe instructional to talk about it just a little and I’m glad to respond to the question.

But in the end, we’re going to make a lot of mistakes at Berkshire. And we’ve made them in the past, we’ll make them in the future.

You know, if every shot you hit in golf was a hole-in-one, it wouldn’t be — you know, the game would soon lose interest. So you have to hit a few in the woods occasionally just to make it a little more interesting.

We’ll try not to do that too often. But those will be the kind of mistakes we make. We probably won’t make the kind of mistakes — although we have — we made one with Dexter Shoe — but we probably won’t make the kind that cost us a ton of money. They’ll be much more of omission than commission, I think, you’ll find in the future.

Charlie, you want to add any more?

CHARLIE MUNGER: Yeah. At least we are constantly thinking about the past occasions when we blew opportunities. Since those don’t hit financial reports, the opportunities you had but didn’t accept, most people don’t bother thinking about them very much. At least that is a mistake we don’t make. We rub our own noses in our mistakes in blowing opportunities, as we just did.

21. Very hard to find a good, honest stock advisor

WARREN BUFFETT: OK, number 2.

AUDIENCE MEMBER: Warren and Charlie, my name is Peter Brotchie from Beverly, Massachusetts. And I would like to thank you both for helping me become a better businessman and a better investor. Perhaps more importantly, you have created, by example, a kind of true north on the moral compass for me to steer by.

While the education has been fantastic, I have found that the demands of owning a successful business and having a large family do not leave time to apply the research stance I have become so wonderfully accustomed to by being a member of this cult.

Please imagine, for a moment, that you are 30 years younger, and have only —

WARREN BUFFETT: I like him.

AUDIENCE MEMBER: — a few holes left in your investment punch card. If you were in my situation, to the extent that you would diversify your holdings beyond Berkshire Hathaway, given this environment, how would you choose the investment managers? Or as Charlie has just discussed when addressing foundations, would you hunt for two more great companies to invest in via common stocks?

WARREN BUFFETT: Charlie, why don’t you take a swing at that?

CHARLIE MUNGER: Well, of course you’re hunting, that’s part of the fun of life. And — but I would say that the chief lesson would be that you’re unlikely to find very many in a whole lifetime. And when you find one in which you really have thought it out and have confidence, for God’s sakes, don’t do it in a niggardly fashion.

The idea that very smart people with investment skills should have hugely diversified portfolios is madness. It’s a very conventional madness. And it’s taught in all the business schools. But they’re wrong. (Applause)

WARREN BUFFETT: The question of finding other advisers is a tough one. I mean, when I wound up my partnership in 19 — at the end of 1969 — and I had all these partners that had counted on me and I was going to mail them back a lot of money, you know, I felt an obligation to at least suggest some alternatives for them.

And I recommended two people who I knew were exceptionally good and exceptionally honest. We put one of them on the board not long ago and reaffirmed it today — Sandy Gottesman. The other one was Bill Ruane.

Now, I’d been around the investment world for a long time at that point, and those were the two I knew, but they were more or less contemporaries of mine. And I’d gotten to know them over the years and I’d seen them for a long time.

So I not only knew their results, but I knew how they’d accomplished their results, which is terribly important. I don’t know that generation of managers now. But the fact that, with the number of people I knew, that I could only come up with two, at a time when I was very active, says something about the difficulties of finding managers.

The one thing I can almost guarantee to you is that the promotional types going around to solicit the institutional investors are very unlikely to meet any long-term tests of ability, and sometimes, integrity.

It’s not an easy job spotting an investor. I think it’s probably easier, depending on the amount of time — you know, you mention having children and a business and the amount of time you can spend on. Every now and then you do — if you’re conscious of the investment world and you have some kind of sort of grounding knowledge about what’s going on, and you can see something, you know, as we did in junk bonds a couple of years ago, or as we did with all kinds of things, some years back, when stocks were cheaper.

You will occasionally see something that you should load up on. And, as Charlie says, that’s what you really have to do. I mean, some of the people in this room loaded up on Berkshire many years ago. And the truth was, they didn’t need diversification, you know. I loaded up on it. Charlie did. And you’ll see opportunities occasionally but you’re not going to see them every day or every week.

If you think you’re going to see an opportunity every week, you’re going to lose a lot of money because people will come around and tell you that they’ve got them, and they may not be quite as flagrant as that fellow we had in the movie — (laughs) — but they’re a version of them.

Charlie?

CHARLIE MUNGER: The business of selecting investment managers was recently shown to be even harder than I had previously thought it was. A significant fraction of the institutional investment managers who run the nation’s mutual funds actually accepted propositions to take bribes for betraying their own shareholders.

It was as if a man came to you and said, “I have a wonderful proposition. Why don’t I kill your mother and we’ll split the insurance money?” And it was that ridiculous. And yet, a significant number of the people said, “Gee, I would like some insurance money.” And they just went right ahead.

WARREN BUFFETT: And they were already rich beforehand.

CHARLIE MUNGER: Yes. And they’ve destroyed themselves, many of them, by making this insane decision. And I think many of them will probably think the outcome is unjust.

WARREN BUFFETT: And the —

CHARLIE MUNGER: I mean the downfall they’ve had.

WARREN BUFFETT: And the interesting thing about it, of course, is that here is a huge industry that — where the people who weren’t doing it have a great interest in having that reputation of the industry not get stained. And a number of them had to know what was going on.

I mean, this was — I don’t — it’s hard for me to imagine that people at most large mutual funds, even the ones that didn’t — that are mutual fund management companies — even the ones that weren’t engaging in the activities mentioned weren’t aware of it. I mean, you just — if you’re in an industry like that, you’re going to hear what’s going on.

And the Investment Company Institute was busy patting itself on the back, you know, at one meeting after another and becoming very cozy with legislators.

And there wasn’t one thing done until a whistleblower when to [New York State Attorney General] Eliot Spitzer and he got active in a very strong way with a very limited staff.

And he uncovered, and put on the front pages, what was taking place. But the industry itself, with hundreds and hundreds and hundreds of people that most have known what was going on — and it went on for a long time. Never said a word. It’s — you know, it makes you wonder a little bit.

22. Asset allocation models are “pure nonsense”

WARREN BUFFETT: Number 3?

AUDIENCE MEMBER: Hi, I’m Bob Klein (PH) from Los Angeles.

You’ve touched on the issue of asset allocation — capital allocation — in response to previous questions. But I wonder if you could elaborate from a risk management perspective. Wall Street and financial planning firms charge a lot of money for their asset allocation models, say, 50 percent stocks, 40 percent bonds, et cetera.

I know you take a more opportunistic approach to building your portfolio and managing risk, as you mentioned by — as you illustrated — by your junk bond example.

And so I just want you to hammer out how you use price and value as a tool of risk management and asset allocation as opposed to coming at it with a pre-conceived idea of how much should be allocated to each asset class.

WARREN BUFFETT: Yeah, we think the best way to minimize risk is to think. (Laughter)

And the idea that you have — you know, you say, “I’ve got 60 percent in stocks and 40 percent in bonds,” and then have a big announcement, now we’re moving it to 65/35, as some strategists or whatever they call them in Wall Street do.

I mean, that has to be pure nonsense. I mean, 60/40 or 65/30 — it just doesn’t make any sense.

What you ought to do is have — your default position is always short-term instruments. And whenever you see anything intelligent to do, you should do it. And you shouldn’t be trying to match up with some goal like that.

I found it entertaining — I was just reading yesterday in an article, I think it was, about the two fellows at Google and all of the problems they’re going to have because they’re each going to get a few billion dollars. I mean, it was — I want to send a sympathy card. I almost went down to Hallmark store because this article went on — they’ve got this terrible problem and that terrible problem and they’re going to need lawyers, and they’re going to need financial — they don’t need anybody.

Those guys are smarter than the people that are coming to them. And they do not have a big problem, and they are very capable of thinking it through themselves.

The people that have the problem are the people who want to sell their services to them and are going to have to convince them that they have a problem.

But so much of what you see when you talk about asset allocation — it’s just merchandising. It’s a way to make you think that if you don’t know how to determine whether it should be 60/40 or 65/35, that you need these people. And you don’t need them at all in investing.

Most of the professionals that tell you that you’re going to get in great trouble unless you listen to them and sign up for their services, you know, they’re good at selling, but —

It’s what my brother-in-law — former brother-in-law — that worked at the stockyards used to say was that people would bring in cattle or something. And I’d say to him, you know, “How do get the farmer to employ you to sell to Swift or Armour or Cudahy instead of the guy right next to you. I mean, you know, a cow is a cow and Armour’s going to buy it the same way.”

And he gave me this disgusted look and he said, “Warren, it’s not how you sell them, it’s how you tell them.” Well, there’s a lot of that in Wall Street.

Charlie?

CHARLIE MUNGER: Yeah, people have always had this craving to know the future. You know, the king used to hire the magician or the forecaster and he’d look in sheep guts or something for an answer as to how to handle the next war. And so there’s always been a market for people who purported to know the future based on their expertise.

And there’s a lot of that still going on. It’s just as crazy as when the king was hiring the forecaster who looked at the sheep guts.

And people have an economic incentive to sell some nostrum. It can be sold over and over and over again.

The really interesting figures are when you combine the underperformance of the market, say, by the mutual fund industry, which is probably a couple of points per annum. And that understates it.

Now, if you take all of the investors in the mutual funds who are constantly whipsawing from one fund to another by a bunch of brokers who want commissions, now you take a sub-normal performance and it goes on another three or four percentages points due to the shuffling of the mutual fund investments.

So the poor guy in the general public is getting a terrible result from contacting the experts. And these guys are hitting the Scout troop and the Community Chest drive and are locally reputable people.

I think it’s disgusting. It’s much better to make a living by being part of system that delivers value to the people who are buying the product. But nobody refrains from creating gambling casinos or something, on my theory.

If it’ll work to make money, why, we tend to do it in this country.

23. Workers’ compensation insurance fraud

WARREN BUFFETT: Microphone 4.

AUDIENCE MEMBER: Good morning Mr. Buffett and Mr. Munger. My name is Steven West and I am a framed art manufacturer in Morganton, North Carolina.

I feel especially tied to Berkshire Hathaway as I am both a vendor to Nebraska Furniture Mart, Star Furniture, and RC Willey, and also a customer of Larson Jewel.

My question relates to workers’ compensation fraud being committed by workers’ compensation carriers on manufacturers such as myself, a scandal which I believe is far greater than the scandals that have been mentioned heretofore at this meeting.

As an example, in 1998, when I was trying to figure out why my experience mods were going way out of whack, I received a loss run and I believe, mistakenly, also a check run from my insurance carrier.

It was shocking. Four losses for $152,000 they claimed to the state of North Carolina actually amounted to less than $6,000. And one claim, which they claim they spent $70,072 on, they actually only spent $86.88.

Now naturally, this threw my company into the high-risk pool. It’s cost me hundreds of thousands of dollars.

And my question is, are they trying to pull the same stunt on Berkshire Hathaway companies, especially in labor intensive operations, such as Dairy Queen. Because I have not, in the intervening years, been able to get one single copy of a negotiated check out of these insurance company. They will not give it up, even under subpoena, and their behavior is entirely consistent with criminal fraud.

Now, my question relating to the Berkshire Hathaway problems — or companies — is, are your managers attuned to this and are they receiving the actual copies of the negotiated checks that the insurance companies claim that they’re spending to settle workers’ compensation injury cases? Thank you.

WARREN BUFFETT: Yup. Well, I would say that there’s plenty of fraud in various aspects of insurance.

In auto insurance, for example, I mean, obviously, we have fraud units, but I know you’re directing your question more to the insurance carriers than actually what takes place with policy holders and doctors and lawyers and various other parties.

But we find that for every dollar we spend on fraud prevention or detection, I think we get back well over $10.

In the comp field, workers comp, you know — we have lost more money in workers’ compensation insurance, I would guess — I may be wrong on this, but I would guess than just about any line.

Not necessarily as a percentage of premiums, but in terms of aggregate dollars. It’s been a very tough period.

So from the standpoint of — we have one small workers’ compensation direct operation in California called Cypress. And then Gen Re had — has written a lot of workers’ comp reinsurance and it’s been a bit of a blood bath. The rates have not covered the losses.

And I would say that there is a fair amount of fraud that enters into the losses we’ve experienced, or at least the industry’s experienced, particularly at the direct level.

But I — in terms of your dispute with an insurance company, I don’t know what company that would be, but I would say that most — many companies that have been in the workers’ compensation business, particularly in California in recent years, wish they hadn’t been in the business. I mean, they have not been making a lot of money off of defrauding policy holders that I know about.

But Charlie, do you have anything to say on that?

CHARLIE MUNGER: Well, the experience may be related. If a company gets into a lot of trouble from fraud practiced on it by lawyers, doctors, and claimants, and its own affairs are disrupted by fear and agony, that company is likely to start behaving badly with its own policy holders in order to lay the troubles off on somebody. I think that’s just human nature.

But I don’t think the main fraud in workman’s comp is by the carriers against the small businessmen. It’s by the claimants, the attorneys, and the doctors, against the whole system. (Applause)

WARREN BUFFETT: That really would be our experience.

As a sidelight, I noticed you were from Morganton, North Carolina. We have a business there, Carolina Shoe. We make work boots. And I give a talk at University of North Carolina some time ago. In fact, I think they have a tape of it still.

And afterwards — I had mentioned in the talk that we had this business in Morganton. And one of students came up to me afterwards. And there were a number of them, and I shook his hand and, making idle conversation, I said, “Where are you from?” And he said, “I’m from Morganton.”

And I said, “Oh,” I said, “Do you know Carolina Shoe?” And he thought a second, he said, “I don’t know her, but I think I know her family.” (Laughter)

Never forgotten that fellow.

24. Utility law repeal would help MidAmerican, but no bonanza

WARREN BUFFETT: Number 5.

AUDIENCE MEMBER: Good morning. Andrew Sole from New York City.

I just want to preface my question by saying that I have a deep admiration and affection for both of you men. And in that spirit, I had got a Golden Retriever puppy a few months ago, and he’s been proudly named “Munger.”

WARREN BUFFETT: Is he housebroken? (Laughter)

AUDIENCE MEMBER: And Charlie, you’d be very proud. He’s just like you. I bring him to Central Park and hundreds of women flock over to pet him.

CHARLIE MUNGER: Really?

WARREN BUFFETT: He’s well-named. He’s well named. (Laughter)

AUDIENCE MEMBER: That’s serious, but this is also serious.

My question has to do with the Public Utility Holdings Company Act, which obviously affects MidAmerica’s businesses.

You’ve spoken that, if it were repealed, you’d be able to commit billions of dollars into the energy infrastructure for the country.

And despite the fact that there was a massive blackout in this country over the last summer, the act has not been repealed. And I’m curious as to what effect it might have if PUHCA wasn’t repealed for MidAmerica.

WARREN BUFFETT: Yeah. The Public Utility Holding Company Act was passed in 1935. It was a reaction, and a justified reaction, to some real wild antics that had taken place in the ’20s in the public utility field that were most dramatic in the case of Sam Insull, but occurred with a lot of other companies, Associated Gas and Electric and various other companies.

And there was pyramiding of the utility capital structure. And there were a lot of things that were wrong that were addressed in that act. And in our view, that act is long outmoded. And I think that — I mean, the SEC, which has responsibility for administering it, I think there’s a lot of feeling there that it’s long been unneeded.

And I think that there’ve been various energy bills that have included the repeal of it. But there was no energy bill passed in the last year. So we live with the Public Utility Holding Company Act. And it does restrict what we do.

It’s an interesting question, though, if it were repealed, whether that necessarily would open up lots of opportunities. Because if it were repealed, it’s quite conceivable that a number of other companies would also be competing with us, in terms of possibly buying utilities that might have been difficult for us to acquire, or for them to acquire, back when the law was in existence.

So I don’t want you to think that, if it gets repealed, that Berkshire Hathaway is necessarily worth a lot more money.

But I do think it should be — I mean, I think it’s logical. It’s — there are lots of — there’s plenty of appropriate regulation in the public utility field and there are advantages to having strong companies like Berkshire Hathaway pouring money — energy requires enormous sums of money. And to the extent we can use capital advantageously in that business, we’re ready to do it. And it should not be impeded by the act.

If I had to bet, that act will probably go off the books at some time. But it doesn’t seem to be, you know, in the immediate future. It will not necessarily mean we get a lot richer.

Charlie?

CHARLIE MUNGER: Yeah, but if we had a wonderful opportunity in the field now, we would find a way to do it. Probably through MidAmerican, right?

WARREN BUFFETT: Well, we’d find a way to do it. Yeah.

There’s been nothing that’s been presented to us that we couldn’t get done so far. Now it might involve a more awkward structure, but we have not — you know, there’s been nothing that we wish we could have done and when we got to the finish line, or a yard from the finish line, we said, “Well, we can’t do this because of the Public Utility Holding Company Act.”

Now, there might have been other things presented if that act hadn’t been on the books.

But it will be no bonanza for us at all if it goes away. It may make life simpler on some very large transaction.

25. Berkshire real estate business will grow

WARREN BUFFETT: Number 7? I’m sorry, number 6. I skipped 6. Number 6.

AUDIENCE MEMBER: Good morning. My name is Andy Lewis Charles from Miami. I think I speak for everyone when I wish both of you gentleman continued health. I would wish you continued wealth, but I think you have that covered.

WARREN BUFFETT: We could use more. (Laughter)

Of each.

AUDIENCE MEMBER: Speaking of MidAmerican Energy, a unit company underneath it, HomeServices, I see as a great opportunity. I would love to see and hear your thoughts about the future growth potential for it, especially against large consolidators like Cendant Corporation. Thank you.

WARREN BUFFETT: Yeah, HomeServices will grow. HomeServices, as you know, owns a number — I can’t recall how many, but probably in the area of 15 or 16 maybe — controls a number of local real estate firms. And they retain all of their local identity.

In that way, it’s somewhat akin to the whole Berkshire Hathaway model, where we leave our subsidiary companies quite autonomous and they operate as if they were — the managers operate as if they own them themselves.

Well, HomeServices is somewhat along the same line in that we have no national identity, where Cendant works under a couple of big names.

We’ve acquired one company in North Carolina here in the last month or 6 weeks, Prudential of North Carolina. And we will end up — unquestionably, in my view — we’ll end up buying either a few or a whole lot of additional companies over the next 10 years.

We will — we’ve got great management. We like the business. We hear about opportunities from time to time.

Last year, you know, we participated in roughly $50 billion of transactions. And I think — I’m really vague on this one, but — I better not give you a percentage of the national total that is, but it’s a very small percentage. It’s a lot of transactions, a couple hundred-thousand transactions.

We’re very big in Southern California, for example. We’re very big in Minnesota. We’re very big in Iowa. Very big right here in Omaha and in Lincoln. But there’s an awful lot of places where we aren’t at all.

We like to buy leading firms as we go around. And we sometimes like to buy more than one in a community.

It’s a good business. It’s a very cyclical business. Right now, it’s very good. We will go through periods in the next five years. I’m sure we’ll go through a period where it’s very slow. But we’ll keep buying. We’ll buy when business is slow, we’ll buy when business is good, depending on the price of the institution and the kind of business we’re buying.

I don’t know how big it can become. It will become bigger than it is now. Relative to Berkshire’s total market value, it may not be that — a huge factor. But it’s conceivable as we buy more operations, we’ll find other things to do with them, too.

I mean, the purchase of a home is a big deal to people. You know, often they’re buying furniture at the same time and maybe we can make a suggestion or two.

Charlie?

CHARLIE MUNGER: I’ve got nothing to add about that business.

26. Charity program reluctantly dropped after anti-abortion boycott

WARREN BUFFETT: Number 7.

AUDIENCE MEMBER: Good morning. I’m Jim Hayes (PH) from Alexandria, Virginia.

I hate to beat a dead horse, but I really like the charitable plan. Suppose you brought it back and then personally opted out and then we floated you a bonus equal to what you might otherwise be entitled. Would you consider that?

WARREN BUFFETT: Are you talking about renewing the shareholder-designated contribution program?

CHARLIE MUNGER: Yeah.

AUDIENCE MEMBER: Yes. And then personally opting out, and then we could have a shareholders’ vote to grant you an option bonus or some kind of tax-advantaged bonus.

WARREN BUFFETT: Yeah, I think that might get a little complicated.

Additionally, I wasn’t the only one giving money at all, nor was Charlie, to organizations, primarily pro-choice organizations, in fact over — I don’t know of any other than pro-choice organizations — that the people that were causing harm to the Pampered Chef representatives. We had dozens and dozens, maybe even hundreds, giving money on both sides of the issue.

I mean, if you looked at one class — well, the largest classification of gifts went to churches. Probably the largest classification in that, I’m (inaudible) positive, were Catholic churches.

And we had people giving money to everything in the world, which is exactly the way we wanted it. I mean, whatever — it’s the shareholders’ money.

So even if you had the two of us opt out, we would have organizations that would get violent about the fact that some money was going to pro-choice organizations. And rather than take it out on us, whom they can’t hurt, they’ve taken it out on some very innocent people.

And neither Charlie nor I like the idea of somebody — you know, some woman that’s developed a living, you know, in Dubuque, Iowa or in Casper, Wyoming, having her livelihood destroyed because of what we’re doing.

So reluctantly, we gave up the practice. I mean, we — actually, I received a letter one time from somebody — some organization was monitoring — said they didn’t give — they didn’t care if we were giving $10 million to pro-life organizations and $1 to pro-choice organizations, they were still going to boycott our people.

Well, boycotts don’t bother me. We had some of that right along, always on a small scale. But — because they can’t — they basically can’t hurt us in any significant way.

But they can hurt individuals very badly and we’re not going to have something around Berkshire that’s hurting a bunch of people that have devoted their lives to working with us. So we reluctantly gave it up.

Charlie?

CHARLIE MUNGER: Well, as I said, it’s a dead horse and I miss it, too.

27. Buffett family and Berkshire managers will protect the company

WARREN BUFFETT: Number 8, please.

AUDIENCE MEMBER: Good morning. I’m Jay Leiber (PH) from Houston, Texas.

Mr. Buffett, since I’m older than you and maybe even as old, or older, than Charlie, I feel like I can ask this question. And I’ll ask it as delicately as possible.

When the time comes that you, I, and Charlie have gone to that big stock market in the sky, I understand that you planned — or at least, I have read — that you plan to give the bulk of your Berkshire Hathaway stock to your charitable foundation, along with your 30 percent of the votes of the company.

If this is correct — and if it’s not correct, this question is moot — but if so, what assurance do the Berkshire Hathaway shareholders have that the company will continue to be run as honestly and straightforward as it is now, such as only 15.8 employees or so at headquarters and no —

WARREN BUFFETT: Yeah, the —

AUDIENCE MEMBER: — huge salaries or other ridiculous giveaways to dilute and weaken the equity of the shareholders at that time.

WARREN BUFFETT: Well, for a short while there’ll only be 14.8, actually. (Laughter)

But it’s a good question — a very good question. Since you’re older than I, apparently, I hope we don’t go at the same time. The —

There’s one slight twist to the estate plans we have. If I die first, all of my Berkshire goes to my wife. And if we died simultaneously, it would all go to the foundation.

But all of the stock will end up in the foundation. In fact, if I died first, she might put my stock in the foundation before her death, but that would be up to her. But it will end up in the foundation — all of the stock.

As you mention, it has 30-odd percent of the votes, although under the tax law, once it’s in the foundation, within five years, it would have to either convert to be some of it — it would have to get down to 20 percent of the vote. That’s required under foundation law.

In terms of how it would be run in the future, I think it has a far better chance than any company — any major company I know in the country — of maintaining the culture, because it has — it will have people running it who have grown up in the culture.

Earlier, it was — the criticism was made about my wife and my son being on the board, but they are guardians of the culture. They are not there to profit themselves, they are there to profit as the shareholders profit, but also to keep the company in the same way as previously.

One great example of that, of course, has been at Walmart where, when Sam Walton died, a not too dissimilar amount of stock was left among the family. And essentially the Walton family has, in my opinion, done a magnificent job, not only of selecting successors to run the place, but having successors who, if anything, reinforced the culture of Walmart. And it’s been an enormously successful arrangement.

The Waltons are there, in case anything goes wrong, to make a change if needed, but they’re not there to run the business. And that’s exactly the pattern that we hope to have at Berkshire. And I think we have it.

I think I — you know, I can’t give you a hundred percent guarantee, but I would far rather bet on the integrity of the family that succeeds me, plus the managers that succeed me, at Berkshire remaining true than I would any other company in — for a long, long time — any other company I can think of.

Charlie?

CHARLIE MUNGER: Well, I would have a reason to fret about this subject, just as you would. And I, of course, have known the members of the Buffett family that would be here after Warren is gone for decades. Don’t worry about it. You should be so lucky. (Laughter and applause)

WARREN BUFFETT: It’s a question we don’t wish to have an instant answer for, though, however. (Laughter)

28. Profits as GDP percentage won’t be moved by technology

WARREN BUFFETT: Number 9, please.

AUDIENCE MEMBER: Good morning. James Easterlin (PH) from Durham, North Carolina.

My question — statement is, you have often written in reference to average corporate profitability remaining fairly consistent in the long run, such that return on equities are in the 12 percent range for U.S. companies, and after-tax profits as a percentage of GDP is sticky in the 4 to 6 1/2 percent range.

And the question is, given the advances in technology that brought the inventory-to-sales ratios down to historic lows, given the widespread adoption of the EVA principles by companies, might you think that might change over time?

WARREN BUFFETT: Yeah, I don’t think any of the factors that you mentioned will act to move corporate profitability out of the range that has historically existed.

It’s going to bob around, obviously, some, but I certainly don’t think EVA will do a thing for American corporations in terms of making them receive a greater share of GDP in profits.

Technology, that’s just as likely to reduce profits as to increase profits. I mean, as the economic machine of the United States works better and better over time, the main beneficiaries are going to be consumers.

If you took whoever you think is the best business manager in the United States and you put a clone of that person in charge of each one of the Fortune 500, the profits of the Fortune 500 would not necessarily go up, because there’s this competitive nature to capitalism where the improvement you get one day, your competitor gets the next day.

And it very much tends to work to the benefit of consumers but not to increase overall profitability.

We see that in the industries we’re in. Every — we were in the textile business for a long time and various new products — various new machinery — would come along and it would promise to deliver a 40 percent internal rate of return and get rid of 43 employees or something like that.

And, you know, we just did one after another of those, and when we got all through we didn’t make any money, because the other guy was doing the same thing.

And I liken it to everybody at a parade — you know, a huge crowd watching it and somebody stands up on tiptoes and, you know, 10 seconds later, everybody in the crowd is up on tiptoes and they’re not seeing any better and their legs hurt. Well, that was the textile business.

And there’s an awful lot of self-neutralizing things in capitalism. So I don’t really expect any of the factors you named, or any other factors that I can think of, that will move profits up as a percentage of GDP.

And indeed, I think that if you’re looking at GDP as being the national pie and profits being what investors get out of it, and the rest belonging to people who are out there working for a living every day, I don’t think the relative — the proportions — are inappropriate.

Charlie?

CHARLIE MUNGER: I’ve got nothing to add to that.

29. Method for estimating a company’s future growth and establishing a margin of safety

WARREN BUFFETT: Number 10.

AUDIENCE MEMBER: Good morning. I’m Marc Rabinov from Melbourne, Australia.

Mr. Buffett and Mr. Munger, I’d like to ask you, when you assess a business and derive its intrinsic value, how do you estimate the future growth of the business, and how do you decide what margin of safety to use? Thank you.

WARREN BUFFETT: It was the future growth and what, Charlie?

CHARLIE MUNGER: Well — I have difficulty understanding that question fully. He’s talking about how do we combine our estimates of future growth with our passion for having a margin of safety. Surely, you can handle that. (Laughter)

WARREN BUFFETT: Well, I can certainly handle it as well as you can. (Laughter)

Every time he laterals them off to me, you know, he calls those audibles. (Laughter)

You calculate — I think you take all of the variables and calculate them reasonably conservatively. But you don’t try and put too much windage in at every level.

And then when you get all through, you apply the margin of safety. So I would say, don’t focus too much on taking it on each variable in terms of the discount rate and the growth rate and so on. But try to be as realistic as you can on those numbers, but with any errors being on the conservative side. And then when you get all through, you apply the margin of safety.

Ben Graham had a very simple formula he used for just the most obvious situations, which was to take working capital — net working capital — and try and buy it at a third off working capital. And overall, that worked for him. But that method sort of ran out of steam when the sub-working capital stocks disappeared.

But it’s the same thing we do in insurance. I mean, if we’re trying to figure out what we should charge for, we’ll just say, the chances of a 6.0 earthquake in California, well, we know that in the last century, I think that there have been 26 or so 6.0 or greater quakes in California.

And let’s forget about whether they occur in remote areas, let’s just say we were writing a policy that paid off on a 6.0 or greater quake in California, regardless of whether it occurred in a desert and did no damage or anything.

Well, we would look at the history and we’d say, “Well, there’ve been 26 in the last century.” And we would probably assume a little higher number in the next century, that’d just be our nature. But we wouldn’t assume 50. If we did, we wouldn’t write any business.

So we would — we might assume a little higher. I would, if I was pricing it myself, I’d probably say, “Well, I’ll assume there are going to be 30, or maybe 32, or something like that.”

Then when I get all through, I’ll want to price the — I’ll want to put a premium on it that now puts in a margin of safety. In other words, if I figured the proper rate for 32 is a million dollars, I would probably want to charge something more than a million dollars to build in that margin of safety.

But I don’t want to hit it at — I want to be conservative at all the levels and then I want to have that significant margin of safety at the end.

And I guess that, as I understand the question, that’d be my answer. And Charlie, do you want to add to that?

CHARLIE MUNGER: Yeah, that book, “Deep Simplicity,” that I recommended to you says that you can predict out of those 26 earthquakes how the size will be likely to be allocated.

In other words, there’s a standard power law that will tell you the likelihood of earthquakes of varying sizes. And of course the big earthquakes are way less likely than the small ones.

So you count the math and you know the applicable power law and you guess as to how much damage is going to — it’s not that difficult.

WARREN BUFFETT: It becomes more difficult if somebody said they really want protect against a 9.0 or something like that. You know, is it one in 300 years? Is it one in a thousand years? You know, when you get really off the data points.

But that is not what you’re looking at in investments. You don’t want to look at the things that are that — you don’t want to come up with the companies where you make the assumptions that get that extreme.

And you don’t have to, that’s the beauty about investments. You only have to look at the ones that you feel capable of evaluating and you skip all rest.

30. No single formula for regulatory impact on businesses

WARREN BUFFETT: Number 11?

AUDIENCE MEMBER: Good afternoon. It’s James Tarkenton of Durham, North Carolina.

Current examples, including discussion of media ownership rules, FCC regulation of the telecom industry, and proposed oversight changes for mortgage giants Fannie Mae and Freddie Mac are all examples of the legislative, regulatory, and lobbying process as an influence in shaping and reshaping economic moats.

We would be interested in your comments on these and other examples of how competitive advantages are shaped by government.

In general, how do you incorporate the impact of regulation on the size and ferocity of economic moats for various businesses?

WARREN BUFFETT: Well, that varies enormously by the business. I mean, there’re some businesses that we think that it’s not a very big factor, and there’s other businesses we’re in — the energy business, the insurance business — where regulatory change could have a huge impact.

You know, we don’t have any one-size-fits-all type arrangement. We just try to think intelligently about any business we’re in. And if it’s — when we bought GEICO in 1995, or bought that last half of it or whichever year it was, the question, you know, whether the regulatory climate would change in some major way, you nationalize auto-insurance — well, all of those things go through our mind and we evaluate them.

But there is no — there’s no formula. You know, if we’re — if we’re in furniture retailing, you know, that is not something we’re going to worry about. We’re going to worry about plenty of things, in terms of competition, but there are different variables that apply with different intensity to each business we’re in. And it’s up to Charlie and me to try and think about any of the variables that might hit those businesses, and to weigh them appropriately, and to crank that into our evaluation.

Charlie?

CHARLIE MUNGER: I think it would be fair to say that in our early days, we tended to overestimate the difficulties from regulation. We refrained from buying television station stocks for a long, long time because it seemed like such a peculiar asset when anybody could just ask to have your license jerked away from you each year and they could ask a government agency to do it. And — but it turned out, the way the system evolved, that almost never happened.

WARREN BUFFETT: Yeah, Tom Murphy figured that one out before we did. (Laughs)

CHARLIE MUNGER: Yeah, and we had it — we were slow on the learning curve. Murphy was way better at it than we were.

31. Buy Berkshire or low-cost index fund?

WARREN BUFFETT: Microphone 12, please.

AUDIENCE MEMBER: Hello, gentleman. My name is Vivian Pine and I’m from Tarzana, California.

And my question is, for a new investor buying stocks today, would you recommend that they buy a low-cost S&P index fund or Berkshire Hathaway, and why?

WARREN BUFFETT: Well, we never recommend buying or selling Berkshire. But I would say that, among the various propositions offered you, a very low-cost index fund where you don’t put all your money in at one time.

I mean, if you accumulate a low-cost index fund over 10 years with fairly regular sums, I think you will probably do better than 90 percent of the people around you that take up investing at a similar time.

Charlie?

CHARLIE MUNGER: I would agree with that, totally. It’s awkward for us sitting here at these annual meetings where we have a sampling of some of the most honorable and skillful stockbrokers around who’ve done a wonderful job for their own clients and families. But the stockbroking fraternity, in toto, can be guaranteed to do so poorly that the index fund is a better option.

32. Leverage can prevent you from playing out a winning hand

WARREN BUFFETT: We’ll go to number 1 again.

AUDIENCE MEMBER: John Bailey from Boston.

As of last week, my house is almost totally covered with Benjamin Moore now. (Laughter)

But more seriously, you spent a fair amount of time talking about the low-probability transformative events. I recall a discussion on the probability of a nuclear event not occurring in any given year for, say, 50 years, at which point it begins to look like, over the time period, it’s pretty darn likely and therefore the expected value is a pretty big negative.

There are some other things that could be happening that somebody might expect. For instance, perhaps there is, in fact, a ceiling on consumer debt coverage ratios. If they quit falling, there — that could be a big change.

If you even listen to the United States Geological Survey, they’re now saying that sometime in the next 50 years, there could be a fall in the production of oil.

And so, I’d like you to address how you conceive of the portfolio of businesses in the context of these possible transformative events, especially given that over this same time period of maybe the next 50 years, at some point, you’re not going to be able to personally revise the portfolio.

WARREN BUFFETT: Yeah, I think it’s a fair statement that over the next 50 years at some point, Charlie and I will not personally be able to — (laughs) — participate in portfolio revisions. The —

Well, you’re quite correct that people tend to underestimate low-probability events when they haven’t happened recently and overestimate them when they have happened recently.

That is the nature of the human animal. You know, Noah ran into that some years back. But he looked pretty good after 40 days. The —

What you mention on the nuclear question, it’s a matter — you can do the math easily. What you don’t know is whether you’re using the right assumptions. But it —

For example, if there is a 10 percent chance in any given year of a major nuclear event, the chance that you’ll get through 50 years without it happening, if the 10 percent is correct, is a half of 1 percent.

I mean, 99 1/2 percent of the time a 10 percent event per year will catch up with you in 50 years. If you can reduce that to 1 percent, there’s a 60 percent chance you get through the next 50 years without it happening.

That’s a good argument for trying to reduce the chances of it happening.

In terms of our businesses, I think Charlie and I are — I mean, we think about low-probability events. In fact, in insurance, we probably think about low-probability events more than most people who have been insurance executives throughout their years. It’s just our nature to think about that sort of thing.

But I would say, if you talk about transforming events, or really talk about major events that could have huge consequences that are low probability, they’re more likely to be in the financial arena than in the natural phenomena arena. But we’ll think about them in both cases.

But we do spend a lot of time thinking about things that can go wrong in a very big and very unexpected way.

And financial markets are — they have vulnerabilities to that, you know, we try to think of and we try to build in ways to protect us against it and perhaps even build in some capabilities where we think we might profit in a huge way from it.

Charlie?

CHARLIE MUNGER: Yeah, that temporary collapse in the junk bonds, where they got down, many of them, to 35 and 40 percent yields, that’s a strange thing. And to have all those things pop back — you know, quadrupling in a short time. There was absolute chaos at the bottom tick of that.

And that isn’t as much chaos as you could have. And of course, it can happen in common stocks instead of junk bonds.

So I think if you’re talking about the next 50 years, we all have to conduct ourselves so that we — it won’t be all that awful if a real financial crunch of some kind could come along. Either inflationary or a typical deflationary crunch of the time [kind] that people used to have a great many decades ago.

WARREN BUFFETT: Probably the most dramatic way in which we are — give evidence of our — of your worries, is we just don’t believe in a lot of leverage. I mean, you could have thought junk bonds were wonderful at 15 percent because they eventually did go to 6 percent, you would have made a lot of money.

But if you owed a lot of money against them in between, you know, you wouldn’t have been around for the party at the end.

So we believe almost anything can happen in financial markets. And the only way smart people can get clobbered, really, is through leverage. If you can hold them, you have no real problems.

So we have a great aversion to leverage and we would predict that a very high percentage of the smart people operating in Wall Street, at one time or another, are likely to get clobbered through the use of leverage.

It’s the one thing that forces you — it’s the one thing that ends — or can prevent you from playing out your hand. And all of the hands we enter into look pretty good to us. But you do have to be able to play them out.

And the fascinating thing to me is that — just take the junk bond situation. In 2002, you had people with terrific IQ — tens of thousands of them operating in Wall Street. You had the — money was available. They all had a desire to make money.

And then you see these extraordinary things happen in markets and you say to yourself, you know, can these be the same individuals that two years later or two years earlier were buying these things at prices that were double or triple or quadruple what they sunk to in between? And did they all go on vacation? You know, did they lose their ability to raise money?

No, the money was — you know, Wall Street was awash in money, and it was awash in talent, and yet you get these absolutely extraordinary swings.

I mean, it doesn’t happen with apartment houses in Omaha or, you know, with McDonald’s franchises or farms or something. But it’s just astounding what can happen in the marketable securities department.

And the big thing you want to do is, at a minimum, you want to protect yourself against that sort of insanity wiping you out.

And better yet, you want to be prepared to take advantage of it when I happens.

Now it’s about noon, so we will come back and begin at microphone 2 about, say, a quarter of one.

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