Berkshire Hathaway Annual Meeting 1995 Transcript

Warren Buffett [00:00:03] Morning. I’m Warren Buffett, the chairman of Berkshire Hathaway, and on my left is Charlie Munger, the vice chairman of my partner, and we’ll try to get him to say a few words at some point in the proceedings. The format today is going to be just slightly different. We have one item to… normally we breeze through the meeting pretty fast, and we’ll do that, but we have one item a business on the preferred stock that I could tell cause some confusion with people, so I’ll discuss that a little bit. And if before the vote on that anybody would like to talk about the preferred issue, we’ll have any comments or questions at that time, and then we’ll breeze through the rest of the meeting, and then we’ll open it up, and I’ll have one announcement to make then too.

And then after that we’ll go for maybe close to noon, and feel free earlier, anybody that would like to leave, you’re free to, obviously, at any time. Better form to do it while Charlie’s talking, as I mentioned, and you’ll have to be quick. The… but then we’ll have a… then we’ll have a break a little before noon for a few minutes while a more orderly retreat can be conducted. We’ll have buses outside to take you back to the hotels or to any of the commercial establishments that Berkshire’s involved in. And then, because so many… we have people here, at least based on the tickets reserved, from 49 of the 50 states. Only Vermont is absent. We have… but we have Alaska, why, we have a delegation from every place. We have people from Australia, Israel, Sweden, France, UK, 40-some from Canada.

So people… a lot of people have come a long way, so Charlie and I will stick around. In fact, we’ll eat our lunch right up here, and we will… you don’t want to… we don’t want to watch what we eat. The… but the… well, we’ll stick around until perhaps as late as even three o’clock, but if the crowd gets below a couple of hundred, then we’ll feel we can cut it off. But we do wanna answer everyone’s questions. You people are part owners of the company, and any question that relates to your ownership of Berkshire, we want to be able to give you a chance to ask. And it’s tough because of the numbers of people here. I don’t know how many are in the other room, but they’re about 3,300, I believe, in this room, and we want to get to you, to all of you. So that will come after the meeting.

Now, we’ve got a little business to take care of. The meeting will come to order, and I’ll first introduce the directors of Berkshire. In addition to myself, they’re right down here, and if you’ll stand up when I give your name. Susan T. Buffett. (Applause) And Howard Buffett. These are names we found in the phone book, you can understand them. Malcolm Chase III. (Applause) And Walter Scott Jr. (Applause)

Also with us today are partners in the firm of Deloitte & Touche, our auditors, Mr. Ron Burgess and Mr. Craig Christiansen. They are available to respond to appropriate questions you might have concerning their firm’s audit of the accounts of Berkshire. Mr. Forrest Krutter is secretary Berkshire. He will make a written record of the proceedings. Mr. Robert M. Fitzsimmons has been appointed inspector of elections at this meeting. He will certify to the account of votes cast in the election for directors. The name proxy holders for this meeting are Walter Scott Jr. and Marc Hamburg. Proxy cards have been returned through last Friday representing 998,258 Berkshire shares to be voted by the proxy holders as indicated on the cards. That number of shares represents a quorum, and we will therefore directly proceed with the meeting. We will conduct the business of the meeting and then, during the formal meeting, after that we will entertain questions you might have.

First order of business will be a reading of the minutes of the last meeting of shareholders. I recognize Mr. Walter Scott Jr. will place a motion before the meeting.

WSWalter Scott Jr. [00:04:39] I move that the reading the minutes the last meeting the shareholders be dispensed with.

Warren Buffett [00:04:44] Do I hear a… has been moved and seconded. Are there any comments or questions? We’ll vote on… any comments or questions? We vote on the motion by voice vote. All those in favor say aye. Opposed? The motion is carried. Secretary, I have a report of the number of Berkshire shares outstanding entitled to vote and represented at the meeting?

FKForrest Krutter [00:05:06] Yes, I do. As indicated in the proxy statement that accompanied the notice of this meeting that was sent by first class mail to all shareholders of record on March 7, 1995, being the record date for this meeting, there were 1,177,750 shares of Berkshire common stock outstanding, with each share entitled to one vote on motions considered at the meeting. Of that number, 998,258 shares are represented at this meeting by proxy’s return through last Friday.

Warren Buffett [00:05:31] Thank you. If a shareholder is president who wishes to withdraw a proxy previously sent in and vote in person on the two items a business provided for in the proxy statement, he or she may do so. Also, if any shareholder this president has not turned in a proxy and desires a ballot in order to vote in person on these two items, you may do so. If you wish to do this, please identify yourself to meeting officials in the aisles, who will furnish two ballots to you, one for each item. With those persons desiring ballots please identify themselves so we may distribute them. Just raise your hand and you’ll get one. The first item of business of this meeting is to elect directors. I now recognize Mr. Walter Scott Jr. to place a motion before the meeting with respect to election of directors.

WSWalter Scott Jr. [00:06:18] I move the Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chase III, Charles T. Munger and Walter Scott Jr. be elected as directors.

[00:06:29] Unidentified speaker: I second.

Warren Buffett [00:06:30] The motion has been moved in second on the Warren Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chase the Third, Charles T. Munger and Walter Scott Jr. be elected as directors. Are there any other nominations? There any discussion? Doing fine. 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 for directors and allow the ballots to be delivered to the inspector of election. Collect those, please. With the proxy holders please also submit to the inspector of elections a ballot on the election of directors, voting the proxies in accordance with the instructions they’ve received. Mr. Fitzsimmons, when you’re ready, you may give your report.

RFRobert Fitzsimmons [00:07:17] My report is ready. The ballot of the proxy holders received through last Friday cast not less than 996,892 votes for each nominee. That number far exceeds the majority of the number of shares outstanding. The certification required by Delaware law regarding the precise count of the votes, including the votes cast in person at this meeting, will be given to the secretary to be placed with the minutes of this meeting.

Warren Buffett [00:07:48] Thank you, Mr. Fitzsimmons. Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chase III, Charles T. Munger, Walter Scott Jr. been elected as directors. The second item of business of this meeting is to consider the recommendation of the board of directors to amend the company’s certificate of incorporation. The proposed amendment would add a provision to the certificate of incorporation authorizing the board of directors to issue up to one million shares of preferred stock in one or more series, with such preferences, limitations and relative rights as the board of directors may determine.

Now, we discussed this some in the annual report, but I would say, and we’ll find out the exact number, but I think we probably had 11 or 12, maybe 12,000 or so shares voted against the proposal. I think we had a couple thousand shares that I abstained, and since there really is no downside to the proposal, that indicated to me that I had not done a very adequate job of explaining the logic of authorizing the preferred. So I’d like to discuss that for a minute now, and I’d also like anybody that would like to ask questions about it, they can do so now. We can talk about it later too, but if you’d like to do it before the vote, that’d be fine. The authorization is just that. It’s an authorization. It’s not a command issue shares. It’s not a directive. It simply gives the directors of the company the ability, in a situation where it makes sense for the company to issue preferred shares, to do so.

Now, when we acquire businesses, and I’ll tell you about one when we’re through with this in a few minutes, when we acquire businesses, sometimes the seller of the business wants cash, sometimes they would like common stock, and it’s certainly possible, as one potential seller didn’t let in that case, a convertible preferred stock. Now, from our standpoint, as long as the value of the consideration, the value of the consideration that we give equates, we really don’t care, aside from a question of tax basis we might obtain, but we in other economic respects, we don’t care what form of consideration we use, because we will equate the value of cash versus a straight preferred versus a convertible preferred versus common stock, whatever it may be.

So if the worry is that we will do something dumb in issuing the preferred stock, you should… that’s a perfectly valid worry, but you should worry just as much we’ll do something dumb in terms of using cash or the common stock. I mean, it’s… if we’re going to, if we’re going to do something unintelligent, we can do it with a variety of instruments, and we will not get more licentious in our behavior or anything but simply because we have the preferred stock. And the preferred stock… a preferred stock may offer sellers of a business the chance to do a tax-free exchange with us, and they may not want common stock because they may have an ownership situation where they don’t want to run the risks of common stock ownership.

And that’s why our preferred as flexible is the terms, because we could give those people a straight preferred with a coupon that made it worth par at the time we issued it, and then they would know what their income would be for the next umpteen years, and that may be of paramount interest to them. We could issue them an adjustable rate preferred, which as money market conditions change would also change its coupon, and then they would be sure of a constant principal value for the rest of their lifetimes. And one or both of those factors could be more important to one seller or another. So that we simply have more forms of currency available to make acquisitions if we have the ability to issue various forms of preferred, because a preferred stock, if it’s properly structured, allows for the possibility of a tax-free transaction with the seller, and that’s important to many sellers. Now, in the end, many sellers will prefer cash, just as in the past, and probably most of the sellers that don’t want cash will want common stock, but we will have a preferred stock available.

We’re only authoring, authorizing a million shares because under Delaware law there’s an annual… I think there’s an annual fee. I know there’s an initial fee, and I think there’s an annual fee that relates to the amount of shares authorized. So if we authorized 100 million shares, it would… we would be paying a larger annual fee, which is something Mr. Munger wouldn’t let me do. So what we will do, if we issue this, we will issue, undoubtedly we’ll… we will issue some sub shares, so that the number of shares for taxation purposes is relatively limited, but that we will issue sub shares to make it easier to make change, essentially, in the market. We may issue, if the occasion demands, we may issue a convertible preferred, but that convertible preferred would not be worth any more at the time we issue it then a straight preferred. We would adjust in terms of the coupon and the conversion price and so on. So we can equate various forms of currency to fit the desires of the seller of the business, and this is simply one more tool to do it.

There’s no downside, like I say, unless we do something stupid, and if we do something stupid with us, we would do something stupid with cash or whatever. So it… we probably should have done this some time ago, but we never had a case of a seller wanting that form of currency before. And so it just… and we always felt we could get it authorized promptly, but there’s no reason to lose a couple of months, if a transaction is pending, to call a meeting to get this on the books. So it’s simply one more tool. And if there are any, if there anybody that has any questions or comments on the preferred, like I say, you can’t hold them until later, but I’d be glad to have them before we have the vote. Do we have any? Yeah, there’s a question over there. Now, if you’ll wait just a second, we’ll get a microphone to you. When you ask questions an hour later, if you’ll give your name and where you live, I’d appreciate it.

[00:14:38] Shareholder (Lawrence Wasser, New York): Hi, my name is Dr. Lawrence Wasser. I’m from New York. Question is this. If you want to buy a business and the people in the business want cash, you have to have cash. Cash that, you know, this kind of cash we’re familiar with.

Warren Buffett [00:15:14] Yeah.

[00:15:15] Shareholder (Lawrence Wasser, New York): But it’s… it strikes me that the preferred isn’t really cash. It’s fiat currency.

Warren Buffett [00:15:24] That is its currency that we can create. That’s true. It’s just like… it’s like common stock in that respect. It is the… it is a for… it’s an alternate form of currency, and… but it is… it is just in terms of common stock, for example, assuming we had enough authorized, we have an unlimited ability to create currency. Now, if we created the wrong price, it dilutes the value of the old currency. But go ahead.

[00:15:56] Shareholder (Lawrence Wasser, New York): On until we vote in the affirmative, which I’m sure that this group will probably do because of their confidence in you, but until we vote in the affirmative, it doesn’t exist.

Warren Buffett [00:16:06] That is correct. You were… that would be true, incidentally, with common stock. If we had no more authorized common stock out than we had issued… we have, I think, a million and a half authorized, but let’s assume that we’d issued all that we had authorized, until more was authorized by the shareholders, there would… it would not be available to be issued.

[00:16:27] Shareholder (Lawrence Wasser, New York): But if more were authorized by the shareholders, then isn’t it true that the value of the shareholders holding would be diluted?

Warren Buffett [00:16:35] Only if we receive less in value than we give. That’s the key to it. I mean, if we issue $200 million worth of preferred and we receive a business that’s only worth 150 million, there’s no question you’re worse off than before. So are we, incidentally, but we’re all worse off. The… and that’s true if we give cash that’s worth more for a business than the business is worth. If we give $200 million of cash for a business that’s worth $150 million, we are worse off. We may not have issued a share of stock, but we have diluted the value of your stock if we do that. As long as we get value received, in terms of whether of cash, common stock or preferred stock, then you are not diluted in terms of value.

That’s… it’s an important point that… and I… and obviously a number of companies, as you may have… Charlie and I have commented about in reports and elsewhere, a number of companies, in our opinion, have issued common stock particularly which has a value greater than what they receive, and when they do that, they are running what I… what John Medlin of the Wachovia called a chain letter in reverse, and that’s cost American shareholders a lot of money. I don’t think it’ll cost them any money at Berkshire, but it’s a perfectly valid worry for shareholders to have, because a management can build an empire just by issuing these little pieces of paper which they feel don’t cost them anything. That… I think Charlie had one story about that in the past. I don’t want to comment on that?

Charlie Munger [00:18:09] Sure. No names basis, of course. There was a particular bank where one of the officers wanting stock options pointed out to the management that they could issue all these shares and it didn’t cost anything. Now imagine hiring a manager who thinks that way and paying the money to behave like Judas and you’re very… in your very midst.

Warren Buffett [00:18:31] We have, we have had conversations with managers where they tell us how fortunate they feel because the stock is down and they can issue options cheaper. Now, if they were issuing those to third parties, I, you know, I’m not sure whether they’d have exactly the same attitude. But we have no feeling that we’re getting richer when we issue shares. We have a feeling we’re getting richer when we get at least as much value in the business as the shares are worth that we issue, and we don’t intend to issue them under any other circumstances. But it’s a perfectly valid worry.

[00:19:06] Shareholder (Lawrence Wasser, New York): The second part of the question is that obviously with preferred issue you have a situation where the common shareholder is moves to the back of the line, as it were. Why should the common shareholder in this room want to step to the back of the line if he’s at the front of the line now?

Warren Buffett [00:19:24] Well, it… but it’s also true if we buy a business for cash and we, let’s say, we borrow the money, the bank that we borrow the money from will come ahead of the common shareholder. There’s no question. Any time you move… you engage in transactions that involve the capital structure, potential for each part of the capital structure… if you issue a lot of common and you’ve got some debt outstanding, you’ve generally improved the position of the debt. And the question really becomes whether you think that the position of the common shareholder is improved by issuing either preferred stock or perhaps borrowing a lot of money to make an acquisition.

I mean, a couple of times in the history of Berkshire we’ve borrowed money to buy something, to buy a business, and when we do that we are placing a bank or an insurance company or whomever ahead of the position of the common shareholder. We did that when we issued some debt a few years back, and there’s a question of weighing whether the common shareholders are going to be better off by borrowing money. But borrowing money is not necessarily at all harmful to shareholders, although certainly if it’s carried to excess it is. And the preferred is a form of quasi borrowed money that does rank ahead of the common shareholder, but then at the same time we’re adding a business which we think is going to benefit the shareholder if we issue that. So that’s the trade-off. Yep.

[00:20:51] Shareholder (Matt Zuckerman, Miami, Florida): My name is Matt Zuckerman. I’m from Miami, Florida. My question is, it seems to me that there’s some requirement for shareholder votes if stock of preferred stock is issued beyond a certain limit. What are those limits?

Warren Buffett [00:21:05] There are no limits on the conversion term that we might do, but, for example, if we were going to issue a convertible preferred… now, we have no plans to do it, but it could happen. In fact, it might well happen this year. The… we would, and the alternative, we’ll say, was giving somebody $100 million in cash for a business. If we were to issue a straight preferred, we would figure out what $100 million worth of a straight preferred would sell for, what coupon would be necessary, and that would depend on call provisions and a few things, but for a AAA credit like Berkshire, you know, it would be somewhere in the area of 7% or thereabouts, and then they would have no participation in the upside of the common.

If they wanted something that was sure to maintain its principal value, then you have to issue an adjustable rate preferred that will keep its value around par. That preferred might have an initial coupon of, say, 5% or something of the sort, because it has the ability to go up or down based on interest rates, but it would always be worth about par. If we were to issue a convertible preferred, it might have a conversion price of, just to pick a figure, 28,000 or something of the sort, and a coupon well below the coupon on a straight preferred. And so whatever we did, they would equate out in our mind as to the value we were giving. We’re not gonna, we’re not going to give 120% of X if we’re only willing to pay 100% of X just because the form of a deal changes. But you may well see us issue at some point… you may see us issue a convertible preferred, you may see us issue a straight preferred, message issue an adjustable rate preferred. I hope we do something because I’d like… you know, if we do it, we’ll think we’re better off.

[00:22:51] Shareholder (Matt Zuckerman, Miami, Florida): Based on your past performance, I’m sure you’ll get more value than you give. Well, but in any case, it was my understanding that if the amount of shares issued for conversion of a convertible issue were greater than 20% of the total amount of shares outstanding, then it would require a vote of the stockholders under Delaware law. It may be wrong.

Warren Buffett [00:23:09] I think it’s a stock exchange rule, isn’t it, Charlie?

Charlie Munger [00:23:12] Yes.

Warren Buffett [00:23:12] Yeah, you’re right about the rule, but it’s a New York Stock, you know, Stock Exchange rule. I… that would be $5 billion plus of deal, and, you know, we would love to make a $5 billion deal, but I don’t think we’re going to do it. So I would say that the chances of any acquisition being large enough so that it requires a shareholder vote is probably slim, but it isn’t because we wouldn’t be interested. And if, you know, if we have one, we’ll be coming back to you with the votes already in hand. Are there any other questions on the preferred? We can talk more about it later too. I just want to… oh, here we are. Sure.

[00:24:05] Shareholder (Reina de Costa Lowey, Chicago): Good morning, Mr. Buffett. I’m Reina de Costa Lowey from Chicago. Very proud to be here, and I’ve seen you grow, so that pretty soon we’re going to be out in the football field. I think your explanation was very helpful, because as I read this, and I’m sure many of the other lay folk, I didn’t understand what you were doing. And you mentioned the preferred stock, but in the prospectus it’s not clear whether it would be the convertible preferred, the straight preferred, and you cleared that, answering a few other questions. But some of the people felt it would dilute their stock.

Warren Buffett [00:24:48] Yeah. Well, I should have made that clear in the annual report. I’m glad I’ve had this chance to do it today. Anything else on the preferred? Okay.

[00:25:01] Shareholder: You don’t have to come back to the shareholders for a vote after these shares are authorized for the terms of it, and you’ve discussed this in terms of buying companies. My question is, you yourself, through Berkshire Hathaway, own the preferred shares of several companies, Salomon, USAir, American Express. Did those shareholders have to vote on the terms of the preferred shares that you bought for those companies, or was that left at the board of directors decision level by that point? Go… excuse me, go ahead. Could you clarify that point, please?

Warren Buffett [00:25:34] Yeah, we bought a… I think we probably bought six issues of preferred directly from companies, and since none of those triggered that New York Stock Exchange rule that we discussed earlier, and they could have if they’d been somewhat larger, but they didn’t, none of those deals had to be approved by the shareholders. I think the only deal we’ve had with a company that had to be approved by the shareholders was when we bought the Cap Cities ABC stock. Well, we bought it early in 1986. I think it was approved by their shareholders in 1985. But the only situations where it would have had been approved is if it triggered the New York Stock Exchange rule, and our purchases were not that large that they did that. Any other questions? Yep, there’s one more.

[00:26:28] Shareholder (Dale Valkovitz, Champaign, Illinois): My name is Dale Valkovitz. I’m from Champaign, Illinois. A recent issue of Barron’s indicated that it may be possible to issue a best of all possible worlds preferred, that being one where the dividend looks like interest to the issuer and is tax deductible, and to the purchaser it would qualify for the dividends received deduction. Do you think that structure might be possible with these shares?

Warren Buffett [00:26:54] Well, we haven’t thought about that. I know what you’re talking about on that, but I don’t think it would be possible. For one thing, I don’t think you probably have a tax-free deal that way. Charlie, do you?

Charlie Munger [00:27:15] We probably wouldn’t try and be that cute. I’ve got several quips in mind, but I think I’ll keep them myself.

Warren Buffett [00:27:26] My guess is that that form does not work for a long time. I know what you’re talking about, but my guess is it doesn’t. Some companies, I don’t… then we’ll get on with this, but some companies care about the consideration they give in a deal, whether it’s cash or preferred or so on, because they care about the accounting treatment that they get. They want… they usually want pooling treatment rather than purchase accounting treatment. I won’t get into that here. I know it’s going to disappoint you, but I won’t get into that here, although I may in the next day annual report.

And that is of absolutely no consequence to us. We care not a wit about the accounting treatment that we receive. We feel that we have a shareholder body that’s intelligent enough to understand the economic reality of a transaction, and that by playing various games in terms of how we try to structure it and maybe flow part of the purchase price back through the income statement or anything of sort that which is done, is… that’s not something that we’re… that we care about at all. We would rather do whatever makes the most sense for us and for the seller and then explain to you whatever accounting peculiarities may arise out of the transaction. And that probably differentiates us from most companies, and it probably helps us make a deal occasionally. Anything else? Really? Okay. Now I can hear you fine. Okay.

[00:28:58] Shareholder: And I was wondering, will there be any opportunity for shareholders who may find the preferred issue preferable for any number of reasons to participate in that?

Warren Buffett [00:29:09] Well, if we issued a preferred, it became actively traded, let’s say it was a company with many shareholders instead of a few, obviously that would be something that any new or present shareholder could make a decision on, whether they preferred that issue than others. We could, but we have no plans of doing it. I don’t think, I don’t see it happening. We could offer to exchange preferred for president common, and it’s conceivable a few people would have an interest, but that most people have self-selected in terms of the kind of security they want to own, in terms of owning Berkshire commons. So it’s unlikely they would want to switch into a preferred because there would… we would… we wouldn’t have a premium of value. It would just be an alternative security.

We could do that, though. I mean, that… and it would probably be a tax-free deal. We have no plans of doing that, but it’s something that if we ever thought that enough people might want, we could offer. No one would be obliged to take it. That’s a good question. Okay, we’ll move on. Is there a motion to adopt the board of director’s recommendation?

WSWalter Scott Jr. [00:30:23] I moved the adoption of the amendment to the fourth article the certificate of corporation has set forth an Exhibit A of the company’s proxy statement for this meeting.

Warren Buffett [00:30:32] Is there a second?

[00:30:33] Unidentified speaker: I second the motion.

Warren Buffett [00:30:35] Motion has been made and second to adopt the proposed amendment to the certificate of incorporation. Any further discussion? We are ready to act upon the motion. If there are any shareholders voting in person, they should now mark their ballot on the proposed amendment to the certificate of incorporation and allow the ballots to be delivered to the inspector of election. We’re collecting a few there. With the proxy holders please also submit to the inspector of elections a ballot on the proposed amendment, voting the proxies in accordance with the instructions they have received. Wait just a second here. Mr. Fitzsimmons, when you’re ready, you may give your report.

RFRobert Fitzsimmons [00:31:23] My report is ready. The ballot of the proxy holders received through last Friday cast lot not less than 928,889 in favor of the proposed amendment to the certificate incorporation. That number far exceeds the majority the number of all shares outstanding. The certification required by Delaware law regarding the precise count of the votes, including the votes cast in person at this meeting, will be given to the secretary to be placed with the minutes of this meeting.

Warren Buffett [00:31:52] Thank you, Mr. Fitzsimmons. The amendment to the certificate of incorporation is set forth in Exhibit A to the proxy statement for this meeting is approved. After adjournment of the business meeting, I will respond to questions they may have to relate to the businesses of Berkshire but do not call for any action at this meeting. Does anyone have any further business to come before this meeting before we adjourn? If not, I recognize Mr. Walter Scott Jr. to place motion before the meeting.

WSWalter Scott Jr. [00:32:15] I move this meeting be adjourned.

[00:32:17] Unidentified speaker: I second the motion.

Warren Buffett [00:32:18] Motion adjourn has been made in second. We will vote by voice. If any discussion? If not, all in favor say aye. All the posts say no. The meeting is adjourned.

Now, I’d like to tell you about one thing that, since the annual report, that some of you probably read about in the papers, but maybe not all of you have heard about. Just shortly after the annual report was issued, we completed a transaction with Helzberg’s Diamonds, with Barnett Helzberg, who’s here today. And Barnett, would you stand up, please? There he is. Give him a hand. (Applause)

You may be interested in how it came about, because Barnett attended two of the last three meetings of Berkshire. He had a few shares in an IRA account, and he was here last year, and shortly after this meeting I was back in New York City, and I was crossing the street at 58th Street, right near the Plaza Hotel on Fifth Avenue, and a woman said, “Mr. Buffett.” I turned around and she came up and she said she’d attended the annual meeting last year, a few days ago, and said that she enjoyed, and I said, “That’s terrific,” and I started cross again. And Barnett had been about 30 or 40 feet away. I didn’t know him, and he had heard this woman, so he said the same thing, and I turned around and we shook hands, first time I met him, and he said, you know, he said, “I might have a business you’d be interested in.” And I get that all the time, so I said, “Well, why don’t you write me?” And a time went by, and I got a letter from Barnett, and he’d been thinking about doing something with the business his father started in 1915 and based in Kansas City all that whole time. And he’d been exploring various avenues, but probably in some part because of his background as a Berkshire shareholder, he had some specific interest in the company becoming associated with Berkshire. He cared very much about the company having a permanent home. He cared very much about it having an environment in which it could grow and be run autonomously and be based in Kansas City, and he wanted to receive something in exchange that he was happy about, happy to own for rest of his life.

And so we worked out a transaction shortly, just very shortly after the annual report went to press, and so now Berkshire, as of 12:01, I guess, yesterday morning, the deal closed. There’s this waiting period because of the Hart-Scott-Rodino Act and a few other things. The transaction closed, and now Berkshire is the owner of Helzberg’s Diamonds, which has roughly 150 stores around perhaps 26 or 27 states, I’m not sure the exact number, and mostly in malls, although some others. It’s been enormously successful. Barnett brought in Jeff Comment, who formerly ran Wanamaker’s, about eight years ago, I guess it is, and the company has both expanded in its traditional format, it’s gone with a new format recently which has been very successful.

It is, in its position in the jewelry industry, it tends to compete with the Zales recordings, but it does a far, far better job. Their sales per store on roughly equivalent square footage will be… it’ll be very close to double what the competitors achieve. It’s got a magnificent morale, an organizational structure, and the people. Barnett was very generous with people in making the sale. He took it out of his own pocket to treat people right, because they’ve done such a terrific job over the years. And I think you’ll see Helzberg become a very big factor in Berkshire over time. And it just shows you what can come out of these annual meetings, so the rest of you, you know, do your stuff. The… so anyway, that’s that.

That is an acquisition that was made for, largely for common stock. It did not involve preferred, because Barnett preferred, preferred common. And… but different people have different needs, and sometimes there’s a group of shareholders that can have different priorities, and that’s the reason we want to have various currencies. If we had not been able to use common stock, we would not have made this transaction, because Barnett has been in no hurry to write a large check to the government, and we can help him in that respect with a common stock deal. So anyway, we’re glad that, we’re glad to have Helzberg become part of Berkshire. I wouldn’t be surprised if we have another announcement or two the next year before we have the next meeting. I hope so, but there’s no guarantees.

Now we’re going to turn the meeting open for questions. We’ll do it as we’ve done before. We’ve got this room divided into six zones, and if you will raise your hand, the monitor and that in your zone will recognize you, and we’ll keep going around. We will not go to a second person in any zone until we’ve exhausted all those who have yet to ask their first question. We have, we also have a zone in the overflow room, so there’ll be a total of seven, and we’ll just keep going around. If you’ll identify yourself, please, and we’ll be delighted to answer your questions, and the more the better. So we’ll start with zone 1.

[00:39:06] Shareholder (Fred Ilfeld Jr., Sacramento, California): My name is Fred Ilfeld Jr. from Sacramento, California, and I wanted to ask if you could elaborate upon the logic of adding two family members to the board of trustees.

Warren Buffett [00:39:22] Well, it’s terrific for family harmony, just to start with. The… as I’ve talked about in the annual report, the… if I die tonight, you know, my stock goes to my wife, who is a member of the board of directors, and she will own that stock until her death, when it will go to a foundation. So there is a desire to have as long a term and permanent ownership structure as can really be done in terms of planning and the tax laws and so on. I mean, I… we have invited people like Helzberg’s to join in with Berkshire into what we think is a particularly advantageous way for them to conduct a business, and to know the future that they’re joining.

And part of knowing the future that they’re joining involves knowing that the… knowing that the ownership is stable, and it will be stable for a very long period of time in Berkshire, probably about as long as you can, anybody can plan for in this world. After my death, the family would not be involved in the management of the business, but they’d be involved in the ownership of the business, and you would have a very large concentrated ownership position going well on into the foundation that would care very much about having the best management structure in place. And to, in effect, prepare for that over time, I think it’s very advisable that family members who will not be involved in management, but who will have a key ownership role to play, become more and more familiar with the business and the philosophy behind it.

I discussed that some in the, I guess it was the 1993 annual report, because I think it’s important that you understand, and anybody that wants to sell us a business. If you’ve built a business since 1915 and you care enormously about it and you care about the people that you’ve developed, but you’ve got something else you want to do in life, it’s more, you know, than advertising your car in the paper to sell it. I mean, it is an important, a very important transaction to you, not just in terms of how much money you receive, but in terms of who you deliver thousands of people that join you, who you deliver them to. And I think we have a structure that is about as good as you can do. Nothing is forever, but we have a structure that’s about as good as you can do in terms of people knowing what they’re getting into when they make a deal with us, and being able to count on the conditions that prevail at the time of the deal continuing for a long period in the future.

Many people… I had a fellow tell me the other day about a business where he’d been wooed by the acquirer, and, you know, the day after the deal, they came in and fired the top half dozen people. They had a secret plan all along. Well, I don’t think you run into much of that, but what you do run into is the acqui… the company, this acquiring company itself either being acquired or some new management coming along or some new management consultant coming along and saying, “Well, this doesn’t fit our strategic plan anymore, so let’s dump this division.” And people to join in with Berkshire and be relatively, I think, comfortable about nothing like that happening. That… Charlie, you want to elaborate on…

Charlie Munger [00:42:57] No.

Warren Buffett [00:42:58] I was hoping Charlie would have a near-life experience this morning, but keep encouraging him. Zone 2.

[00:43:08] Shareholder (Jim Lichty, Des Moines): Hello, my name is Jim Lichty from Des Moines. I’m interested in, like, Chrysler. Can you make a comment on the Chrysler Corporation?

Warren Buffett [00:43:24] No, I don’t think I can make a comment on the Chrysler. I think Salomon Brothers, incidentally, has been retained by that. We have nothing to do with it. Charlie and I read that in the paper, and Charlie and I are not familiar with, normally, with investment banking arrangements at Salomon, but it has been in the paper that Salomon’s involved. That we have no involvement. Charlie, you’re not commenting on the question?

Charlie Munger [00:43:56] No.

Warren Buffett [00:43:57] Try him on something else. Zone 3.

[00:43:59] Shareholder (Jim Vardaman, Jackson, Mississippi): I’m Jim Vardaman from Jackson, Mississippi. In describing your allocation of capital to your wholly owned subsidiary, as you wrote in the annual report that, quote, “You charge managers a high rate for instrumental capital they employ and credit them at an equally high rate for capital they release,” end quote. How do you determine this high rate, and how do they determine how much capital they can release?

Warren Buffett [00:44:28] Well, what we try to do with those arrangements… the questions about incentive arrangements we have with managers, or other situations where we either advance capital to a wholly owned subsidiary or withdraw, usually that ties in with the compensation plan. And we want our managers to understand just how highly we do value capital, and we feel there’s nothing that creates a better understanding than to charge them for it. And so we have different arrangements. Sometimes it’s based a little on the history of the company, it may be based a little bit on the industry, it may be based on interest rates at the time that we first draw it up. We have arrangements depending on those variables and perhaps some others, and perhaps just, you know, how we felt the day we drew it up, that range between 14 and 20% in terms of capital advanced.

And sometimes we have an arrangement where, if it’s a seasonal business, where for a few months of the year, when they have a seasonal requirement, we give it to them very cheap at LIBOR, but if they use more capital over beyond that, we start saying, “Well, that’s permanent capital,” so we charge them considerably more. Now, if we buy a business that’s using a couple hundred million of capital and we work out a bonus arrangement, and the manager figures out a way to do the business with less capital, we may credit him at a very high rate, same rate we would use in charging him, in terms of his bonus arrangements. So we believe in managers knowing that money costs money.

And I would say that just generally my experience in business is that most managers, when using their own money, understand that money costs money, but sometimes managers, when using other people’s money, start thinking of it a little bit like free money, and that’s a habit we don’t want to encourage around Berkshire. We, by sticking these rates on capital, we are telling the people who are in our business how much capital is worth to us, and I think that’s a useful guideline in terms of the decisions they’re making, because we don’t make very many decisions about our operating business. We make very, very few. I don’t see capital budgets in most cases from our 100% own subsidiaries, and if I don’t see them, no one else sees them. I mean, that we have no staff at headquarters looking at this kind of thing. We give them great responsibility on them, but we do want them to know how we calibrate the use of capital.

And so far, I would say it’s really worked quite well. Our managers don’t mind being measured, and they like getting… I think they enjoy seeing a batting average posted, and a batting average that does not include a cost of capital as a phony batting average. Charlie?

Charlie Munger [00:47:51] Well, I certainly agree, and his name isn’t even Buffett. I mean…

Warren Buffett [00:48:00] Zone 4.

[00:48:00] Shareholder (Dave Lancason, Business Insurance magazine): Hi, my name is Dave Lancason with Business Insurance magazine. Some of property casualty risk management experts are advising commercial insurance buyers to forge five- and ten-year policies with their property casualty insurers to promote stronger partnerships with their insurers, as well as to maintain the smooth PC market of the past seven, eight years. Do you believe this idea will take hold for most policy holders, and if so, what would be the implications for policyholders’ costs and insurers’ underwriting results?

Warren Buffett [00:48:43] The question is about partnerships between, probably, commercial policyholders and their insurers, and there are a lot of ways of doing that by various retrospective plans or adjustable rates of various sorts and self-insured retentions and that sort of thing. As a general matter, the only two reasons for buying insurance… one is to protect yourself against a loss that you are unable or unwilling to bury yourself. And that is partly an objective decision, that’s partly subjective. For example, a manager that’s terribly worried that his board of directors may second guess him if he has an uninsured loss is going to buy a lot more protection, probably, than the company really needs. But he knows he’s never going to have to go in front of his board of directors and say, “We just had a million dollar fire loss,” and then the next question the director asked is, “Was it insured?” And he doesn’t want to answer no. So he may do something that’s very unintelligent from the company’s standpoint merely to protect his own position.

But the reason for buying insurance is whether, and this is true of life insurance, it’s true, it’s true property casual, it’s true personal insurance, it’s true of commercial insurance, is to protect against losses that you’re unwilling or unable to bear yourself. Or the second reason, which occasionally comes up, is if you think the insurance companies actually selling you a policy that’s too cheap, so that you really expect, over a period of time, to have a mathematical advantage by buying insurance. Well, we try to avoid selling the second kind and to concentrate on selling the first kind. And we think any company we and sell insurance to, and of course we… much of the insurance we sell is to other insurance companies. I mean, we are a reinsurer and very large part, we are selling them insurance against a loss that they are either unable or unwilling to sustain. And a typical case, you know, might be a company that had a lot of homeowners policies in California, and if those include earthquake coverage, they may not be able to sustain the kind of loss that is possible, even though they want to keep a distribution system in place that merchandises and mass to homeowners in California. So we will write a policy. They may take the first $5 million of loss, they may take the first $50 million of loss, depends on their own capabilities, but then they come to us, and we are really uniquely situated to take care of problems that no one else, that the companies can’t bear themselves and that they can’t find anybody else to ensure. But we really don’t want to insure someone for a loss that they can afford themselves, because if we’re doing that, it may be because they’re dumb, but it may be because they also have a loss expectancy that’s higher than the premium we’re charging, which is not what we’re trying to do in business.

I think that, I think probably, as compared to 30 years ago, that risk managers at corporations are probably more intelligent about the way they buy their insurance than many years ago. I think it’s become a… I think they’re more sophisticated. They’ve thought it through better. But there is… there’s a lot of insurance, there’s some, there’s a fair amount of insurance bought that doesn’t make sense, and there’s a fair amount of insurance that isn’t bought that should be bought. There are certain companies that are exposing themselves in this country to losses which would wipe them out, and they prefer not to buy reinsurance because it’s, quote, expensive. But what they’re really doing is betting on something that won’t happen very often happening not at all. And if you take a huge hurricane on Long Island, or you take a major quake in California, there are a number of companies that are not, that have not positioned themselves to withstand those losses. And if you’re a 63-year-old CEO and you figure, “I’m going to retire in a couple of years,” you know, the odds are pretty good that it won’t happen on your watch. But the… it will happen on somebody’s watch, and we try to sell reinsurance to those people, and usually we do, but sometimes we don’t. Charlie?

Charlie Munger [00:53:46] Nothing to add.

Warren Buffett [00:53:48] Okay. Zone 5. He’s fighting himself. He’ll be dynamite when he gets going.

[00:53:54] Shareholder (Hugh Stevenson, Atlanta, Georgia): My name is Hugh Stevenson. I’m a shareholder from Atlanta, Georgia. My question involves the company’s catastrophe lines of insurance. It seems that there’s a relative ease of entry into that business through Bermuda-based companies and others, and given the importance of that business to the overall company, I’m curious how the ease of entering into the business affects its long-term competitive position and its rates of return.

Warren Buffett [00:54:24] Well, you’re very right. There is an ease of entry into the catastrophe business, and, you know, it’s sort of attractive for… it’s particularly attractive for promoters, because if you start an insurance company to write earthquake insurance in California and you raise a few hundred million dollars, and you’ll either have essentially no losses, or you… if you write enough of it, you’ll go broke. And most years you’ll have no losses. So if your intention is to sell your stock publicly in a year or two, that the odds are very good that you will have a beautiful record for a couple of years, and you can sell. And, you know, maybe one time out of ten you’ll go broke, and nine times out of ten you’ll sell to somebody else who eventually will go broke. And it… there’s really ease of entry. The only thing that may restrict that is that if the buyer is sophisticated enough to question the viability of that company under really extreme conditions, which is the only conditions that count when you’re buying catastrophe insurance, that may restrict.

The second thing is, of course, none of the people that have started up can offer anywhere near the amount of coverage that Berkshire has. Berkshire is really one of a kind in terms of its capital strength in the business. I’m… I don’t think anybody in Bermuda that I can remember, I don’t think Ajit’s out there, but I don’t think anybody has a billion of net worth. And, you know, we have, at present, we probably have close to $13 billion of net worth and considerably more of value. So we can sustain shocks that, and we will sustain shocks, I should add, that others can’t, and we try to get paid appropriately for that. But when we say we can take a billion dollar loss, we can take a billion dollar loss, and we will have a billion dollar loss at some point. And anyone buying it knows we can take it, or something greater, and they should know that very few other, very few of our competitors can.

So there’s competition. We do an unusual proportion of our business with the eight or ten largest insurance, reinsurance companies and insurance companies in the world. So we really have established with the people who understand the real risks of the business, they come to Berkshire a lot more often than they stop in Bermuda, because they know that we’ll pay, and they’ve been around long enough to know that in the end that’s what really counts with an insurance company. If the rates… if there were enough capacity at really ridiculous rates, I mean, in the end we wouldn’t be riding that business at that time. But I don’t think that will happen. It certainly hasn’t happened so far. And if it happens, you know, so be it. We will all play golf until the loss occurs. Enjoy.

Charlie Munger [00:57:37] Nothing there.

Warren Buffett [00:57:38] Zone 6.

[00:57:38] Shareholder: What do we do, Chairman? Most company Berkshire invest at this time are not hyped in, are not in high technology sector. What we have seen in the last few years, that there seems to be a significant growth both in sales and earnings of the high technology area, and also what invest, what your shareholder believe that the times are changing from a brand named high technology. My question is, can someone apply your investment principle, business philosophy and your discipline in life to build a portfolio of, say, five or six high technology company? Let’s call it Berkshire Hathaway Technology Fund.

Warren Buffett [00:58:32] Well, I think it would sell. The… the question about… Charlie and I won’t be able to do it. We… Charlie probably understands high tech, but you can see how hard it is to get information out of him, so he hasn’t told me yet. We try not to get into things we that we don’t understand. And if we’re going to lose your money, we want to be able to come before you, you know, next year and tell you, “We lost your money because we thought this and it turned out to be that.” We don’t want to say, you know, somebody wrote us a report saying it’s, you know, this is what’s going to happen, and in some field that we don’t understand, and therefore we lost your money by following someone else’s advice. So we won’t do it ourselves.

At… I think that the principles, I think Ben Graham’s principles are perfectly valid when applied to high-tech companies. It’s that we don’t know how to do it, but that doesn’t mean somebody else doesn’t know how to do it. My guess is that if Bill Gates were thinking about, you know, that he understood and that I didn’t understand, he would apply much the same way of thinking about the investment decision that I would. He would just understand the business. I might think I understand Coca-Cola or Gillette, and he may have the ability to understand a lot of other businesses that seem as clear to him as Coke or Gillette would seem to me. I think once he identified those, he would apply pretty much the same yardsticks in deciding how to act.

I think he would act… I think he would have a margin of safety principle that might be a little different, because there’s essentially more risk in a high-tech company, but he would still have the margin of safety principle on a sort of adjusted for the mathematical risk of loss in his mind. He would have… he would look at it as a business, not as a stock. You know, he would not buy it on borrowed money. I mean, a bunch of principles would be carried through. But our circle of things we understand is really unlikely to enlarge, maybe a tiny bit here or there. But if the capital doesn’t get too large, the circle’s okay. And… but we will not… if we have trouble finding things within our circle, we will not enlarge the circle. You know, we’ll wait. That’s our approach. Now, how are we set up for zone 7? Can we do it up? Yeah, here we are. Are you there?

[01:01:18] Shareholder (Susie Taylor, Lincoln, Nebraska): Hi, I’m Susie Taylor from Lincoln, Nebraska. By way of explaining, we wrote down the value of USAir, reflecting our investments current market value. You had a good explanation in your report as to why the economics of the business are unattractive, and I presume, given the choice, we wouldn’t do it over again.

Warren Buffett [01:01:39] I think that’s a fair assumption. And I should mention, anybody want to ask about USAir, we put them in the other room, just so you’ll know why.

[01:01:50] Shareholder (Susie Taylor, Lincoln, Nebraska): And then the second part is better, but I’m watching you, I can see you on the monitor. And quoting from your profound statement, “You don’t have to make it back the way you lost it.”

Warren Buffett [01:02:01] Right.

[01:02:01] Shareholder (Susie Taylor, Lincoln, Nebraska): Wouldn’t it be a good idea to put that 89 million in something you wrote are really behind, as opposed to USAir?

Warren Buffett [01:02:07] Well, that’s a very good question, because it is true that a very important principle in investing is you don’t have to make it back the way you lost it. And in fact, it’s usually a mistake to make, try and make it back the way that you lost it. And we have… when we write our, an investment down, as we did with USAir to 89 million, we probably think it’s worth something more than that, but we tend to want to be on the conservative side. But it’s worth a whole lot less than we paid. And the nature of that preferred, as well as other private issues we’ve bought, usually makes it quite difficult to sell. That’s one of the things we know going in.

When we bought preferred, some people thought that we were getting unusually favorable terms. I haven’t heard from them lately on USAir. But the… but one of the considerations in that is that if you buy 100 shares of a preferred that’s being offered through a securities firm, from the same issue, you can sell it tomorrow. And we are restricted in some ways legally and another way simply by the way that markets work from disposing of holdings like that. And we know that there’s an extra cost involved to us if we should try to sell, or it may be impossible. And that’s not a… that’s not of great importance with us, because we don’t buy things to sell, but it’s of some importance.

And we are not in the same position owning our Series A preferred of USAir as we would be if we bought 1,000 shares or 5,000 shares of the Series B preferred, I believe it is, the trades on the New York Stock Exchange. That would be very saleable. And our preferred could well even be sellable at a price modestly above what we carry it for, but it would require… it would not be very easy to do it. It might, if it were dual, if it… if we went about to do it, we could probably, assuming we could do it at all, we could probably get a little more money for it. But it would not, and would not be easy to do, partly because of the legal restrictions. Charlie and I are on the board. That complicates things. We always know something, just by being on the board, that the public doesn’t know, so that complicates things. And in the end, we usually find that dealing with anything where we’ve got fiduciary obligations is maybe not practical at all. And… Charlie?

Charlie Munger [01:04:45] Well, it’s certainly been an interesting experience, the USAir experience.

Warren Buffett [01:04:48] Is that it, darling? Hunting?

Charlie Munger [01:04:51] Oh, no. I’d like to repeat that business about not having to get it back the way you lost it. You know, that’s the reason so many people are ruined by gambling. They get behind, and then they feel they have to get it back the way they lost it. It’s a deep part of the human nature, and it’s very smart just to lick it by will. And little phrases like that are very useful.

Warren Buffett [01:05:24] Yeah. One of the important things in stocks is that the stock does not know that you own it. You know, you have all these feelings about it, you know, and you remember what you paid, you know, remember who told you about it, all these little things, you know. And it, you know, it doesn’t give a damn. It just sits there. And it… you know, you a stock at 50. Somebody’s paid 100, they feel terrible. Somebody else paid 10, they feel wonderful. All these feelings, and it has no impact whatsoever. And so it’s… it’s, as Charlie says, gambling is the classic example. Someone builds a business over years, you know, that they know how to do, and then they go out someplace and get into a mathematically disadvantageous game, start losing it, and they think they’ve got to make it back, not only the way they lost it, but that night. And it’s a great mistake. Zone 1.

[01:06:28] Shareholder (Donald Stone, Riverside, Connecticut): My name is Donald Stone. I’m from Riverside, Connecticut. I… this is my second shareholders meeting ever, at age 61, so I’m really very privileged to be here. My first was Coca-Cola a week and a half ago, and there were only 200 people there. I’m trying to figure this out. I think the rule is that the number of people present is in direct proportion to the price of the shares.

Warren Buffett [01:07:02] In that case, we won’t split.

[01:07:06] Shareholder (Donald Stone, Riverside, Connecticut): Preferatory comment to my question. The November 24th, 1994 issue of Fortune magazine had an article, a featured article, entitled “America’s Greatest Wealth Builders,” dealing with the concepts of market value added and economic value added. It was with great glee that I noticed that Coca-Cola was number two on that list, second only to General Electric, and that Coca-Cola had done twice as well as Pepsi-Cola, number nine on the list, with one-third as much capitalization. My question is this, whether the concept of market value added and economic value added, as such, or any of its variants, is a concept that’s applicable and useful to Berkshire Hathaway as a whole or in analyzing its line of business segments. I’d really like to hear from Charlie Munger on this first, because I’ve heard Charlie, I’ve heard that he’s thought a lot about this particular subject.

Warren Buffett [01:08:15] Right.

Charlie Munger [01:08:15] If Warren is using economic value added exactly the way they’re now teaching it in the business schools, he hasn’t told me. Obviously the concept has some merit in it, but the exact formal methods, I do not believe we use. Warren, are you using this stuff?

Warren Buffett [01:08:34] Seeking… wait, wait. In a sense they’re trying to get at the same thing we do, where we’re trying to get at the same thing they do, but I think it’s a… I think it has some flaws in it, although I think it generally comes out with the right answers. It sort of forces itself to come up with the right answer. But I really don’t think you need that sort of thing. I mean, I do not think it’s that complicated to figure out, you know, where it makes sense to put money. You may… you can make mistakes doing it, but in terms of the mental manipulations you go through, I’ve… I’m… I don’t think it’s a very complicated subject. And I don’t think that… I think that the people marketing one or another fad and management tend to make them a little more complicated than needed, so that you have to call in the high priest. And you know, if all that really counts is the Ten Commandments, you know, it’s very tough on religious counselors and everything. It doesn’t take… it just doesn’t make it complicated enough. And I think there’s some of that, quite a bit of that, in management consulting and then the books that you see and all of that that come out.

Charlie Munger [01:09:53] It’s way less silly than the capital assets pricing model, so that at least academia is improving.

Warren Buffett [01:09:59] Yeah, yeah. The capital as a pricing model, which is… I don’t know how much it’s used now. Certainly, you know, they have these great waves of popularity. You get that in management, you get an investing. I mean, real estate, you know, may have been popular, or international. You can read Pensions & Investments magazine, which is a pretty good magazine, but you can just see these fads sort of going through, and then they have seminars on them and everything, and you know, the investment bankers create product to satisfy the demand. And there’s these fads in management. I mean, obviously listening to your customer and things like that, I mean, that… nothing makes more sense, but it’s hard to write a 300-page book that just says listen to your customer.

And you know, that’s one of the things I liked about Graham’s book. I mean, you know, he wrote… everything he wrote sort of made sense. He didn’t sort of get into all the frills and try and make it more complicated. And it really truly is, you know, I really didn’t need to read the November-ish 1994 issue of Fortune to know that Coca-Cola had had a lot of value. We added about $4 billion sum of value to Berkshire, so that’s good enough for me. Zone 2.

[01:11:14] Shareholder (Morris Spence, Omaha, Nebraska): My name is Morris Spence from Omaha, Nebraska. I have a two-part question on derivatives. Does Berkshire Hathaway currently, or have they in the past, engaged in strategies and involving derivatives? If so, do you as CEO fully understand these financial instruments, whoever suggested that crazy notion? Finally, would Charlie care you, or Charlie carried comment on the use of these by other financial institutions?

Warren Buffett [01:11:42] The question about derivatives. The reason I inject that remark in a Fortune article that all of you should read if you haven’t, I suggested that the use of derivatives would be dramatically reduced if the CEO had to say in the report whether he understood them or not. And the answer to your question, though, is we have two types, I guess it would be, of derivative transactions of my very modest size. But that doesn’t mean we wouldn’t, if the conditions were right, we either wouldn’t have them on a much greater scale now or we wouldn’t have done it in the past. We have two types of transactions, and I do understand them.

And there are times when there are things that we would want to do, not often, but there would be times when they could be best accomplished by a transaction involving a derivative security, and we wouldn’t hesitate to do so. And we would obviously care very much about the counterparty, because that transaction is just a little piece of paper between two people, and it’s going to cause one of the two to have to do something painful at the end of the period, usually, which is to write a check to the other person. And therefore you want to be sure that that person will be both willing and able to write the check. And so we’re probably more concerned about counterparty risk than most people might be.

Last year and the year before, I think I said that derivatives often combine borrowed money with ignorance, and that that is a rather dangerous combination. And I think that we’ve seen some of that in the last year. When you can engage in sort of non-physical transactions that involve hundreds of millions or billions or tens of billions of dollars, as long as you can get some party on the other side to accept your signature, that really has the potential for a lot of mistakes and mischief. And if you’ve looked at the formulas involved in some, particularly, I guess, interest rate type derivative instruments, it is really hard to conceive of how any business purpose could be solved by the creation of those instruments. I mean, they essentially had a huge, really gambling element to them. And I used that in the terms of engaging in a risk that doesn’t even need to be created, as opposed to speculative aspects. That they involve the creation of risk, not the transfer of risk, you know, not the moderation of risk, but the creation of risk on a huge scale.

And it may be fortunate that in the last year half a dozen or so cases of people who have gotten into trouble on them have come out, because it… that may tend to moderate the troubles of the future. The potential is huge. I mean, you can do things in the derivative markets… Well, I’ve used this example before, but in borrowing money on securities, the Federal Reserve of the US government decided many decades ago that society had an interest in limiting the degree to which people could use borrowed money and buying securities. They had the example of the 1920s, with what was 10% margin then, was regarded as contributing to the Great Crash. So the government, through the Fed, established margin requirements and said, “I don’t care if you’re John D. Rockefeller, you know, you’re gonna have to put up 50% of the cost of buying your General Motor stock or whatever it may be.” And they said that maybe Mr. Rockefeller doesn’t need that, but society needs that. We don’t want a bunch of people on thin margins gambling, you know, essentially in chairs where the ripple effects can cause all kinds of problems for society.

And that’s still a law, but it means nothing anymore, because various derivative instruments have made 10% margins of the 1920s, you know, look like what a small town banker and Nebraska would regard as conservative compared to what goes on. So it’s been an interesting history. And like I said, perhaps the experiences of the last year, they’ve got everybody focused on derivatives. Nobody knows exactly what to do about them. Berkshire Hathaway will, if we think something makes sense and Charlie and I understand it, we may find ways to use them to what we think will be our advantage. Charlie, you want anything on them?

Charlie Munger [01:16:58] Well, I disapprove even more than you do, which is hard. If I were running the world, we wouldn’t have options exchanges. The derivative transactions would be about 5% of what they are, and the complexity of the contracts would go way down. The clearing systems would be tougher. I think the world has gone a little bonkers, and I’m very happy that I’m not so located in life that I have to be an apologist for it. You know, a lot of these people, I feel sorry for them. You know, they had great banks and they have to go before people, sometimes even including their children and friends, and argue that these things are wonderful.

Warren Buffett [01:16:58] Zone 3.

[01:17:45] Shareholder (John Nuger, Kingsburg, California): Good morning. I’m John Nuger from Kingsburg, California, and my question relates to Salomon. And where… I’m just asking if you could take us out the next two or three years in your vision. It started out as a good investment, you got a good return on it, or your interest, and it’s clearly had some problems, and we have gotten in deeper and deeper as those problems have continued, and it doesn’t look like it’s super bright. So you must understand where it’s going, but could you just give us where you see it going in the next two or three years?

Warren Buffett [01:18:30] Well, I think it’s very difficult to forecast where Salomon, or really almost any major investment bank slash trading house, will do over actually the next two or three months, let alone the next two or three years. The nature of that business is obviously far more volatile than the blade and razor business. Now the… and the tough part is assessing over a longer period of time whether… because of volatility, it’s much harder to assess whether what the average returns might be from a business. And the answer is, Charlie and I probably, if we were to try and write the forecast for the next two or three years, we would not have a high… a feeling that we had a high probability of being able to predict what that company or other companies in that industry either would earn three years out or would probably have in the way of average earnings.

Our own commitment is to a $700 million preferred issue, which has five redemption dates starting in October 31st of this year and then every year thereafter. On those dates we can either take cash or stock, and that’s an advantage, obviously, to have an option. Anytime you have an option in this world, let’s do an advantage, it’s an itch to your advantage. It may be a very small advantage, but it’s… giving options is generally a mistake, and accepting options is usually a good idea if it doesn’t cost you anything. And we will… the other thing about options is you don’t make a decision on them until you have to make a decision. But so we, in addition to that $700 million are preferred, which in our view is 100% money good, I mean, we’d like to own more of that, but we also have about 6 million odd shares of common, which we paid perhaps $48 a share for, something in that area, and in any event considerably more than the present market of 35 or 6.

So we’re… we have got a… we have a loss of probably $80 or $90 million or some number like that at market in the common. The preferred is actually treated as fine. We’ve received $63 million a year. Incidentally, by owning the amount of common we own, this probably isn’t generally known, but or recognized, if you own 20% of the voting power of a company, you have a somewhat different dividends received credit, you have somewhat different tax treatment than if you own less than 20%. So until we own that common, we paid somewhat more tax on our preferred dividend than we now pay. It’s not a huge item, but it’s not immaterial either. Charlie?

Charlie Munger [01:21:35] Well, I certainly agree it’s hard to forecast what’s going to happen in the big investment banking dash slash trading houses. I would like to say that Berkshire Hathaway was a large customer of Salomon long before we bought the preferred, and that we’ve had marvelous service over the years. I think Salomon’s going to be around for a long time, rendering very good service to various clients. We satisfied clients. We sold our first debt issue of Berkshire, I think in 1973, through Salomon. So we’ve had an investment banking relationship for 21 or 22 years there, and actually we’ve done business with them before that in various other ways. So it’s a long-term relationship.

Warren Buffett [01:22:22] Well, there’s no question about Salomon being around. The question… and that’s why our preferred is absolutely money good. But the question is what the average return on capital will be, and we knew that was difficult to predict when we went in, and we found out it’s even more difficult to predict than we thought. Zone 4.

[01:22:42] Shareholder (Dick Jensen, Omaha): Thank you for the opportunity. Dick Jensen from Omaha, a fellow Nebraska University supporter. A rather convoluted question. I’m very interested in your recent purchase and your future intention of American Express. And as I understand the company, I know it’s a rather involved and complicated and rather expansive company, in so far as it has its interests in many areas. I know one of which, of course, is the credit card, but there is also the major part of the organization of IDS and others that I don’t even know about. And I wondered what’s your hopes are for that investment. And I also just recently, as perhaps you have, became curious to know if you are personally acquainted with Mr. Phil Carret, I believe his name is, and how about the purchase of his firm in your future? Thank you.

Warren Buffett [01:23:56] Dick, I think Phil Carret is here today. But Phil was right back there. But would you stand up? There he is. (Applause) Give him a hand. Phyllis, Phil is 98. I first met him in 1952, 40… 43 years ago. He attends every eclipse around the world, and you can run into him in some very strange places. That wrote his first book on securities, I believe, in 1924, I am, and wrote an autobiography here recently. Probably the greatest long-term investment record in this country’s history. And But I think, you know, my impression is that Phil sold part, or a good bit, of Pioneer some years ago, which he managed for decades, many decades. In fact, I first learned about Phil when I was leafing through Moody’s Banks and Financial Manual 40-odd years ago, and I saw this company with us, with this great record and with some securities that looked terribly interesting. So we got in touch, and he was out in Omaha, and we got acquainted. That, so I… anybody that can get Phil to talk to him, listen carefully, I advise that.

The question about American Express. We own just under 10% of American Express. And obviously, even though you mentioned there in a number of businesses, by far the key, the most important factor in American Express’s future for a good many years to come, great many years to come, will be the credit card. And that is a business that has become and will forever probably become ever more competitive. I mean, it… I’ve followed it since, I think I met Ralph Schneider at the Diners Club in the late 1950s. And American Express entered into the credit card business being out of fear. I mean, they were worried about what the credit card was going to do. Their travelers check business, travelers check business had been originated back in 1890-something, I believe, and that was in turn building off of the old express business, where I think Henry Wells and William Fargo, they would chain themselves to the express boxes as they delivered them through to the West. And they decided that maybe issuing travelers checks would be a little easier than carrying all this stuff around. So that the travelers check was the… evolved out of the express business.

And the credit card business with American Express arose out of fear of what, particularly, Diners Club. At the time they were all terrified of Diners Club, which got this… got the jump on everybody, and they became enormously successful with it. And the American Express card, as you know, had a terribly strong position in what they called the travel and entertainment part of the card business. And of course the bank’s entered in on a big scale, and Visa has been enormously successful. So the card has a strong franchise in certain areas, like the corporate card, although people like First Bank Systems are very aggressive in going after them there. The card… but the card has a significant franchise, but it does not have the breadth of franchise that it had many years ago. For a while it was the card, and now it’s the card in certain areas, but nothing like as broad an area as before.

It has certain very important advantages and economic strengths, and it has some weaknesses, and you have to assess those in deciding where it’ll be in the year 2000 or 2005. And we think that the management of American Express thinks well about the question of how to… how you keep the card special in certain situations. And they’ve reacted to the merchant backlash for higher discount fees, I think, in an intelligent way. So we’ll see how it all plays out. But the key… IDS, which has now been renamed, but is a very big part of American Express, accounts for close to a third of their earnings. But the real key will be how the card does over time. Charlie?

Charlie Munger [01:28:31] Nothing to add.

Warren Buffett [01:28:32] Zone 5.

[01:28:32] Shareholder (Philip King, San Francisco): Hi, my name is Philip King from San Francisco, and my question has to do with how the FASB has caved in on the stock option proposal. And the people opposed to the proposal argued that it would hurt capital formation for companies, and that the cost of stock options is already reflected in chairs outstanding in fully deluded calculations. And I was curious, what is your feelings about what’s happened?

Warren Buffett [01:29:00] Well, as those of you who followed this issue, the FASB did came, and they were… they hated it. I mean, they knew they were right. As a matter of fact, most of the… what are now, I guess, the Big Six auditing firms, are big, many years ago sided with the position. But in my opinion, the auditing firms cave to their clients in that respect. And in terms of capital formation, I would argue that the most intelligent form of capital formation follows from the most accurate form of accounting. I mean, that if all the companies with the… whose names began with A through M didn’t have to count depreciation, and all the ones with M through Z did, or something, you know, that might help in capital formation for companies that were… had names with A through Ammon. Incidentally, they probably all changed their names. But I don’t think that bad accounting is an aid to capital formation. In fact, I think probably over time it distorts capital formation. Because if we were to pay all of the shareholders with… I mean, all of the people who worked for Berkshire Hathaway in stock, and therefore record no wage expense, you know, we might be able to sucker in a bunch of people who thought the earnings were real, but that would not be a great step forward for capital formation, in my view.

I really think that, you know, I’ve talked privately to a number of managers about this, and they understand it, but they, you know, they prefer the present situation. And they used a lot of muscle in Washington. Many years ago, and I think I have this authenticated now, I… that the fellow mathematics professor sent me some material after I’d written this, I’d probably get a little proof after the fact when I can. I believe in the Indiana legislature, where a legislator introduced a bill to change the value of pi, the mathematical symbol pi, to three, because he said that it was too difficult for the school children to work with this complicated 3.14159. And he was right. I mean, it was difficult. And I… and Congress, in connection with the stock option question, received all kinds of pressure to in turn pressure FASB and the SEC to not count stock option costs as part of compensation.

I’ve never met anybody that wanted to be compensated that felt that if he received his present salary plus an option, he was not getting compensated more than if he just received the salary. So he thought it was compensation. And I will tell you that if we’d been issuing options over a period of time at Berkshire for things unrelated to the performance of the entire business, that we would have had a cost, perhaps measuring in the billions of dollars, whether it was recorded or not. So it goes back to Bishop Berkeley’s question of whether a tree that falls in the forest and doesn’t make a sound, you know, etc. But it… I think it is… I really think that it… that it makes you a bit of a cynic about American business when you see the extent to which a group has pressured, even to the extent of talking about financial… withdrawing financial support from the Financial Accounting Standards Board, the degree to which they pressured people to make sure the value of pi stays at three instead of 3.14, simply because it was their own ox that was being gourd a bit. And in any event, it’s… it looks like it’s all over now for some time. In fact, now they’re pressuring them to even weaken further the standards that have been set. So self-interest is alive and well in corporate America. Charlie?

Charlie Munger [01:33:15] Yeah, I think dishonor one. And I think that, I think it is quite important for a civilization to have sound engineering and good accounting. And it is a very regrettable, regrettable episode, leading politicians, leading venture capitalists. I think to some extent it’s an indictment of the educational system that this thing could be so widely looked at and so wrongly. It’s bad enough people want to cheat on their accounting, and they do cheat on their accounting, but to want it to be endorsed as the system, yeah, is really kind of disgusting. Yeah, corruption one.

Warren Buffett [01:34:02] Well, put us down as undecided on that, and we’ll move on to zone 6.

[01:34:10] Shareholder (Mike Lee-Chin, Hamilton, Ontario): Good morning, Mr. Buffett, Mr. Munger. Mike Lee-Chin from Hamilton, Ontario. Could you consider availing a videotape of this meeting to us, the shareholders?

Warren Buffett [01:34:23] I didn’t quite get that.

[01:34:25] Shareholder (Mike Lee-Chin, Hamilton, Ontario): Would you consider availing this a videotape of the shareholder… this particular shareholder meeting to us, the shareholders?

Warren Buffett [01:34:31] Distributing a video, a transcript, or a videotape?

[01:34:34] Shareholder (Mike Lee-Chin, Hamilton, Ontario): Yes.

Warren Buffett [01:34:34] Yeah, we’ve had that suggested a number of times. It’s a good suggestion, and we’ve considered it. The thing we’re worried about in connection with that is discouraging attendance. I mean, we’d hate to have two people here asking questions and then sending it out to tens of thousands.

Charlie Munger [01:34:54] So I make sales go down at the jewelry store.

Warren Buffett [01:34:58] Yeah, since we were just attacking hypocrisy in American business, Charlie felt like he should add that to my comments. But we… it’s a close call on that, because we would like everybody… but we, of course, we try to cover great many subjects in the annual report. But we would… we like the idea of the meeting answering a lot of shareholders’ questions and getting it to be… we don’t want to discourage attendance. And it’s fun to have everybody come in and ask questions, and the chances are, if we had far fewer people, we would have, you know, far more… far fewer good questions. So that the quality of the meeting is enhanced, I think, by having a lot of people come. And… but you’ve come a long way, so I can understand why you might be interested in transcripts.

[01:35:55] Shareholder (Mike Lee-Chin, Hamilton, Ontario): I appreciate that. Thank you. Or no? Is that a yes or no?

Warren Buffett [01:36:03] It’s… it was a no. It’s a no. Thank you. Most everything we say is a dole, but we have various ways of getting there. But okay. And zone 7, from the other room. I can see you.

[01:36:23] Shareholder: Good morning, Mr. Buffett and Mr. Munger. I was wondering if you could tell us what the sales at Borsheims were yesterday and how it compared to a year ago.

Warren Buffett [01:36:33] Well, I can tell you how compared to a year ago. They were 15% above a year ago, and a year ago was 40-odd percent above the year before, and I forgot how much that was before. So we keep setting records. But we haven’t announced any numbers, but it’s a pretty good size number. You’re a sporty crowd. Thank you. Zone 1.

[01:36:54] Shareholder (Patrick Terhune, Fort Lauderdale, Florida): Good morning. My name is Patrick Terhune from Fort Lauderdale, Florida. And first of all, I see, per your request, there are a lot of people who wore red in honor of the Cornhuskers.

Warren Buffett [01:37:07] All right.

[01:37:08] Shareholder (Patrick Terhune, Fort Lauderdale, Florida): Of course my team was the… or is the Miami Hurricanes, and I’ve got my… yeah, my green and orange on under my clothes. So, but if we were to lose, I’m glad we lost to Nebraska and Tom Osborne. I’ve got a request for Warren and Charlie, and that is, recognizing that the value, both intrinsic and extrinsic, of Berkshire Hathaway is the result of your combined skills in acquiring growth companies and with your prudent and expert investing of the company’s capital for growth, I’d like to know if you have a plan, a succession plan, to be executed in the event, God forbid, something happens to one or both of you, which would remove your input to these strategic decisions. I sincerely hope you’re in the process of developing individuals to carry forward your collective visions and to manage the company’s resources as effectively and as profitably as is being done now.

Warren Buffett [01:38:06] Well, I appreciate that question. And the answer is, obviously we do care enormously about that, because both Charlie and I, in addition to a lot of other reasons, but… and we both have a very significant percentage of our net worth in Berkshire, and neither one of us has figured out how to sell it all exactly, you know, 15 minutes before we get hit by a truck. So we will not have the jump on the rest of you. And therefore our continuing interest will go… financially will go well beyond our deaths, and it will, in terms of foundations or something like that, it will go to organizations that we care very much about having a maximal resources available too. So we do have some plans. We don’t name names or anything of the sort.

It’s not quite as tough as you might think, because we have a collection of fabulous businesses, some of them own totally, some of them owned in part. And I don’t think razor blade sales or Coca-Cola sales are going to fall off dramatically the day Charlie or I die. That we’ve got some great businesses, and same through the wholly owned businesses. So the question is more that of allocating capital in the future. And, you know, that will… that’s a problem for Charlie and me right now. It’s simply because of the size, but it’s not easy to find things to do that makes sense with lots of money. And sometimes a year will go by and we don’t find anything, and other times a year goes by and we think we found something, but it turns out we were wrong. So it’s not easy. But we think we will have some very smart people working on that, and we don’t think it will be the end of the world if they don’t find anything the first year, because the businesses will run very well.

We have a big advantage in that, as contrasted to virtually almost every other company, we now and in the future are willing, eager to buy parts of wonderful businesses or all of them. I mean, most managements have a… most investors are limited to buying parts of businesses, and most managers psychologically or are geared to owning all of something that they can run themselves. We, you know, it’s like, I think Woody Allen said some years ago, it’s the advantage of being bisexual is that you doubles your chances of a date on Saturday night. And yeah, but we can go either direction in that respect, and our successors will also. So very… Charlie, you want anything?

Charlie Munger [01:41:00] I think few business operations have ever been constructed to require so little continuing intelligence in corporate headquarters. An idiot who was willing just to sit here would have a very good record long after the present incumbents were dead.

Warren Buffett [01:41:25] I think that’s true.

Charlie Munger [01:41:27] Yeah, I think it would be a little better if Warren would keep alive in terms of allocating the new capital. I don’t think we’ll easily replace Warren, but, you know, we don’t have to keep getting rich at the same rate we have in the past.

Warren Buffett [01:41:52] That’s a Thai vote.

Zone 2.

[01:41:54] Shareholder (Keith Briar, San Francisco): Hi, I’m Keith Briar from San Francisco. I have a question. When you’re valuing the companies and you discount back the future earnings, you talk about how many years out you generally go? And if you don’t go out a general number of years, how do you arrive at that time period?

Warren Buffett [01:42:13] Well, that’s a very good question, and it’s… I mean, it’s the heart of investing, or buying businesses, which we regard as the same thing. But, and it is the framework in which we operate. I mean, we are trying to look at businesses in terms of what kind of cash can they produce if we’re buying all of them, or will they produce if we’re buying part of them, and there’s a difference. And then at what discount rate do we bring it back? And I think your question was how far out do we look and all that. Despite the fact that we can define that in a very kind of simple and direct equation, you know, we are… we’ve never actually sat down and written out a set of numbers that, to relate that equation. We do it in our heads, in a way, obviously. I mean, that’s what it’s all about. But there’s no piece of paper, and we never… there never was a piece of paper that shows what our calculation on Helzberg’s or See’s Candy or the Buffalo News was in that respect.

So it would be attaching a little more scientific quality to our analysis than there really is if I gave you some gobbledygook about, while we do it for 18 years and stick a terminal value on and do all of this. We are sitting at the… in the office thinking about that question with each business or each investment, and we have discount rates in a general way in mind, but we really like the decision to be obvious enough to us that it doesn’t require making a detailed calculation. And it’s the framework, but it’s not applied in the sense that we actually fill in all the variables. Is that a fair way, sitting in chairman?

Charlie Munger [01:44:11] Yeah. Berkshire is being run the way Thomas Hunt Morgan, the great Nobel laureate, ran the biology department at Caltech. He banned the Friden calculator, which was the computer of that era. And people said, “How can you do this? Every place else in Caltech we have Friden calculators going everywhere.” And he said, “Well, we’re picking up these great nuggets of gold just by organized common sense, and resources are short, and we’re not going to resort any damn placer mining as long as we can pick up these major aggregations of gold.” That’s the way Berkshire works, and I hope the placer mining arrow will never come.

Warren Buffett [01:44:58] Somebody once subpoenaed our staffing papers on some acquisition, and of course, not only did we not have any staffing papers, we didn’t have any staff. Zone 3.

[01:45:17] Shareholder (Tom Morrow, Laguna Beach, California): I’m Tom Morrow from Laguna Beach, California, and the question I have to ask pertains to the issuance of the news stock. And again, as Charles mentioned, is there some potential gold mine out there that you have specifically in mind with the… some large acquisition that you have specifically in mind at this time, without revealing any strategic secrets?

Warren Buffett [01:45:46] There are things we would like to do. Whether we ever got a chance to do them or not, it’s another question. But, you know, I will be surprised if in the next five years we haven’t used some preferred stock one time or another. As I mentioned in the report, we had one last year that if we’d done it, it would have involved the issuance of maybe a billion dollars’ worth of… no, more than that, I’m sorry, a couple billion dollars’ worth of preferred. That one isn’t going to happen, in my view. I mean, there’s one chance in a hundred it’ll… it could happen, or something sort, but probably it isn’t going to happen. I mean, we want to be prepared for it. Something will happen. That’s always been our experience. That, you know, we have sat through some dry spells, and this is true in both the stock market and the acquisition business.

You know, I closed up the partnership in 1969 because there was nothing that made sense to do, and I’m glad I did, because that situation prevailed in ’71 and ’72. But in 1973 and ’74, you know, there were all kinds of things to do. And that will happen from time to time. People will behave, particularly in markets, just as foolishly in the future as they have in the past. It’ll come at unexpected times, but we will get a chance to do something. Now, that’s more of a cash type purchase, obviously, in the market. But we will get a chance to use the preferred, and we will try to think about big things. That we may not find them, but Charlie and I, the larger something is, the more interested we are. Zone 4.

[01:47:38] Shareholder (Jim Moss, Los Angeles): Jim Moss from Los Angeles. Tim, I was reading through your annual report, and to me an eye-popping number in there was the amount of float in 1994 at a cost of less than zero. I think it was $3 billion. And I was wondering if there are any restrictions on your investment of that money, or can that go into your marketable equity securities?

Warren Buffett [01:48:08] The question relates to what we have… that long table we put in, we’ve introduced about four years ago or so in the annual report, that shows the amount of float and the cost of float. And that’s a very important table in terms of our operating businesses. That’s probably the most important piece of information in the report. And that float is, as you noted, well over $3 billion now. Last year, because of various favorable factors, including the fact that our super-cat business was favorable, but also because our other insurance businesses did very well, amazingly well, the cost of that float, which is money that we’re holding that eventually does not belong to us, but will… and will go to somebody else, the cost of that float was less than zero. And that is a very valuable asset.

And the question is how much flexibility we have in investing that, which I think was the core of your question. The answer is we have a lot of flexibility at… we are not disadvantaged by that money being in float as opposed to equity, really, in any significant way. Now, if we had a very limited amount of equity and a very large amount of float, we would impose a lot of restrictions on ourselves as to how we would do it, because we would want to be very sure that we were in a position to distribute that float, in effect, to policyholders or claimants or whatever it may be at the time that was appropriate. But we have so much net worth that, in effect, that float is just about as useful to us as equity money. And that means quite useful. It’s a big asset of Berkshire’s. Let’s see, we got zone 5.

[01:49:59] Shareholder (Susan Scott, Madison, Wisconsin): Susan Scott from Madison, Wisconsin. On a more serious note, are you beginning to feel threatened by the success of the Beardstown Ladies?

Warren Buffett [01:50:09] Which lady was that? I didn’t get it. I got everything except what lady that was.

[01:50:18] Shareholder (Susan Scott, Madison, Wisconsin): But the Beardstown Ladies, the investment group.

Warren Buffett [01:50:22] Oh, that group.

[01:50:24] Shareholder (Susan Scott, Madison, Wisconsin): Yeah, the best seller.

Warren Buffett [01:50:26] Yeah, I have not read that book. I hate to admit that to an audience of shareholders, that I… that this is a book that’s… I think it’s probably number, I don’t know, seven or eight or something like that on the Times bestseller list, and it’s been up there for a couple of months now. It’s a group, an investment group, that apparently it has… is sharing with the world their secrets of success. I’m always suspicious of people that are sharing with the world any great ideas on investments. But we are not threatened at the moment. Now, zone 6.

[01:51:03] Shareholder (Mike Assael, New York City): Mike Assael from New York City. In the mistake does your section of the annual report, you mentioned a fundamental rule of economics that you missed. I’d like to know the two or three most important fundamental rules of economics you habitually get right. In other words, what are the fundamental rules of economics you used to make money for Berkshire? And I’m not talking about Ben Graham’s principles here, but rather rules of economics which may be found in an economics textbook.

Warren Buffett [01:51:35] Yeah, we try to… I mean, we try to follow Ben’s principles in terms of the attitude we bring toward both investing and in buying businesses. But the most important thing you can, you know, what we’re trying to do is we’re trying to find a business with a wide and long-lasting moat around it, surrounded and protecting a terrific economic castle, with an honest lord in charge of the castle. And in essence, that’s what business is all about. I mean, you may want to be the lord of the castle yourself, in which case you don’t worry about that last factor. But what you’re trying to… what we’re trying to find is a business that, for one reason another, it can be because it’s the low-cost producer in some area, it can be because it has a natural franchise because the surface capabilities, it could be because of its position in the consumer’s mind, it can be because of a technological advantage, for any kind of reason at all, that it has this motor on it.

And then our… then what we have to decide is… all moats are subject to attack in a capitalistic system. So everybody is going to try… if you’ve got a big castle in there, people are going to be trying to figure out how to get to it. And what we have to decide… and most moats aren’t worth a damn in, you know, in capitalism. I mean, that’s the nature of it, and it’s a constructive thing that that’s the case. But we are trying to figure out what is keeping… why is that castle still standing, and what’s going to keep it standing or cause it not to be standing 5, 10, 20 years from now? What are the key factors, and how permanent are they? How much do they depend on the genius of the lord in the castle? And then, if we feel good about the moat, then we try to figure out whether, you know, the lord is going to try and take it all for himself, or whether he’s likely to do something stupid with the proceeds, etc. But that’s the way we look at businesses. And Charlie, you want anything?

Charlie Munger [01:53:48] Well, I think he wants it translated into the ordinary terms of economics. The honest lord is low agency costs. That’s the word in economics. And the microeconomic business advantages are, by large, advantages of scale. Scale of market dominance, which can be a retailer that just has huge advantages in terms of buying cheaper and enjoying higher sales per square foot. So yeah, by and large you’re talking economies of scale. You can have scale of… scale of intelligence. In other words, you can have a lord with enough extra intelligence that he has a big advantage. So you’re, by and large, you’re talking scale advantages and low agency costs.

Warren Buffett [01:54:44] To some extent, Charlie and I try and distinguish between businesses where you have to have been smart once and businesses where you have to stay smart. And I mean, retailing is a good case of a business where you have to stay smart. You can… you are under attack all the time. People are in your store. If you’re doing something successful, they’re in your store the next day trying to figure out what it is about your success that they can transplant, and maybe add a little something on, in their own situation. So you cannot coast in retailing. There are other businesses where you only have to be smart once, at least for a very long time. There was once a southern publisher who was doing very well in and with his newspaper, and someone asked him the secret of his success, and he said, “Monopoly and nepotism.” And I mean, he wasn’t so dumb. I mean, he didn’t have any illusions about himself.

And if you had a big network of television affiliate station 30 years ago, there’s still a major difference between good management and bad management. I mean, a major difference. But you could be a terrible manager and make a fortune, basically, because the one decision to own the network TV affiliate overcame almost any deficiency that existed from that point forward. And that would not be true if you were the first one to come up with some concept in retailing or something of the sort. I mean, you would have to be out there defending it every day. Ideally, you know, is you want terrific management at a terrific business, and that’s what we look for. But as we pointed out in the past, if you have to choose between the two, get a terrific business. Charlie, anymore? See, zone 7, I believe, is next. To no questions from zone 7? Okay, how about zone 1?

[01:56:59] Shareholder (Paul Miller, Kansas City): Paul Miller from Kansas City. First, I’d like to comment on your purchase of Kansas City-based Helzberg Jewelers. You commented about Barnett Helzberg and his… what he’s done retailing-wise. For those of us in Kansas City, you’ve also picked up Barnett and Shirley Helzberg, who are the first family in philanthropy in Kansas City. And for the shareholders in this room, the Helzbergs are wonderful people, and to have them added to this group of companies says miles about Warren Buffett, and that they pick companies based upon their management, their people. So kudos to Berkshire Hathaway for picking up the Helzbergs, and thanks to Helzberg’s for everything they’ve done to Kansas City.

Warren Buffett [01:57:58] Now, I appreciate that.

[01:58:00] Shareholder (Paul Miller, Kansas City): My question relates to value. We can look in the annual report, and we can all see the purchase of a Washington Post, for instance, for $10 million that has a value today of $420 million. But discerning the value of the other consortium of non-publicly traded businesses, the Nebraska Furniture Mart, the Borsheims, etc., the value of their purchase price over the years versus their value today, how can we understand that value, and how is it reflected in the annual reports?

Warren Buffett [01:58:36] Yeah, well, we try to… that’s a good question. We try to give you the information that we would want in answering that question in the annual report. Now, part of what we do in those pages where we say it’s not according to GAAP accounting, but there’s a lot of useful information in there. We’re not… we don’t stick a number on each company, but we try to give you enough information about the capital employed, the margins, and all of that sort of thing on the big… bigger businesses that you can make estimates that are probably just about as good as ours. Charlie and I would not need more information than is in the report to come up with a pretty good idea of what the controlled businesses are worth. And there’s no information we’re holding back that we think would be of any real importance in evaluating those businesses. But you’re right, it’s a lot easier with marketable securities than it is, at least in terms of current numbers, than it is with the wholly owned businesses. The wholly owned business is, generally speaking, some of them worth a whole lot more than we’ve… than they’re carried on the books for. And we feel pretty good about essentially all of them. But they’re… it… they’ve turned out remarkably well, I would say, over the years, and my guess is that they keep working pretty well.

We have managers of a number of those businesses here. I’m not going to introduce them all, because we have so many that it would take a considerable period of time. But you name the Washington Post. In the front row, or close the front row, we have Don Keough, would you step up, of Coca-Cola, and we have Kay Graham for the Post. (Applause) And Tom Murphy from Cap Cities. Is Paul Hayes in here too? And I’m gonna try and do… well, there’s a whole bunch more. I don’t want to get… but those three were sitting together, and I was struck by the fact that if those three combined, we have about $6.5 billion of profit in so far. So I would say that’s a… those are three businesses that have been fantastic. And like, I emphasize so far because of people we want that… I’d like to be able to name a bigger number in the future. But we have a group of managers, both at the controlled companies and at the partly owned companies, that have just created incredible, incredible value for Berkshire. I mean, Charlie and I sit around and read the paper every day and a lot of magazines and things and watch O.J. Simpson or whatever it may be, and these people are out there creating a ton of value for us. So we’re not going to change it. That… now let’s see, I think zone… is it zone 2 now, or is it…

[02:01:41] Shareholder (Tim Palmer, Dillon, Colorado): Yeah. Hello, I’m Tim Palmer from Dillon, Colorado. I have a question for you regarding Salomon. In the past week there’s been an article in the New York Times, the Wall Street Journal, and I believe it’s BusinessWeek, that we’re rather unflattering as far as what’s going on with the management and your selection there. Seems to be a somewhat of a cultural clash there. I don’t know that to be a fact, but I wondered, number one, how you keep yourself open to bad news before it’s news, and what is going on in Salomon there, the compensation plan, et cetera. How do you think that culturally is going to work out?

Warren Buffett [02:02:17] Charlie and I are always… we’re more interested in bad news, always, than good news. We figure good news takes care of itself. And one… we only give a couple of instructions to people when they go to workforce, and one of them is to think like an owner, and the second one is to just tell us the bad news immediately, because good news takes care of itself, and we can take bad news, but we don’t like bad news late. So I would say, in connection with Salomon, that there is and has been some culture clash, and there probably almost always would be a culture clash in a business where there is that amount of tension. And whether it be the entertainment business or the investment banking business or the sports business, there’s going to be a certain amount of tension when… between compensation to the people that work there and compensation to the owners. And I think there’s been some… that strain has existed at Salomon from the day I was first there, and far before that. I mean, that was no surprise. It’s understandable.

You’re seeing a tension, actually, in the airline business between the people that work there and capital, and it’s produced terrible results in the airline business. And the people that work there have been able to… and I’m going to talk about USAir specifically, that… although that’s a case, but goes beyond that. They have had contracts which were, as I pointed out in the report, were executed in an earlier age, which essentially will not allow, in many cases, capital to receive any compensation. And that produces a lot of tension. You don’t have contracts like that in the investment banking business or Wall Street generally, but you have that same sort of tension. And changing a culture around, A, takes time, and B, probably takes some change in people. I mean, I don’t think that’s a great surprise, if you expect to do it.

I have… I don’t think you can find two better people than Bob Denham and Deryck Maughan. And they’re smart, they’re high grade, they’re willing to work very hard, and there will be people that buy into the arrangements they want to have, and there’re people that won’t. Not all of the people that have left, by a long shot, are leaving of their own volition. But most of them are, but some aren’t. I mean, they’re… Salomon lost a lot of money last year, and many of the people that have left were not responsible for some of those losses, but some of the people were. So that is not something where you announce names in the paper. But some people are leaving because they can make more money elsewhere, and some people are maybe leaving because we think we can make more money without them. Charlie?

Charlie Munger [02:05:28] Yeah, I don’t think the tensions that have been commented on within Salomon are all that unusual. I think they pretty well exist everywhere on Wall Street, and even in the banks which have tried to imitate Wall Street. I just think it comes with the territory.

Warren Buffett [02:05:49] I don’t know what percentage of the Goldman Sachs partners left this year, but it… they had tensions that were produced, obviously, when they had a… they had a bad year. They’re going to have a bad year from time to time. Everyone’s going to have a bad year. But the partners, the general partners of Goldman Sachs, in the year end of November 30th, 1994, did not do well. They may not have done anything at all. And they made some very big money in prior years, and I’ll probably make some very big money in subsequent years. But in the year when they didn’t make any money, and there was a lot of turnover, maybe some of that turnover also was not all at the volition of the general partners that you read about leaving. I don’t know the facts in that case. But there’s a certain amount of tension exists in Wall Street under any circumstances, and when you aren’t making money, there’s a lot of tension. Zone 3.

[02:06:50] Shareholder (Michael Johnson, Dhahran, Saudi Arabia): Yeah. My name is Michael Johnson, a native Omaha. However, my family and I are Americans living abroad in Dhahran, Saudi Arabia. My question is related to intrinsic value and Ben Graham’s Security Analysis. I read a book earlier this year by Janet Lowe who said that you were more toward the first or second editions of Security Analysis and not so much toward the fourth. Yet the fourth edition seemed to move more toward growth and value being kind of joined at the hip, like you’ve said in your last few annual reports. And so, if I’m a person that’s always studying Security Analysis, like I do, I think I spend more time with that, do you think I’m… I need to get those first editions, or is the fourth edition kind of more what you’ve moved toward with your comments such as value and growth are joined at the hip?

Warren Buffett [02:07:41] Yeah, Janet Lowe is here, incidentally, today. She wrote a very good book on Ben Graham. I recommend that any of you that haven’t read it go out and buy a copy. The… I still prefer the… I think the second edition is cheaper to buy than the first edition by some margin, and I think it’s basically the same book. So I… that’s the one I would recommend. I… it isn’t because of differences on value and growth. I just think that the reasoning is better and more consistent throughout the second edition, which is really the last one that Ben was the 100%, along with Dave Dodd helping him in various ways, was responsible for writing. And I… so I think that the book has gotten away to quite an extent from both Graham’s thinking and from his way of expressing himself. So I… but I have no quarrel with anybody wants to read later editions at all. I do think, probably, the second edition, if you’re a real student of security analysis and you read and understand that, you’ll… you should do all right.

In terms of a lot of the mistakes that were made in terms of junk bonds and accounting and all of that sort of thing were covered in 1934 in that first edition, and subsequently in 1940 in the second edition. There’s a lot of meat in there. Later on, I, you know, I must admit I didn’t read the last edition as carefully as the earlier ones, but it struck me it was… it… what was said was not as… is not as important, and it wasn’t said as well, and it was more expensive. Charlie, you have any thoughts on that?

Charlie Munger [02:09:34] No.

Warren Buffett [02:09:34] No. Zone 4.

[02:09:35] Shareholder (Jeff Peskin, New York City): Yes, Jeff Peskin from New York City. And I was… have a question of the annual report, where you say that, obviously, going forward, due to the size of Berkshire, the returns going forward probably won’t match the returns of the past. And then you go on to state that one thing that may hinder that is the fact that you don’t really like to sell companies that you own. And I would just like to know what the reasoning is in that. If you’ve got a company or investment that you don’t think is going to do as well as where you can put the money going forward, what really the reasoning is for holding on and not redeploying the money elsewhere.

Warren Buffett [02:10:14] Yeah, I’ll just correct you just slightly on that. A, I didn’t say we’d probably do worse than the past. I said we will do worse than the past. I mean, there’s no way we could match percentage numbers of the past. That, you know, we would, in a period that would not take that long, we would, assuming we paid out nothing, we would gobble up the whole GDP, which is something we may think about occasionally, but we don’t really expect to accomplish the… but… and this… and the second point, that relates to size. That does not relate to our unwillingness to sell businesses, because that unwillingness has existed for decades, but the size has not existed for decades. The size is, you know, doubling $12 billion or so is harder than doubling $1.2 billion, which was harder than doubling $120 million. I mean, there’s no question about that. So eventually, well, already, it will be a drag on performance. It doesn’t mean that the performance will be terrible, but it does mean that 23% is an historical figure that has no predictive value.

The unwillingness to sell businesses, like I say, goes back a long way. That is not what that… if that hurts performance, it’s peanuts. That’s simply a fact, a function of the attitude Charlie and I have, is that if we want to live our lives… we find that rarity when we find people in the business that we want to associate with. When we do find that, we enjoy it. We don’t see any reason to make an extra half a percent a year or 1% a year. Don’t try us on higher numbers. But the… we don’t see a reason to go around ending friendships we have with people, or contact, or relationships. It just doesn’t make any sense to us. That… we don’t want… we don’t want to get committed to that sort of activity. We know we wouldn’t do it if we were a private company.

Now, in Berkshire we feel we’ve enunciated that position. We want to get that across to everybody who might join with us, because we don’t want them to expect us to do it. We want to expect us to work hard to get a decent result and to make sure that the shareholders get the same result we get and all that sort of thing. But we don’t want to enter into any implicit contract with our fellow shareholders that will cause us to have to behave in a way that we really… we don’t want to behave. If that’s the price of making more money, it’s a price we don’t want to pay. There’s other things we… that other things we forego also, but that is the one that people might disagree with us on. So we want to be very sure that everybody understands that going in. That’s part of what you buy here. And it may… I don’t think it’ll hurt performance that much anyway, but to the extent it does, it’s a limitation you get with us. Charlie?

Charlie Munger [02:13:29] I don’t think there’s any way to measure it exactly, but my guess is that if you could appraise something you might call the character of the people that are running the operating businesses in Berkshire, many of whom helped create the businesses in the first places and are leading citizens in their community, like the Helzbergs, I don’t think there’s any other corporation in America that’s done as well as we have, if you measure the human quality of the people who are in it. Now, you can say we’ve collected high-grade people, because we sure as hell couldn’t create them. But one way or another, this is a remarkable system, and why would we tinker with it? If you want to attract high-grade people, you probably ought to try and ba pretty well yourself.

Warren Buffett [02:14:26] Yeah, I mean, it’s just… besides, it wouldn’t be any fun doing the other. I mean, I was in that position a little bit when I ran the partnership back in the ’60s, and I really… you know, people were coming into partnership with me, and my job was to turn out the best return that we could. And I found that if I got into a business that presented certain alternatives that I didn’t like. So Berkshire is a much more satisfactory in that respect. Zone 5.

[02:14:59] Shareholder (John Rankin, Fort Collins, Colorado): John Rankin, Fort Collins, Colorado. Thanks for having us. In the book The Warren Buffett Way, the author describes the capital growth model that you’ve used to evaluate intrinsic value in common stock purchases. My question is, do you also still use the formula Ben Graham described in The Intelligent Investor that uses evaluating anticipated growth, but also book value? It seems to me that fair value is always a bit higher when using Mr. Graham’s formula than the stream of cash discounted back to present value that is in Warren Buffett Way, and also that you’ve alluded to in annual reports.

Warren Buffett [02:15:37] Yeah, we’ve tried to put in the annual report pretty much how we approach securities. And book value is not a consideration, virtually not a consideration at all. And the best businesses, by definition, are going to be businesses that earn very high returns on capital employed over time. So by nature, if we want to own good businesses, we’re going to own things that have relatively little capital employed compared to our purchase price. That would not have been Ben Graham’s approach.

But Ben Graham was… Ben was not working with very large sums of money, and he would not have argued with his approach. He just would have said his was easier. And it is easier, perhaps, when you’re working with small amounts of money. My friend Walter Schloss has hewed much more toward the kind of securities that Ben would have selected, and… but he’s worked with smaller amounts of money. He has an absolutely sensational record, and it’s not surprising to me at all. I mean, when Walter left Graham, though, I would have expected him to do well. But I don’t look at the primary message, from our standpoint, of Graham really as being in that, in anything to do with formulas. In other words, there’s three important aspects to it. You know, one is your attitude toward the stock market. That’s covered in Chapter 8 of The Intelligent Investor. I mean, if you’ve got that attitude toward the market, you start ahead of 99% of all people who are operating in the market. So they have an enormous advantage. Second principle is the margin of safety, which again gives you an enormous edge and actually has applicability far beyond just the investment world. And then the third is just looking at stocks as businesses, which gives you an entirely different view than most people that are in the market. And with those three sort of philosophical benchmarks, the exact evaluation technique you use is not, it’s not really that important, because you’re not going to go way off the track, whether you use Walter’s approach or Walter Schloss’s or mine or whatever. Phil Carret has a slightly different approach, but it’s got those three cornerstones to it, I will guarantee, and believe me, he’s done very well. Charlie?

Charlie Munger [02:18:04] Yeah, to the extent that the method of estimating future cash flow requires projections, I would say that projections, while they’re logically required by the circumstances, on average do more harm than good. In America, most of them are put together by people who have an interest in a particular outcome, and the subconscious bias that goes into the process and its apparent precision makes it, makes it some… well, it’s fatuous or dishonorable or foolish or what have you. Mark Twain used to say, “A mine is a hole in the ground owned by a liar.” And a projection prepared in America by anybody with a commission or an executive trying to justify a particular course of action will frequently be a lie. It’s not a deliberate lie in most cases. The man has gotten to believe it himself, and that’s the worst kind. So I don’t think we should… projections are to be handled with great care, particularly, yeah, when somebody has an interest in misleading you.

Warren Buffett [02:19:19] Charlie and I, I think it’s fair to say we’ve never looked at a projection in connection with either a security we bought or a business we’ve bought. We’ve had them offered to us in great quantities. Now, the fact that we voluntarily turned them away when people tried to thrust them upon us, I mean, it, the very fact that they are prepared so meticulously by the people who are selling the businesses or by the executives who are presenting to their boards and all of that sort of thing, you know, that, I mean, either we’re wrong or they’re wrong. I mean, it’s a ritual that managers go through to justify doing what they wanted to do in the first place in about 99 cases out of 10.

I have never, you know, I have never met an executive who wanted to buy something that said, “Well, I had to turn it down because the projections didn’t work.” I mean, it just, it’s never happened. And there will always be somebody that will come up with the projections that will satisfy the guy who’s signing his paycheck or who will sign the deal that provides the commissions, and they will pass those along to whomever else they need, the bankers or the board, to approve it. And it is total nonsense. I was recently involved in some, in a situation where projections were a part of the presentation, and I asked that the record of the people who made the projections, their past projections, also be presented at the same time. It was a very rude act, and it was regarded as apostasy. It, but believe me, it proved the point. I mean, it was a joke. I mean, so we’ll leave it at that.

We’re going to have another, one more question maybe, and then we’ll take a break, and Charlie and I will be eating up here. The ones who want to stick around can stick around, and the ones are in the other room and valley, there will be seats in here to fill. So we’ll sort of regroup in 10 or 15 minutes, and then we’ll go on as long as that group lasts. So let’s take one more from zone six, and then we’ll take a break.

[02:21:44] Shareholder (Peter Bevelin, Sweden): Hello, my name is Peter Bevelin from Sweden. What is the absolutely first question you ask yourself when you look at a potential investment, and do you and Mr. Munger ask yourself the same first question?

Warren Buffett [02:21:58] Yeah, well, I think I don’t, I don’t ask myself whether Charlie is going to like it, because that will be a tough one. I, now, the first question is, can I understand it? And unless it’s, unless it’s going to be in a business that I think I can understand, there’s no sense, there’s no sense looking at this. I’m just kidding myself into thinking that I’m going to understand some software company or some biotech company or something. What the hell am I gonna know about it? I mean, you know, I can… So that’s the first threshold question. And then the second question is, you know, does it look like it have, has good economics? Does it, has it earned high returns on capital? You know, is it, does it strike me as something that’s likely to do that? And then I sort of go from there. How about you, Charlie?

Charlie Munger [02:22:49] Yeah, I, we tend to judge by the past record, by and large. If the thing has a lousy past record and a bright future, we’re going to miss the opportunity.

Warren Buffett [02:23:02] We’ll take a break now and we’ll reconvene in 10 or 15 minutes. Those of you in the other room want to come in, and we’ll stick around then. If you want to get some food and come back later, you’re welcome to do that too. Thanks.

Okay, we’re ready to start here with a question from zone one, if you’ll take your seats, please. We’ve gotta…

[02:23:31] Shareholder (Brian Murphy, Clearwater, Florida): Mr. Buffett, I’m Brian Murphy from Clearwater, Florida. I’d like to ask you a question concerning your present thinking behind your acquisitions of banks such as PNC and SunTrust, particularly in light of the fact that banks were selling so cheaply in 1990 and now many have tripled in price, and it would appear from recent publications in the financial literature that you’ve become much more interested in banks at these higher prices relative to the 1990 valuations. Could you comment on your thinking there?

Warren Buffett [02:24:03] Yeah, we really have no different cri… there’s no difference in the criteria we apply to banks than do to other businesses. And a couple of publications have maybe made a little more of that than is warranted, because I doubt if there’s more than a couple percentage points difference. And we don’t think of it that way, incidentally, and we do not have a lot of sector, we don’t have any sector allocation theories whatsoever. So we simply apply the same criteria when looking at banks that we would at any other business that… They’re, incidentally, there, sometimes you should know that there’s, I would say that maybe half or maybe even a little more of the reports about our activities are in the press are erroneous.

Now, now some are accurate too, and then of course some are way out of date. I mean, we get confidential treatment on our, on the filings we make with the SEC as to our holdings, so they’re published well over a year after we filed them. And therefore there have been a couple of stories in the last month or two as to something we’ve bought, and of course if you read the story carefully, it’s, we bought it a year and a half ago maybe, and we may have sold it, we may have bought more, all kinds of things. So that, I’d be careful about press reports generally. We’ve, we actually, we bought a bank for Berkshire in 1969, the Illinois National Bank and Trust of Rockford. We’ve had an interest in the banking business. We feel it’s something that we can, that falls within our circle of competence to evaluate. That doesn’t mean we’ll be right every time, but it, but we don’t think it’s beyond us to understand the banking business. And so it’s, we look at businesses in that area. Charlie?

Charlie Munger [02:26:10] Nothing to add.

Warren Buffett [02:26:11] Okay, and we have zone two.

[02:26:13] Shareholder (Larry Myers, Omaha): Larry Myers from Omaha. Warren, two quick questions. The first one, very brief: do you have any timetable regarding when you will write your own book about your career in philosophy?

Warren Buffett [02:26:24] Yes, my time day has always been six months from now. The answer on that is I’ve thought about doing it a few times, and I, and I think about it. It always seems to me there’s way more interesting, than more interesting things yet to happen that have happened so far, and I don’t want to, I know I won’t write a second one, so I keep postponing it. That’s my rationale on it, anyway.

[02:26:47] Shareholder (Larry Myers, Omaha): Thank you. The second question concerns dividends. Last Friday night, by coincidence, on Louis Rukeyser’s weekly television show, the special guest was Philip Carret, and Mr. Carret made the statement that his favorite American stock is Berkshire Hathaway, and one of the major reasons he stated was that Berkshire has never paid a dividend, as we all know, and consequently you had superior utilization of the extra cash. Now, if you extend that reasoning, could it also be a beneficial policy if Coca-Cola and Gillette stop paying dividends and utilize the cash in other ways?

Warren Buffett [02:27:24] Well, it depends what they could use that, how they would utilize the cash, what they could use it for. Those are more focused enterprises than Berkshire, at least in terms of products, and they, I think, I commend managements that have a wonderful business for utilizing cash in those wonderful businesses, or in businesses that they understand and will also have wonderful economics, and for getting the rest of the money back to the shareholders. So Coca-Cola, in my book, is doing exactly the right thing with its cash when it both, when A, it uses all the cash that it can effectively in the business to expand in new markets and all of that sort of thing, but then beyond that it pays the dividend, which distributes cash to shareholders, and then it repurchases shares in a big way, which returns captive basis to shareholders, but in a way that benefits all of them.

So we, you will benefit from us not paying dividends just as long as, just as long as we can use the every dollar we retain to produce more than a dollar of value and of market value over time. Whether we can continue doing that, you know, how long we can continue doing that, I can’t promise you, but that is the, that’s the yardstick by which the decision is made. And that is the yardstick, I think, by which Coca-Cola is making the decision too. And I think that they deserve great credit for exercising the discipline to quit when they, using cash when they run out of the opportunities to use it well, and then to use it, then to further deploy it advantageously by repurchasing shares.

I think one of the things I admire about my friend Bill Gates, he’s got $4.5 billion of cash in Microsoft, and very few managements can stand having $4.5 billion of cash and not doing something unintelligent with that. So far it’s made sense for us to retain everything we earn, and I think it’ll make sense for a while longer, but it may not make sense indefinitely. Charlie?

Charlie Munger [02:29:35] I hope it lasts a long time.

Warren Buffett [02:29:39] Zone three.

[02:29:40] Shareholder (Dan O’Neill, Santa Fe, New Mexico): My name is Dan O’Neill from Santa Fe, New Mexico, and I would ask, like to ask you a more specific question about Salomon Brothers, which is why do we pay our employees there so much? Why, what, why do we pay our employees there so much money? The conventional theory seems to be that there’s just a different pay scale on Wall Street than the rest of the world, and it’s based on the idea that traders are smarter than, that some traders are smarter than others, and in some supernatural way are able to receive signals that the future is sending back to the present. And how do we know that that isn’t just an urban legend, like alligators in the New York City sewers? Another theory would be that the large amount of shareholders’ capital allows the traders to capture inefficiencies that are in the market in the same way that the house does in Las Vegas. I mean, if we owned a casino, it wouldn’t make any difference if we hired Albert Einstein or Forrest Gump to run the blackjack table, and we would pay them the same. And I wonder which theory you think is closer to the truth.

Warren Buffett [02:30:46] Well, you put it well. In the end, of course, you end up paying them at a, what you think at least is a market rate, and to some extent the market tests you out by whether people leave because they can get a higher rate. But the limiting factor on that should be that you pay them a market rate as long as you are getting a market rate on capital. But is harder to measure the market rate on capital in a short period than it is to measure the market rate on compensation. So the, a good many of the people that have left, but far from all, have left because they felt that they would obtain, presumably because they would obtain greater compensation elsewhere. The market was working in that way, just as it works in entertainment that way, and it works in the athletic field that way.

And whether it, when it works that way, it leaves a return for capital that’s adequate is an open question. I mean, I haven’t looked at the figures on all the baseball teams, but I’ve seen some of them, and certainly in some of the smaller markets it really, I mean, the books were not phony. I mean, it is very hard to pay market rates for ball players in Kansas City and still make money running a ball team. Well, you’ve got a smaller television market and all of that of the big cities. So in the end you’re going to have to pay market rates to retain people, but part of that will also depend upon the period over which they measure their, what they’re going to be paid. I mean, if you want to look at Goldman Sachs, last year they were paid nothing. Does that mean that everybody will leave because they can get paid something someplace else? No, because 80% of the partners or 90% of the partners have a longer time horizon than that, and they have an anticipated earnings figure in mind when comparing it with what they’re being offered elsewhere.

If you have a situation where market rates, you know, exceed the earning capacity of the business, then at some point capital will flow away from the business. In the airline industry, which I use example, the market rate the most, well, the, in terms of the bigger airlines, people are not being paid market rates, they’re being paid contractual rates. Well, you look, you can’t blame anybody for that. If you have a contract that entitles you to X and the current market is a half of X, you’re going to hang on to that contract very aggressively. And like I say, you don’t blame anybody for that. It’s just, if you end up in that condition, though, you’ve got a real problem. And if you have the same problem that you have if the market is higher than the, or similar problem, the one you have if the market is higher than one that you can sustain in your own business. My guess is that there, that in effect Salomon has put in a more Goldman Sachs-like system, because essentially it created, to a degree, a partnership within it. That, to have that work, A, over time the partners have to earn good money, and it won’t work. But B, you have to have people that have a partnership mentality in it. And if you change from one culture to another, you are not going to get 100% acceptance of any new system. Charlie?

Charlie Munger [02:34:27] Yeah, it was kind of a bad break to put in a new compensation system and then have a very bad year. In the very nature of things, people are going to blame the compensation system subconsciously. And then two, I think that Wall Street generally has more envy, jealousy effects than are typically present elsewhere. I have a friend whose grandmother used to say that she couldn’t understand why people got into envy, jealousy, because it was the only one of the sins that you’d never possibly have any fun at. And, but generally speaking, on Wall Street, I think a lot of people have had the wrong kind of grandmothers.

Warren Buffett [02:35:26] Yeah, I’ve commented from time to time that, but today Robin Leach has it all wrong on Lifestyles of the Rich and Famous, because he’s presenting all these wonderful things that will happen to you if you get rich, but they really aren’t that, all that wonderful, these fancy houses and boats and all that. That the real advantage of being rich, as I explained to people, is that it enables you to hate so effectively. That if you’re terribly rich, you know, and but you, you’re, your brother or whatever, whomever, cousin or somebody is getting a little more attention in the world or something of the sort, you can hate in a very major way. You can hire accountants and lawyers to cause them all kinds of trouble. If you’re poor, you just snub them at Thanksgiving and don’t show up or something of the sort.

But I’ve noticed that these rich people, particularly when they inherit great amounts of money, sooner or later they start, frequently they get very antagonistic toward siblings or cousins or whatever it may be, and they really can, they can hate in a way that, or get envious in a way that the, you know, the rest of us really can’t really aspire to. So that’s a benefit that hasn’t appeared on Robin Leach lady. But I, but you see that, you see a little of that in the athletic field, in the entertainment field, and perhaps even Wall Street, that they, that making $1 million a year looks great until this guy that sits next to you that can’t possibly be as smart as you is making a million too, and then the whole world turns into a very unfair place. Zone four.

[02:36:58] Shareholder: Good afternoon. My question is simply about the cash and cash equivalents that are shown on the balance sheet this year versus last year. In my thinking, cash equivalence is always something good to have around the case of a big market drop, being able to make opportunistic buys, as I know you’ve referred to Mr. Market getting manic depressive at times. Is there something that is less than obvious here that I’m not seeing, or is the position not there now should that happen in the marketplace?

Warren Buffett [02:37:27] Cash at Berkshire is a residual. I mean, we would like to have no cash at all times. We also don’t want to owe a lot of money at any time. But we, if we have cash around, it’s simply because we haven’t found anything we like to do, and we hope, always hope to deploy it as soon as possible. We never thinking about whether the market’s going to go down or something of the sort, or whether we might buy something even cheaper. If we like something, we’ll buy it. And when you see cash on our balance sheet of any size, that’s an acknowledgement by Charlie and me that we have not found anything, in size anyway, attractive at that point. It’s never a policy of ours to hold a lot of cash. Zone five.

[02:38:24] Shareholder (David Winters, Mountain Lakes, New Jersey): David Winters, Mountain Lakes, New Jersey. David Winters, Mountain Lakes, New Jersey. Years ago you said you loved the newspaper business, and then over time, I guess, it said it declined a bit and how much you loved it. And I’m kind of wondering how you feel about it now, and if you can prognosticate a little bit for us at all.

Warren Buffett [02:38:44] Well, I used to love it in two respects. I love the economics and I love the activity, both. And the activity, the love of the activity is not diminished. The economics are still exceptionally good compared to virtually any business in the world. They aren’t quite as good as they were 15 years ago. So they have, I wrote about that a couple of years ago, whereas what was, seemed almost the most bulletproof of franchises is still an exceptionally good business, but it isn’t quite as bulletproof as might have been the case 10 or 20 years ago. I still think it’s about as interesting a business as there is in the world, I meant. But if you’re talking pure economics, the, I can’t think of many other businesses that, if I just owned one asset over my life, that I would rather own than a newspaper in a single newspaper town. But I wouldn’t have quite, I wouldn’t have quite the feeling of absolute certainty that I had, that I would have had 10 or 15 years ago. Charlie?

Charlie Munger [02:40:02] Yeah, I, I think it’s obvious, I, the newspaper for predators are getting a touch of paranoia for the first time. I mean, they worry about the electronic revolution, they worry about the young people, you know, don’t read. It’s not as much fun going to newspaper conventions as it used to be. They’re still making exceptional money. I mean, that’s the interesting thing.

Warren Buffett [02:40:32] Ah, but they, I’ve heard you say a dozen times, people don’t seem to care what floor they’re at, just whether the elevator is going up or down. That is true. People feel better when they’re on the second floor of an elevator that just come from one that they do when they’re on the 99th floor coming down from 100. There’s no question about that. They have this projection, and of course it’s particularly the case where they’ve been in a business where the money, with the profits were automatic, because they start thinking about, you know, questions of whether they really have the ability to make a lot of money absent this favored position, and that’s not something they’ve had to dwell on before. So it could make them uncomfortable.

They’re all streaming about newsprint prices. We probably scream about them a little bit too. But I mean, if you compare being in the newsprint business over time to being in the newspaper business, I mean, it’s a joke. And newsprint prices, if you, you can graph them from any point, you know, 15 or 20 years ago or 10 years ago, and the price of the newspaper, the price of advertising has gone up more. I mean, it is interesting to hear them yelling foul because they have moved a lot in the last 12 months, and they’ll move some more in the next six months. But believe me, it’s better to be in the newspaper business than the newsprint business. Zone six.

[02:41:55] Shareholder (Liz Pruss, New York City): Mr. Buffett, my name is Liz Pruss, I’m from New York City. I was wondering, on your acquisition criteria, I know part of that is that Berkshire Hathaway won’t participate in unfriendly takeovers. I wondered how that philosophy may or may not apply to your role as a member of the board of several other companies.

Warren Buffett [02:42:18] That’s a interesting question, and I haven’t been on the board of any company where the CEO is brought to the board the question of a hostile takeover. Do you think anything I’m gonna know? And but there’s no rule that that can’t happen, so I don’t know exactly. I don’t exactly, I don’t know exactly what I would do if that came along. That’s a very good question. I used to be, I used to have a whole different attitude on that. I mean, in effect, we actually go back 40 years, we bought in effect control of companies. Well, in the case of Berkshire, Malcolm Chace, the chairman, was all in favor of us buying our stock in Berkshire, but Seabury Stanton, the president, would not have been in favor of it, and Seabury was, was the, was managing the business. So it wasn’t, it wasn’t hostile, but Seabury would not have been in favor of it, but Malcolm would have been. So I don’t know what, I don’t know what the situation would be today if somebody walked in Gillette or Cap Cities or someplace like that. I don’t think it’s going to happen, but I have not, I don’t have any policy on at this point. What do you think we do, Charlie?

Charlie Munger [02:43:51] I don’t think our behavior is totally predictable.

Warren Buffett [02:43:54] And he’s right. Zone one.

[02:43:56] Shareholder (Neil McMahon, New York City): Yes, Neil McMahon, New York City, also a Sequoia shareholder. Ben Graham investing encouraged turnover. Looking at Berkshire’s holdings, concentration and long term, are you still a 15% Phil Fisher and 85% Graham?

Warren Buffett [02:44:12] I don’t know what the percentage would be. I’m 100% Ben Graham in those three points I mentioned earlier, and those really come… I am very, I was very influenced by Phil Fisher when I first read his two books back around 1960 or thereabouts, and I think that they’re terrific books. I think Phil is a terrific guy. So I think I probably gave that percentage to, I think I first used it in Forbes one time when Jim Michaels wrote me, and I think I, you know, it was one of those things, I just named a number. But I think it, I think I’d rather think of myself as being a sort of 100% Ben Graham and 100% Phil Fisher, and in the points where they don’t… and they really don’t contradict each other, it’s just that they had a vastly different emphasis.

Ben would not have disagreed with the proposition that if you can find a business with a high rate of return on capital that can keep using more capital on that, that’s the best business in the world. And of course he made most of his money on GEICO, which was precisely that sort of business, so he recognized it. It’s just that he felt that the other system of buying things that were statistically very cheap and buying a large number of them was an easier policy to apply, and one that was a little more teachable. He would have felt that Phil Fisher’s approach was less teachable than his, but his had a more limited value because it was not workable with lar… really large sums of money.

At Graham-Newman Corp, Graham-Newman Corp was a closed-end fund. It was, it was technically an open-end, but had $6 million of net worth, and Newman & Graham, the partnership that was affiliated with, had $6 million. So you had a total pool of $12 million. Well, you could go around buying little machine tool company stocks and machine tool companies, whatever it might be, that all statistically cheap, and that was a very good group operation. And he had, you have, if you own a lousy business, you have to sell it at some point. If you own a group of lousy businesses, you better hope some of them get taken over or something happens. You need turnover. If you own a wonderful business, you know, you don’t, you don’t want turnover, basically. Charlie?

Charlie Munger [02:46:22] What was interesting to me about the Phil Fisher businesses is that a very great many of them didn’t last as wonderful businesses. One of his businesses was Title Insurance and Trust Company, which dominated the state of California. It had the biggest title plant, which was maintained by hand, and it had great fiscal solvency and integrity and so forth. It just dominated a lucrative field. And along came the computer, and now you could create it for a few million dollars a title plant and keep it up without an army of clerks, and pretty soon we had 20 different title companies, and they would go to great big customers like big lenders and big real estate brokers and pay them outlandish commissions by the standards of your, and bid away huge blocks of business. And in due course, in the state of California, the aggregate earnings of all the title insurance companies combined went below zero, starting with a virtual monopoly. So very few companies are so safe that you can just look ahead 20 years. And technology is sometimes your friend and sometimes your bitter enemy. If Title Insurance and Trust Company had been smart, they would have looked on that computer, which they saw as a cost reducer, as one of the worst curses that ever came to man.

Warren Buffett [02:47:54] You can, it probably takes more business experience and insights, to some degree, to apply Phil Fisher’s approach than it does Graham’s approach. If you, the only problem is you may be shut out of doing anything for a long time with Ben’s approach, and you may have a lot of difficulty in doing it with big money. But if you strictly applied, for example, this working capital test security, it will work. It just may not work on a very big scale, and there may be periods when you’re not doing much. Ben really was more of a teacher than a, I mean, he had no urge to make a lot of money. It did not interest him. So he was, he really wanted something that he thought was teachable, and as a cornerstone of his philosophy and her approach. And he felt you could read his books sitting out here in Omaha and apply buying things that were statistically cheap, and you didn’t have to have any special insights about business or consumer behavior or anything of the sort. And I don’t think there’s any question about that being true, but I also don’t think you can manage lots of money in accord with it. Zone two.

[02:49:17] Shareholder (Rob Pitts, New York City): Hi, Rob Pitts, shareholder from New York City. This is a question for Mr. Munger. I’ve noticed in the insider sales activity sheets that you’ve been a rather consistent seller of your Berkshire stock over the last few months. I wondered if you would comment on why you’re doing this, especially in light of the prospective tax change in capital gains, where it might be reduced, which would obviously be beneficial to you and beneficial to Berkshire by reducing its deferred tax liability.

Charlie Munger [02:49:54] I’ve given away a fair amount of Berkshire in the last couple of years, and I’ve also sold some. I gave away the Berkshire because I thought it was the right way to behave, and I sold some because I had uses for the money.

Warren Buffett [02:50:12] He doesn’t know anything I don’t know. I was sure it’d sell, like I checked that. But zone three. Charlie has a very high percentage of his net worth and Berkshire is…

[02:50:25] Shareholder (Goran Pulich, New York City): Do I go ahead?

Warren Buffett [02:50:27] I’m sorry, go ahead.

[02:50:29] Shareholder (Goran Pulich, New York City): That, I don’t think it’s working, Claire. Hello? Okay. Hi, Goran Pulich from New York City. I have a two-part question. First part, very short. I think a lot of people have difficulty valuing businesses because of some convoluted accounting schemes that are out there. Do you have any suggestions in terms of books or something you can read where you can sort of make sense of some of the accounting stories that are going around?

Warren Buffett [02:50:57] Well, that’s a good question. And Abe Briloff used to write for Barron’s quite frequently on various accounting machinations, and Barron’s has continued that somewhat. But you’re right that there are people out there who will try to paint pictures with accounting that are something far from the economic reality, and sometimes the rules of accounting themselves lead to that. I would say that when the accounting confuses you, I would just tend to forget about it at, as a company. I mean, it’s probably, it may well be intentional, and in any event, you don’t want to, you don’t want to go near it. I, we have never had any great investment results from companies whose accounting we regarded the suspect. I can’t, I can’t think of a one. Can you, Charlie?

Charlie Munger [02:51:42] No, no, no. It’s a, it’s a very bad sign. I made a short sale once that worked out well in a case like that.

Warren Buffett [02:51:55] It really, accounting, accounting can be a, accounting can offer you a lot of insight into the character of management. And I would say there’s a lot, you know, there’s a, you run into a fair amount of a bad economy used to call it creative accounting, but you, that, and you probably won’t do a lot more if it was allowed. But some companies have been able to push their auditors pretty far, and I would be very skeptical of anything that looks suspicious to you. I think there have been, there have been a couple of things written, but I can’t, I can’t think of where they’ve appeared, where people talk about the questions of, you know, what, obviously, if some prepaid expense, deferred asset accounts start building up suspiciously high, when inventories look out of line, you know, with sales, and particularly the trend of them and all, you want to look twice at companies like that.

Life insurance, you know, frequently that, you know, we see weak accounting, and you can, when you don’t have a product where revenues and expenses are being matched up on something close to cash in the short term, you have the opportunity for people playing games with numbers. And some people have learned how to do that very well, and they’ve, and they’ve sometimes created long-lasting stock manipulation or promotion schemes that have enriched themselves at the, where they’ve enriched the managers or the creators of it at the expense of the public over time. Now, you ever get suspicious about accounting, just go on to the next company. Zone four.

[02:53:44] Shareholder (Miss Wasserman, Chicago): Yes, Miss Wasserman from Chicago. In order to understand the reinsurance business a little better, can you explain your relationship with Lloyd’s of London in the marketplace, how you, which is probably the leader in the field, how often you compete directly, or if you’ve ever done reinsurance business for them since they’ve had losses in recent years, and how you see the industry changing as their economics exchanges?

Warren Buffett [02:54:06] Well, Lloyd’s, which is not an insurance company, as you know, but a, but a, well, originally it was a place, it was a coffee house, but it’s, it, people think what it’s a, it’s a place where a large number of syndicates operate and congregate in a given physical location, and has had a history for larger, more exotic risks. Over time, Lloyd’s has lost its relative position to a fairly significant degree in the last 10 or so years, partly be… well, in significant part because of bad results, which had the other effects of causing capital withdrawal and people who backed the syndicates to become unhappy. So Lloyd’s is still an important competitive factor in the reinsurance business and in certain specialized kinds of primary insurance. It’s a very, you know, it’s a very important factor, but it’s not a, it’s not the factor it was 10 or 15 years ago.

And I’m not sure how Berkshire’s capital compares with the capital of all those syndicates of Lloyd’s, but it certainly changed in its relative importance in the last five or ten years, and the ability of Lloyd’s to attract capital with the problems they had has been diminished, although they’re working on that problem. But we regard Lloyd’s as a competitor, just like we would regard any one of a number of reinsurance companies as competitor, but we also do business with a number of syndicates at Lloyd’s, and we’ll probably do a lot of business over the next 10 years with various syndicates. Charlie?

Charlie Munger [02:55:56] Yeah, Lloyd’s is a very interesting institution, because it had this reputation for integrity, what they paid off in, what, the San Francisco fire and so on and so on. And but I would argue that 10 or 15 years ago a lot of slop and folly got into Lloyd’s and certain syndicates particularly. Too many commissions coming off the top as the same risks circulated around the system, too much fine tailoring and three-hour lunches with fine wines, and, yeah, it wasn’t right, and they got in a lot of trouble.

Warren Buffett [02:56:37] Yeah, that actually, in the history of Berkshire, the most significant insurance problem we ever had was in connection with Lloyd’s, almost, or certain syndicates at Lloyd’s, almost 20 years ago. And as Charlie said, they had this terrific reputation, behavioral reputation, over centuries, and I think that they coasted for a while on that. And we had a behavioral problem with, in one situation, and it was very expensive to us, so we may have gotten an early lesson in what was coming. There are a lot of different syndicates at Lloyd’s, and there are different people running them, and they have, they have had different standards of behavior to some extent, and people who assumed that because they were dealing with Lloyd’s that they would have no problems of any kind, if I, not otherwise. But they will continue to be a major force in insurance, and they will get by their present troubles, and they’ll probably come out of it the better structure than they went in. That, zone five.

[02:57:50] Shareholder (Christopher Jones, Scottsdale, Arizona): That we did there for… Christopher Jones from Scottsdale, Arizona. I had a couple of questions for you. You’ve mentioned several times today about the difficulty and the frustration that you both have in trying to find capable companies to acquire, acquire parts of, in the United States. And I realize that, of course, when we own Coca-Cola and Gillette, we are a part of the global environment, but it’s surprising to me that there haven’t been any global franchises or global managements that have been interesting to either of you, that I, and I realize in the past we’ve owned some pieces of some. So I was questioned, because of the size of Berkshire now, might we see something more of a global flavor to the portfolio? And second question, you’ve also addressed the intelligent use of cash is something that you look for in management. Many management teams now are buying back their own shares because they can’t find anything cheaper or better in the marketplace. Does your current philosophy of not buying back your own shares suggests that maybe you think Berkshire is overpriced at these prices?

Warren Buffett [02:59:06] Well, we have, we have never, we’ve never bought back shares. We actually bought a few back in the ’60s, but we basically have never bought back shares, although there were plenty of times when we thought it would be quite attractive to do it. But we’ve also felt that if we could create more than a dollar of market value by, and maybe well more than, well over a dollar market value, by retaining a dollar, that on balance that would work out better over time. As long as we can find ways to use the cash which overall we feel will turn dollar bills into something larger than dollar bills, we’ll keep retaining the money. And we won’t measure that on whether we can find anything this week or this month, but we’ll certainly measure it based on whether we can find anything in a couple of years.

Always we’ve, we’ve had, we’ve had dry spells. Actually, right now there’s a little more going on than usual, but we’ve had dry spells a lot of times over a 20-odd year period. And, you know, as I said, I wound up the partnership during wonder I spell. So that it will be me, it’s measured partly on what’s going on now, and it’s measured partly on the expectancy. And I don’t think whether our stock was selling at X or three quarters of X right now would make a lot of difference, but it would make a difference if we thought we couldn’t find things to do with the money externally.

The question about non-domestic operations, and as you mentioned, we’ve got almost $8 billion in Coca-Cola and Gillette combined, and Coke has 80% plus of their earnings from non-US sources, and Gillette has maybe two-thirds or thereabouts. So you can argue that almost 40% of the net worth of Berkshire, 35% to 40%, is operating outside the United States, right, interest in those two investments alone. In terms of buying a business outright, we don’t preclude buying a non-US domicile business, but it’s not too likely that it’ll happen. We’d like to do it, particularly if it were large and if we understood it. But are we as likely to get a fix on a Helzberg’s of Europe as is a Helzberg as we would at Helzberg’s United States? You know, I doubt it. I just don’t know whether we would develop as much confidence in understanding the scene in which they operated and understanding the management and all that. But we might. It would have to be a pretty simple business, and it would have to be a business where we thought we really understood the moat for a long time, and it would have to be a business where we could establish a rapport with the management despite coming from somewhat different backgrounds. It’s not impossible, but I would say it’s, you know, it’s less than likely. Charlie?

Charlie Munger [03:02:19] I’ve got nothing to add.

Warren Buffett [03:02:21] Zone six.

[03:02:21] Shareholder (Lee Dubrov, Morgantown, West Virginia): Hi there. My name is Lee Dubrov from Morgantown, West Virginia. Ever since the Salomon debacle, appears that you have attracted more and more media attention. In this regard, there have been numerous displays that would appear to be distractions from the actual business of investing to it. We watched as you attended Bill Gates’ wedding in Hawaii and bought a personal computer, and now we’re striking designer ties, and, yeah, yesterday, Bill would have invited me to the wedding, you, if I hadn’t been in Salomon, but yesterday we got those pennants during the rain out. A very serious question: how, now that you’ve become this media darling, how can you assure us that you’re still keeping your eyes concentrated on the proverbial ball?

Warren Buffett [03:03:10] Well, I do get more mail than I used to, so we’ve developed a little more of a system on that. But I just, I do what I like to do, and just take speeches. I probably got invited, asked to make maybe 20 times as many speeches as I would have been asked to make 10 years ago, but I make the same number. I, you know, I’ve got the, I’ve got my own selection process for what I do on that. And it’s the same way, you know, I’m invited to, you know, I don’t know how many dinner tributes, etc. And, you know, basically I don’t change the way, what I do, because I don’t want to change the way. If I wanted something else, if while I was building Berkshire that was being done to end up in some other spot, I’d have been there by now. And it just doesn’t, it doesn’t, it doesn’t change anything. It does change the volume of mail, but I’ve got that, so that is not a big distraction for me. Oh, I’ll remain in Omaha, yeah, there’s no question about that. I mean, if I hadn’t wanted to be a normal, I would have figured out ways to change, and it’d been very easy to change decades ago. I think, I think it’s, you know, we got a lot of people here who aren’t from Omaha, but that’s their problem.

Charlie Munger [03:04:36] I mean, I’ve been watching Warren for a long time, and people who are concerned that he will change have a huge appetite for needless worry.

Warren Buffett [03:04:45] The odds that I will change are about as good as the odds that Charlie will change. I, the mail thing is a, you know, I wish it didn’t, there was an easier way to handle it, because, but you essentially can’t answer all the letters you get. That’s that simple. And that’s about the, once you get past that and get a formulator that takes care of it, that’s, that takes care of. Zone one.

[03:05:13] Shareholder (Samuel Park, Tulsa, Oklahoma): Yes, and Samuel Park from Tulsa, Oklahoma. My questions regarding GEICO. I noticed that for last five years their return on equity has come down every year. Is this something signifies change of a business, or just temporary things?

Warren Buffett [03:05:31] Questions about GEICO’s return on equity?

[03:05:34] Shareholder (Samuel Park, Tulsa, Oklahoma): Yes.

Warren Buffett [03:05:35] Yeah, well, it’s true it has come down to some extent. The GEICO’s growth is more or less a function of, basically, I mean, there’s a natural rate of growth there, and the growth in capital has been greater than the growth rate in premium volume and invested assets, so that achieving the same success on underwriting and achieving the same success on investments will produce a lower return on capital, unless they buy in stock, which they have done fairly significantly. But that’s limited by availability too. But it’s a very good business, but it’s not a business where if you double the capital you can double the earnings easily. Charlie?

Charlie Munger [03:06:20] Nothing to add.

Warren Buffett [03:06:21] Zone two.

[03:06:22] Shareholder (Mark Hake, Scottsdale): My name is Mark Hake from Scottsdale, and I think your question, my question about foreign equity investment was pretty much answered by the other gentleman. But I noticed that you had made an investment in Guinness in the past, and can you comment on that? Is it still owned, and if not, why not?

Warren Buffett [03:06:46] We don’t comment on purchases and sales of securities or ownership unless either we’re legally required to or they hit this threshold level where we report annually. And we move the threshold level up as our assets move up. We don’t move it up as a percentage of assets, so that we used as a cutoff this year $300 million, I believe, a market value as to where we reported. Now, if we’d owned the same amount of Guinness, which I’m not saying that we did, but if we’d own the same amount of Guinness on December 31, 1994, it would not have hit that threshold, as we had on December 31st, ’93, it would not have hit that threshold. And we really don’t want to get in the business where we are talking at all about what we’re buying or selling. We get a lot of speculation on that, but it’s of no use to Berkshire to be talking about purchases or sales. If we were, if we were acquiring a piece of land downtown, and we bought a quarter of what we intended to buy, for example, we would not feel we were benefited by a front page story in the paper saying that we were acquiring land. And it, we are not in the business of giving investment advice, basically. We will talk about our principles. So the only conclusion you can come to about Guinness or anything else that does not show up on our list at year end is that we did not own $300 million worth at market value at that time. Zone three.

[03:08:19] Shareholder (Don Breska, Boston, Massachusetts): Yes, Mr. Buffett, my name is Don Breska, I’m from Boston, Massachusetts. Recently I’ve noticed you wearing an Izod shirt with Berkshire Hathaway, and in the middle there was a fist grasping cache. Is that the new insignia? And the second question is, is that a shirt available to stockholders?

Warren Buffett [03:08:37] The shirt is not available. That shirt was a gift from someone, and the shirt is not available to stockholders, but you can draw your own conclusions the meaning of it soon. Zone four.

[03:08:51] Shareholder (Lyle McIntosh, Missouri Valley, Iowa): Yes, I’m Lyle McIntosh from Missouri Valley, Iowa, about 25 miles up the road. And Warren, recognizing this is corn country, and I farm, and there’s several other farmers shareholders, this meeting hits right in the middle of corn planting. Could you move it back about three weeks? And also, I noticed Phil Carret was on Wall Street Week Friday night. I’m sorry, I don’t know his marital status, but if he is available, have you thought about introducing to Mrs. B?

Warren Buffett [03:09:23] Well, Mrs. B, incidentally, was out working yesterday. We, I went out and dropped by to see about four o’clock, and she was, she was doing fine. She will be 102 late this year, and my guess is she will be working on her 102nd birthday as well. But I’ll let owlette Phil and Mrs. B handle their own affairs in that respect. He’s probably a little too young for her. Zone five.

[03:09:54] Shareholder (Ken Donovan, Cincinnati): I’m Ken Donovan, a city in Cincinnati investor. You’ve addressed the subject of your feelings about buying entire corporations. I wonder if you’d say something about our, is Berkshire looking for opportunities to buy, we’ll call them near-franchise companies, that might be based overseas, buying a stock interest or a part interest? And also, how do you feel about fixed debt investments of overseas companies?

Warren Buffett [03:10:22] Debt investments, was that?

[03:10:24] Shareholder (Ken Donovan, Cincinnati): Yeah.

Warren Buffett [03:10:24] Well, the first part was buying a stock investment rather than a whole company?

[03:10:29] Shareholder (Ken Donovan, Cincinnati): Right.

Warren Buffett [03:10:30] The second part was debt investments?

[03:10:32] Shareholder (Ken Donovan, Cincinnati): Yeah.

Warren Buffett [03:10:32] Right. Well, we’re open to buying anything. When, when you say are we looking at them, I’ve never been quite sure how we look at things anyway. I mean, they just seem to sort of pop up, as from reading or something of the sort. But we are, we are, it’s less likely we end up doing it for some of the reasons I’ve given earlier, but we have bought stock in companies that, aside from Guinness, that are domiciled outside of the United States. And we would have, we could conceivably buy debt instruments, if, we don’t buy a lot of debt instruments anyway, so it’d be very unlikely. But we will do anything we think makes sense at Berkshire that’s compatible with the way we want to operate, and certainly we don’t care where the domicile is, not that important. Charlie? Okay. Zone, zone five.

[03:11:30] Shareholder (New York City): Is it Scott Spoke of its New York City. My question is regarding the Helzberg acquisition. Can you comment on things such as the acquisition price, your sales and profit expectations, and how much debt were on the books at the time of the acquisition? This is in reference to which acquisition, for example.

Warren Buffett [03:11:53] Well, we have not put out the figures on Helzberg’s, and we won’t be. But we evaluate, the sales have been published at about $280 million for the year that ended in February, and there’ll be a considerably more in the current year, but we have not put out the figures. I can tell you that, obviously, that we think that in terms of the amount we are laying out in terms of shares and/or cash, we think over time that it’s going to be a very decent acquisition. It’s the same line of reasoning we’ve applied in other businesses. Retailing, as I mentioned earlier, is the kind of business where you have to stay smart over time, and we’ve got a terrific manager, a fellow named Jeff Comment, who’s going to be running it, and his record is extremely good, and I would bet the record would stay good.

It earns good returns on invested capital, or we wouldn’t be, we wouldn’t be buying into it. We always look for good returns on capital, and a lot of companies in the jewelry business do not get good returns on capital. I mean, it’s not an industry that, where most of the participants are prosperous. It takes, it takes unusual sales per square foot compared to competitors succeed in that, and we have one operation that does that in spades at Borsheim’s, and then a different type of operation that does it at Helzberg’s. The typical jewelry store operation is not a, is not a very good business, but we think we’ve got two good operations. Charlie?

Charlie Munger [03:13:49] Yeah, we frequently find that owners of entire businesses have schizophrenia. They want to sell their business for a little more than it’s worth, taking stock so they don’t have to pay taxes, and they want the stock to be the kind of, to be in a kind of business that will make just one dumb acquisition, theirs, and thereafter will guard the stock like gold, making no more dumb acquisitions. Needless to say, the world is not that easy. And I think over time we’ve made acquisitions that were fair on both sides, and averaged out they’ve worked well for Berkshire. And I think a company that behaves that way is giving the best long-term value to the private owner who wants to sell. You do not want to sell your business for stock to a firm that likes issuing stock.

Warren Buffett [03:14:54] Zone sex, that was six. Where do we have the mic? Oh, there. I don’t think it’s on.

[03:15:03] Shareholder (Jack Landing, Knoxville, Tennessee): Can you, can you hear me now?

Warren Buffett [03:15:06] Sure.

[03:15:07] Shareholder (Jack Landing, Knoxville, Tennessee): Jack Landing from Knoxville, Tennessee. I have a question which may not be appropriate for the officers of Berkshire to answer, but I think I’ll ask it anyway. You focused on intrinsic value in your annual report, and you suggested that by reviewing the grade pages in the back that one could come up with, possibly come up with a value of intrinsic value for Berkshire. I’ve made an effort to do this, and I think I come up with a price to earnings ratio of somewhere around 21, which seems to be a little overvalued. I’d like to ask you, Mr. Buffett, if you would care to divulge what you believe is the intrinsic value of Berkshire, and if you’re not willing to do that, do you consider the price of Berkshire at this level to be fair?

Warren Buffett [03:16:02] I, every year I get asked that in one form or another, and I always say that I don’t want to spoil the fun for those of you who are working out the intrinsic value for yourself. You have all the numbers that we have that are key to it. And I would say that there are some, there’s some important factors besides P/E. I mentioned earlier that I thought that the page where we described float, for example, is probably as important the pages there, there is in the report. And then the question is, you know, how, what do you do with the capital as you allocate it over time, and obviously that makes a difference in intrinsic value too. But I would say in a general way that I, and this has been true virtually all of the time, that I think, I would say that the intrinsic value of Berkshire in relation to its, I’ll put it the other way, the price of Berkshire in relation to its intrinsic value, I think, probably offers as much value as, or more than, the majority of stocks that I say. But I won’t, I don’t want to go any further than that. Charlie?

Charlie Munger [03:17:27] I’ve got nothing to add. The, your story about the fun of working it out, there was a famous English headmaster who used to say to each graduating class, he said, say, “5% of you are going to become criminals, and I know just who you are, but I’m not going to tell you, because I don’t want to deprive your lives of a sense of excitement.”

Warren Buffett [03:17:58] And we’ll explain that later on. There’s, there’s a lot more to, there, there’s more to intrinsic value, as we’ve discussed earlier, than just adding up what you think you can sell the pieces for at any given time, because it is a prospective figure. It is the, it is future cash discounted back to the present, and capital allocation is a good part of that. What you expect the float to do, for example, over time would not, that would lead to a large swing in possible numbers relative to value. I mean, if, when we bought National Indemnity in 1967, when it had whatever it had, $15 or $20 million in float, we didn’t see it then, but if we could have foreseen the eventual development of float over time, it might have turned out that the intrinsic value of National Indemnity was many multiples of what most people might have thought at the time, or probably what we thought at the time. Zone one.

[03:19:10] Shareholder (Richard Duck, Melbourne, Florida): Richard Duck from Melbourne, Florida. I have a two-prong question. First, on the stock, as we all know, is the first month this year we ramped up about 25 and then we pulled back, I guess, about 20. Just wonder if your thoughts on that, specifically, do you attribute that to the books perhaps, or institutional buying, or, you know, what explanation you might have for that?

Warren Buffett [03:19:31] And I would say, I’ll answer that first. I would say Hagstrom’s book undoubtedly had some effect on that. It’s impossible to measure, but that book sold a lot of copies, and my guess is that that had some effect.

[03:19:43] Shareholder (Richard Duck, Melbourne, Florida): Okay. More so than institutional binding? Because I’ve heard rumors, like Fidelity and whatever, were buying.

Warren Buffett [03:19:48] I can’t, I can’t, I just don’t know the, I don’t know how to separate out the variables. But I would say that the book was a certainly a factor that at that time, and it’s unreasonable to assume that it had no effect.

Charlie Munger [03:20:02] Well, a lot of the buying came in and odd lots, so a lot of outlet activity.

Warren Buffett [03:20:09] Yeah, yeah, certainly look like book buyers.

[03:20:12] Shareholder (Richard Duck, Melbourne, Florida): Secondary question. I’m electronics engineer by profession, so the technology sector is of prime interest to me, and I think we’ll all agree at least last six to eight months has been phenomenal for the technology sector. And I also see that you’re somewhat befriending Mr. Gates, inviting you into your house, etc. Is there a possibility down the road a piece of you doing some type of purchase of Microsoft, or acquiring that, or is there something you could work out together?

Warren Buffett [03:20:39] I bought 100 shares one of the day, first day I met Bill, and that was the end of it. I just want to be sure I got his reports from that point on. This was personal, not in the, not in Berkshire. There’s no chance we’ll be in businesses we don’t understand, and I won’t understand that.

[03:20:55] Shareholder (Richard Duck, Melbourne, Florida): No, you’re quite clear on that. I just thought maybe there’d be an exception, because apparently…

Warren Buffett [03:21:01] Well, if you made an exception, he would be a good guy to make, a very good guy to make an exception with. But I don’t think I’ll make an exception. Zone two.

[03:21:14] Shareholder (Bassy Uniorima, Arlington, Texas): Name is Bassy Uniorima from Arlington, Texas. Mr. Buffett and Mr. Munger, with the possibility to use these two great mind of for a long term in life by either taking apprenticeship in Berkshire or openness school?

Warren Buffett [03:21:29] I didn’t follow that one. You analyze the question?

[03:21:33] Shareholder (Bassy Uniorima, Arlington, Texas): What, what, what the possibility using these two great minds of yours to educate a new generation as a long-term investment in this country, to either throw a brent’s ship in Berkshire for young people or over in a business school?

Charlie Munger [03:21:56] Well, let me try that one, because I have a demonstrated record of non-performance. I have had great difficulty enabling my children to know what I know.

Warren Buffett [03:22:13] And one, maybe you have failed less. My children in many ways are a lot smarter than I am, so I had a different experience. Charlie, oh, I think you can, you know, I’ve mainly learned by reading myself. So I don’t, I don’t think I have any original ideas that I certainly, but I’ve certainly got a lot. I mean, I’ve talked about reading Graham, I read Phil Fisher, and I’ve gotten a lot of ideas myself from reading. And in my own case, I mean, to talk about your parents having influences, and, you know, my parents had enormous influence. So I think you can, I think you can learn a lot from other people. In fact, I think if you learn reasonably well from other people, you don’t have to get any new ideas or do much on your own. You can just apply the best of what you see.

Charlie Munger [03:23:12] Generally speaking, I think we always get a group of wise people after sifting millions, but I don’t think anybody’s invented a way to teach so that everybody is wise. It’s extraordinary how resistant some people are learning anything.

Warren Buffett [03:23:26] Well, and really what it’s astounding is how resistant they are when it’s their, in their self-interest to learn. I mean, I was always astounded by how much attention was paid to Graham. I mean, he was regarded 40 years ago as the dean of security analysts, but how little attention was paid in terms of the principles he taught. And it wasn’t because people were refuting them, and it wasn’t because people didn’t have a self-interest in learning sound investment principles. That it was just this incredible resistance to thinking or change. I mean, I quoted Bertrand Russell one time, was saying, who said that, “Most men would rather die than think. Many have.” You know, and in the financial sense, that’s very true. It’s not complicated. I mean, human relations, you know, usually aren’t that complicated, but, and certainly it’s people’s self-interest to develop habits that work well in human relations, but an amazing number of people seem to mess it up one way or another. How much has Berkshire Hathaway been copied, either in investing America or corporate America? I’m not saying we deserve to be, necessarily, but people don’t want to do it differently than they’re presently doing it. You might argue that Mrs. B, having started what you may have seen out there this weekend with $500 in 1937, you know, without a day in school in her life, and building that into a great enterprise, you might say, well, that is something to study. I mean, that, you know, is it because she couldn’t speak English when we got, you know, she got over here? Maybe people, I mean, what are the, you know, what is there to learn from seeing somebody create an incredible success like that in a competitive business? She didn’t invent something that the world had never seen before. She didn’t have a lock on some piece of real estate that protected her from competition. You know, all of these And yet she accomplished something that virtually no one has accomplished. Now why aren’t business schools studying her? You know, why are they talking about EVA, you know, economic value added, as we talked about earlier, any of this? I mean, here is a success. Something has made her a success. You know, is it something… is it a 202… it’s, she’s very smart, but is it a 220 IQ? No, it isn’t. It’s a very smart woman, but it’s not something that’s incapable of being replicated in the habits and the way of thinking. But who is studying here? I mean, they present her as a curiosity, but if you go to any of the top 20 business schools, you know, there’s not one page that’s being given to anybody to study what is an incredible success.

And I, it, I just, I find that very interesting that, and to some extent, you know, I’ve seen it in the investment world, there’s this, for one thing, the high… you know, it’s probably a little discouraging to a professor of management in some major business school who’s gone on to get his doctorate and everything to think he has to come on, hang around the Furniture Mart, study a woman in a golf cart. I mean, but you could. They’d be better off if they did. Where were we on that? What zone are we on for? Are we zone 3, maybe? Huh?

[03:27:14] Shareholder (Jim Ludke, Phoenix, Arizona): Yes, thank you. I’m Jim Ludke from Phoenix, Arizona, and I haven’t been to one of your annual meetings for about 10 years now. The last one was down at the Red Lion Inn by the water, and I congratulate you on your popularity. I wish I had bought more stock, but like Charlie, I too have been giving mine away for charitable purposes, so your beneficial effects have reciprocated and rippled throughout the economy. I congratulate you, I congratulate you. What do you think has changed? Well, one thing is that Ben Graham commented on what you just said. I’m a student of Ben Graham, and he said it never seems to amaze me how widely ready was and least followed. But how have you changed in the last 10 years, much, if any, or none at all, or…

Warren Buffett [03:28:08] Well, we’ll let Charlie, he’s been watching me.

Charlie Munger [03:28:11] I’d say about one stone. Takes one to no one.

Warren Buffett [03:28:14] Yeah. If we wanted to change, we would have changed a long time ago. I mean, I’ve never believed much in this theory of, you know, if I have X, 2X instead of X, then I’m going to do this or that, and then, or I’ll take this job I don’t like now and I’ll get a one I like later on, or… It doesn’t make much sense to me. I mean, there aren’t that many years around, so you ought to be doing what you like at the present time, and Charlie and I’ve always followed that pretty well. Zone 4.

[03:28:55] Shareholder (Peter Burma, Chicago): Peter Burma, Chicago. Every year you have your operating company send a check back to Omaha. What percentage do the heads of the operating companies keep as a bonus, and how do you set that figure?

Warren Buffett [03:29:10] But we have different bonus arrangements at different companies. It would be a big mistake, with businesses with as many different economic characteristics, there’s varying economic characteristics as existing as they do with Berkshire, to have, trying to have some formula approach that paid managers in all of these different businesses based on a simple formula of one kind. So we have, I think, four businesses where they own a part of it, and we have varying arrangements with the various businesses. Some businesses, capital employed is unimportant. There simply isn’t a way to employ a lot of capital, so we do not have a capital charge even at those businesses. We don’t believe in going through a lot of machinations if it’s going to involve peanuts at the end. So some businesses have a capital charge, some businesses don’t have a capital charge. If they use a lot of capital, they’re going to have a capital charge, is what it amounts to.

Some businesses are easy business, businesses, some businesses are tougher businesses, so we have different thresholds where things kick in based on that. We simply sit down and try and figure out, in the case of each business, what makes sense, and that usually isn’t very hard to figure out. I mean, we want something that’s fair. The best managers, we aren’t going to change their behavior much by the compensation thing. We may a little bit in terms of teaching them how we think about capital employee, but in terms of their enthusiasm for the business, imagination and marketing and all that, basically we usually buy businesses with those people in place. But yeah, but it would be a, it’d be wrong not to treat people fairly, and they would resent it if they weren’t treated fairly, too, understandably. So we try to have a system that rewards the things that we want to have rewarded and treats them fairly in a way that they understand they’re treated fairly.

And I don’t think we have, I don’t think we have any two businesses that have the same arrangement. I mean, they’re different in each case. Incidentally, that applies in their policies, too. We don’t get into, very seldom, I should say, maybe once or twice, but they have different arrangements in terms of compensating their employees. Some of our businesses have budget, some of them don’t. We don’t have any budgets that come up the headquarters, that we let 400 hitters swing the way they want to swing, and some of them, you know, have a little different swings than others, but they’re, but overall they’re extremely effective. And they feel, we want them to feel like they own their own business. But if they felt, if somebody that’s independently wealthy sold us a business and started, and we started telling them how to swing, they would tell us what we could do with it very quickly, because they don’t need that in life.

So it, what we have to do is create a situation, or maintain a situation, where they are having more fun doing what they’re doing than anything else they can do in life, and that’s what we’re designing for. And then we have to treat them fairly in respect to them. Charlie?

Charlie Munger [03:32:23] Nothing to add.

Warren Buffett [03:32:24] Zone 5.

[03:32:24] Shareholder (Roger Hill, Racine, Wisconsin): Roger Hill from Racine, Racine, Wisconsin. Gentlemen, a little change of pace. Could we get your opinion on the present situation with international exchange? Do you think we have a dollar problem, or is the Japanese have a yen problem?

Warren Buffett [03:32:39] Well, I’m going to let Charlie answer that.

Charlie Munger [03:32:42] I have no comment.

Warren Buffett [03:32:44] That’s probably… that’s a very good question, but the trouble is, anytime I say that’s a very good question, it’s probably because I don’t know the answer. That, and I, you know, I don’t know the answer to that. Foreign exchange baffles me, frankly. I mean, you know, I think in terms of purchasing power parity, because that’s a natural way to approach it, but purchasing power parity does not work very well as a guide to how exchange values will behave in any shorter, immediate, medium, or maybe even long term, because the world adapts in different ways. Sometimes it adapts by high rates of inflation to a sinking currency. Usually it does. It hasn’t done that in respect to ours, but we’re only sinking relative to a couple of other important currencies. I don’t have a great answer for you on that, sorry. Zone 6.

[03:33:39] Shareholder (Howard Winston, Cincinnati, Ohio): Hi, I’m Howard Winston from Cincinnati, Ohio. First, I wanted to thank you and your char… you and Charlie for your sharing your time with us today. My question is, you’ve repeatedly said that you see many wonderful stock ideas but can’t invest because they’re too small. Given that many in the audience today have a lower dollar investment threshold, do these stocks have names?

Warren Buffett [03:34:04] Well said. Well, the answer to that is that we don’t look anymore. We assume that there are a reasonable number of opportunities as you work with smaller amounts of capital, because it’s always been true. I mean, it was over the years, as I looked at things. Clearly you run into companies that are less followed as you get smaller, and there’s more chances for inefficiency when you’re dealing with something where you can buy $100,000 worth of it in a month rather than $100 million. But that is not because I’m carrying around in my head the names of 25 companies that we could put $100,000… and I just don’t look at that universe anymore.

I sometimes, people send me annual reports or get letters from managers, and they say, well, you know, I’ve got this wonderful thing, and I look, I usually know ahead of time, but I mean, though, I would first look at the size, and if the size isn’t right, and it isn’t going to be virtually any time, I don’t look any further, because there’s just no time to be looking at all kinds of smaller opportunities. I do think, I do think if you’re working with very small amounts of money that there almost always are some significant inefficiency someplace to find. Things that I’ve mentioned to some people, when I started out, I actually went through the, all of the Moody’s manuals and the Standard manuals, page by page, and you can, and, you know, it’s probably 20,000 pages, but there were a lot of things that popped out, and none of them were in any brokerage report or anything sort. They were just plain overlooked, and you had to, you could find out about them, but nobody was going to tell you about them. And my guess is that that continues to be true, but not on anything like the scale it was then. Charlie?

Charlie Munger [03:36:04] Well, I can remember when you bought one membership in some duck club that had oil in under it when you were young.

Warren Buffett [03:36:12] Yeah, there was a company…

Charlie Munger [03:36:13] When you got down to one duck club membership, well, you’re really scavenging for cigar buds.

Warren Buffett [03:36:19] What? Not a bad cigar. But there were 98 shares outstanding. It was the Delta Duck Club, and the Delta Duck Club was founded by 100 guys who put in 50 bucks each, except two fellows didn’t pay, so there were only 98 shares outstanding. They bought a piece of land down in Louisiana, and one time somebody shot downward instead of upward, and oil and gas started spewing forth out of the ground. So they renamed it Atled, which is Delta’s spell backwards, which was sort of illustrated the sophistication of this group.

And a few years later, they were taking up at $3 barrel oil, they were taking about $1 million a year in royalties out of the place, and the stock was selling at $29,000 a share, and it was earning $10,000 a share. No, it was earning about, turning about $7,000 a share after tax, about $11,000 pre-tax, and it had about $20,000 to share in cash, and it was a long lived field. So, you know, I use that sometimes as an example of efficient markets, because somebody called me and offered me a share of it, and those things, you know, is that an efficient market or not? You know, 29,000 for 20,000 of cash plus 11,000 of royalty income and 25 gas and $3 oil? I don’t think so. That, you can find things out there. I’ll give you hunting rights on all my duck clubs in the future. Zone 1.

[03:37:54] Shareholder: Don’t think the mike… How do Berkshire and barsher companies protect themselves against lawsuit-heavy lawyers, and is it possible for American businesses to survive the financial and time-consuming costs of dealing with lawyers?

Warren Buffett [03:38:13] It’s a good question, and we’ve probably had less litigation than any company that, you know, with a $25 billion market value in America. But, but it’s, you know, and we were sued one time at Blue Chip Stamps. What was it for, Charlie, and how many billion? By some guy that lots. Yeah, it was, you know, you cannot protect yourself against lawsuits, and there are, there’s certainly a lot of frivolous ones. We’ve, like I say, we have, it’s not been a drain on our time or money, but particularly time, to date. And I think one thing, yeah, you’d have to do is, if you ran into anything of that sort, you would not pay, and you would make life as, try to make life comparably difficult for the other party as they made it for you. But that has not been our experience so far. Charlie?

Charlie Munger [03:39:15] Yeah, well, I can tell an Omaha story on that one which demonstrates the Berkshire Hathaway technique for minimizing lawsuits. When I was a very young boy, I said to my father, who was a practicing lawyer here in Omaha, why do you do so much work for X, who was an overreaching blowhard, and so little work for Grant McFayden, who is such a wonderful man? And my father looked at me as though I was slightly slow in the head, and he said, Charlie, he said, Grant McFayden treats his employees right, his customer’s right, everybody right. When he gets involved with somebody who’s a little nuts, he gets up from his desk and walks to where they are and extricates himself as soon as he can. And he says, Charlie, a man like Grant McFayden doesn’t have enough law business to keep you in school. Ah, but X, he said, he’s a walking minefield of continuous legal, legal troubles, and he’s a wonderful client for a lawyer. Now, my father was trying to teach me, and I must say it worked beautifully, because I decided that I would adopt the Grant McFayden approach, and I would argue that Warren independently reached the same approach very early in life.

Warren Buffett [03:40:31] Boy, has that saved us a lot of trouble. That is a, it is a good system. You can’t… We basically have the attitude that you can’t make a good deal with a bad person, and you can, and that means you just, we just forget about it. I mean, we don’t try and protect ourselves by contracts or getting into all kinds of, you know, due diligence, or it just, we just forget about it. We can do fine over time dealing with people that we like and admire and trust. So we have never… and a lot of people do get the idea, because the bad actor will tend to try and tantalize you in one way or another, and you won’t win it. It just pays to avoid him. And I, we started out with that attitude, and, you know, maybe one or two experiences have convinced us even more so that that’s the way to, the way to play the game. Zone 2.

[03:41:36] Shareholder (Clarence Cafferty, Long Pine, Nebraska): I’m Clarence Cafferty from Long Pine, Nebraska. I’d like to know if we can get another 400 hitter by starting another Borsheim store someplace in this United States.

Warren Buffett [03:41:48] Well, it’s an interesting question about both the Borsheim’s and the Mart. I mean, they, and of course they’re owned, as you probably know, historically by the same family. I mean, it was Mrs. B’s sister’s family that bought Borsheim’s, but in effect started virtually from scratch. And the, both of those institutions offer this incredible selection, low prices brought about by huge volume low operating costs and all of that. Operating multiple locations, you would get some benefit, obviously, from the name and the reputation, but you would lose something in terms of the amount of selection that could be over… There’s $50 million plus at retail of jewelry at Borsheim’s, one location. Well, when someone wants to buy a ring or a pearl necklace or something of the sort, they can see more offerings at a place like that than they possibly could at somebody who’s trying to maintain inventory at 20 or 50 locations. Similarly, that gives us a volume out of a given location that results in operating costs that, again, can’t be matched if you have an enormous number of locations. So I think those businesses tend to be more successful in that particular mode, as one location businesses.

Now, Helzberg’s will be bringing merchandise to people all over the country at malls, and they will do, through that mode of operation, they perform that exceptionally well. But Borsheim’s can’t be Helzberg, and Helzberg’s can’t be Borsheim’s. They’re both going for two different, in a sense, two different customers, and to some degree. And Sol Price, Charlie’s friend who started the Price Club, the first big wholesale club, said that part of his success was due to figuring out the customer he didn’t want. I think that’s right. Right. Yeah. And you have to figure out what you’re good at, who you really can offer something special to. Borsheim’s offer something very special to people, but in part it comes about through being at one location. You can see more of almost any kind of jewelry you want there than you’re going to see virtually any place in the world, and that will bring people there, or will bring male people there, and that gives you operating costs that are many, 20 percentage points off of what somebody else will be doing without that pulling power. And that, in turn, enables you to offer the lower prices, which keeps the circle going. I mean, it’s very hard to replicate something like that, and trying to do it in 10 spots probably wouldn’t work well. But it’s a question you ask yourself as you go along, obviously. When you, McDonald certainly did well by deciding to open a second store. I mean… Zone 3.

[03:45:08] Shareholder (Frank Martin, Elkhart, Indiana): Warren, I’m Frank Martin from Elkhart, Indiana. You have written extensively on the subject of the immutability of return on equity for American industry as a whole being stuck in the 12% to 13% range. What forces do you see, since we’re above the mean, to cause that number to regress to the mean over time?

Warren Buffett [03:45:30] Yeah, it’s true, it has been higher in the last few years, although Fortune’s got some interesting figures in the current issue on the 500 that shows, decade by decade, what the return has been on the Fortune 500 group, which is a shifting group, of course. And it’s tended to stick, although I would say it was more between 12% and 13% and 11% and 12%, probably, in that one. The return, to some extent, in certain businesses has gotten a big kick because they finally put the health liabilities on the balance sheet and therefore reduce equity. So if you, anything you do that tends to pull down equity, if it doesn’t change your ability to do the same sales value, it’s leveraged American business, in effect, by putting the health, I, liabilities on the balance sheet.

I, I’m, it may be wrong, and maybe the business can earn 15% or so, but I think competitive factors tend to, over time, keep pushing that number down somewhat. And 12% or 13%, when you think about it, is not bad at all. I mean, it’s a level, with 7% interest rates, that allows stocks and equity to be worth much more when employed in equity than elsewhere in the world. But if I had to pick a figure for the next 10 years, I would pick some figure between 12% and 13%, but that doesn’t mean I’d be right on it. Charlie?

Charlie Munger [03:46:57] Yeah, I think all of those published averages overstate what’s earned anyway. They’re the biggest companies, they’re the winners, they’re the ones whose stock sells at high multiples, so they can issue it to other people for high earning assets, and many of the lower turn people are constantly being dropped out of the figures. Now, you can say that was true in the past, too, but it would be remarkable to me if, on average, American business earn 13% on capital after taxes.

Warren Buffett [03:47:32] Those figures, incidentally, isn’t a huge item, but it, but it’s not totally insignificant, they don’t show us the cost, for example, the cost of stock options, and the American shareholders paid that. So the American shareholder has not gotten the returns on equity shown by those numbers. Although it’s not a huge factor, but I wouldn’t be surprised if it was, you know, two or three tenths of a percent just for that one cost that’s omitted.

Charlie Munger [03:48:02] If you let me admit my costs, I can show a very high return on equity.

Warren Buffett [03:48:09] Zone 4.

[03:48:09] Shareholder (Jeff Peskin, New York): Jeff Peskin from New York, and I have a question for you. It’s really more of an observation, in that you’ve written about, when you look at acquiring a business, you look at a lot at how they allocate capital. And my question is, once you acquire stake in a company, do you find that just by the fact that you are helping doing the allocation capital and doing the compensation, that that alone makes a company have a lot higher return? Or is there some benefit by the fact that you own, or some major shareholder owns a big slug of the company, that also allows a company to increase its return on capital?

Warren Buffett [03:48:56] Yeah, well, that’s a good question. The answer is sort of some of the times, some of the places. It’s the, there’s no question, in a business that earns a high rate on capital that doesn’t have natural ways to employ that money within the business, that we actually may contribute significantly to the long-term results of that business by taking the capital out. Because that, if they don’t have a place to use it, nevertheless they might well use it someplace. And we have the whole universe to spread that money over, so we can take the money that earned in some operating business, and we can buy part of the Coca-Cola Company with it and buy into another wonderful business, whereas very few managements probably would do that. So there’s an advantage there.

Now, on the other hand, Helzberg’s, for example, will probably grow very substantially. They’ll probably use all the capital they generate. Maybe they’ll even use more. Well, they don’t really need us for that. I mean, they would have done that under any circumstances. We may actually give them the ability to grow even a little faster, because if a company, and this is not the, these are not the Helzberg figures, but if a company is earning 20% on equity but can grow 25% a year, you know, they’re going to feel equity strains at some point. And we, we’re, we obviously would love the idea of supplying extra capital that would earn 20% on equity. So there can be some advantage to having us as a parent in terms of sending capital to the business as well as taking capital from the business.

We also, I think, can be helpful in some situations in that, once we are there, a lot of the rituals of, particularly in a public company, but a lot of the things that people waste time doing in business, they don’t have to do with us. I mean, they, there’re an awful lot of time spent in some businesses just preparing for committee meetings and directors meetings and all kinds of things like that, show and tell stuff, and none of that’s needed with us. We won’t go near them. And so we really free them up to spend 100% of the time thinking about what is good for the business over time. If they have extra money, they don’t have to worry about what to do with it. If they need extra money for a good business, it’ll be supplied. So there are some advantages that way. And I guess, Charlie, can you think of any further?

Charlie Munger [03:51:24] Yeah, I think our chief contribution to the businesses we acquire is what we don’t do.

[03:51:31] Shareholder: It’s hard to continue to grow at the rate you’ve grown in the past, because the company has gotten so big, and I wonder if you could elaborate a little bit on that. My second question, which is totally unrelated, but I’ve also read where you’re very good with numbers, with working things in your head, and I’m totally a rookie when it comes to economics and accounting and things like that, but I’m very good with numbers and keeping things in my head. And I’m wondering if there’s some way, a mathematician who knows very little about the business world, what I could read or what I could do to learn how better to invest, and how you did that.

Warren Buffett [03:52:16] Well, going to the first question, when you say it’s going to be hard, it’s going to be impossible. I mean, that’s the answer. We cannot compound money at 23% for, from a $12 billion base. We don’t know how to do that, and it would be a mistake for anybody to think that we could come close. That we still, we think we can do okay with money, but the, we did not start with a $12 billion base, and we’ve never seen anybody in the world compound numbers like that at that rate. So we’ll forget it, that part of it, but we’ll, there are intelligent things we can be doing.

The second part of the question, I don’t think, I don’t think any great amount of mathematical aptitude is, I’d have to do, but mathematical knowledge is, advanced math is of no use in the investment process. An understanding of mathematical relationships, sort of an ability to quantify, a numeracy, as they call it, I think that’s generally helpful in investments, because it, something that tells you when things make sense or don’t make sense, or sort of how one, an item in one area relates to something someplace else. But that doesn’t really require any great mathematical ability. It really requires sort of a mathematical awareness and a numeracy. And I think it is a help to be able to see that. I mean, I think Charlie and I, probably when we read about one business, we’re always thinking of it against the screen of dozens of businesses. It’s just sort of automatic.

And, but that’s just like a ball, you know, a scout in baseball thinking about one baseball player against an alternative. I mean, you only have a given number on the squad, and they’re thinking, you know, one guy maybe a little faster, one guy can hit a little bit better, all of that sort of thing. And it’s always in your mind. You were, you are, you’re prioritizing and selecting in some, in some manner. My own feeling about the best way to apply that is just to read everything in sight. You know, I mean, if you’re reading a few hundred annual reports a year, and you’ve read Graham and Fisher and a few things, you’ll soon see whether it kind of falls into place or not. Charlie?

Charlie Munger [03:54:46] Yeah, I think the set of numbers, the ones out of numbers in America that are the best quick guide measuring one business against another, are the Value Line numbers.

Warren Buffett [03:54:59] I’d agree with that. But that stuff on the log scale paper going back 15 years, that is the best one-shot description of a lot of big businesses that exists in America. I can’t imagine anybody being in the investment business involving common stocks without that thing on the shelf. And if you sort of have in your head how all that looks in different industries and different businesses, then you’ve got a backdrop against which to measure. I mean, you know, if you’d never, if you never watched a baseball game and never seen a statistic on it, you wouldn’t know whether a 300 hitter was a good hitter or not. You have to have some kind of a mosaic there that you’re, you’re thinking is implanted against an effect. And the Value Line figures, that, you know, they cycle it every 13 weeks, and if you ripple through that, you’ll have a pretty good idea of what’s happened over time in American business. By the way, I pay no attention to their timeliness ratings or stock ratings or, no, none of that means anything. It’s too bad they have to put that there, but it’s the statistical material, not the…

Charlie Munger [03:56:13] I would like to have that material going all the way back. They cut it off about, what, 15 years back.

Warren Buffett [03:56:20] Yeah, but I saved the old ones.

Charlie Munger [03:56:23] Yeah, well, you know, I wish I had that in the office, but I don’t, you know.

Warren Buffett [03:56:29] Yeah, we, Charlie and I, maybe even I do it more, we tend to go back. And I mean, if I’m buying Coca-Cola, I’ll probably go back and read the Fortune articles from the 1930s on it or something. I like a lot of historical background on things, just to sort of get it in my head as to how the business has evolved over time and what’s been permanent and what hasn’t been permanent and all of that. I probably do that more for fun than for actually decision making, but it, I think, I think it is, I think if you think about, if we’re trying to buy businesses we want to own forever, you know, and if you’re thinking that way, you might as well see what it’s been like to own them forever and look back always. Zone 6.

[03:57:12] Shareholder (Stewart Horejsi, Salina, Kansas): I’m Stewart Horejsi from Salina, Kansas. When you first bought part of Wells Fargo a few years back, I looked at it and I couldn’t tell it was any better than any of the other banks. I think now anybody that would look at it can tell it’s better than almost any bank. Now you’ve bought PNC Bank, and again, I can’t see how it’s distinguished from any of the other banks. What did you see in PNC Bank that made you select it over all the other banks that were available?

Warren Buffett [03:57:42] Well, we’re not going to give any stock advice on that. So I think that, going back to Wells, it was very clear that if you, I knew something about Carl Reichardt, and to a lesser extent at that time, Paul Hazen, from having met him and also from having read a lot of things they said. So they were different. They were certainly different than the typical banker. And then the question was, how much did that difference make in terms of how they would run the place? And they ran into some very heavy seas subsequently, and I think probably the difference, I probably think those human differences that were perceived earlier are what enabled them to come through as well as they did. But that’s about all I can say on, on…

Charlie Munger [03:58:25] We might add to that slightly, because that Wells Fargo thing is a very interesting example. They had a huge concentration of real estate lending, a field in which people took the biggest, there was the biggest collapse in 40 or 50 years in that field. So that if they had been destined to suffer the same sort of average loss per real estate loan that an ordinary bank would have suffered, the place would have been broke. So we were basically betting that their real estate lending was way better than average, and indeed it was, and they also handled it on the way down way better than average. So you can argue that everybody else was looking at this horrible concentration of real estate loans and this sea of troubles in the real estate field and in bankers to the real estate field, and they just assumed that Wells Fargo was going to go broke. And we figured, no, that, but since their loans were way higher quality and their loan collection methods were way higher quality than others, it would be all right. And so it worked out. Probably couldn’t have told that if we hadn’t, if we hadn’t gone a little further, though, then just looking at numbers, we would not have been able to make that decision.

Warren Buffett [03:59:53] Zone 1.

[03:59:54] Shareholder (David Carr, Durham, North Carolina): David Carr, Durham, North Carolina. Tambrands and U.S. Tobacco are two companies which are primarily single focused product companies that seem to possibly have some barriers to growth and unit sales and pricing, and have employed a strategy of returning cash to shareholders through stock repurchases. Both companies have, at times when they thought the stock was at a discount to intrinsic value, use debt to accentuate the repurchases. Those companies recently have talked about problems with going into a negative shareholders, a negative stated shareholders equity position through the use of additional debt to repurchase more shares, at a time when, when that both companies believe their stocks very cheap, and they appear to have the type of long-term cash flow that would at least allow that. Would you comment on the police accounting treatment and the stated shareholders equity, and if you think that should be a real concern for management of those areas?

Warren Buffett [04:00:59] What was the first coming, besides U.S. Tobacco?

[04:00:59] Shareholder (David Carr, Durham, North Carolina): Tambrands.

Warren Buffett [04:01:04] Tam browns? Yes.

[04:01:05] Shareholder (David Carr, Durham, North Carolina): Yes.

Warren Buffett [04:01:05] Yeah, yeah. I don’t think there’s anything magic about whether shareholder equity is positive or negative. The Coca-Cola has a shareholder equity of $5 billion. It has a market value of $75 billion or so. Now, they’re not going to do it, and I’m not going to recommend it, but if they were to spend $10 billion buying in their stock, they would have a negative shareholders equity of $5 billion. They would, their credit would be sound. I mean, if somebody else were to buy the company for $75 billion, they’d have $5 billion of tangible assets and $70 billion of intangible assets. And there is nothing magic about a company having a positive shareholders equity. And it isn’t done very often, and I can’t even think of a case where it’s been done, but it may have been. But I see, I see no, I see nothing wrong with a company having a negative shareholder’s equity, although maybe prohibited by the state in which they’re incorporated in terms of repurchasing shares at a time that would produce that. I, you have to look at the state law on that.

But anytime a company in an LBO or something is bought out at some very large number over book value, in effect they’re creating a negative, if they borrow enough money on it, they’re creating a negative shareholders equity in terms of the previous shareholders equity. It’s just a fiction as to the numbers between the two organizations. That you should buy in your stock when you don’t have a use for the money, and that could be management specific. I mean, some managements might have a use for the money if they, if they’re, if their field of capital allocation were large enough, whereas another management that was more specialized in their own business might not. But once a company has attended to the things that are required or advantageous for the present business, we think re-acquisition of stock is a very logical thing to consider, as long as you don’t think you’re paying more than the intrinsic value of the business in doing it. And obviously, the bigger the discount from intrinsic value, the more compelling that particular use of money is. Charlie?

Charlie Munger [04:03:29] I’ve got nothing to add. Generally speaking, maybe Coca-Cola can have a negative equity, but I don’t think would be a good idea for General Motors. I think there’s something to be said for a positive shareholder’s equity.

Warren Buffett [04:03:44] Zone 3.

[04:03:45] Shareholder (Edward Barr, Lexington, Kentucky): Edward Barr, Lexington, Kentucky. I had a twofold question. Number one, you mentioned American Express earlier, and I was curious as to whether the fact that credit card usage is only 10% of all transactions, and that may continue to grow for some time going forward, was a factor in your decision. And to the other part of the question pertains to the durability and permanence of the banking franchise with regard to alternative delivery channels that may appear over the next few years, including the possibility of the Microsoft Intuit merger.

Warren Buffett [04:04:28] Well, the specific number you mentioned about credit card usage and so on, that’s not a big factor with us. We think, we think credit cards are both here to stay and likely to grow to some extent, although at some point you start reaching limits, at least in terms of outstandings, if people are, that make any sense. But the credit card field is a very big field. The question is who’s got the edge in it, because everybody’s going to want to be in it, and they already are. And there are a lot of different ways you can play the game if you’re in the credit card business, and you better have some way of playing one part of the game, preferably a large part, but you better have some way of playing one part of the game better than others, or natural capitalistic forces are going to grind you down.

I mean, it’s a business that people are willing to change their minds about what they do in. I mean, if they, if you offer somebody a credit card that gives them some advantages that don’t exist on the earlier card, people are quite willing to shift cards. So you need some kind of an edge in some particular segment of the market. So the growth aspects over all of the market were not a big, are not a big factor with us. It’s really a question figuring out who’s going to win what game and who’s going to lose what game. And what was the second question again?

[04:06:04] Shareholder (Edward Barr, Lexington, Kentucky): On that second question, pertain to the permanence and durability of the banking franchise.

Warren Buffett [04:06:10] Oh, yeah, sure.

[04:06:11] Shareholder (Edward Barr, Lexington, Kentucky): And whether alternative delivery channels over the next few years may erode the durability of that, including the Microsoft Intuit larger.

Warren Buffett [04:06:19] That’s a good question. You’re certainly seeing the value of bank branches diminish significantly, and used to be a point of enormous pride with managements, and how many man branches they had, and it was, you know, often political influence and everything else was called into, to obtaining branch permits. And the world will change in banking, probably in some very major ways, over a 20 or 30 year period. Exactly what players will benefit and which ones will be hurt, you know, is a very tough question. But I would, I would expect, I would not, I don’t think I like, I’d expect a really significant change in banking over the next five years, but I certainly expected over the next, the next 20 years. And there are a lot of people that have their eye on that market, including Microsoft, as you mentioned. It may be to their advantage to hook up with the present players. I mean, I know it’s certainly something that gets explored, but they may figure out a way to go around the present players, too, and that’s one investment consideration. Charlie?

Charlie Munger [04:07:32] Yeah, the interesting player that went around the rest was Merrill Lynch. Merrill Lynch went heavily into banking with its cash management accounts, and I don’t think it’s the only innovation that’ll come along. What’s the name of that book? You know, I’ve forgotten. That’s a marvelous… there’s a great… baby Molly remembers. What was that book you gave me? It was the history of the credit card.

Warren Buffett [04:07:59] Was it Joe Nocera’s, or… Yeah, Joe Nocera was the author. I don’t remember the title, but it came out about six months to a year ago. It’s a terrific history of the credit card business, and you, if you read that, you will get some idea of the amount of change that it can occur in something like, you know, the movement of money. And my guess is that if there’s another edition of it in 20 years, there’ll be plenty more to write about.

Charlie Munger [04:08:26] So, by the way, that is a fabulous book. Most of the people who are here will not be able to put it down. I mean, for a book about an economic development, it captures the human background in a very interesting way.

Warren Buffett [04:08:45] Zone 4. That seems far over there for his own dream. Yeah.

[04:08:50] Shareholder (Adam Angle, Boulder, Colorado): I would, I was, Adam Angle from Boulder, Colorado. I was wondering if you could comment on the moat you see around the castles of SunTrust and PNC.

Warren Buffett [04:09:04] Well, I don’t think I should comment on anything on specific holdings like that. But so I would, I would say you would look at those in a general way very much as you look at banking operations first. Then you try and figure out what are the specific strengths or weaknesses of both organizations. But there again, I don’t want to spoil the fund for you. Charlie?

Charlie Munger [04:09:30] Nothing to add.

Warren Buffett [04:09:32] Zone 5.

[04:09:32] Shareholder (Bob McClure, Singapore): My name is Bob McClure. I’m from the States, but I live in Singapore. About a week ago, in the Asian Wall Street Journal, a remark was attributed to Mr. Munger, specifically that owning Salomon Brothers was like owning a casino with a restaurant in the front, the casino alluding to the proprietary trading, and the restaurant to the so-called client-driven business. If that attribution is correct, or accurate, can you, well, I don’t, elaborate on why you view the business in that way?

Charlie Munger [04:10:12] I don’t think it’s entirely correct, but I have a pithy way of speaking on occasion, and I frequently speak in a way that works with an in-group but wouldn’t necessarily work everywhere else. And every once in a while, when you take one of those wise ass comments out of context, do I, I very much wish that it hadn’t occurred. This was such a case.

Warren Buffett [04:10:48] It won’t stop him in the future, though.

Charlie Munger [04:10:54] Or me.

Warren Buffett [04:10:55] Zone 6. Where are we? In 5? Which one are we in? Kelly here?

[04:11:03] Shareholder (Randall Bellows, Chicago): Mr. Buffett, I’m Randall Bellows from Chicago, and the two questions I have, since you’re answering questions so far afield, are: if you were to look at the balance sheet of the United States of America, is the national debt as frightening as that it appears to be? And secondly, in terms of redeployment of capital, if Coca-Cola is such a wonderful investment, has returned so much, why not redeploy some capital in purchasing additional shares of Coca-Cola? And finally, thank you for letting Jane do that portrait of you, and if it’s good, we’ll do Mr. Munger next. Thank you.

Warren Buffett [04:11:47] First question, about the U.S. balance sheet. That the net national, that is about, it would be about 60 odd percent of GDP.

Charlie Munger [04:11:58] Without counting unfunded pensions.

Warren Buffett [04:12:00] Yeah, but that’s, but also with a claim on the income, in effect, of future citizens, which all was an asset too, that you could set up the… But that figure, I think, at the end of World War II may have been, I know it was around at least 125%, may have been 150% or so of GDP. So we have sustained, now interest, the interest rate on that debt was much lower. A lot of it was a 2.9%, because that’s what savings bonds paid. But that level of debt, which I don’t advocate, in relation to GDP, turned out to be quite sustainable. As a matter of fact, it drifted down year after year for a long time, until the early ’80s, when it started rising again. And now it’s actually fallen a little bit in the line, the ratio of debt to GDP. There are a lot of measurements of how much debt is too much and all of that, is too much and all of that, but probably, I think that if I had to look at one single statistic, I would look at that ratio of, just like I would look at a ratio of debt to income for an individual. Then you’d get into the question of the stability of the income and to whom it is owed.

But I do not think that the level of debt relative to the economy is of anything that’s of a frightening nature. I like the idea of it trending downward a little bit over time rather than trending upward, and if it keeps trending upward, it can get awkward. Although it’s, I think in Italy it’s close to 150% now, and you start getting to 150% and talk 8% interest rates, and you’re talking 12% of GDP essentially going to interest. The, if you were to put a balance sheet of the country together, it’s kind of interesting, because you would have this $4 billion of net debt on the liability side, and you’d also have a lot of pension obligations, as Charlie mentions, on the liability side. But you got a lot of assets, too. You’ve got a 35% interest, profits interest, in all the American corporations. I mean, the government, if it has a 35% tax rate, really owns 35% of the stock of American business. They own a significant part of Berkshire Hathaway. We write them a check every year. We don’t write you a check every year, but we write them a check. We plow your earnings back to create more value for their stock, with the, in other words, the taxes. They are trying to cheer these people up.

But what would you, what would you pay to have the right today to receive all the future corporate tax payments made by all the companies in the United States, the discounted value of? You pay a very big number. What would you pay to have a right to take a percentage of the income of every individual that makes more than X in the United States, and also the right to change your percentage as you went along? That’s a very big number, too. So you’ve got a very big asset there, that, and you’ve got some very big liabilities, too, but the country is very solvent. And I would not like to see debt rise at any rapid rate. I wouldn’t like to see a rise at all, but I wouldn’t like to see it particularly at rise at a rapid rate, because that sets a lot of things in motion, if it’s rising as a percentage of GDP. But if you tell me that 20 years from now the national debt will be $10 trillion, but that it’ll be the same percentage of GDP, does that alarm me? Not the least. I mean it. So I expect it to increase, and I think there’s some arguments why, even why it may be advisable to have it increase, but I don’t think it’s a good idea to have it take up more and more of your income, because that sets a lot of other things in motion. So I welcome what’s happened in the last couple years, which is to see a decrease, modestly, from the trend that existed the previous 10 or 12 years. Charlie?

Charlie Munger [04:16:47] Well, generally, I think that you’re right, that it isn’t all bad, and to the extent that it is bad, a great nation with a capitalistic economy will stand quite a bit of abuse from the political side. It’s a damn good thing, too. Because I don’t think we should be terribly discouraged. If there’s anything that’s really going to do the country, and it’ll be what I call a Serpico effect, where you start rewarding what you don’t want more of, and it just grows and grows and grows.

Warren Buffett [04:17:21] Yeah, but I don’t think that’s necessarily a bad fiscal result, it’s just a bad result. Berkshire owes $700 or $800 million or whatever it is now, and that, then we have another $3 billion, so I’m a float. You know, those numbers would have sounded very big to me 25 years ago, and yet, you know, we’re one of the most conservatively financed operations you’ll find. Ten years from now, we may owe more money, and maybe a smaller percentage still. I mean, you can’t talk about debt levels without relating it to the ability to pay debt, and this country is probably in better financial shape now than it was in 1947. Zone 1.

Charlie Munger [04:18:00] But there was a second, was there a second question?

Warren Buffett [04:18:04] I didn’t answer on the internet… Oh, in terms of repurchasing shares, right.

Charlie Munger [04:18:09] No, you said why don’t we buy more.

Warren Buffett [04:18:12] Well, we think about it, but we did not… yeah, we did, we bought more last year. And it’s not a bad measuring stick against buying other things. That there’s, we, I would not rule out Berkshire buying more. I don’t have any plans to do it right now, but I wouldn’t rule that out at all, because it’s, if I’m going to look at another business, I will say, you know, why would I rather have this than more Coca-Cola?

Charlie Munger [04:18:42] Well, there he’s saying something that is very useful to practically any investor, when he said use this as a measuring stick in terms of buying other things. For an ordinary individual, the best thing you have easily available is your measuring stick. If it isn’t, if the new thing isn’t better than what you already know is to as available, it hasn’t met your threshold. Then that screens out, you know, 99% of what you see, and it’s an enormous thought conserver. And it is not taught in the business schools, by and large.

Warren Buffett [04:19:22] No. And that’s why we think it’s slightly nuts when big institutions decide, because everybody else is doing it, to put 4% of their money in international equities, or 3% an emerging growth country, some damn thing like that. I mean, it, that the only reason to put the money in there is that they measured against what they’re already doing. And if they measure against what they’re already doing, and they think it’s a screamingly good idea to leave 97% in the other place and put 3% in, you know, I mean, that, it just doesn’t make any sense whatsoever. But it’s what committees are talked to about, and what keeps investment managers going to conferences and everything. So they’re deliberately using a technique that takes away the best mental tool they have.

Charlie Munger [04:20:07] You can say this is nuts, and you’re right. And I think Nietzsche said it pretty well when he said he laughed at the man who thought he could walk better because he had a lame leg. I mean, they literally are blinding themselves, and then they’re teaching our children how to do this in our own business schools. Very interesting, don’t you think? And what all Warren says is, deciding whether to do something, just compare the best opportunity you have. If that one is better and you’re not taking it, why would you do this just because somebody tells you you need 2% in international equities?

Warren Buffett [04:20:50] Zone 1.

[04:20:51] Shareholder (Mark Wheeler, Portland, Oregon): Hi, my name is Mark Wheeler. I’m from Portland, Oregon, and I have a few eggs in your basket. My grandmother always said don’t put all your eggs in one basket. I have a question. I think you answered this a couple years ago in one of your reports, about a Little Abner’s investment approach. Suppose I had $100,000 and I decided to buy four or five more of your shares, and that was sort of a buy and hold thing for four or five years. And also I have a money manager, I’ve already got one, and he does pretty well, 10%, 15%, but he churns the assets all the time. You know, every time I turn around, all this mailbox full of paperwork. I guess my question is, how can I arrive at which is a better deal for me? In other words, to buy Berkshire, which I like, and obviously I’m here, so I’m interested in it, or hang on to my money manager, who just seems to be churning the hell out of the account?

Warren Buffett [04:21:55] Well, better have a broker turning the hell out of the account. He had a little less incentive if he’s getting a management fee. But I can’t answer your question as to which decision you should make in that case. But I had, I would say that if, you’re right in the sense that if you buy Berkshire, you should only think about buying it for a very long period of time. I mean, we have no idea what Berkshire is going to do, either intrinsically or in the market, in the next year. And frank, you know, we don’t, we care about the intrinsic part of it. We don’t care about the market aspect. We do care about building in intrinsic value. And, you know, in the end, we don’t think, when we own Berkshire, we don’t think of all our eggs being in one basket. I mean, because we have got a lot of good businesses.

But, but in, if you’re talking about some, you know, lightning from some place, huge, the huge liability suit or something like that hitting one corporate entity, we’re one corporate entity. But if you think about it in terms of the business risk implicit in an entity, we have a lot of different good businesses. In fact, we probably have as decent a collection of good businesses as any company I can, I can think of. But your money manager will also undoubtedly have the advantage of working with, probably, with smaller sums, too, and that gives them a bigger universe of opportunity. We’re not set up tax-wise perfectly as compared to an individual working with their own capital. We’re set up tax-wise fine for somebody’s going to sort of own it forever, but we’re not, we’re not set up…

Charlie Munger [04:23:36] Nothing to add.

Warren Buffett [04:23:42] Zone what? Hope back there?

[04:23:44] Shareholder (Jeff Johnson, Tulsa, Oklahoma): I don’t think it’s on. Okay. I’m Jeff Johnson. I’m grateful to be here from Tulsa, Oklahoma. I have two questions. First, I was hoping you could explain, or offer an opinion, as to why investors in property casualty insurance companies are willing to accept traditionally below average type of returns. Second question relates to an answer you gave me yesterday, that being that intuition or gut feeling has nothing to do in your, in making investment decisions. I was wondering if there is anything subjective in yours and Mr. Munger’s assessment of whether or not you like someone, and how it is that you determine whether or not you like the lord of the castle.

Warren Buffett [04:24:33] Well, I don’t know. Charlie, you want to answer the second part?

Charlie Munger [04:24:39] Well, we spoke about agency costs, and there are two different kinds of agency costs. One, the guy favors himself at the expense of the shareholders, and the other is he’s, he does foolish things, or he’s not trying to favor himself, he just is foolish by nature. Either way, it’s very costly to you as the shareholder. So you’re, you have to judge those two aspects of human character, and they’re terribly important. And on the other hand, there are some good businesses so good that they’ll easily stand a lot of folly in the managerial suite.

Warren Buffett [04:25:24] And I, much as we like perfect people, I don’t think we’ve always invested with them. But generally, we like, we like, we like people who are candid. We can usually tell when somebody’s dancing around something, or whether, when the reports are essentially a little dishonest or biased or something. And it’s just a lot easier to operate with people that are candid. And we like people that are smart, you know, that, then, I don’t mean geniuses, but… And we like people who are focused on the business. It’s not real complicated. But we generally, you know, there may be a whole bunch of people in the middle that we don’t really have any feeling on one way or the other, and then we see some that we know we don’t want to be associated with, and some that we know we very much enjoy being associated with. Averaged out, we’ve been very fortunate, very lucky.

And your other question, you said, why is it that these investors accept below average results? Well, in the nature of things, approximately half the investors are going to get below average results. They didn’t exactly accept it in advance. It’s just the way it turned out. And the money tends to be fairly captive once it’s in a company. It takes a lot, if you have a business that gets subnormal returns over time, it, there’s a big threshold in terms of either a takeover or proxy fight or something like that to unleash the capital. So money that’s tied up in an unprofitable business, or a sub-profitable business, is likely to stay tied up for a good period of time. Eventually something will probably correct it, but capitalism does not operate so efficiently as to move capital around promptly when it’s misallocated. We are in a better position to do that when Berkshire owns the company, and obviously we’re in no position to do it, because it involves something we don’t want to do, if we own it through some other, in some other enterprise. We just sell to somebody else who takes another, takes our chair at the table, in effect. Zone 3.

[04:27:46] Shareholder (Philip King, San Francisco): Hi, Philip King from San Francisco. I’ve got another question about valuation, more specifically the relation of P/Es to interest rates. I understand that you don’t want to lay down a rigid formula for valuation, but I also know that you don’t want people to think that a multiple of 20 times earnings is cheap or a multiple of five times earnings is expensive. So Benjamin Graham, he devised a central value theory that valued the average stock at an earnings yield that’s about a third above bond yields. In other words, that would work out to maybe 11 times earnings currently. And I know that you’ve compared the average business to a 13% bond that’s worth roughly book at 13% interest rates and worth perhaps roughly twice book at 6% interest rates. So, given current interest rates of 7% to 8%, as they are now, that would tend to imply that stocks are worth perhaps 12 to 13 times earnings. And yet the acquisitions that I’ve seen in the private market have gone out at more like 17 to 20 times earnings. And I’d like to know, what do you think is the rough range of multiples that make sense?

Warren Buffett [04:29:01] Yeah, well, it isn’t a multiple of today’s earnings that is primarily determinative. Things we, we bought our Coca-Cola, for example, in 1988 and ’89, on this stock, at a price of $11 a share, which, as low as 9, as high as 13, but it averaged about $11. And it’ll earn, we’ll say, most estimates are between $2.30 and $2.40 this year. So that’s under five times this year’s earnings, but it was a pretty good size multiple back when we bought it. It’s the future that counts. It’s like what I wrote there, what Wayne Gretzky says, to go where the puck is going to be, not where it is. So the current multiple interacts with the reinvestment of capital and the rate at which that capital is invested to determine the attractiveness of something now.

And we are, we are affected in that valuation process to a considerable degree by interest rates, but not by whether they’re 7.3% or 7.0% or 7.5%. But I mean, we will be thinking much differently if they’re, long-term rates are 11% or 5%. And, but we don’t have any magic multiples in mind. We’re thinking we want to be in the business that 10 years from now is earning a whole lot more money than it is now, and that we will still feel good about the prospects of the business at that time. That’s the kind of business we’re trying to buy all of, and that’s the kind of business that we try and buy part of, and then sometimes we buy others, too. Charlie?

Charlie Munger [04:30:50] We don’t do any of that rigid formulaic stuff. There’s a general framework that you can call a formula in our mind.

Warren Buffett [04:31:03] About that, we would act calculation in terms of the equation. When we bought Coke in ’88 and ’89, we had this idea about what we thought the business would do over time, but we never reduced it to making a calculation. Maybe we should, but I mean, it just, it just, we don’t think there’s that kind of precision. We think, we think it’s the right way to think, in a general way, and we think if you try to, if you think that you can do it to pinpoint it, you’re kidding yourself. And therefore we think that when we make a decision, there ought to be such a margin of safety that it ought to be so attractive that you don’t have to carry it out to three decimal places. We’ll take a couple more, and then we’ll have to leave. We’ve got directors, we have one director’s meeting a year, and we don’t want to disappoint them. Zone 4.

[04:31:56] Shareholder (Roy Christian, Aptos, California): Yes, I’m Roy Christian from Aptos, California. I wanted to ask one question about USAir, which has not been questioned much of this meeting. When you were on television talking about the losses there, it was funny how so many of my friends, or maybe acquaintances, came forward to tell me this piece of startling news, and, you know, I tried to stand up for you a little bit, and…

Warren Buffett [04:32:21] It was a mistake. You should have just taken a dive.

[04:32:26] Shareholder (Roy Christian, Aptos, California): Well, at least I wanted to point out to you that you did have dividends over a period of about five or six years, and that that money was reinvested, maybe at a better return than the USA or so, that it wasn’t quite the disaster that was pictured on television when you spoke about it, or the impression that all my friends, or I shouldn’t call them acquaintances, pointed out to me. Just a comment, I guess, is what I’m asking for.

Warren Buffett [04:32:52] Yeah, well, you’re right, it could have been worse, but it was a mistake. But we, we received five years, right? I guess. Yeah, be five years of dividends at a good rate while we got it. But, but it’s like somebody says, it isn’t the return on principal that you care about, it’s the return of principal. And we, but we’re better off, we’re a lot better off, obviously, than if we bought the common, and we’re even better off than we bought some other stocks, but it was still a big mistake on my part.

But just keep standing up for me, I need all the help I can get on this one. Zone 5.

[04:33:41] Shareholder (Chris Stavrou, New York): Hi, I’m Chris Stavrou from New York. Charlie, in addition to Warren, are there any books that you’ve been reading that you’d recommend? I know you’re a fan of Bertrand Russell. Any favorite one or two of his books?

Charlie Munger [04:33:56] Been a long time since I read those, though. I mean, I read a lot of Russell, but I did that a lot.

Warren Buffett [04:34:04] He hasn’t written much in the last 10 or 15 years, Charlie.

Charlie Munger [04:34:08] There’s a textbook which is called, I think, Judgment and Managerial Decision Making, and it’s used in some of the business schools, and it’s actually quite a good book. It’s not sprightly, it’s not written in a sprightly way that makes it fun to read, but there’s a lot of wisdom in it. It’s something like Braberman, or, but it’s Judgment and Managerial Decision Making.

Warren Buffett [04:34:30] Since taking up computer bridge, which is 10 hours a week, it’s really screwed up my reading. It’s a lot of fun, though. Zone 6. So we’ll take a couple more, and then we’ll…

[04:34:43] Shareholder (Dick Leighton, Rockford, Illinois): Yes, I’m Dick Leighton from Rockford, Illinois. This is the first annual meeting that I’ve attended, and it’s been very beneficial to me. I’ve been extremely impressed with the number of people here, but even more so with the number of young people who have come. And I would like very much to be able to bring my grandchildren as shareholders, but I find it difficult to get shares into their hands with the current per unit…

Warren Buffett [04:35:13] That’s the nicest introduction to the stock split question we’ve had. It really is, too.

[04:35:19] Shareholder (Dick Leighton, Rockford, Illinois): I thought you would appreciate that. Obviously, you understand the question. I understand the position you’ve taken over the years and the fact that it adds no value to make the split. In this case, however, it could be a tax savings to many of us who would like to get stock shares into the hands of other family members. Should I just go to work on my congressman to change the tax code, or would you consider a change?

Warren Buffett [04:35:47] Well, that’s a very valid question. And there’s certainly a couple of areas, one of which you’ve just mentioned, and I had someone else mention to me that it didn’t work well in terms of using the Berkshire, although I think they could sell it and then pay out a percentage of it. But there are certain aspects, primarily of gifting, where it is anywhere from awkward to disadvantage, disadvantageous, to have the price per share on a stock that exists with Berkshire. And, you know, we’re aware of it. We’ve thought about it, and we’ve got our own personal situations, even, sometimes that are involved in that. I’ve got one in the family that, which we’ve worked, figured out ways around.

The disadvantage, of course, is that, is that you saw a little, even earlier this year, of what a book can do, or we want to attract shareholders who are as investment oriented as we can possibly obtain, with his long-term horizons. And to some extent the publicity about me is negative in that respect, because I know that if we had something that it was a lot easier for anybody with $500 to buy, that we would get an awful lot of people buying it who didn’t have the faintest idea what they were doing, but heard the name bandied around in some way. And secondly, to the extent that ever created a market that was even, that was stronger, you then would have people buying it simply because it was going up. We got a little bit of that going on this year. There are a lot of people that are attracted to stocks that are going upward. Doesn’t attract us, but it attracts the rest of the world to some degree.

So we, we are almost certain that we would get, we just, we don’t know that, we don’t know the degree to which it would happen. We were almost certain we would get a shareholder base that would not have the level of sophistication and the synchronization of objectives with us that we have now. That is almost a cinch. And what we really don’t need in Berkshire stock is more demand. I mean, that is not, we don’t care to have it sell higher except as intrinsic value grows. Ideally, we would have the stock price exactly parallel the change in intrinsic value over time, because then everybody would be treated fairly among our shareholders. They would all gain, just, or lose, as the company gained or lost over their ownership period. And anything that artificially stimulated the price in one period simply means that some other period shareholders are going to just be disappointed. I mean, if we don’t want the stock to sell at twice intrinsic value or 50% above intrinsic value, we want the intrinsic value to grow a lot.

But, and I don’t think there’s any question but that we would get a worse result in that aspect if we introduce splits in, because then people would think about other possibilities that might give the stock a temporary boost. We had a tabulation in Business Week a couple of months ago on turnover on the exchange. We were, well, those are people are simply, you know, their shareholders leaving frequently been, and new shareholders coming in with shorter term anticipations. We wanted this to be as much like a private partnership as we can have, with everybody having the ability to buy it at… We don’t think the minimum investment is too high, that, in this investment world. I mean, all kinds of investment opportunities that are limited to $25,000 or $50,000 and that sort of thing. But the problem of making change, you know, in terms of gifts, or, you know, that I wish I had a better answer for, because I think that is a… That is, my grandchildren pay me the difference between $20,000 and the current price, and I think that’s a very reasonable way for them to behave, particularly when they are, sometimes are only six weeks old.

Yeah, you need, you need a spouse’s consent to make it to work with 20, obviously. But it, they’re, most of the things can be solved, but I’ll admit it isn’t as easy to solve as if we just had a stock denominator than a lower dollars per share. I do think that once you get a shareholder base that is, has got, that has different objectives or expectations or anything, you can’t get rid of it. I mean, you could, you can keep, you can keep your shareholder base like Berkshire, but you can’t reconstruct it if you destroy it in some way. And it’s important to us who we’re in with. I mean, it enables us to, I think, I think it helps us in our operation. I think it even may, in some cases, it may even help us in acquisitions, in terms of who we attract. It may, it, for all I know, it may hurt some place, too, that I don’t know about, but I don’t think so, because I think we can design, particularly with a preferred stock, we can design something to satisfy somebody who might have in mind a different denomination security.

Charlie Munger [04:41:24] Look around you. Are we really likely to do a lot better? This is a good bunch.

Warren Buffett [04:41:31] That may be a good question to end on. And I appreciate it. I appreciate all of you coming, and we’ll see you next year. Thank you.