Berkshire Hathaway Annual Meeting 1997 Transcript

Warren Buffett [00:00:00] (Applause) Foreign. I’m Warren Buffett, the chairman of Berkshire Hathaway. As you probably have gathered by now, I had a real problem last night. I was losing my voice almost entirely. I don’t want you to think I lost it cheering for myself this morning here, that… I think I’ll do all right, but we’ve always got Charlie here too. He’s always done the talking, I just moved my lips, you know.

So I’d like to tell you a little bit about how we’re going to conduct things, and then we’ll go through a script that was written by the speechwriter for Saddam Hussein. It has all the warmth and charm and participatory elements you’d expect. We’ll get through the business of the meeting as promptly as we can, which is usually about five or six minutes, and then Charlie and I will answer questions, your questions, until noon, when we’ll have a break for about a half an hour. There’s food outside all the time. And then at 12:30, we’ll reconvene, and we’ll go till 3:30 or thereabouts, and I hope my voice lasts. We’ve got various non-Coca-Cola products here that designed to keep it going.

We’ll have a zone system where we have 12 microphones placed around, and I believe it’s 12, and we’ll just go around in order. And if you’ll go to the microphone nearest you, there will be someone there who will try to arrange the people get to ask questions in the order in which they arrived, and we’ll make sure that everybody gets a chance to ask your questions before people go on the second questions.

Particularly in the afternoon, we’ll make a special effort to answer the questions from people that have come from outside North America. We really got quite an attendance today. We all 50 states, at least in terms of tickets, all 50 states are represented. We had, I had it here somewhere, yeah, we had ticket requests at least, and I met a number of people from South Africa, Australia, Brazil, England, France, Germany, Greece, Hong Kong, Ireland, Iceland, Israel, Saipan, New Zealand, Saudi Arabia, Singapore, Sweden, Switzerland. So when people have come from that sort of distance, we want to make sure that they, obviously we want to make sure that they particularly get their questions answered.

Interestingly enough, we have a, an increased percentage from last year who come from Nebraska this year, and you have to be a little careful in interpreting that, because some people, for status reasons, they, you know… So make them produce their driver’s license if they tell you they came from Nebraska. I think that’s most of the preliminary.

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

Also with us today are partners in the firm of Deloitte & Touche, auditors. They are available to respond to appropriate questions you might have concerning their firm’s audit of the accounts of Berkshire. To Forrest Krutter, Secretary of Berkshire, he will make a written record of the proceedings. Ms. Becki Amick has been appointed an inspector of elections at this meeting. She will certify to the count of votes cast in the election of for directors. The name the proxy holders for this meeting are Walter Scott Jr. and Marc B. Hamburg.

Proxy cards have been returned through last Friday representing 1,012,050 Class A Berkshire shares and 645,940 Class B Berkshire shares to be voted by the proxy holders as indicated on the cards. That number of shares represents quorum, and will therefore procedure directly proceed with a meeting. We will conduct the business of the meeting and adjourn the formal meeting. After that, we will entertain questions that you might have.

First order business will be a reading of the minutes of the last meeting of shareholders, and I recognize Mr. Walter Scott Jr. will place the motion before the meeting. Do I hear a second? We got a second. The motion has been moved in second. Are there any comments or questions? We will vote on this motion by voice vote. Those in favor say aye. Opposed, say, I’m leaving. The motion is carried.

Does the Secretary have a report of the number of Berkshire shares outstanding, entitled to vote and representative?

FKForrest Krutter [00:06:10] Mail for all shareholders of record on March 7, 1997, being the record date of this meeting, there were 1,025,078 shares of Class A Berkshire Hathaway common stock standing in Insurance count to one vote a motion is considered at the meeting, and 815,015 shares of Class B Berkshire Hathaway common stock outstanding, with each year in 2012 emotionally considered at the meeting. Of that number, 1,012,050 Class A shares, 645,945 B shares are representative by which proxies returned through last Friday.

Warren Buffett [00:06:48] Thank you. To shareholders present who wishes to withdraw proxy previously sent in and vote in person on the election of directors, he or she may do so. Also, of any shareholder that is present has not turned in a proxy and desires a ballot in order to vote in person, you may do so. If you wish you do this, please identify yourself to meeting officials in the aisles who will furnish a ballot to you. With those personal so that we may distribute them. Okay.

The one 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. [00:07:39] Chace III, Charles T. Munger and Walter Scott Jr. be elected as director.

Warren Buffett [00:07:44] It sounds good to me. Is there a second? It has been moved in second with a Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace III, Charles T. Munger and Walter Scott Jr. be elected as directors. Are there any other nominations? Is there any discussion? My kind of group. The nominations are ready to be acted upon. If there are any shareholders voting in person, they should now mark their ballots on the election of directors and allow the ballots to be delivered to the inspector of elections. I think we had one or two to collect there. Would the proxy holders please also submit to the inspector of elections ballot on the election of directors, voting the proxies in accordance with the instructions they have received. Ms. Amick, when you are ready, you may give your report.

BABecki Amick [00:08:34] Through last Friday cast not less than 1,015,697 and 2,300 votes for each nominee. That number are exceeds the majority of the number of the total votes related to all Class A and Class B shares outstanding. The certification required by Delaware law of the precise counter to vote, including the additional votes to be cast by the property holders in response to proxies delivered at this meeting, as well as those cast in first Memphis meeting, if any, will be given to the secretary to be placed with the minutes of this meeting.

Warren Buffett [00:09:15] Thank you, Ms. Amick. Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace III and Charles T. Munger and Walter Scott Jr. have been elected as directors. After adjournment of the business meeting, I will respond to questions that you may have that relate to the business of Berkshire but do not call for any action at this meeting. Does anyone have any further business to come before this meeting before we adjourn? If not, I recognize Mr. Walter Scott Jr. to place a motion before the meeting.

Second. Motion to adjourn has been made in second. We will vote by voice. Is there any discussion? If not, all in favor say aye. Opposed? I know. The posts, I know. The meeting is adjourned. (Applause)

A very good group. You know, in that movie they said something about $350,000 an hour, and I see you’re conserving your money here by holding this thing right along. Now we’re going to answer questions, and if you’ll just go to the nearest microphone, and let’s see where we start here. I’m just orienting myself to a map here, and we have, area one is right here. I might describe this ahead of time. We have six areas on the main floor and we have six areas throughout the balcony, and they sort of work their way back, one through six, and then seven starts over here and then it works its way around to 12. We look forward to having questions, tougher the better, and if you always would just identify yourself and where you’re from and that you’re a shareholder. Yes, sir.

[00:10:56] Shareholder (Tom Conrad, McLean, Virginia): My name is Tom Conrad, and I’m from McLean, Virginia, and I’m a shareholder. And I asked a question last year, Mr. Buffett, to you. I was struck with what you said, that it takes only three quality companies to be, to invest in and set for a lifetime. And I asked you the question, should, last year, should I wait until the market goes down, or should I get in now? And you advise to get in now. And the three companies that I chose were Coca-Cola, Gillette and Disney, and because of that advice, I was able to afford the ticket to come back this year to ask them a second question. My question is this…

Warren Buffett [00:11:32] You ought to quit wager I had. But go ahead.

[00:11:38] Shareholder (Tom Conrad, McLean, Virginia): McDonald’s, man, I said. I just wanted to ask you, it has the same ability to dominate the way Coca-Cola and Gillette has? And secondly, you feel that if the answer is yes, that I should wait until the prices comes down a bit or get in now? And that’s my question.

Warren Buffett [00:12:05] Yeah, would you like it to the eighth of a pointer? Yeah, shall we round off the… We, in the annual report, we talked about Coca-Cola based business being what I call the inevitables. And but that, that reluctant product, oh, would you let it doesn’t extend every necessarily everything they do, but fortunately in both those companies those are very important products.

I would say that in the food business you would never get the total certainty of dominance that you would get in products like Coca-Cola and Gillette. People move around in the food business, from where they eat from. They may favor McDonald’s, but they will go to different places at different times. And somebody starts shaving with a Gillette Sensor Plus is very unlikely to go elsewhere, in my view. And so they do not, you just, you never would get in the food business, in my judgment, quite the inevitability that you would get in the soft drink business with a Coca-Cola. You’ll never get it again in the soft drink business. I mean, it took 100, I guess, the 1886, so they get to the point where they are, and the infrastructure is incredible.

And so I wouldn’t put it quite in the same class in terms of an availability. That doesn’t mean it can be a better stock investment depending on the price, but you’re not going to get the price from me, and knowing Charlie, I doubt if you get the price. Remember, we’ll give them a chance. He’s breathing, folks, he’s breathing. We’ve got this down to a routine, so…

Charlie Munger [00:14:05] I have nothing to add.

Warren Buffett [00:14:08] I didn’t have anything to say either, I just took longer. How about area two?

[00:14:18] Shareholder (Pete Banner, Boulder, Colorado): Mr. Buffett, my name is Pete Banner, and I’m from Boulder, Colorado, and I’m a shareholder. Recently Mr. Greenspan made his comments about exuberance, and it wasn’t long thereafter that you came out in the annual report and the major comments that you felt the market was fully valued or something of that nature. Did you have, or have you had, any communication with Mr. Greenspan regarding the valuation of the stock market?

Warren Buffett [00:14:55] Now, the answer to that is no. I have, the last time I, well, I can’t remember precisely when the last time I saw Alan Greenspan with, it was a long time ago, that we had one conversation today of the Salomon crisis. And he was formerly on the board of Cap Cities before he took his job with the Fed, and Cap Cities/ABC, so I knew him then. But, you know, it’s very hard to understand what Alan says sometimes, so there’s not much sense talking to him. I mean, they, he’s very careful about what he says.

But I should, I’m glad you brought up the subject of the annual report, because it, what I was doing in the annual report is I had talked about Coke and Gillette as being the inevitables and what wonderful businesses they were. And I thought it appropriate, particularly the report goes to a lot of people, that they would not take that as an unqualified buy recommendation about the companies, because they’re absolutely wonderful companies run by outstanding managers, but you can’t pay too much, at least in the short run, for businesses like that.

So I thought it was only appropriate to point out that no matter how wonderful a business it is, that there always is a risk that you will pay a price where it will take a few years for the business to catch, or for this, for the business to catch up with the stock, that the stock can get ahead of the business. And I don’t know where that point is with those companies or any other companies, but I did say that I thought that the risks were fairly high that that situation existed with most securities in the market, including companies such as inevitable. But it was designed to be sure that people did not take the remarks that I made about those companies and just take that as an unqualified buy recommendation, regard, regardless of price. We have no intention of selling those two stocks. We wouldn’t sell them if they were selling at prices considerably higher than they are now.

But I didn’t want particularly relatively unsophisticated people to see those names there and then think this guy is just outing these, is a wonderful buy. Generally speaking, I think if you’re sure enough about a business being wonderful, it’s more important to be certain about the business being a wonderful business than it is to be certain that the price is not 10% too high or 5% too high or something of the sort. And that’s a philosophy that I came slowly to. Originally, was incredibly price conscious. We used to have prayer meetings before we would raise our bid and eight or, you know, around. I mean, we’d miss things because of that.

And so what I said in the report was not a market prediction in any sense. We never try to predict the stock market. We do try to price securities. We try to price businesses, is what we try to do. And we find it hard to find wonderful, good, average, substandard businesses that are, that looks like they’re cheap now. But, you know, you don’t always get a chance to buy things cheap. Charlie?

Charlie Munger [00:18:11] Well, I certainly agree with that. They funding weekend and competently guarantee is that the real inflation-adjusted returns from investing in a standard collection of stocks will be lower in the long-term future than they’ve been in the last 15 years or so. This has been an unprecedented period, and there will be some regression toward the mean in average returns from investing in the stock market.

Warren Buffett [00:18:48] Business has done extraordinarily well in the last decade plus, and that’s a huge plus for securities, because they just represent pieces of those businesses. Interest rates over the last 15 years have fallen. That’s a big plus for stocks. Anytime interest rates go down, the value of every financial asset goes up in rational, and rational calculation. Both of those factors have combined in recent years to produce conditions that enhance the true value of American business. But those are pretty widely recognized now.

And after a while, Ben Graham always used to say you can get more trouble in investment with a good premise and with a bad premise, because the bad premise will shout out to your immediately as being fallacious, whereas with a good premise, it’ll work for a while. You know, businesses are worth more money if interest rates fall, and stocks rise. But that eventually the market action of the securities themselves creates its own rationale for a whole, for a large crop of buyers, and people forget about the reasons and the mathematical limitations that were implied in what they, and what got them excited in the first place. And after a while, rising prices themselves alone will keep people excited and cause more people to enter the game. And therefore the good premise after a while is forgotten, except for the fact that it produces these rising prices, and the prices themselves take over.

He wrote about that in the connection with the 1920s, when Edgar Lawrence Smith in 1924 wrote a fine book on why stocks were better than bonds, and that was sort of the Bible of the bull market of the 20s. And it made sense if you paid attention to a couple of the caveats which were in Edgar Lawrence Smith’s little book, which was related to price. But people tend to forget about the importance of the price they pay as the experience of a bull market just sort of dulls the census generally. Zone three.

[00:21:02] Shareholder (Lola Wells, Florida): Mr. Buffett, my name is Lola Wells, and I come from Florida. I’m a very minimum stockholder, and I’m curious why stockholders whose stock is held in street name aren’t eligible to make recommendations for your donations group.

Warren Buffett [00:21:22] Yeah, the distinction really isn’t whether their stock is held in street, well, that’s one distinction. The Class B shareholders, as was pointed out in the prospectus originally for the B shares, do not participate in the program. The A shares that are held by the beneficial owner do participate. We obtained a tax ruling 1981 or thereabouts that really, that made sure that there would be no taxation as a constructive dividend of the amount that shareholders could designate. There always was that possibility that the IRS would take a position that by allowing shareholders to designate a contribution to a charity, that we were giving them something which first would be taxed as a dividend and then they would later give away. So we have a tax ruling, and that tax ruling applies to… So we have a tax ruling, that tax ruling applies to shares held by beneficial owners themselves, and we follow that ruling subsequently.

I might say it would be sort of a nightmare, too, frankly, if we got into street name holders. With the point now where we probably have 30 or 35,000 street name holders of the A, and with a B it’s probably 60,000 or some number like that. And it’s, it would be quite a nightmare to do. And anyone, you know, unless they have margin debt against their stock, they can put it in their own name, and we encourage people to do it. One reason we encourage people to do it is that they’ll get their shareholder communications more promptly, too. We find that it’s quite erratic, the distribution of reports is quite erratic when handled through brokerage houses to street name holders. So we really do encourage you to have your stock registered in your own name. You’ll get the communications promptly, and if you get the A shares, you’ll be able to participate in the contributions program. And don’t minimize your holdings. Incidentally, between the two of us, we control the company, so I’m glad to have you here. Charlie?

Charlie Munger [00:23:46] There’s no ideological bias against the small shareholder. It’s just not technically feasible to do it as a matter of administration.

Warren Buffett [00:23:55] I should point out that entire shareholder designated contributions program, really all of the work in relation to this meeting, I mean, Aksarben has been terrific, they’ve helped out enormously, but in terms of sending out 11,000 plus tickets to the meeting, the baseball tickets, the planning that goes into and everything, it’s all done by the people at Berkshire, basically. They pitch in to do all kinds of work. So when you look at that 3,000 plus square foot office, we get help from internal audit, who works, does not work in the auto, in the office, but very few people just do all of their regular jobs, and then they do this on top of it, and they never thought they were getting into this. Thank you. (Applause)

We could have a department of 50 people, you know, and assigned to something like this. But the same way with the, you know, we get thousands and thousands of requests for annual reports, and they all come in, and we’ve got just a few people, and they handle it, courtesy and Sheriff Wilson. I really took my hat to them. Now let’s go to zone four, please.

[00:25:14] Shareholder (Marshall Patton, Bandera, Texas): Good morning. I’m Marshall Patton from Bandera, Texas, and first I’d like to thank you very much for not only giving us a good investment vehicle but giving us a good education along the way. And thanks a lot for the two volume set of the letters to stockholders over the years. It’s required reading around our place. And if you can contain your hostility, I’d like to thank Charlie Munger for the copy of his speech to the University of Southern California business school students back in 1994. It’s also a required reading. And I wanted to ask you, when are you going to write your book?

Warren Buffett [00:25:56] Well, I first of all, I’d like to comment on Charlie’s talk there. I think every investor in the world ought to read that talk before they invest. I think that’s, it’s allowed to the shareholders at that time, but anybody like a copy, that talk could be by the supplier. That there doesn’t seem to be any need for me to write a book. Everybody else was doing it at… We’ve got Janet Lowe here who just wrote the most recent one. And, you know, at one time or another I’ve said everything I know and a good bit more. So I’ve never felt compelled to do. I even feel that the annual reports are sort of a book on the installment system.

Kind of the unwarranted optimism, I guess, that the best has always yet to come, and there are a lot more interesting things are going to happen, and I would hate to preclude commenting on those. So I think it’s going to be a few years, but I may get around to it at some point. But I think maybe it’d be a bad sign if it happened, because it might be that I really thought that what I was writing about was more important than what was going to happen next. And Charlie, are you going to write a book?

Charlie Munger [00:27:15] No. But your comment about why you are unable to write a book reminds me, middle western fellow who left an unfinished manuscript, and he apologized for not finishing his book, which was entitled “Famous Middle Western Sons Of,” and he said he was always meeting a new one and therefore he could never finish the book. (Applause)

Warren Buffett [00:27:44] As a courtesy, Charlie and I are leaving each other out of the book that we write. Charlie was, Charlie grew up in Nebraska, and he’s authentic. He has the credentials to prove it. We worked in the same grocery store at different times many years ago. Area five, please.

[00:28:08] Shareholder (JP, Singapore): My name is JP from Singapore. I flew 24 hours to get here. Mr. Buffett, throughout your life you’re repeatedly under promise and over delivered. For many recent years, for example, we have targeted Berkshire Hathaway’s long-term book value growth at 15%, yet you have come true at about 24%. That is a big gap of 9% between your modesty and the outcome, perhaps the biggest dose of modesty in corporate history. May I ask, why is there such a big gap between your modesty and the outcome?

Warren Buffett [00:28:52] I don’t think it was modesty. I think it was a, for one thing, we’ve had a terrific market that has reappraised all businesses in the last 10 or 15 years. So when we really started worrying about future performance, key factor was having larger amounts of capital. And there’s no question that the larger the amount of capital you worked with, the more difficult the job is. Now, we were fortunate that that Ascension and capital having to coincide with things that just lifted all the boats substantially. And so we have had better luck than I would have guessed we would have had 10 years ago or five years ago, but it’s been aided by a huge tailwind, and it’s done as well in absolute terms. And we won’t have that tailwind in the future, I can assure you of that. But we will have a larger amount of capital, which is the anchor that works on us.

So Charlie and I, could make a deal to increase the intrinsic value of Berkshire at 15% a year over the next 10 years, we would sign up now. And I don’t want you to even tempt us with lower numbers, because it, those numbers get astounding. If we paid no dividend at all over a 10-year period, you know, you can figure out where a 15% rate would take us. And we hope to get there, but we think that is absolutely tops. And it’s, and I think it’s very likely, for a period when the market starts underperforming businesses, that the rate could be very substantially lower than that. Charlie, do you want to expand on that?

Charlie Munger [00:30:50] Well, the questioner came from Singapore, which has perhaps the best economic record in the history of developing a economy, and therefore he referred to 15% per annum as modest. It’s not modest, it’s arrogant. Only somebody from Singapore would call it modest.

Warren Buffett [00:31:15] Yeah, yeah. Be careful, Charlie, or they’ll have a voice vote that we should move to Singapore. I mean, this is the group that watch performance. The large quantities of money are not going to compound at super rates, at super compound rated large. Small sums, probably hard either, but large sums aren’t. And if anybody promises, anybody that manages large sums of money that promises or implies that they can achieve really outstanding returns, you know, I’d stay away from them. The numbers just get too big. And, you know, you’ve seen some of that with certain money management organizations in recent years.

And, you know, 15% on an intrinsic value which is substantially greater than our book value gets to be a very, very big number, and we need huge ideas. We don’t need thousands of ideas. I mean, we might need them, but we could never come up with them. So what we look for is the very large idea. But we’re not finding them now, and we’ll keep looking, and every now and then we will find something. But really, if you think we’re going to have any chance of doing better than 15%, and believe me, that is no number that I’d want to sign my name to, but it, you really shouldn’t. You’re going to be disappointed in Berkshire, and we don’t want to disappoint you. So that’s the reason we try to be realistic about expectations. Zone six.

[00:32:59] Shareholder (Daryl Patrick, Dayton, Ohio): My name is Daryl Patrick from Dayton, Ohio. How many shareholders do you have that alone Berkshire longer than you and Charlie, and have you ever gotten together with them?

Warren Buffett [00:33:10] How many shareholders have had it longer than we have? Well, we started buying in 1962, and it was 7, and I think the first ticket was, it, 7 5/8 or thereabouts. But the was 2,000 shares. I’ve got the trading card on the wall, and I paid a dime commission. I can’t believe I was paying a dime commission in those days. We pay a nickel now, and that’s on much higher price stocks. It’s a good thing I didn’t have a fist fight with a broker about whether to pay it or not. I might not have, never might have not had those 2,000 shares.

We have as a director Kim Chace, and his family’s holdings in Berkshire go back to what… Kim, where are you? Down here. There we are. But what year would you, the 20s? Yeah, the Chace family has been in Berkshire since the 20s. But I would say we bought about 70% of the Buffett partnership, which was a partnership I ran in the 60s, what about 70% of the company. So that means they were 300,000 shares roughly that were not owned by us. Of, aside from the Chace family, I’m sure there are people that, I’m sure we’ve got, you know, 50 or 100 shareholders maybe from that earlier date that are still around, and I’m glad they are. Charlie?

Charlie Munger [00:34:37] Nothing to add.

Warren Buffett [00:34:39] Area seven, up in the balcony over here.

[00:34:43] Shareholder (Maurus Spence, Omaha, Nebraska): Maurus Spence from Omaha, Nebraska. In light of recent stock market volatility, could you give us your definition of stock market risk, and how does your definition differ from the standard definition? Finally, due to Charlie, Charlie’s recent counter-revelation about jets, are you going to rename The Indefensible?

Warren Buffett [00:35:10] Charlie would like to make an announcement on that second point.

Charlie Munger [00:35:18] Prompted by LLC, we are changing the name of the company plane from the Indefensible to the Indispensable. (Applause)

Warren Buffett [00:35:32] It was Chateaubriand, who incidentally was a writer and philosopher in addition to being the father of a piece of meat. Chateaubriand wrote one time, I believe that I have correct on my attribution here, that events make more traitors than ideas. And if you think about that in terms of Charlie’s remark, that the purchase of FlightSafety caused that Charlie to have this counter-revelation, and it’s, it’s an experience that is duplicated many times in life, where people flip over very quickly to a new view based on their new circumstances. Now, what was that first question again?

I might add that I have a friend who’s a United Airlines pilot, and he has recently been promoted into the 747-400. Before he started carrying people like you around for hire, he had to train intensively for five weeks. 100% of his training was in a simulator. They’re that good. So it better be that good. They cost us about $19 million, but they are, they’re fabulous. I mean, it, if you think about it, I think it’s 85% of the problems that you can encounter in a plane, if you attempted to teach people by actually being in a plane, they wouldn’t be here anymore. So there’s a, you want to develop the instincts and responses that can react to 85% of the problem, is the only place to learn them is in a simulator. And probably the other 15%, the best places. Now let’s go back to your first question. Give it to me again.

[00:37:17] Shareholder (Maurus Spence, Omaha, Nebraska): The first part was, would you define, give us your definition of stock market risk, and how it differs…

Warren Buffett [00:37:23] Right, the standard definition. Yeah, we don’t think in terms of, well, we think first in terms of business risk. You know, we, the key to Graham’s approach to investing is not thinking of stocks as stocks or part of a stock market. Stocks are part of a business. People in this room own a piece of a business. If the business does well, they’re going to do all right as long as they don’t pay way too much to join into that business.

So we look at, we’re thinking about business risk. How business risk can arise in various ways. It can arise from the capital structure, when somebody sticks a ton of debt into some business, and so that if there’s a hiccup in the business, the, that the lenders foreclose. It can come about just by the nature of the, certain businesses are just very risky. Back in, when there were more commercial aircraft manufacturers, you know, Charlie and I would think of making a commercial airplane, a big airliner, sort of as a bet your company risk, because you would shove hundreds and hundreds of millions of dollars out into the pot before you really had customers, and then if you had a problem with the plane, you know, the company could go.

There’s certain businesses that inherently, because of long lead times, because of heavy capital investment, that basically have a lot of risk. And commodity businesses have risk unless you’re the low-cost producer, because the low-cost producer can put you out of business. Our textile business was not the low-cost producer, and we had a fine management, and everybody worked hard. We had cooperative unions, all kinds of things, but we weren’t the low-cost producers, so it was a risky business. The guy who could sell it cheaper than we could made it risky for us. So there’s a lot of ways businesses can be risky.

We tend to go into businesses that inherently are low risk and are capitalized in a way that that low risk of the business is transformed into a low risk for the enterprise. The risk beyond that is that even though you buy, identify such businesses, that you pay too much for them. That risk is usually a risk of time rather than loss of principle, unless you get into a really extravagant situation. But then the risk becomes the risk of you yourself. I mean, it, whether you can retain your belief in the real fundamentals of the business and not get too concerned about the stock market. The stock market is there to serve you and not to instruct you, and that’s a key to owning a good business and getting rid of the risks that would otherwise exist in the market.

You mentioned volatility. It doesn’t make any difference to us whether the volatility of the stock market, you know, is, is that average is a half a percent a day or a quarter percent of a day or 5% a day. In fact, we’d make a lot more money if volatility was higher, because it could create more mistakes in the market. So volatility is a huge plus to the real investor.

Ben Graham used the example of Mr. Market, which is the, we’ve used it, I’ve copied it in the report. I’ve copied from all the good writers. And Ben said, you know, just imagine that when you buy a stock, that you, in effect, you bought into a business where you have this obliging partner who comes around every day and offers you a price at which you’ll either buy or sell, and the price is identical. And no one ever gets that in a private business, where daily you get a buy sell offer by a party. But in the stock market you get it. That’s a huge advantage. It’s the, and it’s a bigger advantage if this partner of yours is a heavy drinking manic depressive. I mean, the crazier he is, the more money you’re going to make.

So you should, as an investor, you love volatility. Not if you’re on margin, but if you’re an investor, you aren’t on margin, and if you’re an investor, you love the idea of wild swings, because it means more things you’re going to get mispriced. Actually, volatility in recent years has dampened from what it used to be. It looks bigger because people think in terms of Dow points and so they see these big numbers about plus 50 or minus 50 or something. But volatility was, so it was much higher many years ago than it is now, and you had the amplitude of the swings where it was really wild, and that gave you more opportunity. Charlie?

Charlie Munger [00:42:02] Well, it got to be the occasion in corporate finance departments of universities where they developed a notion of risk-adjusted returns, and my best advice to all of you would be to totally ignore this development. Risk had a very good colloquial meaning, meaning a substantial chance that something would go horribly wrong, and the finance professors sort of got volatility mixed up with a lot of foolish mathematics. And to me it’s less rational than what we do, and I don’t think we’re going to change.

Warren Buffett [00:42:42] Yeah, the finance department states that volatility equals risk. Now, they want them, they want to measure risk, and they don’t know any other way. They don’t know how to do it, basically. And so they say that volatility measures risk. And, you know, they, I’ve often used the example that the Washington Post stock, when we first bought it, had gone, in 1973, had gone down almost 50% from evaluation of the whole company of close to, say, $180 or $175 million down to maybe $80 million or $90 million. And because it happened very fast, the beta of the stock had actually increased, and a professor would have told you that the stock, the company was more risky if you bought it for $80 million than if you bought it for $170 million, which is something that I thought about ever since they told me that 25 years ago, and I still haven’t figured it out.

Incidentally, I should make an announcement on that, because I think that the, I’ve made a certain amount of fun of finance departments over the years. They, a fellow named Mason Hawkins, who runs Southeastern Asset Management, just gave a $1 million gift to the University of Florida, and the State of Florida is matching that with $750,000. So this $1,750,000 is going to be used to have several courses in what essentially is the Graham approach to investing, I think starting very soon. So that there will be at least, and there are more than this, but there will be a finance department in this case specifically devoted to teaching the Graham approach. And I think they’re even going to pick up on my suggestion that I stuck in the annual report about having a course on how to value a business and what your attitude toward the stock market should be. So thanks to Mason, who’s done very well managing money, I should add, and there will be at least one university course that tackles what I think are the important questions in investing. Zone eight, please.

[00:45:02] Shareholder (Richard Sercer, Tucson, Arizona): Gentlemen, my name is Richard Sercer from Tucson, Arizona.

Warren Buffett [00:45:07] Let’s give them a hand. This is the gentleman that led to the, for the FlightSafety purchase. (Applause)

[00:45:19] Shareholder (Richard Sercer, Tucson, Arizona): My question relates to owner earnings. What guidance can you give us as to the calculation of item C, which is maintenance capital spending and working capital requirements?

Warren Buffett [00:45:34] Richard, I was going to ask you a question: how about another company? Richard and his wife Alma have attended what, maybe eight or so meetings, and what he did is covered in the annual report, but I’ve had not been for Richard, we would not have merged with FlightSafety, and for that we owe him a lot of thanks.

Now, the item C, indeed, the compulsory reinvestment, oh, back on the, it goes back some years on that description. Yeah, the, in the case of the businesses that we’re in, both wholly owned and major investee companies, we regard the reported earnings, with the exception of the some major purchase accounting adjustment, which will usually be an amortization of intangibles item, we regard the reported earnings, actually the reported earnings plus, plus or minus, but usually plus purchase accounting adjustments, to be a pretty good representation of the real earnings of the business.

Now, you can make the argument that when Coca-Cola is spending a ton of money each year in marketing and advertising, that they’re expensing, that really a portion of that’s creating an asset, just as if they were building a factory, because it is creating more value for the company in the future, in addition to doing something for them and the president. And I wouldn’t argue with that. But of course that was true in the past too, and if you’d capitalize those expenditures in those earlier years, you’d be amortizing the cost of them at the present time. I think with a relatively low inflation situation, with the kind of businesses we own, I think that reported earnings plus amortization of any, well, it’s really amortization of intangibles, other purchase accounting adjustments usually aren’t that important, I would say that they give a good representation to us of owner earnings. Can you think of any exceptions in our businesses particularly, Charlie?

Charlie Munger [00:48:12] No. We have, after some unpleasant early experience, we have tried to avoid places where there was a lot of compulsory reinvestment just in order to stand still. And, but there are businesses out there that are still like that. It’s just that we don’t have any.

Warren Buffett [00:48:34] Yeah, I would say, and what I would say, that in the case of GEICO, for example, the earnings, the gain in intrinsic value will be substantially greater than represented by the annual earnings. Whether you want to call that extra amount of owner earnings or not, it’s another question. But as we build float from that business, as long as it’s represented by the same kind of policyholders that we’ve had in the past, there is an added element to the gain in intrinsic value that goes well beyond the reported earnings for the year. But whether you want to really think of that as earnings, or whether they just want to think of that as an increment to intrinsic value, you know, I sort of leave to you. But I would say that there’s no question that in our insurance business, where our float was $20 million or so when we went into it in 1967, and where it is now, that there have been earnings, in effect, through the build up of the float, that have been above and beyond the reported earnings that we’ve given to you.

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

Charlie Munger [00:50:59] No more.

Warren Buffett [00:51:00] No more. Zone nine, please.

[00:51:01] Shareholder (Rick Fulton, Omaha): Mr. Buffett, I’m Rick Fulton from Omaha. Really. Recently I was in Washington, D.C., on, with my wife, on a business trip, and I wanted to tell Mrs. Graham, I know she’s here, what a pleasure it is to get up in the morning to a good newspaper like the Washington Post. Also, I have a question about Cap Cities and now Disney, and as Mr. Murphy keeping busy now that ABC’s owned by Disney? Also, every week you read in the paper the Nielsen ratings, and doesn’t matter that ABC now, it seems that less people recently are watching, doesn’t matter to the Disney’s bottom line? Thank you.

Warren Buffett [00:51:43] Yeah, yeah. Well, the first question about Mr. Murphy is that if we could hire Mr. Murphy, we would. I mean, there is no one in this world that is a better manager than Tom Murphy, or a better human being, as far as that’s concerned. So he, I think he’s keeping pretty busy. He has been responsible for NYU Hospital. He wouldn’t say that, but he’s been the chairman of it for some years, and that’s a $800 million a year, thereabouts, organization. Charlie runs a hospital, so he knows how busy he can keep you. And he, but I would say this, and I would love to find a business that I could entice Murph to come back and run, because they don’t get any better than he is. And Charlie, you want to add anything on Murphy?

Charlie Munger [00:52:38] Well, I’d like to, because you’re absolutely right.

Warren Buffett [00:52:41] And what was the other part of the question, sir?

[00:52:47] Shareholder (Rick Fulton, Omaha): Does the recent, the decline in ABC’s Nielsen race ratings have anything to do with the bottom line?

Warren Buffett [00:52:59] Yeah, yeah, it makes a difference. Sure, the ratings translate in many cases into, but overall, who knows, if they’re good in early morning, if they’re good in daytime, if they’re good at late evening, whatever. I mean, it, ratings translate into money. They may not translate immediately. Particularly if you have some big hit show, you may have sold it out too cheap. But over time, the prices you receive for your product relate to ratings, and over time, but over a longer period of time, the price that you pay for the product also relates to the ratings, but there’s a difference in the time cycle. So that it makes a difference to any network’s bottom line what their ratings level is.

And I’m Disney, Disney is conscious of that, and that they are very able operators, and I predict you’ll see in a couple of years. But it, you can’t do it immediately. The schedule fixes don’t work on a, you know, a week-to-week basis, because people have habits, and it, there’s a time lag involved in any change. And you’ve seen over the last 20 years, you’ve seen various networks on top or on the bottom from time to time. So it moves around, it moves around a fair amount. Charlie?

Charlie Munger [00:54:37] I think the TV network business is intrinsically a pretty tough business. And ESPN then they might have forecast, and they probably did a little worse on the network. These things happen.

Warren Buffett [00:54:54] That was, incidentally, the situation when Cap Cities bought ABC in 1985. We made the deal, and I’m taking a closing, I think it closed the first day or two of 86, I may be wrong in that. But the network diminished, the ratings diminished significantly, and particularly in daytime. We’d always thought daytime was almost a certainty to produce big earnings, and it had, even prime time is what people came the most attention to, but daytime slipped significantly after we bought it. It has no relationship to those movies. I mean, that movie you saw earlier, when I started appearing on it, that, I don’t want anybody to make that connection. But it did happen to be at the same time.

The kicker we got again was ESPN. ESPN was losing money when Cap Cities made the deal to buy ABC, and we never really regarded it as that being, that having that big a potential. And the, you know, it has been huge. It’s been, it was enormously better for us than we ever anticipated. Leonard Goldenson, who ran ABC, told us it was going to be that good, but of course we were too smart to pay any attention to them. And I think Disney has been pleasantly surprised by how well ESPN has done, too. It’s a powerhouse. Zone 10, please. Tonight.

[00:56:38] Shareholder (Bill Turan, Des Moines, Iowa): My name is Bill Turan. I’m from Des Moines, Iowa, and I’m a stockholder. It would appear that there’s going to be a capital gains tax cut. That does materialize, would you consider a stock split? Secondly, is there an extra copy of your annual report available on the premises?

Warren Buffett [00:56:58] My guess is we’ll get you an annual report. In fact, if someone could take it up to Zone 10, we’ll be glad to get it to you. I don’t think, well, I’ll put it this way: if they cut the capital gains tax to zero, will, maybe. I don’t think I get Charlie’s vote, though, anyway. No, we have, we will not be splitting Berkshire stock at… (Applause)

Incidentally, we do not consider splitting the stock of pro shareholder move. If we did, we’d do it. I mean, it, we think that net, to take the entire experience, it’s worked out well for shareholders, and we think we have a more investor oriented, or investment oriented, audience in this room today than we would have had if we’d split many times. It is a way of enticing certain types of investors and perhaps discouraging others, and so it’s worked well.

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

Charlie Munger [00:59:00] I think what he’s trying to tell you is that you’ve had your stock split.

Warren Buffett [00:59:06] Zone 11, please.

[00:59:07] Shareholder: Yes, Mr. Buffett, I would like to thank you again for issuing that Class B shares.

Warren Buffett [00:59:15] Well, I’m glad we did, and I hope you own them.

[00:59:21] Shareholder: And I’m a Class B shareholder. I need your comment on some analysis that we did. If someone uses your investment philosophy of building a highly concentrated portfolio of six to eight stocks and adopts your buy and holding principle, so that the maths of compounding and no tax works for you, but however, with one major modification: invest in high octane companies like Intel and Microsoft that are growing at 30% instead of typical 15% growth company in your portfolio. My question is, will this investment philosophy will translate into twice the shareholder return as you have historically provided to your shareholder?

Warren Buffett [01:00:15] Yeah, well, it will certainly work up to twice the return if Intel or Microsoft do twice as well as Coke and Gillette. I mean, it’s a question of being able to identify businesses that you understand and feel very certain about. And if you understand those businesses, and many people do, but Charlie and I don’t, you have to evaluate them, and if you decide their, you’re going to do very well. But there’s a whole group of companies, a very large group of companies, that Charlie and I just don’t know how to value, and that doesn’t bother us. I mean, you know, we don’t know what, we don’t know how to figure out what cocoa beans are going to do, or the Russian ruble, or, I mean, there’s all kinds of financial instruments that we just don’t feel we have the knowledge to evaluate. And really, you know, it might be a little much, too much to expect that somebody would understand every business in the world.

And when we find some that are much harder for us to understand, and when I say understand, my idea of understanding a business is that you’ve got a pretty good idea where it’s going to be in 10 years. And I just can’t get that conviction with a lot of businesses, whereas I can get it with a relatively few. But I only need a few, as you’ve pointed out. You only need a few, a six or eight or something like that.

It would be better for you, certainly would have been better for you, if we had the insights about what we regard as a somewhat more complicated businesses you describe, because they’re was, and may still be, a chance to make a whole lot more money if those growth rates that you describe or maintain. But I don’t think there are, I don’t think you’ll find better managers than Andy Grove at Intel and Bill Gates at Microsoft, and they certainly seem to have fantastic positions in the businesses they’re in. But I don’t know enough about those businesses to be as sure that those positions are fantastic as I am about being sure the Gillette and Coca-Cola businesses are fantastic. You may understand those businesses better than you understand Coke and Gillette, because of your background, or just the way your mind is wired. But I don’t, and therefore I have to stick with what I really think I can understand. And if there’s more money to be made elsewhere, I think the people that make it are entitled to it. Charlie?

Charlie Munger [01:02:58] Take a business like Intel. There are limitations under the laws of physics which eventually stop your putting more transistors on a single chip and the 30 program or something like that. You, I don’t think those limitations are still a good distance away, but they’re not any infinite distance away. That means that Intel has to leverage its current leadership into new activities, just as IBM leveraged the Hollerith machine into the computer. Predicting whether somebody’s going to be able to do that advance is just, it’s too tough for us.

Warren Buffett [01:03:41] Bob Noyce, Bob Noyce, one of the two founders, of the primary founders of Intel, I grew up in Grinnell, Iowa. I think he’s the son of a minister in Grinnell, and went to Grinnell College, and was chairman of the Board of Trustees of Grinnell one when I went on the board of Grinnell back in the late 60s. And when he left Fairchild to form Intel, Gordon Moore, Grinnell bought 10% of the private placement that funded, was the initial funding for Intel.

And Bob was a terrific guy. He was very easy to talk to, just as Bill Gates is. I mean, these fellas explained the businesses to me, and they’re great teachers, but I’m a lousy student. And they, I mean, they really do it. They’re very good to explain their businesses. Bob was a very down-to-earth Iowa boy who could, he could tell you the risks and tell you the upside, and enormously likable, 100% honest every way. So we did buy 10% of the original issue. The genius that ran the investment committee and managed to sell those a few years later, I won’t give you his name. And there is no prize for anybody that calculates the value of those shares now.

The, you know, incidentally, one of the things Bob was very keen on originally, in fact he was probably the keenest on it, was he had some watch that Intel was making, and it was a fabulous watch, according to Bob. It just had one problem. We sent a guy out from Grinnell who was going out the West Coast to where Intel wasn’t, and Bob gave him one of these watches. And when he got back to Grinnell, he wrote up a report about this little investment we had, and he said, he said, these watches are marvelous. He said, he said, without touching anything, they managed to adapt to the time zones as they changed, we went along. In other words, they were running very, very fast, as it turned it out. And they worked with that watch for about five or six years, and they fell on their face.

And as you know, and you know, they had a total transformation in the mid 80s when the product on which they relied also ran out of gas. So it’s not, and Andy Grove has written a terrific book, incidentally, “Only the Paranoid Survive,” which describes strategic inflection points. I recommend that every one of you read that book, because it is a terrific book. But they had an Andy Grove there who made that transformation, along with some other people. But that doesn’t happen every time. Companies get left behind. We don’t want to be in businesses where companies, where we feel companies can’t be left behind.

And that means that, you know, an Intel could have, and almost did, go off the tracks. IBM owned a big piece of Intel, as you know, and they sold it in the mid 80s. So, you know, hear a bunch of people should know a lot about that business, but they couldn’t see the future either. I think it’s very tough to make money that way, but I think some people can make a lot of money understanding those kind of business. I mean, there are people with the insights. Walter Scott, one of our directors, has done terrifically with a business that started, you know, just a gleam in the eye maybe 10 or 12 years ago, here in Omaha, and it turned into a huge business. And, you know, Walter explained that to me on the way down to the football games, but bad student again. So Walter connected, and, you know, I’d share from this dance. But that really, that doesn’t bother me at all. I mean, it, what would bother me is if I think I understand a business and I don’t. That’s, that would bother me. Charlie?

Charlie Munger [01:07:52] So having flunked, when we were young and strong, at understanding some complex businesses, we’re not looking to master what we early, earlier failed at us in our latter years.

Warren Buffett [01:08:05] Zone 12. This may turn out like a revival meeting where we all confess our sins and come forward, you know.

[01:08:15] Shareholder (Cary Blecker, Wellington, Florida): Good morning, gentlemen. My name is Cary Blecker from Wellington, Florida. I know in 1987 when you purchased, or invested in, the Salomon Brothers convertible preferred stock, you had the eight-year win, rather the eight year time frame, taken averted into common or take the cash out. I know in 95 you took cash out, which was not a vote of confidence for Salomon Brothers. Any feelings on that in the future?

Warren Buffett [01:08:47] Yeah, we, as the gentleman mentioned, we bought it 1987, and starting in 1995, we have a, we have every year for five years, we either have to take cash or convert to common 20% of the original issue of $700 million. And we don’t have to make those decisions ahead of time. So we, in 1995, we elected to take cash. In 1996, we elected to take stock. And, you know, we see no reason ever to swing at the ball while it’s still in the pitcher’s glove. We just soon wait till it gets to the plate to make the decision. So the ball will get to the plate on October 31st of 1997, I believe, for the next 20%, and we’ll decide whether to swing at that point. But we don’t need to make that decision today. I would say that, you know, the odds are overwhelming that that will convert, but we’ll wait until that time, until to make the final decision.

We have terrific confidence in the people that run Salomon. They helped us through some incredibly dark days in the past and showed the stuff of which they were made, and so we feel very good about that. We don’t have the same degree of conviction about the profitability of the investment banking or brokerage business as a whole. It’s not to sort of, it, you don’t develop that kind of conviction about that business versus a Coca-Cola or something. They’re different. They have different economic characteristics.

So we will see how the businesses, the industry evolves, but we feel very good about the management and the odds are extremely high that we will convert, but we will swing at the ball when it gets to the plate. Charlie?

Charlie Munger [01:10:42] No more.

Warren Buffett [01:10:43] Let’s see, we did 12, we’re back at one again.

[01:10:47] Shareholder (Ted Vogeli, Corpus Christi, Texas): My name is Ted Vogeli from Corpus Christi, Texas, and I would like to ask a question to you. Companies are purchased from time to time and the purchasing company will give shares instead of cash, and their shareholder will receive new shares. Can an individual investor transfer non-Berkshire to Berkshire with or without going through a broker? And if not, how does Berkshire do this with another company? And if possible, I would like to also receive a copy of the annual report.

Warren Buffett [01:11:25] Okay, we’ll get you a copy annual report. The only way I know of, and maybe Charlie knows some other way, the only way you can switch your shares in one company for, into shares of another companies to have a tax-free merger, and the Internal Revenue Code has specifications about that. You can have a transaction as we had with FlightSafety where a portion is of the shareholders can take cash and a portion can take stock, and it’s still tax-free for the people who elect stock. You can’t have too many people take cash and have that happen. There are a lot of technical rules about what’s tax-free, but there’s no way that you can own General Motors and transfer it into General Electric stock without a tax.

And a broker, well, you don’t have to have a broker if your neighbor hasn’t own it, you can make a deal privately, but the easiest way usually is through a broker. But there’s no way you can do it without tax unless General Motors in General Electric decide to merge at some point. Yeah, so the opportunities to switch from one security to another without tax are really limited to merger. And in terms of brokerage costs, it just happens to be that it’s that, that the most economical way of finding the person in the world that wants to both buy the stock you want to sell and sell you the stock you want to buy is through an intermediary broker, and the cost of that actually can be relatively low. Charlie?

Charlie Munger [01:13:06] Well, I think there’s one way still permitted by the tax laws. You can still form a partnership. If you own General Electric and I own General Motors and we each feel too concentrated, well, you could form a partnership and each put in your stock, and in essence you would each thereafter be invested half and half with some diversification. I will predict that Wall Street will eventually get around to promoting such partnerships.

Warren Buffett [01:13:35] Yeah, well, they did through swap funds in a sense 25 years ago, and then that was where you put in your highly, your stock that had an enormous amount of unrealized appreciation in, and a whole bunch of other people did, and then you owned a fund which itself had a lot of unrealized appreciation in it, and you had a layer of costs.

Charlie Munger [01:13:58] Yeah, it was a new layer of costs always.

Warren Buffett [01:14:01] And you owned a piece of this larger fund, and you owned a piece of everything else, everything that the other people want to get rid of, and they owned a piece of what you wanted to get rid of, and superimposed with some costs. But that vehicle was sort of stopping its tracks, I think, in the mid 70s by an amendment to the Internal Revenue Code. But as Charlie said, you could replicate the effect of a swap fund by doing it with a partnership. It’d be kind of awkward, but it can be done. Zone two.

[01:14:35] Shareholder (Mark Ravenhill, Australia): Gentleman, Mark Ravenhill from Australia. I am a shareholder. I had a question really related to our own businesses and how they’re going and where you’re looking to be in 10 years time. Perhaps I could start with the insurance float. It’s grown at 20%. Do you think that 20% growth rate will continue for the next 10 years? Do you think our stable businesses, which have been growing at, say, 5% or 7%, will maintain that rate? And do you think FlightSafety, which from the SEC filings has been growing at about 5%, do you think that will continue at that rate?

Warren Buffett [01:15:08] Well, we’re glad to have you from Australia. I think we’ve got about 15 people here from Australia, so it got a good representation. I don’t think the insurance float can grow it 20% a year. That’s been helped by some acquisitions and things. It’s, I mean, it’s done way better obviously than we ever thought it would 30, almost 30 years ago when we made the deal with Jack Ringwalt. I would say, though, that I think GEICO is going to do even better than we expected when we bought it, and we thought it was going to do awfully well then.

In Tony Nicely, you know, we have an absolutely outstanding manager of that business, and he is focused on it, he knows it. I think he went to work there when he was 18, and he’s been there 35 years or thereabouts, and he, they don’t come any better. And he is absolutely zeroed in on the things that he should be zeroed in underneath, the implementation gets better all the time. I mentioned in the annual report that the unit growth of GEICO’s voluntary auto business, and we talk about voluntary because you get assigned risk type things that lose your money, but the real business is the voluntary auto business, grew at 10% last year, which was the best growth rate in over two decades. First four months of this year it’s growing at about 16%, and 16% unit growth translates into about 20% a year premium growth.

So GEICO at present would give you some encouragement for at least that segment of the insurance float growing at a rate that sort of comparable to the past. Insurance is going to be a very big business for us, and the float will grow, in my view, at a good rate, but I wouldn’t want to predict that good a rate. Most of our other businesses, very good businesses, they don’t have 20% a year growth possibilities in them. They throw off lots of cash, which we can use to buy other things, which may turn out to be a better strategy than even having a single high growth business.

At FlightSafety, about six weeks ago or they’re about announced a major hookup in the joint venture with Boeing, as you may have noticed, and they’re a terrific partner and it’ll be a great partnership. That’s just for our, the training for our, for larger planes primarily, I think 100 seat enough planes, although I think there may be a few Fokkers in there that are, they’re slightly smaller planes. But it’s basically the big commercial planes, and the combination of FlightSafety and Boeing worldwide in training over the coming decades, I think, will be a very powerful combination.

So we’ve got some very good businesses, and I don’t see that movie that’s presented before I sit out here like you and watch it, but I like the ending of it. And the people we have out there, they’ve run businesses extremely well in the past, they get better results out of those businesses, and frankly, than other people would or that other people in the industry generally do. So I think they have good futures, but they will throw off lots of cash in aggregate, and the tough job, we like to tell people it’s a tough job anyway, is that Charlie and I have to figure out where to put that cash to maintain higher, reasonable growth rate.

[01:19:04] Shareholder (Mark Ravenhill, Australia): Could you… I’m not sure, could you turn that on, please? Other than… I’m sorry, sorry to pin you down, but…

Warren Buffett [01:19:11] That’s okay.

[01:19:11] Shareholder (Mark Ravenhill, Australia): Would you guess the FlightSafety then, it’s more likely to be in that 10 to 15 ballpark?

Warren Buffett [01:19:16] Well, it’s hard, it’s hard to tell on numbers. I mean, there’s certainly, there’s going to be a growth in pilot training around the world, but FlightSafety already has a significant portion of the corporate market, for example. So it would be hard to grow a lot faster in the corporate market, although I can hear Al grinding his teeth, you know, when I say that, because he plans to grow a lot faster than the market. But the corporate market, we’ve got a significant percentage. Commercial market, there could be a lot of potential in. You know, won’t come tomorrow or the next day, but, you know, ideally we would like to see people, when they buy a 777 or 747 or something, by a lifetime pilot training contract at that time. So I wouldn’t want to stick a number on it, but I’ve got high hopes. And FlightSafety also announced recently a very major contract with the government through Raytheon. So it’s a company that’s got its site set a lot higher than where it is now.

[01:20:22] Shareholder (Mark Ravenhill, Australia): And insurance, 15%?

Warren Buffett [01:20:22] Yeah, yeah. Well, you want tenths of a percent or will you… Yeah, they… We just don’t know. I mean, we didn’t know 25, we didn’t, 30 years ago we didn’t know we would be in the insurance business. I mean, it… Berkshire, we have no master plan. And if Charlie and I did not sit down in 1960, early ’65, and say we’re going to do this and that and all that. We’re going to try and do sensible things as we go along. The more money we have, the harder it is to find sensible things, but that’s the criterion.

Insurance is certainly a major area of opportunity for us. It’s been a major opportunity. We have, in certain fields, we have a terrific advantage for the three reasons I laid out in the annual report. But I mean, we have capital strength and a willingness to take on risk and a speed of action and a certainty of payment that in aggregate no one matches. Now, how much demand there is for that depends on circumstances in the business, and how much supply there is at lower prices that we think don’t make sense is another question. But I think we’ll do okay in insurance over time. Zone three.

[01:21:38] Shareholder (Tim Medley, Jackson, Mississippi): Mr. Buffett, Mr. Munger, I’m Tim Medley from Jackson, Mississippi.

Warren Buffett [01:21:44] We’re glad to have you back, Tim. Tim, how many years have you come?

[01:21:51] Shareholder (Tim Medley, Jackson, Mississippi): This is my 11th.

Warren Buffett [01:21:53] Good. There’s been 11 great years.

[01:21:55] Shareholder (Tim Medley, Jackson, Mississippi): Thank you very much. At this meeting four or five years ago, you commented that money managers in the aggregate have not done better than various market indices, and you attributed this in part to the frictional cost inherent in an actively managed portfolio. I wonder if today you would update your thoughts on this, and do you think that this underperformance compared to index funds will continue? And then a related question: if the two of you were giving advice to a classroom of equity mutual fund managers, are there two or three things in particular that you would want to suggest to them?

Warren Buffett [01:22:44] Yeah, well, I would say there’s money managers in the last few years since I’ve made that statement have not disappointed me. In aggregate, they have underperformed index funds, and it’s the nature of the game. They simply cannot over perform an aggregate. There are too many of them managing too big a portion of the pool. And for the same reason that the crowd could not come out here to Aksarben in the past years and make money in aggregate, because there was a bite being taken out of every dollar that was invested in the parimutuel machines, that people that invest their dollars elsewhere through money managers in aggregate cannot do as well as they can do by themselves creating their own index fund, or be easier to have just to buy into an index fund.

It’s, you know, they say in this world you can’t get something for nothing, but the truth is money managers in aggregate have gotten something for nothing. I mean, they’ve gotten a lot for nothing, and people, investors are paid, and the corollary as investors have paid something for nothing. And that doesn’t mean the people are evil, it doesn’t mean that they’re charlatans or anything. It’s just, it’s the nature. If you’ve got a $6 or $7 trillion or whatever it may be equity market, and you have a very significant percentage of it managed by professionals, and they charge you significant fees to invest with them, and they have costs when they change around, they cannot do as well as unmanaged money in aggregate.

And it’s the only field in the world that I, you know, that I can think of, and Charlie will think of some others, but where the amateur, as long as he recognizes his amateur, will do better than the professional does for the people whose money he’s handling. And therefore, if I were in a teaching us glass or speaking to that class, I would probably tell them that for their own psychological well-being they should probably leave the room. Charlie?

Charlie Munger [01:25:01] Yeah, well, I pretty well said what I had to say on this subject in that talk I gave at USC, and anybody that wants to read that and I can read it. I will say that one of the things I like about the annual meeting is I get to interface with a whole lot of people that have even lower annual investment management expenses then Berkshire Hathaway the company does, if you stop to think about it. We’ve got our cost almost a zero, and many of you have gotten it to zero.

Warren Buffett [01:25:39] Yeah, we, Charlie and I would be glad to take any money management organization in the world that manages… Oh, just Manhattan to know it says, unfortunately we don’t have extra annual reports on site. Those shareholders desiring one should call us or write, tell them. And we’re also on the internet, you can run it off there too. So I apologize for not having them on the here, but they’re easy to get. Just dial 346-1400, then there’s an annual report line, and you’ll have one sent to you.

We would be willing to take any money management organization in the world managing $10 billion or more, and in the case of brokerage houses who have their brokers in aggregate handling $10 billion or more, and we would be willing to bet that they’re aggregate investment experience over the next five years or 10 years for the group that they advise will be less, will be poorer than that achieved by a no load, very low cost index fund. And we’d put up a lot of money to make that wage here with anybody that would care to step forward. Gambling may be illegal, but now you can do it through something called derivatives, you see, and we could create an instrument that would allow that even though it might be against the laws of the state of Nebraska. Charlie, would you join me on that or…

Charlie Munger [01:27:17] Well, I certainly agree with you. I always say that the exactly one-fifth have to be in the bottom 20%, and they’re starting fundamental forces at work here that… But it is a very peculiar profession where you have to be in a state of psychological denial to shave in the morning if you do the work.

Warren Buffett [01:27:39] I don’t think that’s true for a handful.

Charlie Munger [01:27:42] Well, it is investment managers. I think we know investment managers who add value, but it’s comparatively rare and small percentage.

Warren Buffett [01:27:50] Yeah, I mean, we, they’re, we have identified in the past, even, I mean, on a prospective basis, not retrospective, managers who have added value, and there’s a couple of them in this room.

Charlie Munger [01:28:04] Well, there’s Lou Simpson of GEICO.

Warren Buffett [01:28:07] He’s the one I had in mind. You know, it, you can do it. You can’t do it with unlimited amounts of money, and a good record tends to attract money. Even a mediocre record presented by a good salesperson tends to attract money. But they, there are people working with smaller amounts of money that foreign, where the probabilities are that and they will do better than that, excuse me, where the probabilities are that they will do better than average, but they’re very rare.

Incidentally, I apologize on this voice. I had to leave garage early last night, and there were a number of you I was hoping to see, but I just, it was gone entirely last night. And then I manage, I like to tell you I did it by Cherry Coke, but I managed to nurse it back to where it’s working again in reasonable shape. Zone four.

[01:29:13] Shareholder (Martha Copeland, San Francisco): I’m Martha Copeland from San Francisco. My question involves the headwinds which face USAir. Are you considering redeploying assets, or how will your management plan to improve this company?

Warren Buffett [01:29:26] Well, we’re just an investor in US, they call it now US Airways, but we’re just an investor. We’ve owned a preferred stock for almost eight years. The company had some very rough going. Charlie and I would not have thought its chances for survival were very good even some years back, but it’s done quite well lately. Stephen Wolf has done a terrific job of running it. So as of the middle of April, all of our dividends are, were caught up current. We’ve received, I don’t know, $260 or $270 million in dividends in the last eight years, and, but we have nothing to do with managing the company.

A matter of fact, there are some people that might have noted that when Charlie and I left as directors, that was when the fortunes that the company turned abruptly upward. But, and we feel very good about what Stephen Wolf has done. I mean, he, there’s no tougher job than running an airline. That is not a job I would wish on anyone. And he’s improved the operating performance dramatically, and the financial performance has improved, and better yet, the preferred dividends have been paid. So I, we thank him for that, but we have nothing to do with it.

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

Charlie Munger [01:31:48] Yes.

Warren Buffett [01:31:49] We’ll get in this year. Zone five, please.

[01:31:54] Shareholder (Eric Butler, Menlo Park, California): I’m Eric Butler from Menlo Park, California. A couple of questions, one serious, one not quite. Considering Berkshire Hathaway is well run, at low cost, and is diversified, why should anyone do anything but put all their money into Berkshire Hathaway instead of maintaining a diversified portfolio? And in some of these hegeographic kind of biographies, it is apparent that you have other investments yourself beyond Berkshire Hathaway. The second question I had: is there any significance to the fact that the Omaha World-Herald does not include Berkshire Hathaway in its stock tables on any day? Is this a sign that they do not honor prophets?

Warren Buffett [01:32:45] No, they, actually they have a separate little table called Midlands, I think it’s entitled Midlands investment, but they pick out about 50 stocks that are of particular interest to people in this area, and they lift those from the regular table and put it in this separate table, which is usually on a second page right following the main stock table. So they give us our just due on that, but you do have to, you should look in a different table for that.

Second question about putting all your money in. I’ve got 99% of my money in Berkshire, and, but it was bought at a different price. And Charlie’s was bought a little cheaper too, I think. So, you know, we like the idea of having it all in there, but we don’t recommend that people do that because it’s, you will get very low cost management. What we hope is that from this point forward that cost does not reflect its value. But the price at which you enter is very important. You do get a great group of businesses, you get a lot of great operating managers, you get very reasonable costs, but that is fairly widely recognized now compared to the past, and people pay more for it than they used to. It, I’m still very comfortable with it, and I think Charlie’s comfortable with it too, but everyone has to make up their own mind about price. Charlie?

Charlie Munger [01:34:19] Yeah, eventually, if the success continues and we have more of this hagiography, the stock will get such a high price that it’s no longer sensible at all to buy. We hope we dampen that process as we go along, you know. And of course, there’s always the very substantial chance that will just fail to meet expectations due to the vicissitudes of life. Falling on her face is what we call it.

Warren Buffett [01:34:59] Zone six.

[01:34:59] Shareholder (Michael Hooper, Grand Island, Nebraska): My name is Michael Hooper, I’m from Grand Island, Nebraska. I applaud Berkshire for starting the Class B shares. My question deals with tobacco stocks, which have been beaten down lately. Does Berkshire own any tobacco stocks, and are some of these stocks attractive now that prices are down on some of them, and in particular a company called UST? Thank you.

Warren Buffett [01:35:29] Yeah, we have owned, we won’t comment on what we owe now, but we have owned tobacco stocks in the past. We’ve never owned a lot of them, although we may have made a mistake by not owning a lot of them. But we’ve owned tobacco stocks in the past, and I’ve had people write me about whether we should do it or not. We own a newspaper in Buffalo, it carries tobacco advertising. We don’t, well, actually Charlie’s a director of the, of a sensational warehouse chain them called Costco, which used to be called Price Costco. You know, they sell cigarettes. So we are part of the distribution chain in, with a 100% on subsidy here. We are part of the distribution chain, and with a 100% on subsidiary.

And so we have felt that I would invest in tobacco stocks. We made a decision some years ago that we didn’t want to be in the manufacturer of chewing tobacco. We were offered the chance to buy a company that has done sensationally well subsequently, and we sat in a hotel in Memphis, and in the lobby, and talked about it, and finally decided we didn’t want to do it. Can I give you some… It wasn’t because we thought it wouldn’t do well. We knew it was going to do it, we knew it was going to do well.

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

Charlie Munger [01:37:45] Yeah, I think each company, each individual has to draw its own ethical and moral lines, and personally, I like the messy complexity of having to do that. It makes life interesting.

Warren Buffett [01:38:02] I hadn’t heard that before. Well, we’ll make him in charge of this decision. I don’t think we can justify our call particularly. We just, we have to draw the line somewhere between what we’re willing to do and what we’re not, and we brought by our own lights. We won’t… We owned a lot of bonds at one time of RJR Nabisco, for example, meant some years back. And should we own the bonds, not on the stock? Should we own the, you know, that should be willing to own the stock but not be willing to own the business? And those are tough calls.

Probably the biggest, the biggest distributor of, the biggest seller of cigarettes in the United States is probably Walmart, but just because they’re the biggest seller of everything. They’re the biggest seller of Gillette products, and they’re huge. And, you know, do I find that morally reprehensible? You know, I don’t. If I owned, if we owned all of Walmart, we’d be selling cigarettes at Walmart. But other people might call it differently, and I wouldn’t disagree with them. Zone seven.

[01:39:08] Shareholder (John Tarsney, Omaha, Nebraska): General… Gentlemen, I’m John Tarsney, a shareholder from Omaha, Nebraska. People have already asked any sophisticated question that I might have, so I’m reduced to my simple ones. I first became a shareholder through FlightSafety, and at that time I wasn’t sure that I wanted to be bought out. However, I decided that any man who could agree with me on FlightSafety might be a good man to go along with.

Warren Buffett [01:39:41] Well, that’s one way of doing it. (Laughter) Maybe you’d fit in well at headquarters.

[01:39:48] Shareholder (John Tarsney, Omaha, Nebraska): I have a couple… Well, I don’t use Gillette products either, as those of you who are close to me can see. My questions, my simple ones then, are: a couple of years ago, or within the recent times, you have said you would not necessarily buy Berkshire Hathaway, and I’d like to know whether you still feel the same way. Secondly, since I came to you through FlightSafety, I’m wondering if there’s any other positions I should be looking at in that same light. And thirdly, there was a very distressing sign to me, sign that I saw when I drove in, and I don’t know what the meaning of it is, or if you do, and it said something about abortion, and I just don’t have a clue if you do. Now, you can use yes or no answers to these to save your voice, or suit yourself and elaborate.

Warren Buffett [01:41:01] Yeah, I will work backwards. I think the science probably relate to the contributions to a Planned Parenthood. I thank you. We follow a policy, as you know, at Berkshire of corporate contributions being designated by shareholders. We have some made by our operating companies to their local communities, and the local managers do what they think appropriate within their communities and with their own businesses. So Tony Nicely at GEICO, I have no idea what GEICO contributes to, but they make those decisions at GEICO. But in terms of the parent company, we let the shareholders designate the contributions. We have a number of shareholders who designate Planned Parenthood. We have other shareholders who designate organizations that are, would be opposed to the ideas of Planned Parenthood. We make no judgment about those.

And in terms of I designate, I designate the Buffett Foundation every year, and then the Buffett Foundation in turn gives money to other things, including Planned Parenthood. And so in the sense that those funds come in directly from Berkshire, they come in direct proportion ownership, the same way as everybody else gets a chance to do with it with their shares. And we’ve had people write us about it, and, you know, I, there’s no way in the world we would… You know, in fact, there’s some that would say that we should be boycotted because I do this. And we would not dream of questioning, you know, the people that we buy our almonds from, or walnuts from, or chocolate from, as to what their beliefs were, you know, before we bought that, or whether we would hire somebody that they’d have to agree with our beliefs.

So, and it just, it seems to me that the perfectly appropriate for people to express their views on it, and they probably don’t like it. Well, clearly they don’t like what I do on that, but it’s where my reasoning and, you know, my own judgment leads me. So, but they’re out there, the field, people are out there expressing their views on it. They’re entitled to do that, and I don’t have any problem with that. I think when they start saying, you know, we don’t want to hire you because you have a different view than we do, or we don’t want to buy your products, I think that’s a little different position to take. I wouldn’t do that, but again, it’s their right to do that.

Going back to whether we would buy the stock. I would say this a year ago, well, it was about March 1st, because that’s when I wrote the annual report, in 1996, the stock was $36,000, and I said it was not undervalued at that point. And since we were more or less forced to have an offering by the unit trust, which I’m very glad in retrospect we did, but it was not our idea, we felt that it was only appropriate in connection with that offering to point out that we had said it was not undervalued, and since Charlie and I like to buy undervalued securities, that we would not bite ourselves at that price or recommend that others do. And in the ensuing year, the intrinsic value of Berkshire changed quite dramatically and the price didn’t change. In other words, the stock, after years of over performing the business, somewhat underperformed the business, which of course it’s bound to do, and we’re glad that they got back more in tandem. So we said this year that we’ve, we regarded the stock as being much more appropriately valued than it was a year earlier, which is obvious. And I would say that the caution I made about securities generally would apply. I would not accept Berkshire from that caution, but I would rather own or purchase Berkshire myself than I would most other securities. I can tell you that. Charlie? (Applause)

Charlie Munger [01:45:10] Aside, take care of that. I’m perfectly willing to have that limelight pass, as well as the opportunity to say more on the subject.

Warren Buffett [01:45:27] Did I miss one question up there? I think there were three of them, and I addressed two of them. And about any other area I should be looking at, that’s the reason I skipped it. We don’t direct people to any specific investments. Zone eight, please.

[01:45:51] Shareholder (Nancy Jacobs, Omaha): Good morning, Mr. Buffett and Mr. Munger. This is Nancy Jacobs from Omaha, a shareholder for about four years now. Before I leave today, I’m planning to purchase the World Book on CD-ROM for my 10 year old daughter, and I’d like a few words from either one of you or both of you about why I’m making the right choice. And second, does purchasing World Book over a competitor give her a somewhat improved chance of becoming a brill, a brilliant billionaire investor?

Warren Buffett [01:46:27] Practically guarantees it, but go ahead.

[01:46:29] Shareholder (Nancy Jacobs, Omaha): Okay, I’m buying them.

Warren Buffett [01:46:31] Charlie, you want to… You love to talk about World Books.

Charlie Munger [01:46:37] Well, I think World Book is clearly the class of the field. They have every word in the English language graded for reading comprehensibility, and the articles are cleverly written, so the difficulty of comprehension rises slightly as you go through it, and it’s very user friendly to young people. And since it’s something you want to encourage, making it user friendly is wonderful. I also find that with whatever intellect I have, it’s more user friendly for the younger old, and for a quick reference system, I don’t think there is anything better.

Personally, I like the reading version, being an old-fashioned fellow, and I can hardly imagine a world where the wise people don’t do a lot of reading. You know, maybe we’re going to have wise peoples in the future who spend all their time in front of screens in the course of getting that wisdom, but I doubt it. So I think you may have bought a wonderful product, but I would have the other one too.

Warren Buffett [01:47:58] The product you see there was the joint development, and was launched in January of this year in conjunction with IBM. IBM has been our partner in that product. I believe it’s being bundled into the IB, all the IBM PCs now being sold. So they’ve worked very well with us, frankly. There’s a book even that deals with us. Bill Gates did a very good job of developing a product that was bundled with millions and millions and millions of PCs. It’s called Encarta. It’s actually Funk & Wagnalls. He hates it when that comes out, but they changed the name to Encarta, which was smart of him.

And there are a few people in this room who are witnessed to a demonstration four or five years ago in Bermuda where, in connection with Encarta, the show the Moon and the Earth, and the Moon bumped into the Earth in this. And I just, I don’t know why it sticks in my mind. I thought I would have mentioned it today that… But his is doing very well, so apparently there are a number of people that don’t care about the fact the Moon and the Earth collide. But in the World Book, the Moon and the Earth never bump into each other. He’s done extremely well with Encarta, incidentally. I mean, it was a masterpiece of moving into an area and pushing hard, and kind of attempt my hat to him. But now we’re gonna…

Charlie Munger [01:49:43] Yeah, we’ve copied him.

Warren Buffett [01:49:44] Yeah, we copied him. Okay, Nancy, be sure to buy the print version too, so Charlie will respect you. Zone…

[01:49:57] Shareholder (Patrick, New Hampshire): I’ve searched for a couple questions upon which I might get the two of you to disagree. First, what level of taxation, and I direct these as much to Mr. Munger therefore is to you, Mr. Buffett. First, what level of taxation on capital gains is most conducive to the long-term economic health of a society, and is that also the fair or just rate? In other words, is the just rate of taxation on capital gains precisely that rate that creates the most economic stuff, or is there some other goal the state might pursue? And as a not so subtly related question, I work in a New Hampshire factory that makes industrial torches.

Warren Buffett [01:50:56] As CEO, I might add, Patrick.

[01:50:59] Shareholder (Patrick, New Hampshire): Say again?

Warren Buffett [01:51:00] As CEO of that workings. Made it sound like you were down there on the floor. I just wanted people… Patrick writes me letters from chairman to chairman, so I think we’ve got to get a bag of it. Continuing.

[01:51:20] Shareholder (Patrick, New Hampshire): Well, it’s a small company. I do work as CEO, but it’s not much of a hierarchy. We make torches used in heavy manufacturing, and the fortunes of our factory echo those of industrial America. Do you agree with the conventional wisdom that maintains that the age of classical industrial America has passed, and that we will, that America cannot be competitive in the long term with a low-wage… Capital gains, and then the second is on a, the future for industrial America.

Warren Buffett [01:52:01] I have a sensational answer on the tip of my tongue, but I think I’ll let Charlie go first. We’ll rewind it a bit.

Charlie Munger [01:52:11] Well, I think there’s an easy answer to your capital gain issue, and one is what makes an economy work best in some abstract mathematical sense, and the other is the consideration that you allude to, which gets into issues of fairness. And it’s, as Aristotle felt, that systems worked better when they were generally perceived as fair. The civilization worked better if people saw the differences and rewards is having been fairly, reasonably fair anyway. And I think that if you had a civilization where if you work 90 hours a week driving a taxi cab with no money, no medical insurance and so forth, and somebody else does nothing but own Berkshire Hathaway shares and said on the country club porch and peel off if you ever hear to pay the bills, that would be regarded as so unfair that even if it had some theoretical economic efficiency, it would be counterproductive for our particular civilization to have that kind of a tax code. So I’m all for having some taxation of capital gains. Once you reach that conclusion, you get into the question, what should, what is the fair rate? I think the fair rate might well be a little lower than it is now, but not much lower.

Warren Buffett [01:53:52] Sounds to me like he’s a seller a Berkshire. Patrick is a former heavyweight boxer and just got his PhD fairly recently from Stanford with a 700 page dissertation, which has entered some commentary that actually bears on this. And I thank Patrick actually for introducing me to a kind of a system of mental construct that to attack questions like this. Patrick gave me the example one time, and I think this may go back to John Rawls at Harvard, but he said: just imagine that you were going to be born 24 hours from now, and you had been granted this extraordinary power to determine the rules, the economic rules of the society that you were going to enter, and those rules were going to prevail for your lifetime and your children’s lifetime and your grandchildren’s lifetime.

Now, you’ve got this ability in this 24-hour period to make this decision as to the structure, but there’s a, as in most of these Gene type questions, there’s one hooker. You don’t know whether you’re going to be born black or white. You don’t know whether you’re going to be born male or female. You don’t know whether you’re going to be born bright or, you don’t know whether you’re going to be born in firm or able-bodied. You don’t know whether you’re going to be born in the United States or Afghanistan. In other words, you’re going to participate in 24 hours in what I call the ovarian lottery. And most, it’s the most important event in which you’ll ever participate. Yeah, it’s going to determine way more than what school you go to, how hard you are 7 billion balls now, and that’s you. Now, what kind of a society are you going to construct with that in prospect?

Well, I suspect you would focus on two issues that Patrick mentioned in this question. You would try to figure out a system that is going to produce an abundant amount of goods, and where that abundance is going to increase at a rapid rate during your lifetime and your children and your grandchildren, so they can live better than you do in aggregate, and the grandchildren can live better. So you’d want some system that turned out what people wanted, there’s the eye could see. But you would also on a system that, while it did that, treated the people that did not win the ovarian lottery in a way that you would want to be treated if you were in their position, because a lot of people don’t win the lottery.

I mean, Charlie, when we were born, the odds were over 30 to 1 against being born in the United States, you know, just winning that portion of the lottery. Plus, we wouldn’t be worth a damn in Afghanistan. You know, we’d be giving talks and ought to be listening. Terrible, that’s the worst of all worlds. So we want it that way. We want it partially in the era in which we were born by being born male. That, when I was growing up, you know, women had, it could be, they could be teachers or secretaries or nurses, and that was about it, and 50% of the talent in the country was excluded from a very large part, virtually all occupations. We want it by being white. You know, it, no tribute to us, it just happened that way. And we want it in another way, by being wired in a certain way, which we had nothing to do with, that happens to enable us to be good at valuing businesses. And, you know, is that the greatest talent in the world? No, it just happens to be something that pays off like crazy in this system.

Now, when you get through with that, you still want to have a system where the people but are born like Bill Gates or Andy Grove or something get to turn those talents to work in a way that really maximizes those talents. I mean, it would be a crime to have Bill or Andy or people like that, or Tom Murphy, working in some pedestrian occupation just because you have this great egalitarian instinct. The trick, it seems to me, is to have some balance that causes the people who have the talents that can produce goods that people want in a market society to turn them out in great quantity and to keep wanting to do it all their lives, and at the same time takes the people that lost the lottery and make sure that just because they, you know, on that one moment in time, they’ve got the wrong ticket, I don’t live a life that’s dramatically worse than the people that were luckier.

And when I get all through that long speech, I probably come out with the idea that the capital gains taxes that it exists today is probably about right. So that’s, I see very few people, and I’ve been around a lot of people with money and talent over time. They don’t always go together, but I’ve been around both classes, and the, I see very few of them that are turned off from using their talents by a 28%. Hasn’t happened. I mean, they do what they like to do. Part of the reason they’re good at what they do is they like to do it. And I just, I’ve just never seen it happen. And I’ve seen a lot of people that pay taxes that are higher than 28% that are contributing more to society by some judgment other than a pure market systems.

The other question about the low-cost industrial, you know, the, how does the industrial society evolve. I, you know, you, the world evolves in a way in a market society so people do what they’re best at, and this country’s done very well in recent years, something like, you know, software, that where Microsoft has been leading, or on Intel or something. I mean, we have done very well. 10 years ago the American public was sort of down on itself, for 15 years ago, in terms of what the economy could do, but here we are with our unemployment rate in Nebraska, it’s under 3%. And, you know, you look at the countries of Europe that were supposedly going to beat us into the ground, or you look at Japan, and I think the American economy encourages adaptation. I mean, Singapore may be better, but in terms of major large economies, I think the American economy does awfully well in encouraging adaptation to what people want, delivering it to them, and in ever increasing amounts. And, you know, I view that as all to the goods. So I don’t regard any industry as sacred, but I regard innovation and industry is sacred, that I regard innovation and of production of goods in a market economy to spend 12 hours a day all the time. I don’t see Andy or Bill letting up at all in terms of where Intel and Microsoft are now. I don’t see Roberto Goizueta at Coca-Cola or Michael Eisner or Disney or any of those people. They don’t work 40 hour weeks, they work 70 or 80 hour weeks, and the, I think that system…

Charlie Munger [02:01:59] I would not like the conclusion that both Airness are properly to be considered in the tax laws to cause anyone here to believe that I have a great respect for Harvard University’s philosopher John Rawls. He is perhaps the world’s best known living philosopher, and personally, I think he’s had a pernicious influence on human thought. He doesn’t know enough science, he doesn’t know enough economics, he doesn’t know enough about how systems work to be really good at figuring out what’s fair in systems, and he studied too much philosophy and too little of everything else. So if anybody thinks we love John Rawls, Roy, if you can count me out.

Warren Buffett [02:02:59] Yeah, I wasn’t endorsing his conclusions, I was endorsing his, as thought, as original construct. Charlie, about, how about the industry’s part of the question that Patrick has?

Charlie Munger [02:03:15] Well, if Patrick isn’t the smartest person in the room, there can’t be many in his class. You were getting questions from a very able man, and he’s deliberately made them very difficult, and that whole issue was too complex for me to usefully discuss here.

Warren Buffett [02:03:40] There are also certain limitations on ability that under the equation. So we’ll go to zone 10.

[02:03:48] Shareholder (Bill Rodenberg, Dayton, Ohio): Good day, gentlemen. My name is Bill Rodenberg from Dayton, Ohio. I’m a shareholder, and my daughter Sarah, who is 13, is also a shareholder. She chose not to join me in the limelight. I think the hot dogs had a higher appeal to her. And I would like to say that it’s very reassuring to know that Uncle Warren and Uncle Charlie are taking care of her college fund, and it’s easy to sleep at night. I have two questions, one related to a question my wife asked me, which I was unable to fake a good answer to, and a second one related to my daughter’s one share of Berkshire A.

My wife asked me: in the annual report you stated that if anyone out there has a good company like FlightSafety, please let you know, and you’d be glad to look it over and given it an answer within five minutes or less. And her question is, how can he do that? Where does he get the information to make that decision, and how does he know that that information is valid? My second question has to do with my daughter. She’s 13. In five years she’ll be off to college, perhaps UNL, perhaps not. In any case, she’s going to face a significant capital gains when she sells that one share a stop.

Warren Buffett [02:05:21] I hope so.

[02:05:23] Shareholder (Bill Rodenberg, Dayton, Ohio): You mentioned earlier, and I believe this is correct, you said that you could trade one share of A for 30 shares of B this afternoon, and I thought, wait a minute, I thought there was a limited window on that. We happen to be out of the country at the time that exchange took effect, and we missed it.

Warren Buffett [02:05:45] No, the exchange exists forever. You could never, you can always exchange a share of A for 30 shares of B. You cannot do it in reverse. You cannot shift 30 shares of B into one share of A. But there was no window or timetable on that. The A stock is forever exchangeable for 30 shares of B. I don’t recommend that she does it, because it’s always an option, and in the meantime she gets the shareholder designated contribution, and there’s always a chance that the A will sell slightly at a price slightly above 30 shares to be. It doesn’t do it very often, and it won’t be very much if it does, but so there’s no, we didn’t want to create an incentive for people to exchange A for B, but we, they will always have the right to do so.

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

Charlie Munger [02:07:36] Sure. I had a partner who bought a lot of it 20 years ago.

Warren Buffett [02:07:40] Yeah, yeah, that 20 years ago. Yeah, yeah. But that’s true of almost any business. And we’ve got a fix on what we don’t understand, and then we don’t care to know any more about them particularly, although we’ll pick up a little as we go along maybe. But, and then the ones that are, we’re capable of understanding, we’ve probably gotten about as far as we’ll get already. So we do know in five minutes.

Now, when we do something with FlightSafety, before the purchase and even for somewhat a little after the person, I’ve never been, I never set foot on a piece. They have 40 or so training centers around the world. I never set foot on one of them. I’ve never been to their headquarters. We never looked at a lease. We never look at title of the properties. I mean, we don’t do all of those things. And I will say this: to date, that’s never cost us a penny. What cost us money is when we misassess the fundamental economic characteristics of the business. But that is something we would not learn by what people generally consider due diligence.

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

Charlie Munger [02:09:26] I’ve got nothing to add to that, except that people underrate the importance of a few simple big ideas.

Warren Buffett [02:09:38] Yeah.

Charlie Munger [02:09:38] And I think that to the extent Berkshire Hathaway is a didactic enterprise teaching the right systems of thought, I think that the chief lessons are that a few big ideas really work. There’s, I think these filters of ours have worked pretty well, and because they’re so simple.

Warren Buffett [02:10:03] Yeah, I think most of the people in this room, if they just focused on what made a good business or didn’t make a good business and thought about a little while, they could develop a set of fillers that would let them in five minutes figure out pretty well what made sense or didn’t make sense. I mean, there may be some reason after five minutes we don’t get together on a deal of some sort. But another thing you can usually tell, at least you can tell it in the extreme cases, you can tell whether you’ve got the kind of manager very quickly that you want to have.

I mean, it, if you’ve got somebody that’s been batting 400 all their life, and fortunately age doesn’t change that picture in terms of business performance, and they love what they do, it’s going to work. If the seller cares a lot about the money, you’re probably not going to make a very good deal. I mean, that with their, if their real interest is going into is what they’re going to do with the money, they may fall out of love or have less interest in their business subsequently. We love working with people who are just plain nuts about their businesses, and it works very well, and you can usually spot that. Now, having said that, we’ll have a few people figuring out how to fake that attitude, you know, when they try and sell us some piece of junk here. But Charlie says we can get conned by some guy with a green eye shade, you know, and a low rent office and all that, but we won’t get taken in by the guy with the suede shoes. Zone 11.

[02:11:48] Shareholder (Dorsey Brown, Baltimore, Maryland): Mr. Buffett and Mr. Munger, thank you for having me here today. My name is Dorsey Brown from Baltimore, Maryland. I have two quick questions for you. Could you please comment on any observations that either of you may have concerning executive compensation and optional issuance, a topic that seems to be getting a lot more media attention, and are we going to getting a little bit of excesses in that area? And my second question to you, Mr. Buffett: could you just give us some idea of what a normal day, how you would like to spend a reasonable normal day, and working on the investment side of the equation, or analysis, or reading, or just to give us some flavor of that? Thank you.

Warren Buffett [02:12:39] Okay, I’ll answer the second question first, very easy. I just, I read a lot, and I talk on the telephone a fair amount. We have no meetings, we have no committees, we have no slide presentations. You know, we have nothing. I mean, it, and so we, so I read a lot. I read annual reports, I read business publications. I could do it in way less time, but I enjoy doing it, so I make it last. I mean, you know, like some other activities in life, the… So it’s, there’s really, it’s the most boring job to anybody watching it, but I’m in love with it, you know.

And so I like doing that, and I don’t like talking about it a lot. I just like to kind of keep up with what’s going on. Like I say, by this point in life I could filter out so much of that, it would, I just don’t need to do that much of it, but I kind of enjoy just seeing what’s going on vicariously through doing a lot of reading. And I spend some time on the phone, and I’m on the computer a lot playing bridge, and I get to do what I like all the time at… We’ll let Charlie describe what he does, which is even more bizarre, and then we’ll talk about compensation and options.

Charlie Munger [02:13:56] Well, there’s a little more foolishness in my life than words, including being chairman of a large hospital. I’m not suggesting that hospitals are foolish. I’m just suggesting that it takes a certain quirk of mine to be willing to be the chairman of a hospital. And so my life is even more, it’s less rational than Warren’s. Warren lives one of the most rational lives I’ve ever seen, and it’s almost unbelievable, and he’s got me wondering why I’m here today.

Warren Buffett [02:14:40] Well, we’ll talk about comp then. Yeah, the cops, there are three or four aspects to that. And on the subject of options, I would say that most options are constructed poorly from the standpoint of the owner, but they’re constructed very well from the standpoint of the person who receives them, which is not entirely unexplainable, because the, it’s a very strange form of negotiation when the, the net, the beneficiary is the one that also really does all the design and hires the experts to come in and tell them what is good for their company, when the expert knows that the guy who signs the check be quite interested also in hearing what’s good for him.

There’s nothing wrong with options per se at all. Frankly, in terms of Berkshire, it would have been perfectly appropriate if a properly designed option had been given to me or to Charlie. I mean, we have responsibility for the whole enterprise, and we believe that any kind of perform, incentive for performance should be related to the area in which you have responsibility. We feel that if you want to type us to type 100 words a minute, that you ought to pay for typing 100 words a minute, not what the earnings per share were last year. We feel if a salesman, someone gets paid for how many of the product is sold, they should get paid for that and not for some production a quote has met.

So we believe in tying incentive comp to performance for which you have responsibility, and there’s certain areas of a business that don’t lend themselves to that, staff performance and so on. But that would lead to the corollary that the people that are responsible for the entire results of the business, is perfectly appropriate to compensate them by options that in some way reflect the performance of that entire business. Now, the trouble is that stock prices reflect other things than the performance of the business. For one thing, over a period of time they reflect simply the reinvestment of earnings.

You know, I have pointed out in the past that if you gave me an option on your savings account, to manage your savings account, then you reinvested all the interest, I would take away a significant payment at the end of 10 years simply because you left the interest in. With a company that pays no dividend like Berkshire, if you’re going to leave all your capital in every year, for me to get a fixed price option for 10 years would mean that I was getting a royalty on the money that you left with me, and I made the choice to have you leave it with me. So that does not strike me as equitable. So I think any option should have a pro, a step up in price that reflects the fact that money is reinvested by the shareholders annually. That if somebody wants to pay out 100% of the earnings every year, then I say that you can have a fixed priced option if you give me the money every year, and you do more with the money that’s left with you in the original sum, that’s fine. But if money is left with someone for 10 years, there’s going to be some increase in value even if they spend every day golfing, and to give a piece of that away simply over, to have a royalty on the passage of time for them as a mistake.

I think options ought to be granted basically at the fair value of the business at the time they’re granted. Sometimes that’s the market price, sometimes it isn’t the market price. But certainly the management of a company would not give an option on their business to some third party at a market price they felt was way too low. So I find it a little disingenuous when management say that they’re, when they get a takeover bid, they say that the companies really were twice that much, but they’re perfectly willing to issue options to themselves at this price, which they say is totally inadequate when the owners get the option elsewhere. But options properly structured for people with responsibility for the business, I think makes, can make sense. And I think that if something happened to me and Charlie, that in terms of the manager of the business subsequently, if it was structured properly, I would not say anything wrong within, with an opera, option arrangement.

We carry this philosophy down to our subsidiaries, where they generally get incentive arrangements that relate to the operation of their business, but they don’t have incentive arrangements that relate to Berkshire overall, because if Chuck Huggins does a wonderful job at See’s Candy, as he has done, and I fall on my face in terms of allocating capital, Berkshire stock will go no place despite what Chuck does. And to penalize him, or to tie his rewards to something over which he has no control, I think is kind of silly. So we tie it instead to the operations of the candy business.

In terms of overall level of compensation, the real, the real sin is having a mediocre manager. I mean, they, that is what costs owners very significant amounts of money over time. And if a mediocre manager is paid a relatively small sum, it’s still a great mistake, and if they’re paid huge sums, it’s a travesty, and that happens sometimes. It’s almost impossible to pay the outstanding manager some that’s disproportionate to the value of that outstanding manager when you get a large enterprise. Coca-Cola had a market value of $4 billion when Roberto Goizueta took over. It had stagnated during the previous decade under an earlier management, despite having the same product and those great Mean Joe Greene commercials you saw. That was, Mean Joe Greene was in the 70s, the Teach the World, the same commercial was in the 70s, all these great commercials, but the company didn’t do much. Roberto, if we’d walk the entire Coca-Cola company, I wish we had, in 1981 or ’82, whenever he came in, for $4 billion, and we now had a business worth $150 billion, Roberto would have earned more money with us than these earned under the present arrangement. I mean, having the right person in place is just enormously important. How much they should take is another question, that’s more philosophical question. Tom Murphy, best manager, you know, in the world, he just didn’t feel like taking a lot of money out of it, you know, and you know, I tip my hat to him. But I don’t think that necessarily makes it wrong for somebody else to take more money for doing the job, but I think it ought to be related to doing the job.

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

Charlie Munger [02:22:18] Well, we have remarked in previous Berkshire Hathaway meetings that we regard present mandated corporate accounting with respect to stock options as weak, corrupt and contemptible. And it is. Otherwise, we’re undecided. If something is so wonderful as a standard technique of compensation, why does it have to be masked under weak, corrupt and contemptible accounting? I think it is no credit to our civilization that we’ve drifted into this particular modality. And you can get, if you overuse stock options, where the whole thing is sort of a chain letter. I mean, in Silicon Valley there’s one company that practically paid everybody in options, and as long as the chain letter galloped, it worked as far as the income account, because nothing went through expense. And then once everybody is issuing stock options, everybody else feels that he has to do it, and the practice spread.

So I am not totally wild about the extreme prevalence of the stock option modality in an American corporate life. Personally, I would vastly prefer different modalities, which would probably involve stock instead of stock options. I’m all for sharing with the kind of people who are doing the important work pretty well down in the organization at a place like Costco or Coca-Cola or any other such company, but I don’t much like the present scheme the civilization has drifted into with respect to the subject.

Do we have some wretched accesses in American corporate compensation? My answer would be yes. I don’t think the excess is necessarily the guy who got the most money. In many cases, I agree with Warren, the money has been deserved. But such is the envy effect that the practice spreads to everybody else, and then the taxi driver and everybody starts thinking the system is irrational, unfair, crazy. And I think that’s what causes some people, as they rise in American corporations, to, at a certain point of power gaining and wealth gaining, they start exercising extreme restraint as a sort of moral duty. And that’s what Warren was saying about Tom Murphy.

And I would argue that the Tom Murphy attitude is the right attitude, and it goes way, way back in the history of civilization. The word liturgy comes from us Greek word of the, which is just the same. I mean, if you were an important citizen of Athens, it was a lot like being an important person in our, in Jewish culture. I mean, you had duties to give back and to act as a certain example, and the civilization had social pressures that enforced those duties. And I would argue that the Berkshire Hathaway compensation system, considering what the people at the top already have, it would be better if we saw a little more of it. I think Warren and I do all right.

Warren Buffett [02:26:06] A few years ago, I think it… An added problem is the sort of, in terms of the accounting, the sort of hypocrisy that it pushes people into, and then which becomes accepted and sort of a norm, particularly when leaders do it. That, you know, he had a situation a few years back when there’s no question that any manager would say that stock options are a form of compensation. They would say that compensation is a form of expense. Then they would say that expense belongs in the income account. But they didn’t want to have stock options counted, because they felt that it might restrict their use.

So when the federal, the FASB, Financial Accounting Standards Board, came up with a proposal to actually have a reality reflected, and mass corporate chieftains descended on Washington to pressure legislators to have Congress start enacting accounting standards. Which, as I mentioned one time, in Indiana in the 1890s there was a legislator that introduced the bill to have the value of pi changed to an even 3, because he thought 3.14159 was too tough for the school children. It would ease computational problems.

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

Charlie Munger [02:28:23] It’s rather interesting though, there’s an earlier example. Commodore Vanderbilt took no salary from his railroads. After all, he controlled the railroads, they paid all the dividends that he needed, and he got the fun of running the whole railroad, and he thought it was beneath Commodore Vanderbilt take a salary. We’ve never quite reached the Vanderbilt standard, but…

Warren Buffett [02:28:53] We don’t have any dividends, Charlie.

Charlie Munger [02:29:14] Well, maybe that’s the reason.

Warren Buffett [02:29:32] Yeah. Well, with that, we’ll take a break for… We’ve got food out in the other room, including See’s Candy for those who haven’t tried it. We’ve almost finished this box up here. And we’ll reconvene at 12:30. Thanks.

Okay, if we’re live now, what we might do is maybe have just, I think maybe we only need four microphones for the afternoon session, so we’ll have two on each side, one toward the back, one toward the front, and we’ll just go around in four microphones. Are we okay on that? And we’ll start just one second, everybody has a chance to get to their seats. Charlie has promised to stop tapping the Coke can during this session.

Charlie Munger [02:32:46] Huh. I only did that when somebody else was talking.

Warren Buffett [02:32:51] Number two, okay. I used to have a friend that was a stock salesman many years ago, and when you’d have lunch with him, he would just keep going like this, and finally it would get you and say, “What’s that?” And he said, “That’s opportunity.” (Laughter) He was pretty good. Okay, let’s, Kelly tells me we should start with number two, zone two. So we’re going to start with zone two. Nope? Yes.

[02:33:30] Shareholder (Fred Cooker, Boulder, Colorado): I’m Fred Cooker from Boulder, Colorado, and this is a question about intrinsic value, and it’s a question for both of you, because you have written that perhaps you would come up with different answers. You write and speak a great deal about intrinsic value, and you indicate that you try to give shareholders the tools in the annual report so they can come to their own determination. What I’d like you to do is expand upon that a little bit. First of all, what do you believe to be the important tools, either in the Berkshire annual report or other annual reports that you review, in determining intrinsic value? Secondly, what rules or principles or standards do you use in applying those tools? And lastly, how does that process, that is, the use of the tools, the application of the standards, relate to what you have previously described as the filters you use in determining your evaluation of a company?

Warren Buffett [02:34:57] If we could see, you know, looking at any business, what its future cash inflows or outflows from the business to the owners or from the owners would be over the next, we’ll call it 100 years, or until the business is extinct, and then could discount that back at the appropriate interest rate, which I’ll get to in a second, that would give us a number for intrinsic value. In other words, it would be like looking at a bond that had a whole bunch of coupons on it that was doing 100 years. And if you could see what those coupons are, you can figure the value of that bond compared to government bonds, if you want to stick an appropriate risk rate in, or you can compare one government bond with 5% coupons to another government bond with 7% coupons. Each one of those bonds has a different value because they have different coupons printed on them.

Businesses have coupons that are going to develop in the future too. The only problem is they aren’t printed on the instrument, and it’s up to the investor to try to estimate what those coupons are going to be over time. As we have said, in high-tech businesses or something like that, we don’t have a faintest idea what the coupons are going to be. When we get into businesses where we think we can understand them reasonably well, we are trying to print the coupons out. We’re trying to figure out what businesses are going to be worth in 10 or 20 years. When we bought See’s Candy in 1972, we had to come to the judgment as to whether we could figure out the competitive forces that would operate, the strengths and weaknesses of the company, and how that would look over a 10 or 20 or 30 year period.

And if you attempt to assess intrinsic value, it all relates to cash flows. The only reason for putting cash into any kind of an investment now is because you expect to take cash out, not by selling it to somebody else, because that’s just a game of who beats who, but by, in a sense, by what the asset itself produces. That’s true if you’re buying a farm, it’s true if you’re buying an apartment house, it’s true if you’re buying a business.

And the filters you described were, there are a number of filters which say to us, we don’t know what that business is going to be worth in 10 or 20 years, and we can’t even make an educated yes. Obviously, we don’t think we know to three decimal places or two decimal places or anything what like that, what precisely what’s going to be produced, but we have a high degree of confidence that we’re in the ballpark with certain kinds of businesses. The filters are designed to make sure we’re in those kinds of businesses. We basically use long-term risk-free, that’s government bond type interest rates, to think back in terms of what we should discount at.

And, you know, that’s what the game of investment is all about. Investment is putting out money to get more money back later on from the asset, and not by selling it to somebody else, but by what the asset itself will produce. If you’re an investor, you’re looking at what the asset, you’re looking at what the asset is going to do, in our case, businesses. If you’re a speculator, you’re primarily focusing on what the price of the object is going to do, independent of the business, and that’s not our game. So we figure if we’re right about the business, we’re going to make a lot of money, and if we’re wrong about the business, we don’t have any hopes, we don’t expect to make money.

And in looking at Berkshire, we try to tell you as much as possible as we can about our business, of the key factors. Those are the things that Charlie and I, what the things we put in our report about those businesses are the things that we look at ourselves. So if Charlie had nothing to do with Berkshire, but he looked at our report, he would probably, in my view, he would come to pretty much the same idea of intrinsic value that he would come to for being around it, you know, for X number of years. The information should be there. We give you the information that if the positions were reversed, we would want to get from you.

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

Charlie Munger [02:39:26] I would argue that one filter that’s useful in investing, it’s the simple idea of opportunity cost. If you have one opportunity that you already have available in large quantity and you like it better than 98 of the other things you see, where you can just screen out the other 98%, because you already know something better. So that people who have a lot of opportunities tend to make better investments than people that don’t have a lot of opportunities, and people who have very good opportunities and using a concept of opportunity costs, they can make better decisions about what to buy. With this attitude you get a concentrated portfolio, which we don’t mind. That practice of ours, which is so simple is not widely copied. I do not know why. Now it’s copied among the Berkshire shareholders. I mean, all you people have learned it. But it’s not the standard in investment management, even at great universities and other intellectual institutions. You, very interesting question: if we’re right, why are so many eminent places so wrong? There are several possible answers to that question.

Warren Buffett [02:40:53] Yeah, the attitude though, I mean, if somebody shows us a business, you know, the first thing goes through our head is, would we rather own this business and more Coca-Cola? Would we rather own it than more Gillette? You know, we, it’s crazy not to compare it to things that you’re very certain of. There’s very few businesses that we’ll find that we’re certain of the future about as companies such as that, and therefore we will want companies where the certainty gets close to that, and then we’ll want to figure that we’re better off than just buying more of those.

If every management, before they bought a business and some unrelated field that they might not have even heard of, you know, more than a short time before that, being promoted to them, if they said, “Is this better than buying in our own stock? You know, is this better than even buying, you know, buying Coca-Cola stock or something?” there’d be a lot fewer deals done. But they don’t, they tend not to measure. We try to measure against what we regard as close to perfection as we can get. Charlie, anyone?

Charlie Munger [02:42:11] Well, I will say this, that the concept of intrinsic value used to be a lot easier, because there were all kinds of stocks that we’re selling for 50% or less of the amount at which you could have easily liquidated the whole corporation if you owned the whole corporation. Indeed, in the history of Berkshire Hathaway, we bought things at 20% of them liquidating value. And in the old days, the Ben Graham followers could run their Geiger counters over corporate America, and they could spill out a few things, and you could easily see, if you were at all familiar with the market prices of whole corporations, that you were buying at a huge discount. Well, no matter how bad the management, if you’re buying at 50% of asset value or 30% or so on down, you have a lot going for you.

And as the world is rised up, and as docs have behaved so well for people that stocks generally have gone to higher and higher prices, that game gets much harder now, to find something at a discount from intrinsic value. Those simple systems ordinarily don’t work. You’ve got to get into Warren’s kind of thinking, and that is a lot harder. I think you can predict the future in a few places best if you understand a few basic ideas that come from a good general education, and that’s what I was talking about in that talk I gave at the USC Business School. In other words, Coca-Cola is a simple company if it’s stripped down and analyzed in terms of some elemental forces. There are certain fundamental models out there that do not take, you don’t have the kind of ability that quantum mechanics requires. You just have to know a few simple things and really know them.

Warren Buffett [02:44:21] Charlie talks about liquidity. Now, you’re not talking about closing up the enterprise, but it’s talking about what somebody else would pay for that stream of cash too. I mean, if you could have looked at a collection of television stations owned by Cap Cities, for example, in them, in the early to, well, 1974, and it would have been worth, we’ll say, four times what the company was selling for, not because you’d close the stations, but just their stream of income was worth that to somebody else. It’s just that the marketplace was very distressed, depressed. Although, like I say, on a negotiated basis you could have gone and sold the properties for four times with the company was selling for, and you got wonderful management. And I mean, those things happen in markets. They will happen again at…

But part of investing in calculating intrinsic values is, if you get the wrong answer when you get through, in other words, if it says don’t buy, you can’t buy just because somebody else thinks it’s going to go up or because your friends have made a lot of easy money lately or anything of the sort. You just, you have to be able to walk away from anything that doesn’t work, and very few things work these days.

Charlie Munger [02:45:27] You also have to work, walk away from anything you don’t understand, which in my case is a big handicap. But you’d agree with your on that, it’s much harder now?

Warren Buffett [02:45:35] Yeah, but I would also agree that almost at any time over the last 40 years that we’ve been up on a podium, we would have said it was much harder in the past too. But it is harder now.

Charlie Munger [02:45:45] It’s way harder.

Warren Buffett [02:45:46] The part of it being harder now too is the amount of capital we run. I mean, if we were running $100,000, our prospects for returns would be, and we really needed the money, our prospects for return would be considerably better than they are running Berkshire. It’s just, it’s very simple. Our universe of possible ideas would expand by it a huge factor. We are looking at things today that by their nature a lot of people have to, are looking at. And there were times in the past when we were looking at things that very few people were looking at, but there were other times of the past when we were looking at things where the whole world was just looking at them kind of crazy, and that’s a decided help. Zone three.

[02:46:35] Shareholder (Bakul Patel, upstate New York): My name is Bakul Patel. I am from upstate New York. I have got a few questions, and I need your permission to ask each question separately and wait for the answer.

Warren Buffett [02:46:47] Well, we’ll take a couple, but… Yeah, I got through college, you know, only answering three or four questions, so I don’t want to go through that again.

[02:46:58] Shareholder (Bakul Patel, upstate New York): They are unrelated questions.

Warren Buffett [02:47:00] Okay. Okay, we’ll give you a couple that will let other people have a chance. How about two?

[02:47:07] Shareholder (Bakul Patel, upstate New York): Okay. Right. Mr. Market is valuing Dow Jones at seventh, above 7,000, and S&P at about 800. By your valuation model, at the current interest rate and current inflation rate and current growth rate, what is the fair evaluation of both these companies?

Warren Buffett [02:47:23] Yeah, well, that’s a good question, but a tough question. But I would say that if you believed American, the American business in aggregate could earn the kind of returns on equity that they have been earning in the last, or it has in the last couple of years, and then you postulate no change in interest rates, you can justify 7,000 on the Dow and 800 on the S&P. Now, you know, there’s a couple ifs I threw in there. And if interest rates go higher, the valuation goes down automatically. And more importantly, if the returns on equity of American industry, which your historic highs, and which sort of classical economics would tell you would be hard to maintain, if those returns go down on average, that also would pull it down. But if you’re willing to accept the current level of returns on equity as being typical of the future case for American business, and you’re willing to assume present interest rates are lower, then you can justify evaluation on the Dow and S&P. And it’s interesting, I, it, because I got all that commentary after I wrote that line in the report, which was, as I said earlier, designed for a little something else.

I’ll give you a little trivia quiz. What two years in this century has the Dow had the greatest overall gain? The two years in the 1900s or 1933, which most of you don’t think it was a banner here, but in 1954, and in both of those years the Dow was up over 50%, accounting dividends. In March of 1955, because of that, the fact that the Dow had gone up, bear in mind that the high on the Dow was 381 in 1929, and it took 25 years before that was surpassed, and in 1954 the Dow went from, say, 280 up to 404 or something like that, just a little over 50%. So what did they decide to do? They decided to have congressional hearings about it. And they did, in March of 1955, they had hearings in the Senate Banking and Currency Committee, Chairman Fulbright, and my boss, Ben Graham, was called down to testify. And it’s fascinating reading. Bernard Baruch was there, all kinds of people. But I’ve got the hearings at home, and Ben’s opening comments about the market at that time where the market looks high, it is high, but it’s not as high as it looks.

Well, that’s about the present situation. I mean, it looks very high just by comparing 7,000, certainly, to the 404 at the end of 1954 when Ben was testifying. But there have been huge changes in earnings and return on equity on American business in general, and then you’ve had this big move in interest rates. Now, those are underlying fundamentals that have had a, powered a huge bull market. After a while, as I mentioned earlier, people get captivated simply by the notion of rising prices without going back to the underlying rationale, and that’s when you get very dangerous conditions in terms of possible bubbles. And it would, you know, it, I have no idea where markets will go, but it, you had the kind of conditions that could cause real excesses, just like you had excesses in 1973 and ’74, going back to when you could buy things at 20 cents on the dollar. You had excesses in the other direction. You know, the country didn’t disappear or anything. It’s just people behave in extreme ways and markets, and over time that’s very good for people that keep their heads. Charlie?

Charlie Munger [02:51:26] I’ve got nothing to add.

Warren Buffett [02:51:29] Okay, get one more.

[02:51:30] Shareholder (Bakul Patel, upstate New York): Oh, Mr. Market goes in a depressed phase, that Berkshire Hathaway has got the investment portion of its mark book value about $28,000 per Class A share. That would put the Berkshire however I share much lower than what it is now. Would Berkshire, how can we consider buying back its own share, or has it done it so in past, or is it out of the question?

Warren Buffett [02:51:55] If the market won in the tank, Berkshire stock would go in the tank too. And so there shouldn’t be anybody in this room that owns the stock that would not find it palatable, if not become positively enthusiastic, about the stock going down 50%. That it would not bother, it would not bother Charlie, it wouldn’t bother me, because we would have very intelligent things than to do with whatever capital we came into, and we would be generating capital as we went along. We wouldn’t have sold our Coke, we wouldn’t have sold our Gillette, we wouldn’t have sold our businesses, so most of our capital would have ridden that down, but at least we would have intelligent things to do with the money.

One of the intelligent things possibly could be to buy in our own stock, but that would imply that our own stock was cheaper relative to value than anything else we could find among possible opportunities, and the chances are we could find things that were more attractive. Back in 1973 or ’74, when we were buying Washington Post a fraction of what it was worth, Berkshire stock may have been cheap then, but it wasn’t as cheap as the Washington Post. In 1987, or well, it was in 1988 and ’89, you know, Berkshire stock may or may not have been cheap, but it wasn’t as cheap as Coca-Cola. And it’s unlikely that among the thousands of impossible investments that Berkshire will be the most attractive at any time. But if it were, you know, obviously we would buy in our own stock. But I think if the Dow went down 50%, we would have plenty of interesting things to do, and we would not be unhappy. Charlie?

Charlie Munger [02:53:32] Yeah, we don’t have any rule against it, if opportunity cost is the game around here.

Warren Buffett [02:53:42] Zone four.

[02:53:43] Shareholder (David Day, Coppell, Texas): I’m David Day from Coppell, Texas, and I’m a Berkshire shareholder. Mr. Buffett, what is your opinion of investing in foreign company stocks?

Warren Buffett [02:53:58] Well, we have a number, well, at least several major businesses, three or four, at least five, six as I count along, that derive very significant percentages of their earnings from international, from the international operations. Coca-Cola earns 80% or more from international operations. Gillette would earn two-thirds or more from international operations. So if you look to where our look-through earnings are coming from, we get a lot from international companies. They don’t have to be domiciled outside the United States. It’s a slight advantage to us to have them domicile in this country. For example, their dividends are treated better. We get better treatment on the dividends if they are domestically based rather than based someplace else, just because of the way the U.S. tax laws work.

But if Coca-Cola were domiciled in Hampshire, damage where domiciled in London, they had the same basic businesses, we would be attracted to them to virtually the same degree we are as having them domiciled in Atlanta and Boston. We look at businesses outside this country that are domicile outside this country. Many don’t meet our size requirements, but that’s true here too. But they’re, we have to look at very big companies. But we have nothing against buying company, buying into companies that are dominant, or even buying the entire business of a company that’s domiciled outside the United States. We feel slightly less familiar with the tax laws and the corporate culture, cultures perhaps, but that would not be a huge factor in a great many countries. And, you know, we will keep looking. We need to look everywhere with the kind of money that we have available for investment. Charlie?

Charlie Munger [02:56:03] Again, we’ve had a wonderful way of playing the rapid development of economies outside the United States, and so far we haven’t seen anything that attracted us as being better. And if you can sell Coca-Cola, you know, do you really want to get into steel in Malaysia or something?

Warren Buffett [02:56:28] We sold a substantial number of Kirby units outside of the United States last year, and that business is growing very significant other recent years. I think it promises to grow on. We’re always looking for opportunities. Some things travel very well and some things don’t. I mean, that Gillette travels, Disney travels, McDonald’s travels, Coke travels. You know, See’s Candy doesn’t travel as well. It might if you spent 50 years working on it, but it’s not an easy thing to travel. Actually, candy bars themselves don’t travel very well. If you look at the top-selling candy bars in France or in England and Japan, you don’t find a similarity that you find in terms of the best-selling soft drinks or movies or fast food hamburgers or razor blades, at, except Snickers, for some reasons. Snickers, well, travels very well. Don’t ask me why. Yeah, Charlie’s had a lot of experiences, he goes around the world. You don’t want to eat where we eat. You may want to invest where we invest, but… Okay, section one.

[02:57:51] Shareholder (Richard Tompkins, Gallatin, Tennessee): I’m Richard Tompkins from Gallatin, Tennessee, and I have just two quick questions. Could both of y’all discuss the Kansas Bankers business and its competitors, how big of a moat Kansas Bankers has in the industry, and if they’re going to expand, you know, outside of the 22 or 20 states that they’re currently in? That’s a… And then secondly, just clue us in a little bit more on the five-year discount notes that you did that were tied to the Salomon stock, and was that a way to unload it, or just kind of give us a little more than what we saw in the annual.

Warren Buffett [02:58:32] Sometimes in the insurance business you have a choice between being a good business or a big business, and fortunately Don Towle, who runs Kansas Bankers Surety, has chosen for a good business. It’s a specialized operation that sells, as its name implies, to bankers, and primarily policies that have fidelity coverage, and that is just not a big volume business in the whole United States. They do it exceptionally well. Don knows every, you know, he knows every account, he knows every claim, he, you know, he, it, he runs a fabulous operation. But it’s not an operation that can double or triple in size doing what it does and doing well. There just aren’t, there’s not the opportunity there. On the other hand, I think it’s tough to compete against Don, because he brings an element of knowledge and personal attention to the account and factors of that sort that a really large company would have trouble duplicating. Charlie, you want to add anything on Kansas Bankers?

Charlie Munger [02:59:40] Yeah, there’s a huge class of businesses in America which are very strong and will throw out large amounts of cash in relation to their size, but which can’t rationally be expanded very much. But if you try and expand certain kinds of businesses, you’re throwing money down the rat hole. The beauty of the Berkshire Hathaway system is that such businesses are very welcome here, because the cash comes into headquarters and is allocated there. If there’s anything sensible to do at the subsidiary level, we always want it done. But there are businesses where, lots of businesses where they’re, there isn’t much of a way of redeploying the cash. Part of the reason they have a motor around them is, it is that they’re of a size and have specialized skills that other organizations just can’t get into it.

Warren Buffett [03:00:34] I’ll give you another example, and that’s a somewhat same field. There’s a company called Western Surety. It’s changed ownership a couple of times. Charlie and I don’t, went up to see him 15 years ago by buying it, that Sioux Falls. They write notary bonds, and they write a whole bunch of things that have $50 premiums or $25 premiums. They have, there was a company doing not that many millions of premiums, but they had 30,000 agents, but each agent, you know, may have done $500 worth of business with them a year, or $1,000. Well, Chubb can’t go after that business the same way. We certainly can at National Indemnity. They have a distribution system that works wonders, but you can’t pump two or three times the volume through that distribution system, and if you could pump it through, there would have been more competition.

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

[03:02:00] Shareholder (Richard Tompkins, Gallatin, Tennessee): Her just the, the $500 million I think that y’all did of the discount.

Warren Buffett [03:02:06] Oh, the Salomon. No, yeah. Well, that is simply an issue of Berkshire, by Berkshire, of $500 million, as you mentioned, of a very low coupon note, low interest rate note too, that is convertible or exchangeable into Salomon’s stock anytime during the next five years. And it’s a way of taking the capital out of that block of stock at a low interest cost to use elsewhere, while retaining a limited portion of the upside in the Salomon stock. And we made that decision whenever it was, six months ago or so, based on the thought that we might have some good opportunities at some point to use that money, and raising the money at a little over a 1% current cost, or a 3% cost to maturity, and we think the actual cost is likely to be close to the 1%, made sense for us.

We have never owned, I mean, we had the convertible preferreds of Champion, of USAir and of Salomon, and those are three industries. I don’t think we’ve ever owned an airline stock, common stock. I don’t think we’ve ever owned a paper company common stock. And we’ve only had a very limited amount of investment in the investment banking businesses. Those are industries that we don’t feel that we’ve got the same kind of long-term economic advantage that we have in something like a Coke or Gillette. So those are not natural places for us to be common shareholders, and the issuance of that exchangeable debt reflected that view. Charlie?

Charlie Munger [03:03:58] I agree.

Warren Buffett [03:04:00] Okay, zone two.

[03:04:02] Shareholder (Kristen Schramm, Springfield, Illinois): My name is Kristen Schramm. I am from Springfield, Illinois. I am a proud shareholder of Berkshire Hathaway. In light of the upcoming capital gains tax reduction, do you envision any increased selling pressure, such as buying opportunities for Berkshire stock?

Warren Buffett [03:04:34] That’s a good question, Christine. We’re proud to have you too. A very high percentage of Berkshire’s shares is owned by people with very low tax basis, so that if I had to guess, I would say that probably 80% at least of the shares are owned by people whose cost is less than $100 a share on the A stock. And that undoubtedly contributes to some people’s reluctance to sell, particularly if they’re older ad. But I think it would probably, might make less difference than you think. I think most people, if there were a lower and lower capital gains rate, I don’t think it’d be a huge change in the propensity to sell the stock. I would hope, even if there was a zero capital gains tax, that there really wouldn’t be any rush for the exits. And it wouldn’t affect my attitude particularly. But I think it’s perfectly reasonable to assume that as the tax rate goes down, there will be some greater tendency to sell by people with a low tax basis on their shares. Charlie?

Charlie Munger [03:06:02] Well, I think the laws of microeconomics and the laws of psychology are such that if you said the tax rate will for one month go down to zero, you would have some very dramatic effects and in the markets.

Warren Buffett [03:06:16] It’s not going to happen, of course.

Charlie Munger [03:06:18] No. But if you said the tax rate was going to zero for one month and then going to 100% subsequently, I think you get a certain amount of activity then. You really, so you could tinker with the tax laws in a way that would cause dramatic market effects. I don’t anticipate any such things happening.

Warren Buffett [03:06:36] We had something similar back when they, what was it, ’86, where, and the tax rate was 20% on long-term capital gains, and it was the last year you could liquidated corporation and not pay gains taxes unappreciated assets that were disposed of in the liquidation, and we got a great flood of liquidations in that year. So it’s possible to do things to the tax laws that have big market effects. It gets very unlikely that any such thing is going to happen this year.

Charlie Munger [03:07:28] Yeah, I agree with that.

Warren Buffett [03:07:32] And zone two years. Is there a zone two? The microphone working? Oh, call zone three. Well, we’ll go to zone three then.

[03:07:44] Shareholder (Charles Parcells, Grosse Pointe, Michigan): I am Charles Parcells from Grosse Pointe, Michigan. Glad to be here. I’m a recent stockholder of Berkshire, I’m sorry to say that, and, but it does not diminish my admiration for past performance or my confidence in future performance. I heard recently a remark by, I think, a very successful investor who I think worked with the Bass family in Texas for a while, and one of his comments, if I understand it correctly, said something like this: Hurricane Andrew destroyed the super cat industry. And that’s about all he said. And I know we’re into it. I’m interested in its importance to Berkshire and your comments on it, Mr. Buffett and Mr. Munger.

Warren Buffett [03:08:40] Yeah, I guess I would say I don’t fully understand why he wouldn’t, or even partially understand why he would say that. I mean, we are in business in the super cat business, and I should explain, super cat business is very much like it sounds. I mean, we write insurance for other insurance companies, other reinsurance companies, to protect them, to pay them at a time when something really big comes along, a super catastrophe. And Hurricane Andrew was certainly a super catastrophe, but that, but that’s the reason people do business with us. So we pay off infrequently, but we pay off big. And we paid off about $120 million at Hurricane Andrew. But if Hurricane Andrew happened today, well, at least one of the policies and steps we have, we would certainly be paying off at least, what, $600, $700 million, something like that. And if it happens five years from now, we’ll pay off a lot more than that, because we will undoubtedly be writing more business at that time.

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

And the Hurricane Andrew was, you know, that was just, that’s part of business with Berkshire, and we will have another one, and we’ll have another one after that. So every three or five or seven years, or who knows what, we will lose significant money in the super cat business, and we expect that over 20 or 25 years we will make more money than we lose. We bring some real advantages to that business, as I wrote about in the report, and it makes sense for us to be in it. It only makes sense for us to be in it when the premium prices are right. But when they are appropriate, we will, we’re more than willing to step up and take on a fair amount of risk.

As I wrote in the report on the California Earthquake Authority, you know, we could tomorrow face a demand for roughly $1 billion, and we are prepared to write a check that day to take care of that, and we will run it if it happens. And there aren’t very many people in the world that an insured can count on to do that. The interesting thing is that the worst exposure still for super cats are not borne by us, but they’re borne implicitly by some very big direct writing companies that have lots of risk on Long Island or along the New Madrid fault or other places. And they have got, well, millions of policies, and maybe hundreds of thousands of exposed policies, and they don’t think of themselves as being in the super cat business, or they really do, but they don’t, they don’t think, you know, day by day about it, and they are very exposed. Our exposures are limited to a given dollar amount. That dollar amount may be large, but at least we know what it is, and we take risks that, we’re willing to take risks when we think we’re appropriately paid. There’s a mentality to bring to the super cat business that’s somewhat akin to the, what you bring to the investment business, so we think we’re well equipped for it. Charlie?

Charlie Munger [03:13:08] Yeah, the $1 billion would be, what, 2.5% or less of the liquid assets and securities around Berkshire. And so that’s irritating, but it’s not going to destroy the enterprise. Whereas if you have an unwitting super cat exposure that you don’t even recognize you have, it could destroy your company. 20th Century, a very well-run director of insurance, they all but went broke with the Northridge earthquake, and they didn’t think it was possible either. They had no idea they had a super cat exposure and what they thought was a simple little direct reading insurance operation.

Warren Buffett [03:13:55] Now, I don’t think we’ve left the main super cat risks at all at Berkshire. GEICO lost something like $150 million in Andrew, and their initial estimate of the loss was like $35 million, and that’s after they thought they’d heard about most of it. You can really get fooled in this business. In fact, 20th Century, which lost the $1 billion at Northridge, just in, at the end of 1996, I think added $40 million, as I remember, to the reserves for the Northridge quake, which I think was in January of ’94. Now, you think on an earthquake you would, you know, you’d kind of know when it was over, but it, you can really, you can get fooled. And down at Andrew, I mean, the cost of construction go up dramatically in an area that’s been wiped out, and then there were all kinds of things in the codes. I mean, I think they started requiring architects’ drawings on everything, you know, over $5,000 in the way of repair, some number like that, I don’t owe me the number. And of course the architects had a field day. And then it turned out that everybody had a homeowner’s policy, at, in the Oakland fire, for example, they all had a $300,000 book collection in their library. And, you know, who knows, after the place is burned down, it’s not… You get a lot of surprises in that field, and the surprises in insurance are never symmetrical. They’re all bad. Zone four.

[03:15:21] Shareholder (Jin Ching Wah, New Mexico): Yes, my name is Jin Ching Wah. I’m from New Mexico, and I’m a shareholder. I have two questions. First, that ’91 letter, you wrote that investors eventually repeat their mistakes. So what do you do to keep you from making the same mistake twice? Now, and the second question is, in your ’92 letter, you wrote that you attempt to deal with the problem of future earning in two ways. First is the business you understand, and the second is the model of safety. And you said they are equally important. But if you cannot find the happy combination of faster groups it’s a low-key, which one do you think is more important, fast growth or low-key? That’s my two questions.

Warren Buffett [03:16:17] I think we were told by some higher authority which one was more important there for a second. Ah, well, they’re bound together. I, obviously, if you understood a business perfectly, the future of a business, you would need very little in the way of a margin of safety. So the more volatile the businesses are possibility is, but assuming you still want to invest in at, the larger the margin of safety. I think in that first edition of Graham and Dodd, if I remember, it was a J.I. Case used, and said, you know, maybe it was worth somewhere from between 30 and 110 or some number. He said, well, that, you know, that sounds perfect. How much good does that do you, to know that it’s worth between 30 and 110? Well, it does just some good selling below 30 or above 110, and that’s, you need a large margin of safety.

Well, if you’re driving a truck across a bridge that holds, it says it holds 10,000 pounds, and you’ve got a 9,800 pound vehicle, you know, if the bridge is about 6 inches above the crevice that it covers, you may feel okay. But if it’s, you know, over the Grand Canyon, you may feel you want a little larger margin of safety, in terms of only driving a 4,000 pound truck or something across. So it depends on the nature of the underlying risk. We don’t get the margin of safety now that we got in a 1973-’74 period, for example. The biggest thing to do is understand the business, if you understand the business and get into the kind of businesses where surprised, by the nature, surprises are few. And we think we’re largely in that type of business.

The earlier part about, you know, I’ve said about learning from your mistakes, the best thing to do is learn from other guys’ mistakes. I mean, you know, it’s like, you know, Patton used to say, you know, it’s an honor to die for your country, make sure the other guy gets the honor, you know. (Laughter) So our approach is, is it really to try and learn vicariously. But there’s a lot of mistakes that I’ve repeated, I can tell you that. At, the biggest one probably, all the biggest category over time, is being reluctant to pay up a little for really, for a business I knew was really outstanding, or to continue to buy it at higher prices when I knew it was outstanding. Some, the cost of that have been in many, many billions, and I’ll probably keep making that mistake.

Yeah, there are, the mistakes are made when there are businesses you can understand and they’re attractive and you don’t do something about it. I don’t worry at all about the mistakes that come about because when I met Bill Gates I didn’t buy Microsoft or something. That’s not my game. But the mistakes are made when you, most of our mistakes have been mistakes of omission rather than commission. Charlie?

Charlie Munger [03:19:29] Yeah, I think most people get very few what I call no-brainer opportunities, where it’s just so damned obvious that this is going to work. And since they are very few, and they may be separated by periods of years, I think people have to learn to have the courage and the intelligence to step up in a major way when those rare opportunities come by.

Warren Buffett [03:19:56] Yeah, you gotta be willing to take a really big bite, and it’s crazy if you don’t, and it’s crazy if you dabble around at the edges so you’re not prepared to take a big bite when the time comes. We apparently have lost mic four, so we’re just gonna use three mics from now on, and if you’ll just make your way to those mics, we’ll see how we do with them. How about zone one?

[03:20:25] Shareholder (Pete Brown, Columbus, Ohio): Mr. Buffett, my name is Pete Brown from Columbus, Ohio, Class B shareholder. I had a couple questions, if I could. The first is, I don’t have a very good idea in my mind how our typical insurance operations work, I mean, in particular, how money leaves the insurance pool and enters the investment pool, and how our operations are different than the typical run-of-the-mill insurance operation, you know, around the country. Why are we able to generate so much more float than, you know, the XYZ company, you know, somewhere else?

And a second question is, it kind of goes back to an article you wrote for Fortune magazine back in the late ’70s about the effect of inflation on equity values and that sort of thing. And you asserted that stocks were, in businesses were really like bonds, they just had their own par, and the par being the average 12% return on equity that companies have averaged. You know, a company does better than that has assets that are worth way more than 100 cents a dollar, a company does less, you know, will be less correspondingly. My question is, when you’re projecting cash flows of a company as a prospective investment, why would you use the going insurance, or interest rate, you know, of risk-free Treasury bills? Why wouldn’t you use the sort of opportunity cost to discount it that maybe Charlie was referring to, maybe 12% return on equity of average corporations, maybe, you know, your 15 goal, maybe Coca-Cola’s return on equity is a comparison? I mean, doing that would dramatically change the value of the company that you’re, you know, evaluating, because I’m sure… You know, why would you use the risk-free rate, is my question.

Warren Buffett [03:22:10] The risk-free weight is used merely to equate one item to another. In other words, we’re looking for whatever is the most attractive, but in terms of present valuing anything, we’ve got it, we’re going to use a number, and obviously we can always buy the government bond, so that becomes the yardstick rate. It doesn’t mean we want to buy government bonds. It doesn’t mean we want to buy government bonds if the best thing we can find is only has a present value that’s, works out at a half percent a year better than the government bond. But it’s the appropriate yardstick, in our view, to simply use to compare across all kinds of investment opportunities, oil wells, farms, whatever it may be. And now it gets into degree of certainty too, but that, but it is, it’s the yardstick rate. It’s not because we want to buy government bonds, but it does serve to make that a constant throughout the valuation process.

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

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

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

Charlie Munger [03:26:10] Yeah, that, you look at a corporate stock, it’s obvious you can buy any maturity of government bond you want. So one opportunity cost of buying the stock is to compare it with the bond. But you may find that half the stocks in America you’re so fearful about, or knows a little about, or things so poorly of, that you’d rather have the government bond. So on an opportunity cost basis, they’re taken out of the filter. Now you start finding corporations where you like the stocks way better than government bonds. You got to compare them one against the other, and when you find one that you regard as the best opportunity, that you can understand, as the best opportunity, now you’ve got one to buy. It’s a very simple idea, and it uses nothing but the most elementary ideas from economics or game theory. It’s just, it’s child’s play is a mental process. Now, it’s hard to make the business appraisals, but the mental process is essential.

Warren Buffett [03:27:18] If Charlie and I were forced, told we had a choice of buying stock A, B, C or D in all 2,500 or 3,000 or whatever may be listed on their Stock Exchange, or buying a 10-year government bond, and we had to hold the stock for 10 years, for the bond for 10 years, probably at least 80% of the cases we take the 10-year government. You know, in many cases because we didn’t understand the business well enough. Elsewhere, secondly, we may understand it and still prefer the 10% government. So, but we would measure everything that way. And I don’t know, what did you come up with, 80 or where, Charlie? Desert island, 10 years, get the fondle of stock certificate or fondle a government bond, which one you’re going to choose?

Charlie Munger [03:28:04] Whatever. I think life is a whole series of opportunity costs. You know, you got to marry the best person who is convenient to find, will have you. You know, investment is much the same sort of a process.

Warren Buffett [03:28:27] I knew we’d get in trouble after lunch. (Laughter) Zone two.

[03:28:32] Shareholder (Martin Wiegand, Bethesda, Maryland): Hello. Martin Wiegand, Bethesda, Maryland, stockholder for myself, my family and other small business owners. I want to thank you for the annual reports. They help a lot in helping us make business decisions and life decisions. My question is, many people come here, many, many people come here to listen to you and to cut and to copy and understand your investment philosophy, but why don’t more people, in your opinion, try to copy your investment vehicle, a corporation that pays no dividends?

Warren Buffett [03:29:12] Well, I don’t really think, if there were… I think there are other things that are probably better to copy at Bob Berkshire, but they don’t get copied either. It was always interesting to me how few people, everybody read Graham’s, and they didn’t really disagree with them, they just didn’t like following them, because it didn’t promise enough, in a sense. I mean, people really wanted something very quickly.

In terms of not paying dividends, we don’t pay dividends because we think we can turn every dollar we retain into more than a dollar a market value. I mean, the only reason for us to keep your money is if it becomes worth more by us keeping it then it would be worth if we gave it to you. And if we can create more than a dollar on market value for every dollar we keep, you’re better off, whether you want to take that dollar out by selling a little piece of your stock or whether you continue to leave it in. That’s the test. If we come to the conclusion that we can’t do that, and we could come to the conclusion sometime, then we should distribute it to you.

The interesting thing is, we are in certain businesses, for example, See’s Candy being one, we don’t have a way to intelligently use all of the money that See’s generates within the See’s Candy company. So See’s were a stand-alone company, it would pay very large dividends, not because it, you know, just had some dividend paying policy, it would be simply because we wouldn’t have a way of using, in this case, $30 million a year intelligently in expanding that business. The Buffalo News is the same way. We don’t have a way of using money within that specific business intelligently to use the money that it generates. We hope that in the overall Berkshire Hathaway scheme of things, that we can intelligently use the money that the company is in aggregate generate for us, and we think so far we have, and we think the prospects are reasonably good that we can continue to do that. But dividend policy should really be determined by that criteria, also bearing in mind the possibilities of repurchase a stock too. But they should be determined by whether a dollar left in the business is worth more than, to the shareholder, than a dollar paid out. Someplace like Coca-Cola, you know, and if Coca-Cola had paid no dividends and simply repurchase shares and develop the bottling system and done the things that they have, the shareholders probably would have been even better off. They’ve been sensationally well off as it is, but they probably would have been even better off than they have been with the dividend policy they have had. And that’s true for Gillette and Disney and the companies of that sort that have got these terrific opportunities to use capital within the business, or to repurchase shares of a company that simply can’t be replaced. If that usually is the best use of capital, it’s probably better than dividends. And, you know, we have written some about that, Martin, but it, people usually keep doing what they’ve been doing. It’s, they’re hard to change. Charlie?

Charlie Munger [03:32:30] Well, it’s interesting that you take that simple standard, you should retain money if you can make it worth more than it is by retaining it. That is not the standard thing that’s taught in the corporate finance departments of our major universities. Why do we have this simple idea and they have another one? Time after time we find that. So I’ve tried to understand why they think the way they do, and I have great difficulty with it. I’ve just concluded that they’re wrong. And, but that isn’t enough. There has to be a reason why so many smart people are that wrong, and that’s a story for another day. But there are things gravely wrong with American education that I hope that Berkshire Hathaway is slowly helping to fix.

Warren Buffett [03:33:30] Can you imagine if the, pick any one of you here, and let’s say the two of us were in a business together, you know, and I was earning $100,000 a year. How would we decide whether to leave the $100,000 each year? And we’d be exactly what we’ve talked about here. If we thought $100,000 would translate into a present value of more than $100,000 by some action, we’d leave it in And if it didn’t, we take it out, you know. And it doesn’t seem to register generally. And incidentally, in our own case, will probably go too long before we come to the conclusion that we’re not really using it that effectively, because there’ll be a certain denial we’ll go through and we’ll say, “Well, that was just temporary last year.” But that will… that is our approach, and we’ll do our best to apply it.

Warren Buffett [03:33:55] Zone 3.

[03:34:25] Shareholder (John Shane, Nashville, Tennessee): Mr. Buffett, Mr. Munger, my name is John Shane. I’m from Nashville, Tennessee. You touched on the subject of return on equity in response to a different question. I wonder whether you might be willing to elaborate along following line. Right now the Standard & Poor’s 500 in aggregate have a return on equity of about 22%, of the average over the decades for Corporate America has been more like 12% or 13%. How did we get to this point of extraordinary profitability, and how likely do you think we are over the next 10 or 15 years to revert back to the mean of the low teens?

Warren Buffett [03:35:08] Well, I would say this. I never thought it would happen. So I start out with the fact that if you’d listen to me, you’d have been dead wrong, if, in terms of what the return on equity in 1996 or 1995, 1997 would be. It does not seem to me that 22% returns on equity are sustainable and a world where long-term interest rate is 7% and where the capability of saving large amounts in the economy, you know, are quite dramatic. You just think that there would be some sort of leveling effect between 7 and the 22 you name, that as savings got directed within the economy and as the competitive forces operate that we’ve been taught will operate over time, would come into play.

But, you know, I’ve been wrong on that subject. And that’s why I say these levels are not unjustified if those kinds of returns can be made. Because let’s just say that you had a 22% perpetual bond, and you had the ability, and let’s say that a quarter of that, a third of that coupon would be paid out. So you got a bond with a 22% coupon and, say, 7% is paid out, being the dividend payout on the S&P we’ll say, and the other 15% is reinvested in more 22% bonds with similar characteristics. Now, what’s that instrument worth on a present value basis in a 7% world? It’s worth a lot of money. In fact, it’s worth so much money that becomes a mathematical fallacy at some point. Because when the compound rate becomes higher than the discount rate, you get into infinite numbers, which are, or you get into infinity. And that’s a number that’s… that’s the concept we like to think about around Berkshire. We haven’t figured out how to attain it.

The… there’s a book called The Petersburg Paradox. There’s an article called the Petersburg Paradox and the growth stock fallacy, I think that’s the name of, my phone, I think David Durand, written about 25 years ago. And it gets into this bit where the growth rate is higher than the discount rate, and it shouldn’t work for an extended period of time. But at sheriff on while it’s going on. Charlie?

Charlie Munger [03:37:45] Yeah, I think a couple of things contributed to this phenomenon that we so carefully mispredicted. Number one, it became very fashionable for corporations to buy in shares, and I think that we helped in a very small way bring on that enlightenment, and I think that was a plus in terms of rational corporate decision making. The other thing that happened is that the antitrust administration got way more lenient in allowing people to buy competitors. And I think those two factors helped raise returns on capital in the United States. But that can’t… you wouldn’t think that could go on forever. And what 15% per annum compounded will do is grow way faster than the economy can grow, way faster than aggregate profits can grow over a long pole. So sooner or later something has to happen. I don’t think we’ve reached a New Order of Things where the laws of mathematics are somehow repealed.

Warren Buffett [03:39:02] If real output in this country grows at, say, 3% a year, called real GDP, was it 3% a year, and the capitalized value of industry in the country grows at 10% a year, at some point you get into mathematical absurdities. I mean, with the low inflation rates, it, you know, you can’t have a… if we have an economy that’s $7 or $8 trillion now in GDP and $7 or $8 trillion in equity valuation, that may or may not make sense. But if you have one that’s $15 billion in GDP and $75 billion in equity valuation, $75 trillion in equity valuation, you know, you get to things that don’t, can’t make any sense. So if you get these differential rates of growth among items that have some relationship, however tenuous, or at least non-specific in the short run, it doesn’t work after a while. And, you know, nobody wants to think about that. They don’t want to think about their own death. But I mean, it’s… it doesn’t go away just because you don’t want to think about it. And we haven’t gotten any point like that, but you can project out numbers, and they just won’t make any sense after a while.

Charlie Munger [03:40:21] Yeah, corporate profits can’t be 200% of GNP.

Warren Buffett [03:40:23] Yeah, indeed they can’t be 50% of GNP. So these high rates are compounding just go automatically into absurdity. Yeah, they really can’t be 20% of GDP or some number like that. So if, and if you start saying you can’t have a multiple of more, you get the… you get differential rates, and they just simply, you leave the tracks after a while.

Charlie Munger [03:40:44] And all you people should be aware of this, because all the people who are professional sellers of investment advice and appropriate service, etc., etc., have an immense vested interest in believing that things that can’t be true are true.

Warren Buffett [03:41:01] Yeah. And not only that, they’ve been selected in the Darwinian process to have formidable sales skills and large energy, and…

Charlie Munger [03:41:11] Well, and this is dangerous to the rest of us.

Warren Buffett [03:41:15] Yeah. Well, you’ve been selected to be the recipients of their advice.

Charlie Munger [03:41:20] Right.

Warren Buffett [03:41:21] Furthermore, they figure out who we are and come in about six o’clock in the evening. Zone 1 again.

[03:41:29] Shareholder (Mike Assael, New York City): Mike Assael from New York City. Could you explain a little more about what you’ve called the mind of the consumer and the nature of the product, and explain how you actually apply these concepts to find the companies with the growing demand and the best investment potential? And thank you for being two of the greatest professors I’ve ever had.

Warren Buffett [03:41:57] Thanks. The… you know, once you really, when you get into consumer products, you’re really interested in finding out they’re thinking about what is in the mind of how many people throughout the world about a product now, and what it’s likely to be in their mind five or ten or twenty years from now. Now, virtually every person in the globe, maybe, well, let’s get it down to 75% of the people in the globe, have some notion in their mind about Coca-Cola. They have, the word Coca-Cola means something to them. You know, RC Cola doesn’t mean anything to virtually anyone in the world, you know, desert the guy owns RC, you know, but, and the bottler. But it… but everybody has something in their mind about Coca-Cola, and overwhelmingly it’s favorable. It’s associated with pleasant experiences.

Now, part of that is by design. I mean, it is where you are happy. It is a Disneyland, a Disney World, and it’s at ballparks, since every place that you’re likely to have a smile on your face, including the Berkshire Hathaway meeting, I might add. And that position in the mind is pretty firmly established, and it’s established in close to 200 countries around the world with people. A year from now it will be established in more minds, and it will have a slightly, slightly, slightly different overall position. And ten years from now the position can move just a little bit more. It’s share of mind. It’s not share a market, it’s share a mind that counts.

Disney, same way. Disney means something to billions of people. And if you’re a parent with a couple young children and you got 50 videos in front of you that you can buy, you’re not gonna sit on a preview an hour and a half of each video before deciding what, when to stick in front of your kids. You know, you have got something in your mind about Disney, and you don’t have it about the ABC video company, or you don’t even have it about other… you don’t have it about 20th Century, you know, you don’t have it about Paramount. So that name to billions of people, including lots of people outside this country, it has a meaning, and that meaning overwhelmingly is favorable. It’s reinforced by the other activities of the company.

And just think of what somebody would pay if they could actually buy that share of mind, you know, of billions of people around the world. You can’t do it. You can’t do it by a billion-dollar advertising budget, or a $3 billion advertising budget, or hiring 20,000 super salesmen. So you’ve got that. Now, the question is, what does that stand for five or ten or twenty years? Now, you know there’ll be more people, you know, there’ll be more people who’ve heard of Disney, and you know that there will always be parents that are interested in having something for their kids to do, and you know that kids will love the same sort of things. And you know that he emphasizes the key points when we get to the… But that is what you’re trying to think about with the consumption product.

That’s what Charlie and I were thinking about when we bought See’s Candy, I mean, here where he learns 1972. You know, we think we know a fair amount about candy. I know more than what I sat down this morning. I mean, I had about 20 pieces already. But, you know, what, who’s… you know, does their face light up on Valentine’s Day, you know, when you hand them a box of candy and say, you know, it’s some nondescript things, “I hear, honey, I took the low bid,” you know, or something? And no, I mean, you want something… you know, you’ve got tens of millions of people, there are at least many millions of people, that remember that the first time they handed that box of candy, it wasn’t that much thereafter that they got kids for the first time or something. So it’s the memories are good, the association’s good.

Total process isn’t just a candy. It’s the person who takes care of you at Christmas time when they’ve been on their feet for eight hours and people have been yelling at them because they’ve been in line with 50 people in line, and that person still smiles at them. The delivery process, it’s the shop in which they get all kinds of things, the treat we give them. It’s all part of the marketing personality. But that’s… that position in the mind is what counts with a consumer product.

And that means you have a good product, very good product, means you may need tons of infrastructure, because you got to have that. I had a case of Cherry Coke waiting me at the top of the Great Wall when I got there in China. Now, you know that you’ve got to have something there so that the product is there when people want it. And that happened in World War II. General Eisenhower, you know, said to Mr. Woodruff that he wanted a Coca-Cola with an arms ring of every American serviceman in the world, and they build a lot of bottling plants to take care of that.

That sort of positioning can be incredible. Seems to work especially well for American products. I mean, people want certain types of American products worldwide, you know, our music, our movies, our soft drinks, our fast food. You can’t imagine, at least I can’t, a French firm or a German firm or a Japanese firm having that, selling 47% or 48% of the world’s soft drinks. I mean, just doesn’t… it doesn’t happen that way. It’s part of something you could broadly call on American culture, and the world hungers for it.

And Kodak, for example, probably does not have quite the same position, and George Fisher is doing a great job with the company. This goes back before that. But Kodak probably does not have the same place in people’s mind worldwide quite as it had 20 years ago. I mean, people didn’t think of Fuji in those days, we’ll say, as being quite the same place. And then Fuji took the Olympics, as I remember, in Los Angeles, and they just, they put them, they pushed those their way to more of a parody with it, with a Kodak. And you don’t want to ever let them do that.

And that’s why you can see a Coca-Cola or a Disney or companies like that doing things that you think, “Well, this doesn’t make a hell of a lot of sense. You know, if they didn’t spend this $10 million, wouldn’t they still sell as much Coca-Cola?” But, you know, that I quoted from that 1896 report of Coca-Cola and the promotion they were doing back then to spread the word. You never know which dollar is doing it, but you do know that everybody in the world that’s virtually has heard of your product, overwhelmingly they’ve got a favorable impression on them, and the next generation is going to get it.

So that’s what you’re doing with consumer products. With See’s Candy, you know, we are no better, we want to… no better than the last person who’s been served their candy, with the last product they’ve been served. But as long as we do the job on that, people can’t catch us. You know, we can charge a little more for it because people are not interested in taking the low bid, and they’re not interested in saving a penny a bottle on colas. They remember we talked about in these meetings private labels in the past. Private label was stalled out in the soft drink business, that they want the real thing. And 900-and-some-odd million eight-ounce servings will be served today of Coca-Cola product around the world. 900 million. And it’ll go up next year, the year after.

And I don’t know how you displace companies like that. I mean, if you gave me $100 billion, and I encourage any of you are thinking about that to step forward, but if you gave, and you told me to displace the Coca-Cola Company as the leader in the world and soft drinks, you know, I wouldn’t have a faintest idea how to do it. But… and those are the kind of businesses we like. Charlie?

Charlie Munger [03:49:47] Yeah, I think this See’s Candy example has an interesting teaching lesson for all of us. Warren said we were… the first time we really stepped up for brand quality. And it was a very hard jump for us. It would have been used to buying dollar bills for 50 cents. And the interesting thing was that if they had demanded an extra $100,000 for the See’s Candy company, we wouldn’t have bought it. And that was after Warren had been trained under the greatest professor of his era and it worked 90 hours a week…

Warren Buffett [03:50:25] I needed a lot of chocolates, too.

Charlie Munger [03:50:28] Yeah.

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

Warren Buffett [03:51:40] You know, when we… if we hadn’t bought See’s, with some subsequent developments after that, because that made us aware of other things, we wouldn’t have bought Coca-Cola in 1988. I mean, you can give See’s a significant part of the credit for the, I guess, $11 billion-plus profit we’ve got in Coca-Cola at the present time. That… now you say, “Well, how could you be so dumbest not to be able to recognize the Coca-Cola?” Well, I don’t know, but I’m only drinking about one again. Yeah, right. It wasn’t… I hadn’t been exposed to it, or, and I… it’s amazing. But it just made us start thinking more. We, I mean, we saw how decisions we made in relation to See’s played out in a marketplace and that sort of thing, and we saw what worked and didn’t work, and it made us appreciate a lot what did work and shy away from things that didn’t work. But it led, it definitely led to a Coca-Cola.

And we’ve had that… we’ve had the good luck to be, to buy some businesses themselves in their entirety that taught us a lot. You know, we bought, we… and this worked in the other direction. I mean, we were in the windmill business one time. I was. Charlie with stayed out of the windmill business, but I was in the windmill business and pumps and third-level department or second-level department stores, and I just found out how tough it was. And now it didn’t… you could apply all kinds of energy to them and it didn’t do any good. It made a great deal of sense to figure out what pond to jump in, and what pond you jumped in was probably more important than how well you could swim.

Charlie Munger [03:53:37] I don’t think it’s necessary that people be as ignorant as we were as long as we were. I think American education could be better, but not in the hands of any of the people who are now teaching it.

Warren Buffett [03:53:55] Is there any group we’ve forgotten to offend? I mean… okay. Zone 2.

[03:54:02] Shareholder (Kansas): Yes. Good afternoon, Mr. Chairman and Mr. Vice Chairman. My name is Hudson Zoo, and the originally from China, and I’m living Kansas. And it’s my honor to speak to you both. My question is, if someone like to form a company doing what you did there 30 or 40 years ago, what is your suggestion to them? And would you share some of your wisdom with us? Thank you.

Warren Buffett [03:54:38] First thing, we suggest they sent us a royalty. But they… Charlie, you take over on that. And you’ve thought more about starting over again than I am.

Charlie Munger [03:54:51] Frankly, say that that’s a question I ordinarily duck. I always believe in getting the fundamental mental tools in place, and I always believe in running reality as it comes in, preferably vicariously through the newspaper, etc., instead of through personal painful experience, through the filter of these sound ideas. And I not only think that that works in life to create success, I think it makes life more fun. So I argue for sound thinking. But the exact specific techniques of turning yourself into another Warren Buffett, I leave to you.

Warren Buffett [03:55:46] Well, the one thing I would advise is, I would be, I, a… I think there’s a ton of opportunity out there. And the… I would do something I enjoy it. I wouldn’t do something because I thought it was going to get me to a life I was going to enjoy later on, or because if I made a lot of money I was gonna be a lot happier, anything like that. I’ve never done that. And I think that you will do well in what you enjoy, and I think it’s crazy in life to endure a whole lot… that I don’t mean… Charlie and I worked in a grocery store. We didn’t really jump up and down over all the time. But in terms of it making a commitment to really be in a business that only, you’re only in it for the money, I think that’s crazy. It… if we were in this road only for the money, you know, we’d have quit a long time ago, obviously. And then it just, you won’t… you ought to have fun while you’re doing it. It should not be jammed tomorrow and not jammed today. It just doesn’t make any sense to me. And I think you’ll get better results that way, too.

Zone 2, or did we just do Zone 2? I think we did. Yeah. Maybe Zone 3.

[03:57:00] Shareholder (Dave Youberg, Sac City, Iowa): Dave Youberg from Sac City, Iowa. And I must… I haven’t heard you on the moral and ethical considerations of stocks like ABC and Disney. They are now getting more and more criticism from mainstream religious groups in this country, main reliance on sex, and their cronyism, homosexuality, and…

Warren Buffett [03:57:40] Did they hear it? I didn’t… I, we didn’t cut anybody off there at the…

Charlie Munger [03:57:55] Yeah.

Warren Buffett [03:57:55] Right, right. The… but I would say that, you know, I’m delighted to have my grandchildren exposed to the full range of Disney product. I’m, and I, you know, I’d love to take them to Disneyland or Disney World, or take them to Disney movies or Disney videos. So, you know, I think that the Disney company is being run in an absolutely first-rate way, and I have no problem whatsoever with gays being employed or receiving benefits or anything with sergeant. (Applause)

Zone 1.

[03:58:37] Shareholder (Bashir Narema, Arlington, Texas): Good afternoon, Mr. Buffett. Good afternoon, Mr. Munger. My name is Bashir Narema from Arlington, Texas. I see in the USA Today article about the shortage of labor in the state, and I was wondering, when you analyze a company, do you take that into consideration by chosen companies who’s not depending so much on labor? The second question is, I heard you in the beginning of the meeting that is so much capital coming from foreign country. You mentioned so many different countries who buy, who bought the Berkshire Hathaway, and I’m sure they buy all companies in the Dow. Do you feel like the analyst who analyzed the Dow had that into consideration, that the Dow now is becoming as the Walmart of the security business in the world, where all the national of different country, they by Ambassador their market, and they come in and buying the United States? And as a result, that the idea of Mr. Greenspan as far as exuberant, it’s mute, because if you remember how the Japanese, when they start to buy the real estate in America, they forced us to pay high premium for the price. And I think that’s what’s going to happen in the market. And we as Americans who’ve been accustomed to low P/Es, now we’re going to miss on, and this, the price is going to continue going up. A, and the third question is…

Warren Buffett [04:00:46] Maybe we better stop it, too.

[04:00:48] Shareholder (Bashir Narema, Arlington, Texas): All right. Thank you.

Warren Buffett [04:00:50] Okay, thanks. The second way, we pay very little attention, we don’t pay any attention to capital flows. In other words, we don’t really care who’s buying or selling any security. Somebody is buying or selling each one. So obviously there’s, you know, you could focus on the buyers, you could focus on the sellers. But you can say now that there’s $20 billion in a month or so going into equity funds and all, but it doesn’t make any difference to us. We all were interested in what is, what the business is worth. And what people are paying attention to in terms of capital flows or whatever, or market signals, or whether the Fed’s going to move, that all changes.

Remember, 10 years ago it was, you know, as M2 that every, everybody, every whatever day of the week it was, you know, what, what’s M2 this week? I was thought of having a mystery, you know, about whatever happened to M2 or so. But there’s always something that people are talking about. There’s so much time to fill with chatter, you know, that, and pages to fill, that they write about all these things that does don’t make much difference. Because we don’t care if the market closes for the next five years. We care how much Coca-Cola sold five years from now, and what percentage of the world market they have, and what they’re charging for it, and how many shares are outstanding, and that sort of thing. But we just, we don’t care who’s buying or selling it in the least, except we like it when the company’s buying it. The same way would you let, we care about whether people are trading up in the shaving experience.

So capital flows and all of those macro factors that people like to write about a lot just have nothing to do with what we do. We’re buying businesses. And I really think it is not a bad mindset, this, whenever you buy a stock, to say, “Would I be happy buying this stock if the market closed for five years?” Because then you’re buying a business. If you say yes to that… if you don’t say yes to that, you may not be focusing on the proper thing.

By its nature, the U.S. is running substantial trade deficit, merchandise trade deficit. If you buy more from the rest of the world and you’re selling them, which is what happens when you’re running a trade deficit, you have to balance the books. I mean, they get something in exchange, and what happens is they get some sort of capital asset in exchange. They may get a government bond, they may get a piece of the U.S. business or something. But you, the key thing in economics, whenever somebody makes some assertion to you about economics, you always want to say, “And then what?” In fact, it’s not a bad idea to say about everything in life, but you always have to say, “And then what?”

So when you read that the merchandise trade deficit is $9 billion, what else does that mean? Well, it means that somehow we have to have created $9 billion of capital assets, claims on our production in the future, with somebody else in the world. So they have to invest. They don’t have any choice. When somebody says, “It won’t be terrible if the Japanese sell all their government bonds,” they can’t sell all the government bonds without getting something else in exchange, you know, look at some other American asset in exchange, because they, there’s no other way to do it. They can sell it to the French, but then the French have the same problem. So trace through where the transactions go anytime someone searching talking about one specific action in economics.

Question about labor. Generally speaking, obviously we like a business with low labor costs, but we like a business with low costs of every kind, because the rest is profit. So it would be true that on balance we would not be high on labor-intensive companies. But there’s some business, there’s some very good businesses that are labor-intensive. But if you say, “Would I rather have a labor-intensive business or a non-labor-intensive business, and everything else is equal?” the answer is the less labor-intensive business. Charlie, you want to come in on either one?

Charlie Munger [04:04:36] No, I don’t think I’ve got any more.

Warren Buffett [04:04:40] Area 2.

[04:04:41] Shareholder (Bob Costa, Evansville, Indiana): First, I’d like to thank you both for being so generous with your time and with your ideas for us today.

Warren Buffett [04:04:51] Thank you. We get paid by the hour.

[04:04:55] Shareholder (Bob Costa, Evansville, Indiana): So I’ll try and talk quickly, then. My name is Bob Costa from Evansville, Indiana. I’ve been a shareholder for four years. This is my first visit to Omaha, and I went to the mega Mart and I actually bought something there, and I tried to pay for it with American Express card, and they told me, just like the, just like the ad, “You can’t use it here.” I hope you both comment on that, or at least one of you. But my real question is that I just stumbled across the idea of intellectual capital, and how that might be useful in valuing a business. And I was hoping that one or both of you could clarify that for me, and whether that’s useful to us as investors, or just another academic theory that we’d be better off ignoring.

Warren Buffett [04:05:50] Yeah. Harvey Golub, who runs American Express and has done a terrific job of running it, has written me about the, about the Furniture Mart, as well as about See’s. And we basically let our managers run their own businesses. So the people at each entity… Borsheim’s takes American Express, others of our businesses do too. We let every manager make his decisions. As soon as I start telling the managers that they ought to, say, take American Express or not take Visa or whatever it may be, you know, at that point they’ve lost some of the responsibility for their operations, and the, and perhaps to an extent even, you know, some of the pride that comes from running them.

They, most of our managers do not need to work for a living. They run their businesses for the same reason Charlie and I run Berkshire. They love doing it. They jump out of bed in the morning because it’s exciting to do. And the one thing that would keep the two of us, or drive the two of us away from Berkshire’s, if we were getting second-guessed all the time, or somebody else was telling us when to swing or not to swing. We would have no interest in running it, and we go run, we do something else then. And maybe our other managers aren’t as extreme as we are in that respect, but we feel they’ve built successful businesses, they know how to do it. We do allocate the excess capital they generate, but aside from that, we really let them make their own decisions. So we have no company-wide policy on virtually anything that I can think of, except send money to Omaha.

But, and, you know, we’re delighted to have American Express give the Furniture Mart the reasons why the Furniture Mart will be better off using American expression. My guess is they have some very good reasons, and, but they’re going to have to sell them on that, and just like any vendor of anything has to sell each operation. We wouldn’t tell the people that See’s who to buy these, the nuts from, or who to buy the container from, or anything of the short.

How to design the stores or whatever it may be. And that’s just the Berkshire philosophy on that. Charlie, you want to come in?

Charlie Munger [04:08:00] Yeah, let me shift to intellectual capital. Berkshire has a lot of intellectual capital in these very able executives in the various businesses, and we hope we’ve got some intellectual capital in the few hundred square feet at headquarters. But we are not in the business of designing oil refineries with armies of engineers, or developing software with armies, doing complicated accounting work all over the world. We just haven’t drifted into that kind of a business. And intellectual capital has gotten to be a new buzzword because we’ve now developed huge businesses like Microsoft, which really didn’t exist on that scale not so very long ago. And so people have suddenly realized, “My God, there’s really a lot of money in aggregation effects and momentum effects when you get a bunch of really bright people working in the same direction.” But that’s what’s made the concept so fashionable. By and large we’ve avoided the field. Again, it’s hard for us to understand.

Warren Buffett [04:09:18] Yeah, we’ve looked for brains and energy and integrity and people that we work with. And if you get that combination and you’re in a decent business, you know, you’re going to own the world. And, you know, whether you call it intellectual capital or anything, you know, you can stick the names on, and that’s who we try to associate with. I mean, it’s a lot easier than doing it yourself. And when we get in our own businesses, you saw that group there at the end of the movie. I mean, that’s a huge asset to Berkshire.

We do… they talk about getting into accounting for it with… that’s nonsense in my view. I mean, you don’t need to do that. But you should pay for it, and you should pay for it as shareholders, you should pay for it as managers. When we get people, you know, whether it’s Tom Murphy or Al Zeien at Gillette or Roberto or Michael Eisner, I mean, those people have added billions of dollars of value. And it’s just, you know, that’s who we want to be associated with. And we don’t want to be associated with the mediocre managers, because the difference is just, is huge. But we don’t go through an elaborate exercise. We just recognize the people who’ve got those… we think we, we try to recognize the people who’ve got those qualities, and then we, and then if they’re in a good business and they’ve got those qualities, we want to take a big bite.

Charlie Munger [04:10:41] But take the intellectual capital. People think patents, they think copyrights. Patents and copyrights have gotten to be way more valuable as a percentage of the investment assets of the world, and so people are very much more interested in intellectual capital. Think of the great drug companies and how small they were 20 years ago, and how everything they have is basically intellectual capital. It’s the few products that have, that really work, that have the patents. No, no, I… but by and large we’re not in drug companies.

Warren Buffett [04:11:19] No, but that’s it. There are different forms, as Charlie said. There’s businesses you sort of think of that way, as their whole being, being intellectual capital. But I would argue that when Roberto goes, what, a 15 years ago, saw how to make the future of Coke, same product, dramatic, and basically the same system, although required some changes it, but saw how to make that dramatically more valuable by doing a lot of little things over a long period of time, and doing them consistently, and not getting his eye on the ball. Michael Eisner did the same thing that Disney hadn’t gone anyplace, you know, in the 15 years or so after Walt died. Now, you know, we all know who Mickey Mouse was and everything, but Michael really saw what the future should be, and he still does it, you know. And how… you say it’s easy when it’s all over, but how many people were doing something about at the time? The place was languishing, basically, 15 years ago. They had the assets. And to me, that’s, you know, it’s different than what Bill Gates does or Andy Grove does, but it’s our form of intellectual capital. It’s one we can understand better. Zone, what do we have, 3?

[04:12:38] Shareholder (Will Jacks, Chicago): Mr. Buffett and Mr. Munger, my name is Will Jacks. I’m from Chicago, and I’m a happy shareholder. I first want to thank both of you for the unusual privilege you give us, your time and your expertise. This is very unusual, and I think is to be commended. And my question has to do with one of the major American industries that, unless I miss something in the reading, if that is the pharmaceutical industry, companies that make medicines. And I wonder under what circumstances you might consider those industries for investment by Berkshire Hathaway.

Warren Buffett [04:13:32] Well, those industries, the pharmaceutical industry has obviously been a terrific industry to invest in. We have trouble, at least I have trouble, distinguishing among the companies in terms of seeing which ones 10 years from now might be the best ones to be in. I mean, it’s easier for me to figure out that Coca-Cola is the soft drink company to be in, or Gillette is the shaving company to be in, where Disney is the entertainment company to be in, than it is for me to figure out which one in the pharmaceutical. But that, I’m not saying you can’t do it. I’m just saying that that’s difficult for me.

We have, we started buying one of them a couple of years ago. We should, and we should have continued, but we didn’t because it went up in eighth, and your chairman was a little reluctant to follow it. That terrible mistake. But I would say the biggest, and we could have bought the whole industry and done very well at various times, particularly when the threat of, what people thought was the threat of the Clinton health program cast a big clout over the pharmaceutical industry. That was a time you could have just bought the whole industry and done very well. We didn’t do it. It was a mistake. Charlie?

Charlie Munger [04:14:44] Well, it’s hard to think of any industry that’s done more good for consumers generally. When you think of the way children used to die, and now they very seldom die. And it’s been a fabulous business, and it’s been one of the glories of American civilization. But it’s… we’ve admired it, but we haven’t been part of it. We’ve missed a lot of things.

Warren Buffett [04:15:13] And I’m dead serious about that. And we missed things that should not have been beyond our capacity to grasp. A lot of things that should be beyond our capacity to grasp, but there’s some that haven’t been, and we’ve just been playing missed them. And Zone 1.

[04:15:37] Shareholder (Srikanta, Chicago): Oh, hello. I’m another Chicagoan, Srikanta, and share owner. This question is directed first to Mr. Munger and then to Mr. Buffett. Mr. Munger, I am intrigued by your marshalling of the Commodore and Aristotle to support your points. Very few of today’s money managers would or could do that. Could you elaborate on what role or study of history of civilization plays in developing a sound investment philosophy?

Charlie Munger [04:16:12] Well, I don’t want to praise the Aristotle too much. You know, he was the one who thought that women had a different number of teeth from man. I never looked in his wife’s mouth. Maybe his wife did. I’m all in favor of a good general education, and I think it helps investment performance, and it helps business performance, and it helps one be a better citizen. And some of the things people say are quite memorable, and therefore they’re helpful to the mind by the very ease of which they’re remembered. I think you’d be surprised how many bright investment professionals could talk a lot about Aristotle, or even people I can’t stand like Hegel. You want to quote a little more from anybody, reinforce your…

Warren Buffett [04:17:16] Oh my. One of my favorite quotations in the whole world is from Einstein. It says, “Everything should be made as simple as possible, but no more simple.” And I think that describes the reality that we all face. Charlie’s favorite, though, is Ben Franklin at… right? But that’s probably true, isn’t it, Charlie?

Charlie Munger [04:17:42] Yeah.

Warren Buffett [04:17:43] We get more from Ben then than anybody else. “Keep the ice shop and it will keep thee,” that sort of thing. I mean, we’re loaded with that stuff. “Three removes are as good as a fire.” “It’s hard for an empty sack to stand upright.” That’s the Bible around Berkshire.

Charlie Munger [04:18:04] Yeah, I once heard Warren say the reason I’m so financially conservative is I don’t want to find out how badly I might behave if I were stretched.

Warren Buffett [04:18:21] I think we better cut them off here. Zone 2. You better, yeah, cut the thumping there. (Laughter)

[04:18:31] Shareholder (Stanley Watkins, Manhattan, Kansas): My name is Stanley Watkins, and from Manhattan, Kansas, and I’m a shareholder. And I have two questions, and the first one I know the answer, so you can just say yes or no. Would you consider investing in indexes such as OEX? Pure speculation. You’re going to say yes. And number two, would you encourage investors to, if they were trying to get a lot of their investment, to use LEAPS on investments such as Coca-Cola instead of buying a stock?

Warren Buffett [04:19:12] Use what on? I missed that.

[04:19:15] Shareholder (Stanley Watkins, Manhattan, Kansas): Leak, LEAPS.

Warren Buffett [04:19:16] Oh. Actually we’re still on options. Oh yeah. Well, yeah, both the questions relate to futures of one sort, calls or whatever they may be. And I think that investors should stick to buying ownership and businesses. I, it’s not that you can’t come up with a theoretical argument for buying, say, it… I mean, if you think Coca-Cola is attracted, you can say, “Well, I’d rather buy a five-year option on Coke than buy the stock directly, because it introduces leverage without the risk of going broke.” But I think that that’s a dangerous path to start down, because it, if it works well, it, so it… it’s dynamite to start playing with things that can expire and become worthless, or can be bought with very low margin, as the OEX options you were talking about.

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

Charlie Munger [04:21:15] Well, this is a group of affluent investors, and I don’t think many of them did it in LEAPS.

Warren Buffett [04:21:23] Yeah, it’s certainly true if we’d operate a Berkshire with considerable borrowed money over the years, you know, it would have done very much better than it has. But nobody knew what that amount of borrowed money would have, the appropriate level would have been. And it wouldn’t have made any difference to us. I mean, we have just as much fun doing what we’ve done that if we’d owned it on leverage and had been twice as much. I mean, it just, it’s just not, it’s not the way we approach it. If you have X and you think you’re gonna be way happier when you’ve got 2X, it’s probably not true. That… it’s… you really ought to enjoy where you are at the point. And if you can make, you know, if you can make 12% or 15% a year, and you desire to save and you like piling it up, you know, it’ll all come in time. And why, you know, why risk losing what you need, you know, in half, for what you don’t need and don’t have? It’s never made a lot of sense to us.

Charlie Munger [04:22:28] Warren wrote a letter when they were developing the security options businesses, and he urged the civilization not to allow the new exchanges, and you can see how much attention they paid to him.

Warren Buffett [04:22:46] I, at the usual amount. Area 3.

[04:22:50] Shareholder (Greg Collart, Calgary, Canada): Hi, my name is Greg Collart, a shareholder from Calgary, Canada, the home of Bre-X Minerals. My question for you is, the companies in the hazardous waste disposal industry have underperformed the market for about a decade now. Do you see any value in that area?

Warren Buffett [04:23:12] Well, we’ve never looked at that business at… familiar with the names of the companies, and… but that’s been a business that I’ve never looked at, and maybe Charlie knows more about it.

Charlie Munger [04:23:26] I do. He almost has to. So we have never really looked at the hazardous waste business. We observe a lot of toxic waste in the securities market. Maybe we get our fill that way.

Warren Buffett [04:23:48] Area 1.

[04:23:49] Shareholder (Hugh Stevenson, Atlanta, Georgia): My name is Hugh Stevenson. I’m a shareholder from Atlanta, Georgia. My question involves GEICO. If I remember correctly, from last year GEICO had about 2% of the insurance market and had approximately $4 billion in float. My question is, as their market share expands, will they’ll float, in your expectation, expand in a somewhat linear fashion? And related to that, what is your guess might be the top end? Could they ultimately become as dominant as a Gillette or a Coke and their businesses, or it’s the nature of it such that, you know, they might stop at 10% of the market or 15% when they start to hit a significant hurdle? And second, to follow up on this other gentleman’s question, if you don’t adjust for risk by using higher discount rates, how do you adjust for risk, or do you?

Warren Buffett [04:24:52] Well, the second question, we adjust by simply trying to buy it at a big discount from that present value calculated using the risk-free Interest rate. So if interest rates are 7%, we discounted back the flows, which Charlie says I never do anyway, and he’s correct. But if, in theory, if we just got them back at 7%, then we would look at a substantial discount from that present value number in order to warrant buying.

Question about GEICO. The float will grow more or less proportionately the premium volume. There’s a moderate amount of our float, a very small amount of the float, that’s accounted for by some discontinued lines from the past. Then, of course, that won’t grow the same way. But if we double the size of GEICO on premium volume, we’ll come close to doubling the size of the float.

The, you know, the history of auto insurance is quite interesting. It’s something that isn’t studied at business schools and should be studied, because the great insurance companies have the early 1900s were, you know, whether it’s Aetna, Hartford, Travelers, they had these agency forces nationwide and wrote what was then more property business. They wrote a lot of fire business in those days. And of course the automobile only came in, you know, in the early 1900s, and so their orientation was to property business. But they had this huge agency force throughout the United States. There were property insurance agents representing these big companies in every… throughout the country. And they had lots of capital.

And now, if you look at the business in 1997, something well over 20%, probably 20, close to 25% of the personal auto and homeowners business and insurance has written is written by a company called State Farm. State Farm was started, I believe, in the ’20s by a fellow in Bloomington, Illinois, with no capital to speak of, no agency force initially, and started as a mutual company. No incentive, I mean, no stock options, no capital investor where he could become a billionaire if he built the business up or anything. So here this company starts without any of the capitalist incentives that we our daughter essential to a business growing, and in a huge industry becomes the dominant player. It has more than twice the market share of Allstate, the second player. Becomes the dominant company against these extremely entrenched competitors with great distribution systems and loads of capital.

Now, I say that’s an… incidentally, State Farm, on the Fortune 500 list of companies, has the third largest net worth of any company in the United States. Number three. From Bloomington, Illinois, with a guy with no money in it. Now, how does that happen? Well, I would say that’s a subject we’re studying, you know, for in business schools, because it… you know, Darwin used to say that anytime he got any evidence that flew in the face of his previous convictions, he had to write it down in the first 30 minutes, sir, the mind was such that it would reject contrary evidence to cherished beliefs. And certainly there’s some cherished beliefs around business schools that might at least find some interesting aspects in studying how a company could become the third largest company in net worth in the country with no apparent advantage going in.

There’s another company down in Texas called USAA. United States, it’s for the United Services Auto Association. And it’s been enormously successful, has billions of net worth, loads of satisfied policy orders, the highest renewal ratio among policyholders in the country. Nobody studies that, to my knowledge, either. The people who started GEICO came from that company. In 1936, Leo Goodwin and his wife, who had worked for USAA, went over and started this little GEICO company with practically no capital. And now it’s, we have about 2.7% of the market, and we’re, we’ll write probably $3.5 billion of voluntary auto this year.

Catching a State Farm, it’s going to be very difficult, so I wouldn’t want to predict we do that. I will predict that we will gain very materially in market share over the next 10 years, and we’ll gain materially this year. But we will… we have got a, we’ve got a very good mousetrap. I said in the report that 40% of you would save money and sharing with… I didn’t say 100 or 80 or 60, because there are areas and professions where somebody else is going to have a lower price than we are. But if, across the country, we are going, and for all classes of citizens, we are going to have a low price, the low price, more often than anyone else. And we’ve got that because we’ve got low costs, and our costs are going to get lower. And it, we’ve got a virtuous circle going in terms of it feeding on itself. So GEICO will grow a lot. But I… State Farm is plenty tough, so I’m not going to predict catching State Farm. I’m not even going to predict catching Allstate. But we’ll catch somebody. And Charlie, you want to say any more?

Charlie Munger [04:30:38] Well, I love your example of State Farm. I mean, the idea of picking some extreme example and asking my favorite question, which is, “What in the hell is going on here?” That is the way to wisdom in this world. And it is too bad a lot of the mutual companies are now trying to demutualize, helped by a bunch of consultants and so forth, and they are not looking at State Farm. They’re looking at some other model. And everybody can’t be a State Farm. That place got some fundamental values into its operating mechanics: the way it’s selected personnel, the way it selected agents, the way it discarded agents. It was huge discipline. Wouldn’t you agree on that?

Warren Buffett [04:31:29] Yeah, yeah. Somebody… you would say somebody had to do something very right. But the question, I don’t know anybody saying what they did that was right. You know, they don’t want to, because it doesn’t fit the pattern. And, you know, something like a State Farm happens in this world, you should try to get, you should try to understand it. When something like a GEICO happens in this world, you should try to understand it.

In 1948, I think it was two-thirds or three-quarters, I think it’s two-thirds of GEICO was for sale, because a fellow that originally backed these two people from USAA died, and the state had the stock for sale. In 1948 you couldn’t sell it. That’s how Ben Graham ended up buying it for Graham-Newman, because they honked it all over for six months. They went to all the big insurance companies, and the insurance companies, who could see this company on a very, very tiny scale offering a product for way less money and making lots of money doing it, they simply couldn’t shake themselves loose from the midst of the past to step up and buy. They could have bought it for $1.2 million, as I remember, you know, and owned the whole company. And instead they’ve watched their own distribution system get their heads beaten in, you know, over the years, and all the time, you know, with these ideas from the past. So you have to be very careful who look hard at what’s really happening. Yogi Bear said, “You can observe a lot just by looking.” And okay, Zone 1.

[04:33:07] Shareholder (Everett Puri, Atlanta, Georgia): I’m Everett Puri from Atlanta, Georgia, and I wanted to ask you if you could comment on the matter of intrinsic value as it applies to some of the Inevitables, given that the overpayment risk now is high, and the share repurchases that are going on there now.

Warren Buffett [04:33:28] Well, we won’t stick a price on them. We just, we tell you that they are absolutely wonderful businesses run by sensational people, and that they are selling at prices that are higher than they sold that most of the time. And then, but that, you know, they may be, they may well be worth it and worth a lot more, even in terms of present terms, or it may turn off there a couple of years ahead of themselves. We don’t know the answer to that. We know we’re very happy owning them.

Gillette does not repurchase his shares, or hasn’t in any significant quantity for many years. Coke consistently repurchases the shares. We generally like the policy of companies that have really wonderful businesses repurchasing their shares. It… there aren’t that many super businesses in the world, and the idea of owning more and more of a company like that over a period of time has, it has an appeal to us, and almost an appeal regardless of price. At the… the problem is that most companies that repurchase their shares, you know, are so-so, are frequently so-so businesses, and they’re being done for motivations other than intensifying the interests of the shareholders in a wonderful business. But where you really know you have a wonderful business, and we think most of the ones we own are anywhere from extremely good to wonderful, we think it usually makes a lot of sense. That it’s hard to do things intelligent with money in this world.

And Coke has been very intelligent about using their capital, to particularly to fortify and improve their bottler network around the world. I mean, they’ve done a terrific job that way. That was a neglected area for a long time, and that comes first. But there’s only so far you can go with that, and to enhance the ownership of the shareholders in a company like Coca-Cola. When we bought our first Coca-Cola in ’88, we bought about 6.2% of the company, and at that time they may have been, maybe been 600 million servings, not only more than that, a day. So we had an interest in 36 or 37 million servings. Now we have 8% of 900 million plus, so we have an interest in 75 million or so servings a day. 75 million people are drinking Berkshire Hathaway share of Coca-Cola products today, and an eight-ounce serving, you know. And the profit’s gone up a little per serving. So that gets pretty attractive, and we just assume they keep doing them.

The bottling is actually kind of interesting. And a fellow from Omaha, they’re at least lived in Omaha for a long time, Don Keough, had a lot to do with us all, and Roberto had plenty to do with the two, obviously. But the camner, Asa Candler, back in the late 1880s, in a series of transactions, I think some of it’s a little fuzzy exactly as the timing of them, but he essentially bought the whole Coca-Cola company for $2,000. And that may be the smartest purchased in the history of the world.

And then in 1899, I believe it was, a couple of fellows from Chattanooga came down. And in those days soft drinks were sold over the counter to people in drugstores, primarily. But there was a little bottling going on. There’s already was somebody bottling in Mississippi, as I remember. But a couple fellows came down and they said, “You know, bottling’s got a future, and you’re busy on the fountain side of the business, so why don’t you let us develop the bottling system?” And I guess Mr. Candler didn’t think much of bottling, so he gave them a contract in perpetuity for almost all of the United States for $1. He sold it to them and gave them the right to buy Coca-Cola syrup at a fixed price forever.

So Asa, who had scored with us $2,000 in a rather big way, managed to write what, you know, it’s easy for us to look back, and, but certainly looks like one of the dumbest contracts in history. And of course, as the years went by, and particularly around World War II, when the prices Sheriff was the primary ingredient in terms of cost and syrup, well, sugar went wild during and after World War I in price. And so here was a guy that an effective contracted to sell sugar at a fixed price forever, and he’d also given these people perpetual rights. And so on those days they sold these sub-rights to bottler contracts, and those were usually the distance that a horse could go in a day and come back. That was sort of the circle that you gave people.

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

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

Charlie Munger [04:40:08] Well, I do think Coca-Cola company is one of the most interesting cases in the history of business, and it ought to be way more studied than it is. And there’s just lesson after lesson after lesson in the history of the Coca-Cola Company. And, but it’s too long a story for today.

Warren Buffett [04:40:34] Section 2.

[04:40:34] Shareholder (Jolene Crowley, San Diego): Jolene Crowley from San Diego. And I want to say I’m, I feel very lucky to be here today, as when I tried to buy my first baby Berkshire share last year, my stockbroker, who’s a value investing devotee, tried to talk me out of it, telling me that it was overvalued. So I feel lucky to be here. I’ve recently also discovered Wesco stock, and I’d like you to explain to me the ownership and management relationships between Berkshire Hask… between Berkshire Hathaway and Wesco, and how you use them together. And since I may not understand the answer to that question, could you just tell me, is it possible that buying Wesco today at about $20 a share is like buying Berkshire Hathaway was 20 years ago?

Warren Buffett [04:41:34] Well, if you could buy Wesco today at $20 a share, you should buy all you can.

[04:41:43] Shareholder (Jolene Crowley, San Diego): No, no, 200.

Warren Buffett [04:41:44] Charlie is chairman of Wesco, and why don’t you talk about it first?

Charlie Munger [04:41:52] Shirley. Wesco’s 80% owned by Berkshire And in terms of operating businesses now, it’s got two. And it has an immense percentage of its net worth in marketable securities in its insurance subsidiary. It’s a very quiet company. And as they chairman of Wesco, I have always delighted in saying that we have way less human value in the executive staff than that Berkshire Hathaway does. It’s a, it’s a… what is it Daniel Webster said about Dartmouth? He’s a small school, but there are those who love her. Well, Wesco’s a small place, and it’s there in Berkshire as sort of a historical accident. But the main current of Berkshire is right here on the Berkshire shares.

Warren Buffett [04:42:53] Yeah, I don’t know which one I would rather buy at present prices. I mean, I think it’s, you could flip a coin. It does not have dramatically better growth potential just because it happens to solid $200 a share instead of $38,000 a share than Berkshire. I mean, I think the prospects probably are relatively close between the two. At, and I, they’re run by the same people, pretty much, in effect. Charlie may spend a little more time on Wesco than I do. But they’ve got the same prospects. But one problem that Wesco would have is that if people, and this is not a huge problem, but if people want to do a share exchange deal, they’re going to want to do it probably with Berkshire rather than Wesco. Had Wesco, we had small acquisitions in fields we knew, Wesco’s a logical place to put them unless they happen to be in areas that Berkshire’s already in, and for the really large things the, you know, Berkshire and doom and Wesco Canada. But there’s nothing, I don’t think there’s anything significantly superior or inferior about investment in Wesco compared to Berkshire.

Charlie Munger [04:44:12] Well, the long run record of Berkshire is better.

Warren Buffett [04:44:16] Yeah. The one thing that, it is a mistake to think that just because it’s cheaper per share on a dollar price, that it’s got way more potential running, because that just isn’t the case. It’s a very large percentage of Wesco’s value is represented by its interest in Freddie Mac, and a very large percentage of Berkshire’s interest is represented, the Berkshire’s values represented by an interest in Coke, for example. So there’s different emphasis between the two places. I think Wesco owned some Coke and Berkshire owns some Freddie, but in different proportions. That’s an historical accident at them. We’d love to see them both do well, obviously. There’s another family that’s in Wesco that we like a great deal, and we would hope that Wesco would perform as well or better than Berkshire. It’s performed fine over the years, but it hasn’t performed quite as well as Berkshire. Area three.

[04:45:15] Shareholder (Jeff Hall, Toronto, Canada): Yes, hi. Hi, it’s Jeff Hall from Toronto, Canada. Mr. Buffett and Mr. Munger, you’re both a positive influence on all of us and our generations to come. There were a few significant individuals that had helped to guide your way in the beginning. Could you please share the current percentage of impact and evolution on your investment philosophy and approach between Graham Dodd, Graham and Dodd, versus Phillip Fisher, and common on each, please?

Warren Buffett [04:45:47] Charlie, you wanna, if you got it worked out there, California, you want that retention percent? (Laughter)

Charlie Munger [04:45:55] But you were closer to…

Warren Buffett [04:45:58] Yeah, Ben Graham. Yeah, well, Ben, yeah. Things would have happened, good things would have happened with following either party irrespect of the other. Graham obviously had way more influence on me than Phil, but I worked for Ben, I went to school under him, and his, what I call the three basic ideas that underlie successful investing, which is to look at stocks as businesses, and they have the proper attitude toward the market, and to operate with a margin of safety, they all come straight from Graham. I didn’t think of any of those.

And Phil Fisher opened my eyes more to the idea of trying to find the wonderful business. Charlie did more about the build it actually, so you’d have to put Charlie, but Phil was espousing that entirely, and I read his books in the late 50s, early 60s. So, you know, I, and Phil’s still alive, as you know, and I, you know, I owe Phil a lot, but I, it doesn’t compare to what I owe Graham. And that in no way reflects poorly on Phil. Ben was, Ben was one of a kind. Sean?

Charlie Munger [04:47:21] Ben Graham was a purely formidable mind, and he also had a clarity in writing, and we’ve talked over and over again about the power of a few simple ideas thoroughly assimilated. And that happened with Graham’s ideas, which came to me, and directly through Warren, but also some directly from Graham. The interesting thing for me is to watch Buffett, the former protege, and by the way, Buffett was the best student Graham had in 30 years of teaching at Columbia. And, but what happened, and since I knew both men, was that Buffett became way better than Graham. That is a natural outcome. It’s what Newton said. He said, “If I’ve seen a little farther than other men, it’s by standing on the shoulder of giants.” And so Warren may have stood on Ben’s shoulders, but he ended up seeing farther. And no doubt somebody will come along and do a course and do a lot better than we have.

Warren Buffett [04:48:40] I enjoyed making money more than Ben. I mean it candidly. I’ve had, with Ben, it just, it really was incidental, at least by the time I knew him. It may have been different when he was younger, but it just didn’t, it, the process didn’t, of the whole game did not interest him more than a dozen other things may have interested him. With me, I just find it interesting, and therefore, you know, I’ve spent way more, a way higher percentage of my time thinking about investing and thinking about businesses. I probably thought way more about businesses than Ben ever did. He had other things that interested him. So I’ve pursued the game a little, quite a bit differently than he did, and therefore measuring the record is really, the two records are not, it’s not a proper measurement. I mean, he was, he was doing victory laps while I still thought I was out there running against, you know, the whole field.

Charlie Munger [04:49:41] But Graham had some blind spots, partly of sort of an ethical proposorial nature. He was looking for things to teach that would work for every man, that any intelligent layman could learn and do well. Well, if that’s the limitation of what you’re looking for, there’ll be a lot of reality you won’t go into because it’s too hard to figure out and too hard to explain. Buffett, if there was money in it, had no such restriction.

Warren Buffett [04:50:09] Yeah, Ben sort of thought it was cheating if we went out and talked to the management, because he just felt that the person who read his book, you know, living in Pocatello, Idaho, could not go out and meet the Maddie. But so he didn’t, he, and we didn’t do it. I mean, when I worked for Graham, though, and it, I don’t think I ever visited a management in the 21 months I was there. He just, but, you know, he wasn’t sure whether it’d be useful anyway, but if it was to be useful, you know, that meant that his book was not all that was needed, that you had to add something to it.

I found it fun to go out and talk about their businesses with people, or to check with competitors or suppliers or customers and all that. But Ben didn’t think there’s anything wrong with that. He just felt that if he had to do that, then his book was not the complete answer, and he didn’t really want to do anything that the reader of his book couldn’t do if he was on a desert island, you know, basically with just one line to a broker.

Charlie Munger [04:51:15] But if you stop to think about it, Graham was trying to play the game of Ken the donkey wearing very dark glasses, and Warren, of course, would use the biggest searchlight he could find.

Warren Buffett [04:51:29] And we still can’t find any doggies these days. Okay, area one.

[04:51:34] Shareholder (Joe Nobbe, Seattle): I’m Joe Nobbe from Seattle, a shareholder. Mr. Buffett and Mr. Munger, I wonder if you could comment a little bit further on McDonald’s, carrying forward your comments of this morning, but more oriented toward how the McDonald’s would stack up against the inevitables in international type business. What your vision would be on their growth potential in places like Germany, China, so on and so forth.

Warren Buffett [04:52:05] Yeah, I guess I just would have to stick with my comment that you won’t get the inevitability in food that you will get in a single consumer product, you know, such as blades. I mean, that it, if I’m using a Gillette Sensor blade today, the chances are I’ll try the next generation that comes out. It’ll be the Sensor Excel right now. But if I, I will try the next one that comes out, obviously, but I will not fool around at all in between. And a very high percentage of people that shave, including women in shaving, they’re happy with the product. You know, it’s not, it’s not expensive. It’s $20 odd a year, you know, if you’re a typical user, and if you’re getting a great result, you’re not going to fool around.

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

Charlie Munger [04:54:03] I can’t think of anybody else who before McDonald’s ever did what McDonald’s did, to create a chain of restaurants on such a scale that worked.

Warren Buffett [04:54:15] Oh, Howard Johnson’s tried. Yeah, there were a lot of failures. Or some of you are old enough around Omaha to remember Reed’s, Harkert’s, or Harkert’s, Harkins, targets wholesome hamburgers, right? Yeah, and they came and they went, those chains. And, but they, it is a much tougher business that McDonald’s is in.

Charlie Munger [04:54:39] It’s price sensitive too. I mean, obviously part of that’s comparative. You can, you could spend a lot more money on hamburgers in the course of a year than razor blades. I mean, you can’t save that much by changing razor blades.

Warren Buffett [04:54:58] Yeah, the average person will buy 27, in the United States, 27 Sensors or Excels a year. You know, that’s one every roughly 13 days. And I don’t know what the retail price is because they give them free to us as directors, but they, you know, if they’re a dollar, it’s 27 bucks. I mean, and it makes a lot of difference. That’s what’s happening, of course, around the world, is people that are using cheap double-edged blades or whatever it is, they keep moving up the comfort scale and their comfort ladder, and Gillette’s a direct beneficiary of that. The difference between having great shaves and very so-so shaves and lots of nicks and scratches and everything, 10 bucks a year, 12 bucks a year, I mean, that is not, that’s not going to cause many people to change their habits.

And tonight the Sensor for Women has just been a huge success, that the, I think they’ve had more razors go out on that and the same period when the original Sensor was, came out for men, that, so that’s been an enlargement of the market. I would not have guessed that would work that well. Before that, all the women just use the disposables or their husbands’, boyfriends’ razor, but thank God they’ve gotten over that. Area two.

[04:56:27] Shareholder (Ted Downey, Mankato, Minnesota): Gentlemen, my name is Ted Downey. I live in Mankato, Minnesota. Mr. Munger, your reference to Einstein, I happen to have an article called “Strange Is Our Situation Here on Earth,” which is somewhat related to my question. This morning you brought up the shortcomings of accountability, and I would like you to address the aspects of the environmental impact in our accounting system, and how this might relate to a social screen for investment in other areas.

Charlie Munger [04:57:12] Well, again, that is broaden up and tough enough so that I think I should pass. I… (Applause)

Warren Buffett [04:57:26] The, I would say the Unseen Hand, or the Invisible Hand, you know, it does not work perfectly for all aspects of an economy. So, but in terms of accounting for it, in terms of an individual balance sheet or income account, you know, that would be way beyond me. But there are things that the Invisible Hand won’t do, and therefore that unfettered market-driven economic action will not lead to the best result for society, in my view. I think the market works awfully well on an awfully, in a tremendous number of ways. It produces what people want and increasing quantities, and it, you know, it’s enormously beneficial to have a market-driven society, but a pure market-driven society will do things that will have anti-social consequences.

Charlie Munger [04:58:29] You certainly need environmental rules. Yeah, the pioneers died like flies because the drinking water was too near the sewage. And one of the glories of the world we live in now is that the sewage systems are so good, and, you know, you don’t think about it much, but it’s dramatically changed our prospects in a, and the general quality of how we live. And there are a lot of other places where you need environmental rules. All that said, some of the environmental stuff has gone way too far, but it’s too complicated to try and offer precise lines.

Warren Buffett [04:59:12] Area three.

[04:59:12] Shareholder (Gul Asnani, Allentown, Pennsylvania): My name is Gul Asnani. I’m from Allentown, Pennsylvania. I have a question, a, concerning page four of the annual report, where you talk about the investments per share, etc. Right. And my question is, how much claim do the operating businesses have on these marketable securities?

Warren Buffett [04:59:32] Yeah, well, that table is a very important table, in my view, and we measure our progress to some extent by the figures in both columns of that table, one of which shows the investments per share, and the other shows the operating earnings from everything other than investments. And the operating businesses have first claim on anything that relates to their business. I mean, if See’s is going to buy a new plant, which it probably is now, or buy an additional building, I shouldn’t say a new plant, you know, that comes first. They, the business is growing, it’ll produce some economies and all that. We do that, you know, we try and do it as intelligently as possible, but that comes first. The, that doesn’t use but a small fraction of the capital. All of those needs don’t use but a small fraction of the capital that Berkshire will generate. The investments reside largely in the insurance companies, because that’s where largely the liquid funds are. They have to have capital strength, obviously, because they have huge promises outstanding. But where they reside does not determine who manages them. Lou Simpson manages GEICO’s portfolio specifically, but in effect Charlie and I manage everything else. So where they precisely reside really makes no difference. I mean, they’re sitting someplace. They’re not for the operating management to use in projects that are far afield from what they’re doing. But if they need money in any operating business, you know, we’ll have a check there that day.

The FlightSafety, for example, will be a fairly capital intensive business. I mean, if our project with Boeing goes as we hope it goes, you know, we’ll, there will be substantial money in there, because there, you know, we will have many more simulators around the world, and we’ll be paying our proportional cost of it. But they don’t need to keep money around to prepare for that day, which they would if they were a standalone operation. We can, money’s fungible, we can deploy it all the time, and whenever anybody needs it, we’ll come up with it. But we don’t leave it around awaiting the day when some specific operation needs it. Charlie?

Charlie Munger [05:01:57] The odds are very good that the marketable securities will keep going up even as the businesses expand.

Warren Buffett [05:02:05] That’s the way the game has worked in the past, and we hope it’ll keep going that way. What we are doing is trying to increase the numbers in both columns. We don’t have any, we don’t have a favoritism for this over that or anything of the sort, but we’re looking all the time for things that we’ll do, will help both columns, and we’d be disappointed if five or ten years from now that they both haven’t increased significantly. But which column will increase at the greater rate, we don’t know. Area one.

[05:02:44] Shareholder (John Zavanovich, Ottawa, Canada): Good day. My name is John Zavanovich from Ottawa, Canada, which incentive incidentally has nothing to do with Brex whatsoever. My question mark goes back to the discussion of intellectual capital, in a particular perhaps your intellectual reserves. In, so speaking of Security Analysis, the first edition 1934, Ben Graham talked about the development of the new era theory and its consequences on the security business. In today’s terms, we see a lot of the same words and phrases being repeated by analysts on Wall Street, and with the historical returns on common stocks dating back to the 1800s coming in at about 7%, pair that together with the concept of regression to the mean and statistics. Do you not think that we’re in a very dangerous period?

Warren Buffett [05:03:49] The answer, we never know. I mean, we, in terms of what markets will do, we, I don’t think that the Coca-Cola Company is in a dangerous position, you know, in a dangerous era, or Gillette is in a dangerous era, or McDonald’s or Wells Fargo or whatever. But, or See’s Candy, or the businesses we own in their entire, Kirby, whatever it may be. Whether valuations are too high gets back to the question that we said, or we talked about earlier. If for businesses in aggregate they keep earning very high returns on equity, and interest rates stay where they are, we are not in an overvalued period. If it turns out that these returns are not sustainable or interest rates go higher, it will, we will look back and say this was a high point, but for, at least for a while. But we have no notion on that, and we really don’t think about it, basically, we, because we don’t know. You know, our job is to focus on things that we can know and that make a difference. And if something can’t make a difference or we can’t know it, you know, we write that one off. So we’re looking for the, the one…

Charlie Munger [05:04:57] You would expect average returns from stock market index type investing to regress somewhat down.

Warren Buffett [05:05:03] Oh, I don’t think, they’ve been, the last few years, I don’t think you’ll get the investment result from owning the S&P over the next 10 years that you’ve gotten over the past 10 years. I would, I would, if someone wanted to put some real money on that, they would find a taker with me.

Charlie Munger [05:05:24] That’s very unlikely to happen. That’s not predicting a crash. It’s just saying that the guaranteed result from the next 10 years is almost certain to be less than…

Warren Buffett [05:05:33] Yeah, yeah. I mean, this is in no way particularly, I mean, it wouldn’t surprise us in the least if stocks average 4% a year, you know, for the next 10 years. That doesn’t mean they will, or we don’t, we don’t know the number, but that is, that would not be a surprising outcome, and it wouldn’t bother us particularly, either. Charlene?

Charlie Munger [05:05:56] What? No.

Warren Buffett [05:05:56] Two.

[05:05:57] Shareholder (Larry Whitman, Minot, North Dakota): Hello, my name is Larry Whitman from Minot, North Dakota. You have both talked today about the shrinking universe of stocks you could purchase, less margin of safety than ever, and a higher opportunity cost. And you’ve also talked about looking to potentially purchase your great companies that you already have at reasonable prices. And so I wonder if by talking so positively about some of your stocks, in particular Disney, such as in the ’95 annual report, when you talked about actually telling everyone that you were buying more shares on the open market, and again at the ’97 meeting, at their meeting, when you talked about maybe not selling the shares. Those were both opportunities maybe when Disney may have dropped because of such things as increased debt or even people’s concerned about the Ovitz compensation package. And I just wonder if that may hurt your ability to buy these great companies at reasonable prices by talking so positively about them, when in fact maybe you could buy them at lower prices when people get irrational.

Warren Buffett [05:06:59] Yeah, you’re saying that, which I probably agree with, that if we would say the world was going to hell at Coke or Disney or Gillette, we might be better off in terms of being able to buy more stock. But, you know, I got asked a question at Disney and I answered it, and that’s my general approach. That I think it’s, I think it’s usually a bad mistake to sell your interest in wonderful businesses. I don’t think people find them that often, and I think they get hung up, if they’ve sold them at X, that they want to buy them back at 90% of X or 85% of X, so they’ll never go back in at 105% of X. So I did, I think on balance, if you are in a business that you understand and you think it’s a really outstanding business, that the presumption should be that you just hold it and don’t worry. And if it goes down 25% in price, you’re 30% in price, if you have more money available, buy more. If you don’t, you know, so what? Just look at the business and judge how it’s doing. But there’s no question, I mean, we don’t, we try not to talk very much about the businesses, except maybe to use them as an illustration in a teaching mode or something.

Charlie Munger [05:08:07] That’s right, we’re not touting anything.

Warren Buffett [05:08:08] And I did try to stick those precautions in when I do talk about them as being wonderful businesses, so people don’t take it as an unqualified buy recommendation or something of the sort. But we’re not, we won’t try and put any spin on any one. We’re talking about business generally. We may not talk about them at all. You know, if we’re buying something, we’re, we might be, that particularly if no one knows that we’ve been in that stock at all, we might be somewhat quiet about the fact. But, you know, we don’t want to talk down something in order to buy it. Charlie?

Charlie Munger [05:08:48] I always, Jerry Newman, as I understand it, didn’t like Ben Graham giving all these courses explaining what Newman and Graham were doing. And, but Graham’s attitude was that he was a professor first, and that he made just slightly less money by being very accurate in what he taught, my, so be it. And I think it’s fair to say that Warren is assimilated a bit of that ethos, and I think it’s all to the good. And if it costs us a tiny little bit of money from time to time, there’re probably compensating benefits, and if there aren’t, it’s probably the right way to behave anyway.

Warren Buffett [05:09:27] Charlie, if you weren’t a less charitable mood, my point, I didn’t behave that way till I got rich. (Applause) Actually, I used to teach a course at what was then the University of Omaha, and we’d use all these current examples, but, and things were so cheap there, but nobody paid any attention. Area three.

[05:09:47] Shareholder (Liza Rima, Burbank, California): Hello, Mr. Munger and Mr. Buffett. My name is Liza Rima from Burbank, California. I wanted to find out, earlier you mentioned you looked at yeast filters to look at a company. So could you elaborate on what those filters are?

Charlie Munger [05:10:02] Well, we’ve tried to do a good deal of that, and opportunity cost is a huge filter in life. If you’ve got two suitors who are really eager to have you, and one is way the hell better than the other, you do not have to spend much time with the other. And that’s the way we filter stock buying opportunities. Our ideas are so simple. People keep asking us for mysteries, when all we have is one of the most elementary idea.

Warren Buffett [05:10:45] The first filter we probably put it through is whether we think, what, and we know instantly, I mean, whether it’s a business we’re going to understand, and whether it’s a business that, if that, if it passes through that, it’s where the, a company can have a sustainable edge. And that gets rid of a very significant percentage of the things. People always want to tell you some story or anything, and I’m sure they regard me and Charlie as very arbitrary in terms of, you know, in the middle of the first sentence saying, “Well, you know, we appreciate the call, but we’re not interested.” I mean, you know, they just think if they explain something, and, I get letters on this all the time. And, but we really can tell in the middle of the first sentence usually whether those two factors exist. And he began to understand it, obviously it’s not going to have, we can’t make a decision as to whether it has a sustainable edge. And if we can’t understand it, we very often can come to the conclusion that it’s not the kind of business where we’ll have a sustainable edge.

So 98% of the conversations we can end, you know, in the middle of somebody’s first sentence, which of course goes over very big with the caller. But, and then sometimes, if you talk about an entire business, we can tell by, we can tell by who we’re dealing with whether a deal is ever going to work out or not. I mean, it’s, it, if there’s an auction going on, we don’t want to, we have no interest in talking about it, and it just isn’t going to, you know, it isn’t going to work. If someone is interested in essentially doing that with their business, you know, they’re going to sit down or want to renegotiate everything with us all over again after the deal is done, and we’re gonna have to buy the business two or three times before we get through it. You just see all these things coming. And on the other hand, we’ve had, you know, terrific experience, basically, with the people we have associated with. So it works, it’s efficient. You know, we don’t want to listen to stories all day, and we don’t read brokerage reports or anything of the sort. It’s just, it just, there’s other things to do with your time. John?

Charlie Munger [05:13:08] Yeah, another filter that Warren was alluding to is this concept of the quality person. And of course most people define quality person as somebody very much like themselves, and, but identical actually is the word we are searching for. But there’s so many wonderful people out there, and there’s so many awful people out there, and they’re certain, and there’s signs frequently like flags, particularly over the awful people, and generally speaking, those people are to be avoided. It just, the amount of misery you bring into your life, boy, trusting some awful person, and the amount of felicity that you can bring in by making the right business associations. Look around this room, and there’s some wonderful people who have created some wonderful businesses, and their customers can trust them, the employees can trust them, the problems can trust them to be fairly faced and reasonably solved. And those are the kind of people you want to, and people will take their promises seriously.

I had some experience recently with a company, and they have their brand on a particular product, and somebody invented a better product in the same field, and they’re taking their brand off their product. I mean, the best, they don’t want their brand on it. People who think like that frequently do very well in business. And the flags are flying. I mean, the, it’s like they got a sign, and they’re just, it just says jerk, jerk, jerk. And then…

Warren Buffett [05:14:50] Yeah, and then you think you’re going to buy the business, now you’re going to be a jerk, you know, anymore. I mean, it is. All right. All right, okay, area one.

[05:15:01] Shareholder (David Winters, Mountain Lakes, New Jersey): Hi, David Winters, Mountain Lakes, New Jersey, shareholder. I’m just wondering if there’s an organizational model where you deal with a plethora of information, so you can physically and intellectually organize it, so you have your maximum output and retained focus. And secondly, if I may, in the domestic soft drink business, is it winner take all? I mean, is it room for three competitors? And honestly, does Dr Pepper have a future?

Warren Buffett [05:15:33] Yeah, I would say Dr Pepper has a future. I’ll answer the second one. But sure, there’s room for more than one. I think Coke’s market share will go up pretty much year after year, but not, you know, we’re talking tenths of a percent in that business, but tenths of a percent are important. The U.S. market is, what, could be 10 billion cases, so, you know, 1%’s 100 million cases. There will be, Dr Pepper appeals to a lot of people. It’s interesting how regional tastes can be. I mean, a Dr Pepper will have a share in Texas that’s, you know, far higher than it will be in Minnesota or something. But, but they’re, people are going to prefer it. And the interesting thing, though, is that the high percentage of people that prefer cola, for example, although the cola percentages have gone down a little bit. The fastest growing big beverage at Coke is Sprite. Sprite has had huge gains in sales. It does well over a billion cases a year, and it sells very well in a whole bunch of countries that, so they’ll, you can make money with a soft drink company that doesn’t dominate the business. She’ll do a lot better with one that does dominate, but it’s not a winner take all. It’s not like two newspapers in a town of 100,000 or 200,000. There are certain businesses that are winner take all, that clearly, but soft drinks are not one of them. What was the first question?

Charlie Munger [05:17:08] Well, the part about organizing.

[05:17:10] Shareholder (David Winters, Mountain Lakes, New Jersey): Oh, I’m just wondering, for those of us on the other side of the table, we get barraged with information, and I’m wondering how, how do you both, did you just read annuals, 10-Ks, and talk to people and ignore everything else? And how do you keep track of everything intellectually?

Warren Buffett [05:17:27] Well, we don’t keep track of everything, but the beauty of, to some extent, of evaluating businesses, large businesses, is that, yeah, it is all cumulative. I mean, if you started doing it 40 or so years ago, you really have got a working knowledge of an awful lot of businesses. But there aren’t that many to start with that are, you know, and you can get a fix, you know, how many, what are there, 75 maybe or so important industries, and you’ll get to understand how they operate, and you don’t have to start over again every day, and you don’t have to consult a computer for it or anything like that. It, so it has the advantage of accumulation of useful information over time. And, you know, you just add the incremental bit at some point.

You know, why did we decide to buy Coca-Cola in 1988? Well, it may have been, you know, just a couple small incremental bits of information, but that came into a mass that had been accumulated over decades. And it’s a very, it’s a great business that way. It’s why we like businesses that don’t change too much, because the past is useful to us. Trying?

Charlie Munger [05:18:43] I can’t add a thing to them.

Warren Buffett [05:18:46] Over there, and two.

[05:18:47] Shareholder (Barbara Morrow, Wisconsin and New York): I’m Barbara Morrow from Wisconsin and New York. If you both live as long as I believe you will, it could happen that there’ll be a year when you write two big checks for super-cat claims when the market is throwing away things at really silly prices. Could you share your thinking about how much debt you would consider taking on to buy great businesses is cheap in that kind of a situation?

Warren Buffett [05:19:16] Well, if we had both a big hurricane in the Northeast or in Florida, and we had a big quake in California in the same year, and we had a financial market, the financial markets tank, perhaps because of those events, but perhaps for other reasons, we would be thinking about ways that might not be borrowing money directly, but we would be thinking about ways to buy a securities if they got cheap enough. I mean, anytime securities get cheap… Charlie, you’re thumping again here. Anytime securities get cheap, you know, way, we don’t like to go to the office and not write a ticket. I mean, that, so we certainly would have the ability to borrow somebody. We would never borrow a ton of money relative to capital. We’re just not set out that way. We don’t want to disappoint anybody in this world. We don’t want to worry about disappointing anybody in this world. So we’re not going to do that. But we’ve got a lot, we have a lot of extra firepower overall, and I would say under almost any conditions that cause securities to get very cheap, we would find a way to buy some of them. Charlie?

Charlie Munger [05:20:38] The beauty of our situation is that it has enormous flexibility build into it. If something were large enough and cheap enough, we could stop writing super-cats. We’re measuring opportunities one against the other, and we understand the way the numbers interplay, and so we have a lot of different options, and that’s a huge advantage. There’s so many places in business life where you have practically no options at all. You’re just doing a channel that you have to waltz down the channel, and you don’t have any options to do anything else. We have enormous options. We may not exercise them, but we have enormous flexibility.

Warren Buffett [05:21:25] Yeah, we know they’re there. Yeah, yeah. And there’s no reason to push on anything now. At least we don’t see, we don’t have any reason to push ourselves. But if it ever became advantageous to push somewhat, we would push, although never to a degree that in any way cause us to lose a minute of sleep upon fulfilling every obligation we had. It’s 3:30. I thank you all for coming. I look forward to seeing you next year, and so on. (Applause)