Berkshire Hathaway Annual Meeting 2004 Transcript

Warren Buffett [00:00:05] Thank you. Good morning. Some of you may have noticed a stuntman was used in that. Arnold just couldn’t handle some of those scenes.

Before we get started, I’d I’d especially like to thank Andy Heyward, who’s here today, and if we can, no way we can find him out in the crowd, it’s a little hard to see from up here, but Andy runs DiC Productions. He he does that cartoon for us, and I, let’s give him a big hand. That Andy has produced a a really extraordinary series telling the story of the beginning of this country called “Liberty’s Kids.” It’s been on public broadcasting the last couple of years. It’s great for kids, but it’s great for adults too. I’ve watched a number of sessions myself, and this summer, in July, it will go on sale at Walmart, a very special celebration.

And for those of you who want to pick out something good for your children or your grandchildren, I can’t think of a better series to have them watching. And thanks again, Andy. And and thanks a also to Kelly Muchemore, who puts this whole production on. This is Kelly’s show. She, along with that dog Dudley, who you saw in the movie, Dudley is a regular at Berkshire Hathaway, we don’t count him in the 15.8, but but she, along with Dudley, handle everything. I don’t even give a thought to what’s going to happen here, as might become evident during the meeting, and she is responsible for putting up that whole exhibition arrangement and and really the whole thing. So Kelly, I don’t know where you are exactly, but in any event, thank you very much.

Now we’ll go through the business part of the meeting, and it may take a little longer than than usual, but please be patient. And I’d like to start out by calling the meeting to order. I’m Warren Buffett, chairman of the board of Berkshire Hathaway, and I welcome you to this meeting. This hyperkinetic fellow next to me is Charlie Munger, the vice chairman, and we will have a good time and I hope you do too. We work together because he can hear and I can see. I mean, it’s, there are times when we can’t remember each other’s name, but but but we have a lot of fun together.

Now, any shareholder who wishes to speak regarding the shareholder proposal expected to be presented by Human Life International, or any other matters germane to the shareholders meeting, should now go to microphone zones 1, which is in section 121 over on my right, or section 2, which is at section 221, I believe that’s higher up on my right, and see if I have that right, yeah, or or go to section E, section 7, which is, or section 105, which is microphone 7 on my left, or to section 205, which is microphone 8.

If you’ll go to, if you’re going to want to talk about anything concerning the business of the meeting, not the questions afterwards, but just that relates to the matters you’re made to the meeting, please please go there now, because I’m not going to be able to spot people in a crowd this size. And when it comes time to do the business, we’re going to ask anybody that cares to speak up on the business to be at those microphones, and that will be in just a couple of minutes.

Now, after adjournment of the business meeting, I’ll respond to questions that you may have that relate to the businesses of Berkshire, but that don’t call for any action at the meeting. At, we had some complaints after last year that some people were asking six or seven part questions. At least that’s the reason I’m giving, that we’re eliminating those. The bigger reason is, Charlie, I can’t remember the first part by the time you get to the fifth part. So we we are asking asking you to ask only one question, and and don’t try to get too clever about working three or four into a single question, and that will give more people a chance to get their questions asked. Only only one question at a time.

And we will go around from microphone to microphone and get as many in as we can. Now, we’re gonna do this until noon, and then we’ll take a break for lunch, and we’ll come back about one, and we’ll continue until 3:30. And anything goes on the questions. We’ll answer almost anything except questions about what we may be buying or selling. And you’re free, of course, to wander around, go over and buy things. You know, we’re, we have a lot of things for sale over there. It’s it’s it’s, as I’ve pointed out in the past, it’s better form to leave while Charlie is speaking than when I’m speaking, but you can use your own judgment on that.

Now, I do want to remind you that any audio or video recording of this meeting is prohibited. That if if anybody’s seen recording the proceedings, we will have to ask you to leave. So if you see anybody doing that, we would appreciate it if you just inform one of the staff personnel around, and because there are certain copyrighted material that that we use, and people like Judge Judy give us permission to use a segment like that, but it’s not intended to be used in any commercial way. So we do ask that no recording take place.

Now, I’ll first introduce the Berkshire Hathaway directors that are present, in addition to myself and Charlie. Now, I’ll ask the directors to stand as their names are read, and ask that you withhold applause, if any, until all are introduced. We have, I don’t know whether we have anybody here from CalPERS, but but they can register their own views as we go along. And it is difficult to see from here, so if you’ll just stand as I mentioned your name and remain standing until the end, when we will see whether you get any applause.

Susan T. Buffett. Howard G. Buffett. Malcolm G. Chace. David S. Gottesman, Sandy had a conflict today, there’s a a bat mitzvah, I believe, for a granddaughter, and so he’s coming in tomorrow for our director’s meeting on on Monday. Charlotte Guyman. Donald R. Keough. Thomas S. Murphy. Ronald L. Olson. And Walter Scott Jr. And now you can go crazy.

Also with us today are partners in the firm of Deloitte & Touche, our auditors. They are available to respond to appropriate questions you might have concerning their firm’s audit of the accounts of Berkshire. In that regard, I wish to report that at Berkshire’s audit committee meeting held on March 2, 2004, Deloitte & Touche responded to the four questions I suggest to be asked to the independent accountants by all audit committees, and we’re going to put these up in just a second. With with respect to Berkshire, the questions and the auditor’s responses will be shown on the following slides.

And I might mention that I really do think these questions should be asked that all of of of all auditors, at least annually, perhaps even quarterly. And I really think that if such a procedure had been followed over the years, don’t need them all, Charlie, if such procedures have been followed over the years, there would have been a lot less trouble in in corporate America. I mean, for for many years, particularly in the ’90s, I think there was a, there was a weakening, frankly, in in an auditor of vigilance.

And the trick, as I’ve said, is really to have the auditors more worried about the audit committee than they are worried about the management. And it’s quite natural, when they are essentially hired by the management and when they’re, when they see the management regularly and they only see the audit committee infrequently, that that it’s tempting to to listen a little bit more to management, the audit committee. But these questions, if asked, in my view, and if the answers are put on the record, I think it would have a very, a very helpful effect on behavior, because once on the record, it it means the auditors, means they’re on the line. And and I’ve I’ve been on a lot of a lot of boards of directors, and and I’ve seen in retrospect things go by that I wish had been called to my attention by the auditor.

So we have these four questions, and if we’ll put up the first one. And I’d like to explain one item. Do we close them? Yeah. And I’d like to explain one item. Do we close them? You can read the question, and these are the responses as we go along that the auditors have given to these questions.

Now, you’ll notice on the first one that there is one item that, and instantly, we owe a shareholder, I think, is going to speak later. It was a suggestion that we actually present these at the meeting, and I think it’s a good suggestion, and I think if more companies did it, it would be a good idea. So I thank him for the suggestion.

The the made, the major item, which is not material as auditors defined it, but the major item in which we disagree and used a method which I will explain further, actually has been changed, but concerns the purchase of life insurance policies, or the reinsurance of people who are purchasing life insurance policies, their so-called viatical settlements. And we have had a business of sorts in that, and it’s likely to even be a larger business in the future.

And what takes place there is that somebody, usually elderly, has a life insurance policy, and they’d rather have the money themselves, they have, then have their heirs get it later on. So they want to cash out early. And as you know, a life insurance policy typically has a cash surrender value, and sometimes those cash surrender values are quite low in relation to the actuarial value of the policy. So sometimes those people wish to sell a policy.

We had a case the other day where a 79-year-old woman had an insurance policy amounting to some $75 million. I’ve never met her, but she must be quite a woman. But the the cash surrender value of that policy was $2 million. Clearly, for even a 79-year-old in the best of health, that was an inadequate summer to receive, but yet she wished to have the cash herself rather than then eventually die and leave it to her heirs.

So we paid, or we actually reinsured a transaction where somebody else did it, and we took only 50% of it, but I’m going to use 100% figures. We we reinsured, we we bought that policy for $10 million. And under accounting rules, GAAP accounting, we, it is recommended that we write that policy down immediately to the cash surrender value of $2 million. Well, obviously, we think it’s worth $10 million or we wouldn’t have paid $10 million for it today. But the rules, as they become more clear, say write it down immediately. I I happen to think that rule’s wrong.

But last year, at the end of the year, there’d been a total of $73 million applicable to such policies that reflected our purchase price as opposed to the cash surrender value. In the first quarter of 2004, our activity has stepped up in this field some. The people we reinsure have stepped up their activity, so we get our 50%, and that amounts to, it’s going to mount in the first quarter, about $30 million. So we have adopted, even though we think it’s incorrect, we have adopted the GAAP accounting, and you will see in the first quarter reporter Berkshire the charge for the $73 million of last year plus the $30 million in the first quarter this year.

And that gets charged, believe it or not, to realize capital gains. And so so by buying these policies for X on one day and immediately writing them down substantially, that becomes a realized capital loss on our book. Now, later on, we expect to get a perfectly satisfactory return from these policies, but that is the main item that is referred to in the auditor’s answer on question one.

Now, if we’ll go to number two. Time to read that. I like the idea of this question being asked. I’ve read many reports where the footnotes are such that even if I reread them several times, I still don’t know what’s happened. And we try to, we try to write everything in plain English at Berkshire, and we try to explain things within the body of the letter that might give people the wrong impression if they simply looked at the figures, or that they might not be able to discern, because Berkshire has gotten so large that we, they’re all kinds of things that are lumped together in the consolidated statements that I think it’s more helpful if we look at separately. And we’re going to work it annually at trying to disaggregate numbers and information in a way that makes it most useful without turning out something as long as the World Book.

And third item is very simple. And the fourth item relates to something that became very prevalent in corporate America in the 1990s, which was moving around numbers from one quarter to another, moving from one year to another. And I have seen a lot of that. It’s deceptive. I like the statement that the two fellows at Google made the other day, where they essentially said that if numbers are lumpy or peculiar when they get to them, they’re gonna be lumpy or peculiar when they get to the public. And if there’s some reason that requires explanation as to why they’re lumpy, that management should explain them. But but the one thing they shouldn’t do is start playing games from quarter to quarter, year to year, in terms of moving numbers around. And that became very fashionable. I hope it’s on the way to being moderated. And we will continue to, each year, we will give you these questions at the meeting, and we will report on the auditor’s answers.

Mr. Forrest Krutter is secretary of Berkshire. He will make a written re-record of the proceedings. Miss Becki Amick has been appointed inspector of elections at the meeting. She will certify to the counter votes cast in the election for directors. The name proxy holders for this meeting are Walter Scott Jr. and Marc D. Hamburg. Does the secretary have a report of the number of Berkshire shares outstanding entitled to vote and represented at the meeting?

FKForrest Krutter [00:16:31] Yes, I do. As indicated in the proxy statement that accompanied the notice of this meeting that was sent to all shareholders of record on March 3rd, 2004, being the record date for this meeting, there were 1,278,436 shares of Class A Berkshire Hathaway common stock outstanding, with each share entitled to one vote emotions considered at the meeting, and 7,766,293 shares of Class B Berkshire Hathaway common stock outstanding, with each share entitled to one two-hundredth of one vote emotions considered at the meeting. Of that number, 1,121,231 Class A shares and 6,473,904 Class B shares are represented at this meeting by proxy’s return through Thursday evening, April 29th.

Warren Buffett [00:17:21] Thank you. That number represents a quorum, and we’ll therefore directly proceed with the meeting. First order of business will be a reading of the minutes of the last meeting of shareholders. I recognize Mr. Walter Scott, who will place a motion before the meeting.

WSWalter Scott Jr. [00:17:35] I move that the reading the minutes the last meeting of shareholders be dispensed with and the minutes be approved.

Warren Buffett [00:17:42] Do I hear a second? Motion has been moved in second. Are there any comments or questions? We will vote on this motion by voice vote. All those in favor say aye. Opposed? Emotions carried.

First item of business at this meeting is to elect directors. The shareholder is president who wishes to withdraw a proxy previously sent in and vote in person on the election of directors, he or she may do so. Also, if any shareholder that is present has not turned in a proxy and desires a ballot in order to vote in person, you may do so. If you wish to do this, please identify yourself to meeting officials in the aisles, who will furnish a ballot to you. With those persons desiring ballots, please identify themselves so that we may distribute them. And I now recognize Mr. Walter Scott to place a motion before the meeting with respect to election of directors.

WSWalter Scott Jr. [00:18:30] I move that Warren E. Buffett, Charles T. Munger, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace, David S. Gottesman, Charlotte Guyman, Donald Keough, Thomas S. Murphy, Ronald L. Olson, and Walter Scott Jr. be elected directors.

Warren Buffett [00:18:46] Is there a second? The moving second, the Warren E. Buffett, Charles T. Munger, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace, David S. Gottesman, Charlotte Guyman, Donald R. Keough, Thomas S. Murphy, Ronald L. Olson, and Walter Scott Jr. be elected as directors. Are there any other nominations? Is there any discussion? Is there anybody that is at the microphones that would? Yes.

[00:19:14] Shareholder (Paul Tomasik, Thornton, Illinois): Paul Tomasik, Thornton, Illinois. I like the idea of inside directors. I think they’re necessary. However, I think we should have the best available. In particular, I’d like you to consider the CEOs of the Berkshire subsidiaries. If you compare their qualifications to Susan Buffett’s and Howard Buffett’s, I think you’ll find that the CEOs have superior qualifications, particularly business savvy and the ability to stand up up to a forceful CEO. I’d like to point out that we’ll hear how many of these CEOs are into independently wealthy and could easily say, take this job and shove it. So this is why I’m withholding my votes for the directors. Thank you.

Warren Buffett [00:20:16] Thank you. Charlie, do you have any thoughts on that?

Charlie Munger [00:20:20] I think we should go on to the next item.

Warren Buffett [00:20:24] The nominations are ready to be acted upon. If there are any shareholders voting in person, they should now mark their ballots on the election of directors and allow the ballots to be delivered to the inspector of election. With the proxy holders please also submit to the inspectors of elections a ballot on the election of directors, voting the proxies in accordance with the instructions they have received. Miss Amick, when you are ready, you may give your report.

BABecki Amick [00:20:58] My report is ready. The ballot of the proxy holders, in response to proxies that were received through last Thursday evening, cast not less than 1,123,189 votes for each nominee. That number far exceeds a majority of the number of the total votes related to all Class A and Class B shares outstanding. The certification required by the Delaware law of the precise count of the votes, including the additional votes to be cast by the proxy holders in response to the proxies delivered at this meeting, as well as any cast in person at this meeting, will be given to the secretary to be placed with the minutes of this meeting.

Warren Buffett [00:21:39] Thank you, Miss Amick. Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace, David S. Gottesman, Charlotte Guyman, Donald R. Keough, Thomas S. Murphy, Charles T. Munger, Ronald Olson, and Walter Scott Jr. have been elected as directors.

The next item of business is a proposal put forth by Berkshire shareholder Human Life International, the owner of one Class B share. Human Life International’s motion is set forth in the proxy statement and provides that the company be required to publish annually a detailed statement of each contribution made by the company and its subsidiaries in various political causes. The directors have recommended the shareholders vote against the proposal. We will now open the floor to recognize the appointed representative of Human Life International to present their proposal. Someone here to present that?

TSTom Strobhar [00:22:24] Yes, Mr. Buffett. My name is Tom Strobhar, and I do represent Human Life International, and I’m here to present the shareholder resolution regarding political contributions. But before I do, I’d like to give you a little background. Some of you may remember, two years ago there was a resolution asking the company to end its charitable giving program. The resolution said corporate charitable contributions should help, not hinder, the company and suggested certain contributions, especially those related to abortion and population control, were doing just that. This proposal was soundly defeated by the shareholders, receiving less than 3% of the vote. Oddly enough, a little over one year later, Mr. Buffett, in his wisdom, did terminate this program, citing the adverse impact his philanthropic interests were having on the livelihoods of some employees at the Pampered Chefs division.

At the time of the resolution, we first learned that Mr. Buffett and Mr. Munger were directing their money to their personal foundations rather than more recognize public charities. While previous chairman’s letters extol the high participation levels among eligible shareholders, no mention was made that Mr. Buffett, who accounted for 31% of the equity of the company, was giving away almost 55% of the charitable gifts. Why? All of you B shareholders, who probably comprise a majority of the people in this audience, were excluded from giving, and whose vote on this proposal was dramatically diluted down to 1/200th of the value of an A share, which, obviously, not quite democratic.

I refer you to the 1983 chairman’s letter. In addressing why you wouldn’t split the stock, Mr. Buffett describes something he calls shareholder eugenics. Mr. Buffett laments how is impossible to screen entering members of the shareholder club for, quote, “intellectual capacity, emotional stability, moral sensibility or acceptable dress. Splitting the stock and lowering the price,” the mission to the club, Class B shareholders take note, “would attract an entering class of buyers inferior to the existing class and downgrade the quality of your present shareholder group,” end quote.

All told, Mr. Buffett gave to his private foundation almost $100 million, much of it other shareholders’ money. This money, in turn, was devoted almost exclusively to population control, seeking to lessen the number of people at a time when the Western nations, especially those in Europe and Japan, face economic calamity from a baby bus.

How did charitable congregations relate to political contributions? It wasn’t until there was a resolution on charitable contributions that we receive some disclosure. So too with a resolution I’m about to present do we find out the company gave a very modest $200,000 to various political candidates or causes. While the charitable contributions may have been too much, the political contributions may be too little, not necessarily from the company, but from other shareholders. If there are politicians or causes in which there is legitimate business interest in supporting, why not give the shareholders the opportunity to help them also? By publishing a list, the word goes out to our thousands of shareholders who may wish to do the same with their own money. It costs little to publish, provides for transparency, checks any personal abuse, and sets an example to the rest of corporate America. It also provides an opportunity for all the members of our shareholder club, even B shareholders, to get involved and help this company and help their investment.

With that, I’d like to read the actual resolution, which I’m required to do. Within one month after approval by the shareholders of this proposal, management shall publish in the Buffalo News a detailed statement of each contribution made by the company or in its subsidiaries, either directly or indirectly, within preceding fiscal year in respect of any political campaign, political party, referendum or citizens initiative, or attempts to influence legislation, specifying the date and amount of each contribution in the person or organization to whom the contribution was made. Subsequent to this initial disclosure, management shall cause like data to be included in each succeeding report to the shareholders. If no such disbursements were made, to have the facts so noted behind the report.

This proposal, if adopted, would require the management to advise the shareholders how many corporate dollars are being spent for political purposes and to specify what politicians or political causes the management seeks to promote with these funds. Political contributions are made of the dollars that belong to the shareholders of the group, and they are entitled to know where their dollars are being spent. A vote for this proposal is a vote for full disclosure. Thank you.

Warren Buffett [00:27:41] Is there anyone else that would care to speak on the motion? Charlie, do you have any comment?

Charlie Munger [00:27:49] Well, I preferred our old charitable giving program to the way most corporations do it in America (Applause) where the controlling officers decide. However, it’s a dead horse. It’s gone, and there’s no point beating on the corpse.

Warren Buffett [00:28:07] The dead horse will now speak. The the, I I I just want to add one point, because it is a little different than occurs at many other corporations. To my knowledge or memory, I don’t believe Charlie and I have ever asked any employee or any vendor to Berkshire, any employee of Berkshire or mender to Berkshire, for either political contributions or charitable contributions. There’s been no, there’s been no use of our positions to, in effect, extract money for our own personal causes, or either in the charitable area or the political area. Is that correct, Charlie?

Charlie Munger [00:29:00] Yeah, but we don’t deserve too much credit for not asking other people for charitable contributions. Think what the reciprocity implications would be.

Warren Buffett [00:29:11] Yeah, yeah, but it’s it’s a fairly common activity. So here we are. We’ll, if any shareholders voting in person, they should now mark their ballots in the, in, on the motion, and allow the ballots to be delivered to the inspector of elections. With the proxy holders please also submit the inspector of elections a ballot on the proposal, voting the proxies in accordance with the instructions they’ve received. Miss Amick, when you are ready, you may give your report.

BABecki Amick [00:29:42] My report is ready. The ballot of the proxy holders, in response to proxies that were received through last Thursday evening, cast 27,080 votes for the motion and 936,045.815 votes against the motion. As the number of votes against the motion exceeds a majority of the number of votes related to all Class A and Class B shares outstanding, the motion has failed. The certification required by Delaware law of the precise count of the votes will be given to the secretary to be placed with the minutes of this meeting.

Warren Buffett [00:30:24] Thank you, Miss. I think the proposal fails. Does anyone have any further business to come before this meeting before we adjourn? If so, they should approach microphone 1 to be recognized. I believe we have someone. Yes.

[00:30:42] Shareholder (Paul Tomasik, Thornton, Illinois): Paul Tomasik, Thornton, Illinois. I have a proposal to put written rules for this meet-eating, the formal part, on the web, in order that this meeting can be conducted fairly and with with good good faith. Would you like a little more comment? I know it…

Warren Buffett [00:31:04] No, the faster you can make it, the better, but go, go to it.

[00:31:11] Shareholder (Paul Tomasik, Thornton, Illinois): That’s it. That’s it, that one.

Warren Buffett [00:31:14] Okay. Is that a motion? What’s that, Marc? Well, do you want to, would you, would you place all, if you have more motions, would you place them, or is that it?

[00:31:30] Shareholder (Paul Tomasik, Thornton, Illinois): No, cert-certainly. The other other three emotions are to put the bylaws and the articles of incorporation up on the website, to write it into the bylaws how shareholders should present motions, and the fourth, to writing into the bylaws how shareholders can make director nomination. To sum up what these motions ask for is just, tell us the rules, we’ll follow. That’s it. Thank you.

Warren Buffett [00:32:03] Okay, thank you. I actually think you came up with a very good suggestion on the audit committee report, which we’ve incorporated. I don’t really think this would add much. But if there are any shareholders voting in person, they should now mark their ballots in the motion, on the motion, and allow the ballots to be delivered to the inspector of elections. With the proxy holders please also submit to the inspector of elections a ballot on the proposal, voting the proxies in accordance with the instructions they’ve received. Miss Amick, when you’re ready, you may give your report.

BABecki Amick [00:32:38] My report is ready. The ballot of the proxy holders cast 1,153,600.52 votes against the motion. As the number of votes against the motion exceeds a majority of the number of votes related to all Class A and Class B shares outstanding, the motion has failed. The certification required by Delaware law of the precise count of the votes will be given to the secretary to be placed with the minutes of this meeting.

Warren Buffett [00:33:12] Thank you, Miss Amick. The proposal fails. I now recognize Mr. Walter Scott to place a motion before the meeting. Just there a second. A motion to adjourn has been made and seconded. We will vote by voice. There any discussion? If not, all in favor say aye. All opposed say no. The meeting’s adjourned.

Okay, now we’re, now we’re going to move into the questions and answers, at least questions, and just ask one, as we spelled out before. And we will start with with microphone 1, which is in section, what, 121, on my right, and we’ll keep moving 1 through 12 until we get till noon. Microphone 1.

[00:34:06] Shareholder (Jonathan Mills, London, England): Jonathan Mills from London, England. I wondered if you could comment on the views of those people who have stated that because of so-called conflicts of interest, you should leave the board of Coca-Cola, and whether you had any intention of doing so.

Warren Buffett [00:34:30] That we should do what with the board?

[00:34:34] Shareholder (Jonathan Mills, London, England): Leave the board. That you personally should leave the Coke.

Warren Buffett [00:34:39] I would say that whoever suggested that should do 500 sit-ups.

Actually, Charlie and I certainly, I have, I’ll let Charlie speak for himself, we like the idea, and we’ve we’ve encouraged the idea of shareholders behaving like owners. I mean, sharehold-shareholders have too often behave like sheep in this country, and and and they got shorn in many cases. And big and institutional shareholders have have sat on the sidelines while some things that might possibly have been corrected, had they gotten active, that took place. And so we have, we actually applaud the idea of shareholders behaving like owners. The question is what they, you know, can behave like intelligent owners.

And I think that in the last year or two, as they’ve sort of woken up, they’ve searched for checklists of one sort or another to determine whether directors are are appropriate in a given company or not. And and frankly, checklists are no substitute for thinking. The real job of the directors is to come up with the right CEO for a company and prevent him or her for overreaching. If they do that job well, the rest takes care of itself. And you have to think some to determine whether that’s taking place. You can’t solve it by just running down a little checklist. I think it was Bertrand Russell who said, most men would rather die than think. Many do. And I think we’ve seen a little bit of what he was thinking about in some of the voting.

I think it’s absolutely silly, frankly, if Berkshire Hathaway owns 200 million shares of Coca-Cola, $10 billion worth, to not be able, it’s a little silly not to think that the interest that Berkshire Hathaway has in selling some hours of training at FlightSafety or something would cause me to do something counter to the interests of the shareholders, when we have $10 billion writing on that side of the table. I mean, it’s it’s almost absurd, and somebody doesn’t understand proportionality at all when they come to that sort of conclusion.

I also think it’s absolutely foolish, if, just to use Coca-Cola as an example, I think the directors of Coca-Cola, haven’t even looked, but I think we probably receive something like $100,000 a year. And if if we were to go out into the welfare line and pick somebody out who has no income and say, we’d like you to become a director, and that person would get $100,000 a year, which would be their entire income, and to say that person would be independent, you know, while they would be 100% dependent on their income, that person would be independent, whereas Berkshire Hathaway, or myself representing Berkshire Hathaway with $10 billion of stock and receiving the same $100,000 dollars a year, as is, is not regarded. So I encourage, I encourage institutional shareholders to enlarge owners to to behave like owners, but I also encourage them to really think logically, as owners should think, in determining what causes they take on and how they vote. Charlie?

Charlie Munger [00:38:20] Yeah, I think that the corporate America needs a fair amount of reform, but the cause of reform is hurt, not helped, when an activist makes an idiotic suggestion to be like the one that having Warren Buffett on the board of the Coca-Cola Company is contrary to the interest of the Coca-Cola Company. Nutty activities do not help the cause forever for which the person speaks.

Warren Buffett [00:38:56] It’s a little bit like having a slicing machine in an orchard, where you’re gathering together apples, but you’re also picking up a lot of rocks in the process, and sticks and stones. So you have a slicing machine with a conveyor belt, and the slicing machine is programmed so that every time something is red and round comes down the line, it slices it and comes down, but it doesn’t come down on the rocks and everything and ruin the blades. And of course, that’s fine until a red balloon comes down the line, and then you get a big pop, and the machine is, has followed its little guidelines, but it it’s not slicing apples anymore.

And I think I just, I actually, institutions are coming new to really thinking about how they behave as owners, and you would hope that, in the evolutionary nature of of learning, that not too many years distance, they were distant, they would actually think about what’s good for the shareholders of the company. Let’s go to microphone number 2, please.

[00:39:59] Shareholder (Akis Sares, Athens, Greece): Mr. Bob, Mr. Buffett, Mr. Munger, good morning. My name is Akis Sares, and I am from Athens, Greece. There is a widespread perception that we’re heading towards an inflationary environment. What advice would you give to investors who need to preserve their capital and their purchasing power in such an environment?

Warren Buffett [00:40:22] The best thing is to have a lot of earning power of your own. If you’re the best brain surgeon in town, or or even the best lawyer in town, you will retain purchasing power in terms of your income no matter what happens, you know, whether people are using seashells for money or whatever, as time goes by. But in the investment world, it’s tougher. But Charlie and I think the best answer is to own fine businesses that will be able to price in inflationary terms and will not have huge capital investment that is required to handle the larger dollar volume of sales.

Some years ago, I used See’s Candy in our, in the annual report, as an example of the kind of business that more or less can handle an inflationary world and and and maintain investment in value no matter what happens to the currency. Unfortunately, most businesses do, will not come out well in real terms during inflation. Their earnings may go up a fair amount over time, but they’re compelled to put more and more dollars into the business just to stay in the same place. And you know, the worst kind of a business is one that makes you put more money on the table all the time and doesn’t give you greater earnings. So you really want a business that can have pricing that reflects inflation and does not have very much capital investment that reflects inflation.

But inflation is the enemy of the investor in terms of real returns. As you know, there are, in this country, as well as a half a dozen other countries, there are what they call in inflation-protective bonds. We call them TIPS in the, in the United States, where the income is adjusted, or the principal amount is adjusted to inflation. And and that’s not a bad investment for people that that have worries about inflation heating up. And I think, incidentally, we’re starting to see it eat up in this country. Charlie?

Charlie Munger [00:42:37] Yeah, most people are going to get a very small real return from investment after considering inflation and taxes. I think that’s an iron law of the world. And if for a brief period some of us do better than that, we ought to be very thankful. One of the great defenses to being worried about inflation is not having a lot of silly needs in your life. In other words, if you, if you haven’t created a lot of artificial demand to drown in consumer goods, why, you have a considerable defense against the possessitudes of life.

Warren Buffett [00:43:19] Charlie, we’re selling consumer goods in the other room. (Laughter) It’s okay to talk that way at home, but (Laughter) it doesn’t do any good there. (Laughter)

Charlie Munger [00:43:31] I know the feeling.

Warren Buffett [00:43:33] Let’s go to microphone 3.

[00:43:35] Shareholder (Larry Coats, Durham, North Carolina): Good morning, gentlemen. My name is Larry Coats, from Durham, North Carolina. Mr. Buffett, after last year’s meeting, my long time friend and business partner, George Brumley, sent you a letter addressing several issues. Having participated in the preparation of that letter, and on his behalf, I thank you for your response. Thank you. And such, you suggested that many of those issues would be appropriately addressed in this forum. In his honor, I’d ask you to address just one of those, and that is the ultimate generational transfer of Berkshire away from its current base of long-term, self-selected and well-informed shareholders, and the potential of instituting a series of analyst meetings to address the relative lack of interest in an ownership and understanding of Berkshire by institutional shareholders and investors. Thank you. Good morning.

Warren Buffett [00:44:36] Well, thank you. I mean, George was a wonderful man, great analyst, and a friend. I have some problem with having meetings with subgroups of investors, such as institutional investors. If we had something like that, I think we would want it to be open to everybody, and, you know, that that gets to be quite a production. But I can understand, you know, why, why a, you’d like to see our managers and and and hear what they have to say about their businesses. We, we try to convey a lot about the businesses in the report. But Charlie, do you have any thoughts on that?

Charlie Munger [00:45:23] I don’t think it fits our temperament at all. Well, many corporations have a huge amount of effort spent in talking to groups of analysts. One of Berkshire’s strengths has been that we don’t spend time in that way. That’s a very time-consuming process, and and it does give some shareholders some advantage over others. We try and be more egalitarian, in events like this and the way we write the annual report, etc.

Warren Buffett [00:45:53] Yeah, we really like the group of shareholders we have. I mean, we’re not about enticing new people into it. But, you know, I know your point also is that the president’s shareholders could better understand Berkshire if they wouldn’t listen to Bob Shaw and talk about Shaw Carpet, or Rich Santulli talk about NetJets. And the truth is, it is fun to listen to those people. But it, one of the things we promise managers when they join up with us, too, is that they don’t have to listen to bankers, they don’t have to listen to investment analysts. They just get to run their businesses. They can devote 100% of their time to it, and people like that, and they’re more productive because of it.

I mean, we we really place no impediments in the way of our managers doing what they do best and what they like to do best, which is run their businesses. And and and frankly, enough of them, are a number of them have expressed to me that they’re very happy, because they existed in a different mode before, and in that mode they they would spend maybe 25% of their time on activities that they didn’t enjoy and they didn’t feel were very productive.

So we want to get across the information about our businesses to you, and and believe me, when when I write the report and Charlie looks at it, and we we we say to ourselves, are we telling you what we would want to know about if our positions were reversed, if we were on the receiving end? And we really try to put in the report everything that’s germane to evaluation. Now, if you have a market cap of $130 billion, you know, it’s really not too important to get keen insights into some business that’s making a relatively small amount of money. But anything that counts, and really, you have to look at them in aggregates when, we want to get across you.

So it, you know, it’s, I’m very respectful of your suggestion. It’s it’s conceivable to do it. The Washington Post has a shareholder day, because their annual meeting is turned into a farce often, because it’s largely dominated by people who are complaining about this story or that story. But the shareholder day is very useful, and they and they do have their managers there and talk about it. But I really think if we spend six hours here answering your questions about the business, and we do a halfway decent job of writing the annual report, we should get across the essential information.

We’re really not trying to get across, we’re not trying to talk to an audience that is trying to get some special insight into what next quarter or next year is going to look like. We’re, we’re really looking for owners who join us in what we regard as kind of a life, a lifelong investment. And and I would say that that certainly analysts like your group have exactly the same objective. We, we do, and want to understand the business that way. But my experience, you know, in in talking to hundreds of them, is that there are relatively few that are actually thinking about, what do we buy and put away forever, like we’d buy a farm or an apartment house or something. So we’ll consider it, but I don’t want to make any promises. Go to number 4, please.

[00:49:15] Shareholder (Matt Sauer, Durham, North Carolina): Good morning, gentlemen. My name is Matt Sauer, and I’m from Durham, North Carolina. Regarding compensation, you have commented along the lines of, people willing to bet big on their abilities usually have a lot to bet on. A MidAmerican regulatory filing indicated some attractive prospective compensation possibilities for its senior executive team, subject, of course, to meeting profitability milestones. Perhaps you might provide some details on the thought process that went into crafting that compensation structure, and in doing so, use this specific example as a reminder about Berkshire’s compensation philosophy related to paper perform, paper performance, versus the more popular approaches. If it’s easier to figure out, in a minister, better for owners, and can still attract talented people, why don’t more companies adopt such practices?

Warren Buffett [00:50:09] Yeah, we, you can make a lot of money working for Berkshire. Not if you’re chairman or vice chairman, but but there’s, there, there’s, there’s a chance to make a lot of money, but it will relate to performance. No one is going to make lots of money at Berkshire for for average performance. And you mentioned the MidAmerican situation. We’ve got some extraordinary management, amer, MidAmerican.

And it’s, in terms of how that compensation arrangement was worked out, I was thinking one day about what would be appropriate for the two individuals who are key to the success of MidAmerican, and I took a yellow pad and I spent about three minutes sketching out a proposal. And I went to Walter Scott, who was our partner in the, in the business, you know, actually heads the comp committee, and I said, Walter, this is an idea I have, what do you think of it? And he looked at it and he said, it looks fine to me. And we talked to the two managers about it.

And actually, as we presented it, we had it so that that some, something over 50% went to the CEO, Dave Sokol, and and something under 50% went to the number two man, Greg Abel, who’s enormously well named. And when we gave it to David, he said, let’s just, he said, I like it fine, but let’s make it 50/50. That’s the extent of it. As you have commented, that’s wildly different than the approach at companies. I mean, most, most companies go through a very elaborate procedures in in working out executive compensation.

I don’t think that Charlie and I have spent over maybe five minutes underneath I’m thinking about any. We have an arrangement at See’s Candy with Chuck Huggins. We worked it out in 1972. It’s still in force. Now, John Holland took over Fruit of the Loom a couple of years ago. I met with him for a couple of minutes, suggested something, takes up a paragraph or two, and that’s what we’ll have with John the rest of his life. It’s it’s not, it’s not highly complex. You have to understand the businesses. There is no one formula we could use a Berkshire that would fit across our businesses. That’s asinine.

You don’t want them complicated. We don’t have anything that goes on for pages and pages. It’s not needed. It establishes a relationship between us and and and the manager that’s not good. So all of our stuff is is very, very simple. At GEICO, we have two variables, and they’re what count, you know. So we make, from Tony Nicely on down, we have everybody participating based on that. We worked that out whenever we took over at GEICO, and it’s it’s it’s worked fine since, and it’ll keep working.

But we do not bring in compensation consultants. We don’t have a human relations department. That we don’t have, we don’t, at the headquarters, as you can see, we don’t have any human relations department. We don’t have a legal department. We don’t have a public relations department. We don’t have an investor relations department. We don’t have those things, because they make life way more complicated, and everybody gets a vested interest in going to conferences and calling in other consultants, and it takes on a life of its own.

In the typical large corporation, there’s a comp committee, and as I pointed out in the past, they don’t put Dobermans on the comp committees, usually. They, they look for Chihuahuas that have been sedated. And and and I’ve been on 19 boards. They put me on one committee once, and I was chairman, and I got outvoted. You remember that, Charlie?

Charlie Munger [00:53:58] I certainly do.

Warren Buffett [00:53:59] Yeah, they, by two very fine guys. Yeah, the terrific guys, actually. And they, you know, the nature of it is that now, particularly with Sarbanes-Oxley, there’s lots of committee meetings. The director’s meetings are filled up with process. And you have on one side of the table some people are usually are spending an hour or two and getting presented with a bunch of material by the human relations department and the, and some outside consultants. And I’ve never seen the head of the human relations department or a consultant come in and say, this bozo you’ve got is only worth about half what you’ve been paying. But this just isn’t going to happen.

So it’s, you know, a, it’s a situation where the intensity of interest on both sides is seldom equal. The, the directors are often dealing with something my, my friend Tom Murphy in the past has called play money, and and the CEO is dealing with something very dear to his heart. So you’ve got to expect a situation like that to get gained over time, not over time, promptly, actually. And and there’s some change in that that’s taking place, but it’s not being, in my, in large part, it’s not being led by CEOs.

And it’s, and it’s, it’s difficult for directors to do, to get a lot done. They get handed a sheet of paper that shows them comparables elsewhere, and everybody thinks they’re CEOs in the top 25 or something, and so there’s a ratcheting effect that takes place. And now stock options are kind of out of favor, so restricted stock comes in. But the, the idea is to keep the pie very large for CEOs. And if I needed the money, I’d probably be doing the same thing. Charlie?

Charlie Munger [00:55:50] Well, I would rather throw a viper down my shirt front than hire a compensation consultant.

Warren Buffett [00:55:57] Tell me which kind of consultants you actually like, Charlie. He’s not going to answer that. We’ll go to number 5.

[00:56:08] Shareholder (Mo Spence, Waterloo, Nebraska): Warren and Charlie, good morning. My name is Mo Spence, from Waterloo, Nebraska. Years ago, you listed the four or five investment vehicles you considered appropriate for Berkshire, including, I believe, common stocks, long-term debt and arbitrage opportunities. In light of your comments in this year’s annual report, I was wondering if you could review that list in order of preference and specifically comment on them, including the current environment for arbitrage.

Warren Buffett [00:56:42] Yeah, well, the items you name, and you could break that down by high-grade bonds, you know, versus junk bonds, and the items you mentioned are all alternatives. You know, Charlie and I sit around and think about what’s the best thing to do with Berkshire’s money. It’s, it’s a fairly simple proposition. And we have a number of things that we feel competent to make judgments on, and we have a number of things that that we’re not competent to make judgments on. So we narrow, we hope, we hope to narrow the field to to, to investments that that we think we can understand. And there are a reasonable number of those, although there are a lot that we, that we can’t understand. Anything, I would say, today, you know, can change tomorrow.

We don’t, we don’t, we don’t think about the categories by themselves. Now, in a period like summer to mid-fall of 2002, when junk bonds became very attractive, we bought a lot of them. But we didn’t make some great decision to buy junk bonds. We just started seeing things, individual items, that started screaming at us, you know, bye, bye, bye. And then that came to an end. And so we don’t go to the office in the morning thinking, what category, how do we prioritize our categories? We, you know, we have an open mind, and whatever we see that day that overcomes, or that crosses the threshold to where we take money out of short-term cash and move into it.

It may, it could be arbitrage. It’s unlikely to be arbitrage now, because that’s a game that, to play on the scale that would have a meaningful effect of Berkshire, is hard to do. I mean, take very big deals. And it’s something we’ve done successfully in the past. We’ve made a lot of money over the years in arbitrage, and quite consistently, sometimes, in the past. But we don’t, Charlie and I do not have a checklist that we talk about every, every day or every month or every year in terms of prioritizing categories. We, we just hope, I hope he gets a good idea, he hopes I get a good idea, and when we get one, we move in a big way. But they have to be big now, and that’s, that’s a limiting factor in terms of what, what’s available for us.

As you know, if you read the annual report, you know, we, we took a significant position in currencies. We’re buying viatical settlements, in terms of the transaction I mentioned a little earlier. We’re open to anything we can understand. Charlie?

Charlie Munger [00:59:35] Yeah, you really asked us to determine an order of presidency among two or three activities we don’t have much interest in at the moment, and that’s not something we spend a lot of time at. In other words, we have all this cash because we don’t much like any of those fields at the moment, and and spending all the time thinking about orders of presidency among things you clearly are not going to do is pretty fruitless for us.

Warren Buffett [01:00:10] Yeah, I thought I had a slide here, but I don’t. But it, when we were buying junk bonds in the, in the summer to fall of 2002, we were literally buying securities, and and we limited it to the kind of junk bonds we can understand, which is far from the whole universe, but we were, we were literally buying things on a 30, 35, 40 yield-to-maturity basis. Now, we buy those with a mental attitude of buying common stocks. Interestingly enough, within 12 months, some of those same securities that were yielding 30% or 35% went to prices where they yielded only 6%. I mean, that is truly remarkable when you think about that happening in a country that was not in the throes of depression or anything.

I mean, prices do amazing things in, in securities markets, and when they do something that strikes us as amazing in our direction, you know, we, we will act. But we do not know today what we’re going to be doing tomorrow. We haven’t, we, you know, we have some things, a few things we may be doing. They’re likely, it’s likely we’re doing them tomorrow. But there’s, we don’t hold any committee meetings on this. And there’s, you know, this business where somebody says you should have 50% of your money from bonds and 35%, you know, in equities and 15, we don’t go through anything like that. I mean, we regard that as nonsense. Any further thoughts, Charlie? No further thoughts, evidently. Microphone 6.

[01:01:50] Shareholder (Tony Ardo, New Jersey): Good morning, gentlemen. My name is Tony Ardo, and I come from New Jersey. Mr. Buffett, my question is on business valuation and growth. In one of your letters, you mentioned the discounting formula, owner earnings divided by the difference between the discount and the growth rate. But if the growth rate is larger than the discount rate, and if we use this formula, then we get a negative number. And one way around this, let’s call method A, is to have two growth stages, one with a high growth and the second stage with the low growth. And the second way, method B, would be to estimate how much the earnings is on the third year for the company and then multiply this by the average price-to-earning ratio to get the price in the 10th year. I don’t know if you use the method A or method B, but if not, I would like to ask Mr. Buffett, how do you estimate how much a company is worth if the growth rate is larger than the discount rate?

Warren Buffett [01:03:08] Well, you put your finger on an interesting, a mathematical relationship, because if you’re using a present value discount formula and you put in a growth rate that is higher than the discount rate, as you have postulated, the answer, of course, will be infinity. And there are a lot of managements around who like to think their stocks are worth infinity, but we haven’t found one yet.

The, that, that precise subject was covered in a paper called “The Saint Petersburg Paradox” by a fellow named Durand, probably 30 years ago. And somewhere we probably have a copy at our office. My guess, if you go to Google and you put in the name Durand and you put in St. Petersburg, you may be able to call up that article, although they aren’t necessarily terrific on old articles. So if you, if you’d like it, we would, you’ll let somebody know what our office, we’ll, we’ll look around a little and we’ll see if we can find that.

That, it gets very dangerous to project out high growth rates, because you get into this paradox. If you say the growth rate of a company is going to be 9% between now and judgment day, and you use a 7% discount rate, it goes off, you know, you get into infinity, and that’s where people get in a lot of trouble. The, the idea of projecting out extremely high growth rates for very long periods of time has caused investors to lose, you know, very, very large sums of money.

There aren’t many companies. Just take a look at the Fortune 500. Go back 50 years, it’s, they’re commemorating that, and look at the companies there that were there and how many of, how many have really maintained rates much above 10%. It’s, it’s, it’s not an easy hurdle. And when you get up to 15%, you know, you’re, you’re in the atmosphere, in a way, a rarefied atmosphere. So that’s, there’s a real danger in projecting out high growth rates. And Charlie and I will very seldom, well, virtually never, get up into, into high digits. You can lose a lot of money doing that. You may miss an opportunity sometime, but I haven’t seen people who have been consistently successful doing that. And you do run into this paradox you mentioned. Charlie?

Charlie Munger [01:05:40] Well, you’re obviously right, when you get a mathematical result that is infinity, to back off and realize that can’t happen. And of course, what people do is they project that the growth rate will, will reduce and indeed eventually stop, and then you get more realistic numbers. What else could anyone do?

Warren Buffett [01:06:05] Okay, we’re going to microphone 7. I believe that’s over here.

[01:06:10] Shareholder (Jack O’Neal, New Brighton, Minnesota): Yes. My name is Jack O’Neal. I’m from New Brighton, Minnesota. Thank you for the opportunity to ask questions here and the opportunity to learn from you and Charlie. I had a two-part question. I’m striking the first part, which dealt with my concern over how long the country can continue with this ballooning national debt. My second, my question then is, what is your opinion of the need for specialists on the New York Stock Exchange? Thank you.

Warren Buffett [01:06:44] Charlie, you want to tackle that one?

Charlie Munger [01:06:47] Well, thank you, Warren. (Laughter) Generally speaking, I think the specialist system has worked pretty well over the years. There may have been a few troubles lately, but averaged out, it’s worked pretty well for a long time, and I’m not all that horrified that some people who stand there all day a fair amount of money.

Warren Buffett [01:07:14] Charlie actually had a specialist firm, you should know that. That’s why I turned the question over. And despite his snide remark, the, how long were you and Jack the specialists and General Motors on the Pacific Coast Stock Exchange?

Charlie Munger [01:07:34] About 13 years.

Warren Buffett [01:07:34] Yeah, yeah. You’re looking at an experienced specialist. The, let’s go to number 8.

[01:07:41] Shareholder (Neil Steinhoff, Phoenix, Arizona): Morning, gentlemen. I’m Neil Steinhoff, in Phoenix, Arizona. Thanks for the TIPS and tips. The, also thanks for the information in the newsletter, your annual letter, about the books. I particularly enjoyed “Bull!” by Maggie Mahar, I think it was. I’m concerned about the future for a number of different reasons in America: the debt, both accumulated by the government and personally; the stock buybacks, which are benefiting the top five executives, continues; the insanity of derivatives; and the overpriced market, with the P/E, which is also insane. Any comments?

Warren Buffett [01:08:28] Well, which one do you want us to comment? You only get one question.

[01:08:35] Shareholder (Neil Steinhoff, Phoenix, Arizona): Derivatives.

Warren Buffett [01:08:35] Derivatives. Well, Charlie and I have expressed ourselves on derivatives. You know, we don’t think the probability in any given year is necessarily very high that derivatives will either lead to or greatly accentuate some financial trauma, but we think it’s there. And I think it’s, it, it’s fascinating to look at something like Freddie Mac, where you had an institution that perhaps even hundreds of financial analysts were looking at, certainly many, many dozens of financial analysts were looking at. You had an oversight office. You had a creature that was created by Congress, presumably with committees that would be interested in their activities. You had on the board two of the smartest and highest-grade people that you could have in terms of fixed income markets, in Marty Leibowitz and Henry Kaufman, and you had a bunch of other very good directors too. And with an auditor present, they managed to misstate earnings by some $6 billion in a fairly short period of time.

Now, all of that wasn’t accounted for by derivatives, but, but a very large portion, a very large portion of it, $6 billion, and, you know, that is real money, even, well, in any place, and a large part of that was facilitated by activities and derivative instruments. Now, you can look at the Freddie Mac annual report for 2000, whatever it is, 2 or 2001, and you can read the footnotes, you can read the auditor’s certificate, and you can look at a bunch of high-class, very smart directors, and you can be comforted by the fact that dozens of people in Wall Street, who are paid just to follow relatively few stocks, were studying this, and that they had conference calls all of the time. And in the end, what happened? It was $6 billion. It probably could have been $12 billion if they’d wanted.

A lot of mischief can happen with derivatives. And we pointed out, Charlie and I have seen it happen, when there’s a derivative transaction, particularly a complicated one, the plain vanilla ones, probably people will not get in big trouble on, but when you have a complicated derivative transaction and the trader at investment house A is on one side and trader on investment house B is on the other side, and they record a transaction which has to be a zero-sum game between the two of them, and both record, both put on the books a profit that day. I’ve never, I’ve never seen one where they both put on a loss that day. It’s, it lends itself to mischief, and the scale is absolutely huge and getting larger all the time.

And I will tell you that I know the managements of some of the companies that have big derivative activities, and they do not have their minds around what is happening. We didn’t have our mind around what was happening at, at Gen Re Securities. We couldn’t. We tried to get our mind around it. We couldn’t, we couldn’t do it. And that was far from, you know, the most extensive or complicated derivative operation around. We had the same experience at Salomon. But whatever the figures were at Salomon, they would be a great multiple today.

And there was a Sunday in 1991 when we were preparing, we had the lawyers preparing bankruptcy papers at Salomon. And if the Treasury hadn’t reversed itself, we would have found a judge someplace in Manhattan. He probably would have been watching baseball, eating popcorn, and we would have walked up to his door and said, you know, here is a situation with Salomon. There’s these 1.2 trillion of derivative contracts that the guy on the other side thinks is good, and they’re not going to be any good, and a lot of other things, and, you know, it’s your baby.

A lot of things correlate in the securities world that people don’t expect to correlate. And there are people following similar strategies all over the world, as happened when Long-Term Capital had its problems. And the world, the financial world, operates on a hair trigger, to some extent. People want to jump the gun and, and move just ahead of the other fellow. And when you get huge amounts of transactions, which many people only vaguely understand, you are creating a, a potential huge problem that may come about because of some other exogenous event that triggers defaults on us on a huge scale, and that can be very disruptive to financial markets.

So we think they’re dangerous as used in society. We, we use them ourselves, incidentally. You know, we get them collateralized. We’ve made money off of them. But I would predict that sometime in the next 10 years, that you will have some very big problems that will either be caused by or accentuated in, in a big way by people’s activities and derivatives. Charlie?

Charlie Munger [01:13:46] Yeah, I think part of the trouble and in, you were talking about, came because people didn’t think enough about the consequences of the consequences. That’s a common error. You start trying to hedge against interest rate changes, which is a very complicated thing to do when you’ve got a mortgage portfolio where people have options to pay the mortgages off early. And then, under the accounting conventions, the hedges started making the quarterly results lumpy instead of nice and regular, the way all the institutional analysts like them. So then they use another bunch of derivatives to smooth out the returns. Well, now you’ve morphed into lying. Well, it’s complicated enough to start with, but when you add lying to the process, it’s a mad hatter’s tea party. And yet this happens with eminent directors of vast financial sophistication sitting on the board. It shows that the sophistication won’t save you. Somebody has to have the common sense to say, we’re just not going there, it’s too tough.

Warren Buffett [01:15:02] Charlie was on the audit committee at Salomon and changed it into, you know, six and seven hour meetings. I think, I think you found miss marks that were in the tens of millions of dollars on a single contract, with the place with many, you know, tens of thousands of contracts. Isn’t that correct?

Charlie Munger [01:15:20] I think it’s fair to say that it was bonkers, and that the accountant sold out.

Warren Buffett [01:15:26] It’s interesting stuff. You might, if you feel in kind of a nasty mood, you might go to the, to a shareholders meeting of some very, some company has very large positions and derivatives and grill the CEO a little bit about, about some of the more esoteric transactions that, they get, they get very, very complicated. They, they get mind-boggling in, in terms of trying to figure out the consequences. And the one thing you can be sure of is that the traitor that puts them on will, will certainly want to mark them at a profit, either immediately or within a year or two, because he gets his bonus too often based on the figures for that year, and will be gone in 20 years, because some of these are very long dated. We’ll be gone when the consequences fall to the firm. Anytime you have incentives with people who are quite smart to mismark things, you’re going to get, you’re going to get miss marks or, or, or temptations to take on risk in, in an inappropriate manner. Originally with derivatives, the argument was made that it would disperse risk, that, you know, the Coca-Cola Company faced foreign exchange risk, or the, some bank based, you know, interest rate risk, and the theory was that you would use these derivatives to spread risk around the system. And indeed there are many people that make that argument now. I would say that that may work in that manner a great percentage of the time, but the time that counts is when it’s, when the system has intensified risks and placed enormous credit risks on very, very few institutions. Believe me, the Coca-Cola Company is in a better position to accept foreign exchange or interest rate risk in a year than some derivatives dealer who has tons of positions on. And I think actually there is much more risk in the system because of derivatives than the proponents of derivatives would say has been dispersed because of the activities. Microphone 9, please.

[01:17:39] Shareholder (Robert Peyton, Chicago, Illinois): Good morning. Robert Peyton from Chicago, Illinois. Thank you very much for your countless insights about investing and life, for that matter. My question has to do with Bill Gates. You’ve gone on record stating that Bill Gates is the smartest person probably met in your life. Charlie, sorry to break it to you.

Warren Buffett [01:18:05] No, and I haven’t said that quite, but you’re close.

[01:18:10] Shareholder (Robert Peyton, Chicago, Illinois): Close. And, you, you’ve also mentioned that he can do your job, you probably could not do his.

Warren Buffett [01:18:18] That’s, that’s entirely correct.

[01:18:20] Shareholder (Robert Peyton, Chicago, Illinois): OK. So that being the case, given his aptitude, his accomplishments, his ability, his ability to keep great people together within Microsoft, would you consider having him become the future chairman of Berkshire in one of two ways? Either a merger, if a merger doesn’t make sense because it’s a technology company and you don’t understand it, so you don’t want anything to do with Microsoft, but the second being he resigned his post as chairman of Microsoft in order to keep the masterpiece that you’ve assembled together, as well as keep these very talented managers of all the Berkshire Hathaway companies together, with a leader that you so respect, of, because of his accomplishments and aptitude.

Warren Buffett [01:19:10] Did Bill put you up to this? (Laughter)

[01:19:13] Shareholder (Robert Peyton, Chicago, Illinois): He did not.

Warren Buffett [01:19:14] I know, I know that. I, he, you know, it’s not a crazy suggestion, but we’ve got a better answer. The Bill, Bill, Bill could do my job very well, and I could not do his job. But we also have at least four people within the Berkshire organization that in many respects could do my job better than I do, and probably in one or two respects they might not be as, as good at certain parts of it, but they would be terrific successors. We, we’re more blessed in that situation than we’ve ever been in the history of Berkshire. If you go back 15 years, we did not have four. And as we add businesses, it’s not inconceivable that more potential future leaders come with those businesses.

So we’re well equipped, and we would, we will, barring something terribly unusual, we will have a, a leader that succeeds me that comes from within Berkshire and has been around for a long time. One advantage of that, and this would not be necessarily a disadvantage if it were Bill, but one advantage to that is that we really like the culture of Berkshire, and having someone that is operated in that culture for a number of years, I think, is a plus. Plus, you know, we’ve seen how they, how they work, and we know their pluses and minuses, and we’re, we’re, we’re very well equipped now. And Bill, I think, to the extent that he spends less time at Microsoft, and he will probably be, you know, the Gates Foundation will, will take up perhaps more of his time. I don’t really think he is looking for my job, although he may salivate at the pay level that’s available with them. Charlie?

Charlie Munger [01:21:09] I’ve got nothing to add.

Warren Buffett [01:21:11] OK, we’ll go to number…

[01:21:14] Shareholder (Oliver Grouser, Vienna, Austria): My name is Oliver Grouser, and I’m from Vienna, Austria. I have studied economics, and I’ve read about 40 books about investing, and want to be such a successful investor as you have been, Mr. Buffett and Mr. Munger. When both of you were younger and had much less capital for investing, how many, which publications were the best to get a few excellent investment ideas, to be so successful? And how many hours per week on average did you spend with reading about companies? Thank you.

Warren Buffett [01:21:58] Well, when we were younger, we spent probably, Charlie, compared to now, spend a lot more time, I spent a fair amount more time looking at companies. But we would, we would, if we were doing it over again, we would do it over again pretty much the same way. We would look at everything in sight that we thought we could understand, and it, the world hasn’t changed in that respect. There may be some more people doing it, but there are a lot more companies to look at now. And we would, we would read everything in sight about the businesses and the industries we thought we could understand. We would look for things that, that jumped out at us as, as being very cheap in relation to the value. And we would have one enormous advantage, because we would be working with far less capital, which means the universe of potential ideas would be, would be far greater. But there’s no, there’s nothing different in my view about analyzing securities now than there was 50 years ago. Charlie?

Charlie Munger [01:23:03] Yeah, we, we read a lot, and we thought a lot. I don’t know anybody who’s wise who doesn’t read a lot. And on the other hand, that alone won’t do it. You have to have a temperament, really, which, which, which grabs the correct ideas and, and does something with those ideas. And I think most people who read a lot don’t have the necessary temperament, and they grab the ideas, or they’re simply confused by the mass of material, and of course that won’t work.

Warren Buffett [01:23:44] There’s probably something, Phil Carret used to talk about having a money mind, or, and I would call it a business mind. And, you know, there are people that are better with, you know, identical IQs, that are, that are better adapted for one than the other. And, and the temperament is all important. I mean, if, if you can’t control yourself, no matter what the intellect you bring to the pros, process, you know, you’re gonna, you’re gonna have, you’re gonna have disasters. And Charlie and I have seen one after another that it’s not a business that requires extraordinary intellect. It does require extraordinary discipline, and that shouldn’t be so difficult, but as I look around the world, sometimes it apparently is quite difficult. I mean, the whole world went a little mad a few years back in terms of investments, and, and you say to yourself, how could that happen? Don’t they learn anything from the earlier ones? But, but, you know, what we learned from history is that people don’t learn from history, and you certainly see that in financial markets all the time. Incidentally, you mentioned books. Charlie, you didn’t recommend any books this year.

Charlie Munger [01:25:04] Well, one book I really like, I couldn’t buy, because it’s published only in England, but it’ll get here in due course, and that’s called “Deep Simplicity” by John Gribbin. It’s a perfectly marvelous book, and of course that’s a great title, “Deep Simplicity.” That’s what we’re all looking for.

Warren Buffett [01:25:23] I’ve been reading “A Short History of Nearly Everything,” and it, it, it is, it’s very impressive to, you know, to read about people pondering how to figure out the weight of the earth or something in the 18th century, and you would think mines that could do that would do, do very well in financial matters. But, you know, if you remember, Isaac Newton spent a significant part of his life trying to turn lead into gold, and he might have made a good stock broker, but it didn’t do much for him financially. Charlie knows more about Isaac than I do, so…

Charlie Munger [01:26:03] And he lost an enormous chunk of his net worth in the South Sea Bubble. So he invested in an absolute crooked mania, and here was the smartest man in the world. So just IQ points alone won’t do it.

Warren Buffett [01:26:20] Microphone 11, please.

[01:26:21] Shareholder (Martin Wiegand, Bethesda, Maryland): My name is Martin Wiegand from Bethesda, Maryland. Thank you for hosting this wonderful, educational and fun weekend.

Warren Buffett [01:26:29] Well, thanks for coming, Mark.

[01:26:32] Shareholder (Martin Wiegand, Bethesda, Maryland): In this year’s annual report, you defended Berkshire’s tax payment record against criticism from certain newspaper columnists and Assistant Secretary Pamela Olson. Compared to other large corporations, particularly insurance companies, does Berkshire pay its fair share, so we can wear our Berkshire activewear with the American flag on it with pride?

Warren Buffett [01:26:55] Incidentally, Pamela Olson is here today. I don’t know whether she can stand up, but I order her an apology. She, she’s done a great job as a public servant. I, I teased her a little bit in the annual report, but she actually has worked actively, and, and at the Treasury, in cracking down on tax shelters and, and some things that Charlie and I think shouldn’t exist. So Pamela has my admiration, and, like I say, if she’s here and can stand up, we’ll, we’ll give her a hand. (Applause)

Some of the tax shelter proposals, I, I met with her yesterday, and she told me of someone, some things that I’d sort of seen myself, but some of the things that have been done in, and in some cases sponsored by the most prominent auditing firms, you know, are absolutely disgusting, and are the reason why, in my view at least, the middle class probably plays a lot more than they should be in, in terms of raising the total funds that are needed to sustain the government. Berkshire, as we noted in the report, has, as a heavy contributor to the Treasury, as I mentioned, if only 540 entities in the, in the country paid what we pay an income tax, no one else would have to pay anything. No Social Security, no nothing. We have not, I mean, we, we, we may own tax-exempt bonds, we own dividends, which receive a dividend receive credit, but we, we pay on a very, very high percentage of our income, including capital gains. We pay at the full 34% corporate rate. So go out and buy the Fruit of the Loom underwear with the flag on it. You’re entitled to wear it. Charlie?

Charlie Munger [01:28:58] I’ve got nothing to add, but you understate the evil that crept into our leading accounts, accounting firms, when they started selling these fraudulent tax shelters in exchange for contingent fees. One of them actually explained to me that they were an ethical seller of fraudulent tax shelters. He said, he said, “The other firms just sold these to anybody, and we just sold them to our 20 most important clients, so they were more likely to stay secret.”

Warren Buffett [01:29:28] Yeah, and of course the, the, the lawyers would write the opinion, so that if they did get caught with these things that they hoped that no one even picked up, because they were so obscure, convoluted, the lawyers wrote the opinion so that, that the, they could walk, you know, when the IRS came around, they could wave that letter and, and say, “Well, gee, we’re sorry, we made a mistake, but we did it on the vice council, and therefore you shouldn’t assess fraud penalties or anything.” I mean, we don’t want to leave the lawyers out of this, surely. The, we, we had people come to our office, not, not our, not, not the auditing firm that we use, I want to make that clear, but we had people come to our office from the top auditing firms with these propositions, which they said we had to sign away a given percentage of the amount we saved, and then they would give us these, these proprietary methods were, you know, which would usually involve about 20 offshore trusts and partnerships around the world and all kinds of things, many of, part of the design being to have so many entities involved so that the numbers that popped up here, there on the return, that no, no agent could know, could figure out what the totality of the transaction was, you know. And then it’s those, the people that don’t pay taxes because of that increase the taxes of the people in this room. So we, I applaud Pamela for her efforts on that, and a lot more are needed. We will go to number 12, please.

[01:31:02] Shareholder (Joanne Fortenberg, Germany): Morning. My name is Joanne Fortenberg from Germany. Mr. Munger, you said in a speech that scientific reality is often only revealed by, by math, as if math is the language of God. Could you elaborate on that, and especially tell us the reason why math often reflects reality? Thank you.

Charlie Munger [01:31:25] It’s just the way it is. Yeah, if you, it’s as though God made the world so that only people fluent in math could understand it. I think you can handle ordinary human activity pretty well, but if you want to understand, say, science, you can’t do it without math. That’s just the way it is. And in business, if you’re innumerate, you’re going to be a klutz.

Warren Buffett [01:31:59] Keep talking, I’m chewing. We’ll go back… Go ahead. The good thing about business is you don’t have to know any high math. It may be a disadvantage, don’t know, high math?

Charlie Munger [01:32:15] Yes, I think it is, because you, you look for opportunities to use this marvelous, complicated tool, and, and by and large that doesn’t work nearly as well as just using the simple math.

Warren Buffett [01:32:31] When my mother sang me songs about compound interest, there really wasn’t any need to go further. Let’s go back to number 1.

[01:32:41] Shareholder (David Farlow, Minneapolis, Minnesota): My name is David Farlow from Minnesota, Minneapolis. Thank you, Warren, Charlie. A few minutes ago you mentioned the importance of learning from history. What have you learned from the investments you did not make over the last few years that you now regret refraining from?

Warren Buffett [01:33:02] Well, the mistakes we made, and we made them, some of them big time, are of two kinds. One is when we didn’t invest at all in something that we understood that was cheap, maybe because we weren’t even working hard enough at looking at the whole list, or because for one reason or other we just didn’t, we didn’t take action. And the second was starting in on something that could have been, been a very large investment, and, and, and not maximizing it. Charlie is a huge believer in, in the idea that you don’t sit around sucking your thumb when you can, when something comes along that should be done, that you, you pour into it. And, and that’s generally what we’ve tried to do. But, but there have been times, and it’s usually happened when I started buying something at X and it went up to X plus an eighth or some intolerable amount like that, and I, I quit or waited for it to come back. And we missed in some cases billions of dollars of profit because of the fact that I’d gotten anchored, in effect, to some initial price, when I could have paid more subsequently, and it really was inconsequential.

Charlie Munger [01:34:18] Do you have anything worse to confess than Walmart?

Warren Buffett [01:34:21] A Walmart. I caught, I cost us about, I probably, it’s up to $10 billion now. I cost us about $10 billion. I set out to buy 100 million shares of Walmart, pre-split, at about 23, and Charlie said it didn’t sound like the worst idea ever came up with, which is, from him, I was just ungodly praise. And, and then, you know, we bought a little, and then it moved up a little bit, and I thought, well, you know, maybe it’ll come back, or what, who knows what I thought. I mean, you know, only my psychiatrist could tell me. And that thumb-sucking reluctance to pay a little more, the current cost is, is, is in the area of, of, of 10, of $10 billion. And there have been other examples too, and there will probably be more examples in the future, unfortunately. But that is, that’s, on the other hand, it doesn’t bother us. I mean, you know, it’s, it’s maybe instructional to talk about it just a little, and I’m glad to respond to the question, but in the end we’re going to make a lot of mistakes at Berkshire. And we’ve made them in the past, we’ll make them in the future. You know, it, if every shot you hit in golf was a hole in one, it wouldn’t be, my, you know, the game would soon lose interest. So you have to hit a few in the woods occasionally just to make it, make it a little more interesting. And we’ll try not to do that too often, but those will be the kind of mistakes we make. We probably won’t make the kind of mistakes, although we have, we made one with Dexter Shoe, but we, we probably won’t make the kind that where they cost us a ton of money, that they’ll be much more of omission than commission, I think you’ll find, in the future. Charlie?

Charlie Munger [01:36:12] Won’t add any more. Yeah, at least we are constantly thinking about the past occasions when we blew opportunities. Since those don’t hit financial reports, the opportunities you had but didn’t accept, most people don’t bother thinking about them very much. At least that is a mistake we don’t make. We rub our own noses in our mistakes in blowing opportunities, as we just did.

Warren Buffett [01:36:39] OK, number 2.

[01:36:39] Shareholder (Peter Brochi, Beverly, Massachusetts): Warren and Charlie, my name is Peter Brochi from Beverly, Massachusetts, and I would like to thank you both for helping me become a better businessman and a better investor. Perhaps more importantly, you have created, by example, a kind of true north on the moral compass for me to steer by. While the education has been fantastic, I have found that the demands of owning a successful business and having a large family do not leave time to apply the research stands I have become so wonderfully accustomed to by being a member of this cult. Please imagine for a moment that you are 30 years younger and have only a few holes left in your investment punch card. If you were in my situation, to the extent that you would diversify your holdings beyond Berkshire Hathaway, given this environment, how would you choose the investment managers? Or, as Charlie has just discussed when addressing foundations, would you hunt for two more great companies to invest in via common stocks?

Warren Buffett [01:37:45] Charlie, why don’t you take a swing of that?

Charlie Munger [01:37:48] Well, of course you’re hunting. That’s part of the fun of life. And, but I would say that the chief lesson would be that you’re unlikely to find very many in a whole lifetime, and when you find one in which you really have thought it out and have confidence, for God’s sakes, don’t do it in a niggardly fashion. The idea that very smart people with investment skills should have hugely diversified portfolios is madness. It’s a very conventional madness, and it’s taught in all the business schools, but they’re wrong. (Applause)

Warren Buffett [01:38:27] The question of finding other advisors was a tough one. I mean, when I wound up my partnership in 19…, to the end of 1969, and I had all these partners that had counted on me, and I was going to mail them back a lot of money, and I felt an obligation to at least suggest some alternatives for them. And I, I recommended two people who I knew were exceptionally good and exceptionally honest. We put one of them on the board not long ago and reaffirmed it today, Sandy Gottesman. The other one was Bill Ruane. Now, I’d been around the investment world for a long time at that point, and those were the two I knew. But they were more or less contemporaries of mine, and I’d gotten to know him over the years, and I’d seen him for a long time, so I not only knew their results, but I knew how they’d accomplish their results, which is terribly important. I don’t know that generation of managers now. But the fact that with the number of people I knew, that I could only come up with two at a time when I was very active, says something about the difficulties of, of finding managers.

The one thing I can almost guarantee to you is that the promotional types going around to solicit the institutional investors are very unlikely to meet any long-term tests of, of ability and sometimes integrity. It’s not an easy job, spotting an investor. I think it’s probably easier, depending on the amount of time, you know, you mention having children in the business, the amount of time you can spend on, every now and then you do, if you, if you’re, if you’re conscious of the investment world and you have some kind of sort of grounding knowledge about what’s going on, you can see something, you know, as we did in junk bonds a couple of years ago, or as we did with all kinds of things some years back when stocks were cheaper. You will occasionally see something that, that you should load up on, and, and Charlie says that’s what you really have to do.

I mean, some of the people in this room loaded up on Berkshire many years ago, and the truth was they didn’t need diversification. You know, I loaded up on it, and that, Charlie did. And you’ll see opportunities occasionally, but you’re not going to see them every day or every week. If you, if you think you’re going to see an opportunity every week, you’re going to lose a lot of money, because people will come around and tell you that they’ve got them, and they may not be quite as flagrant as that fellow we had in the movie, but they’re a version of them. Charlie?

Charlie Munger [01:41:23] The business of selecting investment managers was recently shown to be even harder than, than I had previously thought it was. A significant fraction of the institutional investment managers who run the nation’s mutual funds actually accepted propositions to take bribes for betraying their own shareholders. It was as if a man came to you and said, “I have a wonderful proposition. Why don’t I kill your mother and will split the insurance money?” And it was that ridiculous, and yet a significant number of the people said, “Gee, I would like some insurance money,” and they just went right ahead. And they were already rich beforehand.

Warren Buffett [01:42:09] Yes, they, the absol… And they’ve destroyed themselves, many of them, by making this insane decision. And, and I think many of them are probably, think the outcome is unjust, and, I mean, the, the downfall they’ve had. And the interesting thing about it, of course, is that here is a huge industry that, where the people who weren’t doing it have a great interest in having that reputation of the industry not get stained, and a number of them had to know what was going on. I mean, this would, I don’t, I, I, it’s hard for me to imagine that people at most large mutual funds, even the ones that didn’t, their mutual fund management companies, even the ones that weren’t engaging in the activities mentioned, weren’t aware of it. I mean, you just, if you’re in an industry like that, you’re going to hear what’s going on. And the Investment Company Institute was busy patting itself on the back, you know, one meeting after another, and, and, and becoming very cozy with legislators, and it wasn’t one thing done until a whistleblower went to Eliot Spitzer, and, and he got active in a very strong way with a very limited staff, and he uncovered and put on the front pages what was taking place. But the industry itself, with hundreds and hundreds and hundreds of people that must have known what was going on, and it went on for a long time, never said a word. It’s, it’s, you know, it makes you wonder a little bit. Number 3.

[01:43:52] Shareholder (Bob Klein, Los Angeles): I’m Bob Klein from Los Angeles. You’ve touched on the issue of asset allocation, capital allocation, in response to previous questions, but I wonder if you could elaborate from a risk management perspective. Wall Street and financial planning firms charge a lot of money for their asset allocation models, say 50% stocks, 40% bonds, etcetera. I know you take a more opportunistic approach to building your portfolio and managing risk, as you mentioned by, as you illustrated by your junk bond example. And so I, I just want you to hammer out how you use price and value as a tool of risk management and asset allocation, as opposed to coming at it with a preconceived idea of how much should be allocated to each asset class.

Warren Buffett [01:44:50] Yeah, we think the best way to minimize risk is to think. The, and the idea that you have, you know, you say, “I’ve got 60% in stocks and 40 in bonds,” and, and then have a big announcement, “Now we’re moving it to 65-35,” as some strategists, or whatever they call them, in Wall Street. I mean, that has to be pure nonsense. I mean, it, 60-40 or 65-30, it just doesn’t make any sense. What you ought to do is have your default position as always short-term instruments, and whatever you see anything intelligent to do, you should do it, and you shouldn’t be trying to, to match up with some, some goal like that.

I, I found it entertaining, I was just reading yesterday in an article, I think it was the, about the two fellows at Google, and, and all of the problems they’re going to have because they’re each going to get a few billion dollars. And, I mean, it was, it was, I mean, I wanted to send a sympathy card. I almost went down a Hallmark store, because this article went on, they’ve got this, this terrible problem and that terrible problem, and they’re going to need lawyers, and they’re going to need financial aid. They don’t need anybody. Those guys are smarter than the people that are coming to them, and they do not have a big problem, and, and they’re very capable of thinking it through themselves. The people that have the problem are the people who want to sell their services to them and are going to have to convince them that they have a problem.

But so much of what you see when you talk about asset allocations, it’s just merchandising. It’s a way to make you think that if you don’t know how to determine whether it should be 60-40 or 65-35, that you need these people, and you don’t need them at all. In investing, I mean, most of the professionals that, that tell you you’re going to get in great trouble unless you listen to them and, and adopt and, and sign up for their services, you know, they’re good at selling. But some of my brother-in-law, former brother-in-law, that worked at the, um, stockyards used to say was that people would bring in cattle or something, and I’d say to them, “You know, how do you get, how do you get the farmer to employ you to sell the Swift or Armour or Cudahy instead of the guy right next to you? I mean, you know, it’s a cow, as a cow, and Armour’s gonna buy it the same way.” And he gave me this disgusted look, and he said, “Warren, it’s not how you sell them, it’s how you tell them.” Well, there’s a lot of that in Wall Street. Charlie?

Charlie Munger [01:47:20] Yeah, people have always had this craving to know the future. You know, the king used to hire the magician or the forecaster, and he’d look in sheep guts or something for an answer as to how to handle the next war. And so there’s always been a market for people who reported to know the future based on their expertise, and there’s a lot of that still going on. It’s just as crazy as when the king was hiring the forecaster who looked at the sheep guts. And people have an economic incentive to sell some nostrum, it can be sold over and over and over again. The really interesting figures are when you combine the under performance of the market, say, by the mutual fund industry, which is probably a couple of points per annum, that, that understates it. Now if you take all of the investors in the mutual funds who are constantly whip-sawing from one fund to another by a bunch of brokers who want commissions, now you take a sub-normal performance and it goes down another three or four percentage points due to the shuffling of the mutual fund investment. So the poor guy in the general public is getting a terrible result from, from, from contacting the experts. And these guys are heading the scout troop and the Community Chest drive and are locally reputable people. I think it’s disgusting. It’s much better to make a living by, by being part of a system that delivers value to the people who are, who are buying the product. But nobody, nobody refrains from creating gambling casinos or something, on my theory, if it’ll work to make money away. We tend to do it in this country.

Warren Buffett [01:49:17] Microphone 4.

[01:49:18] Shareholder (Stephen West, Morganton, North Carolina): Good morning, Mr. Buffett and Mr. Munger. My name is Stephen West, and I’m a framed art manufacturer in Morganton, North Carolina. I feel especially tied to Berkshire Hathaway, as I am both a vendor to Nebraska Furniture Mart, Star Furniture and R.C. Willey, and also a customer of Larson-Juhl. My question relates to workers compensation fraud being committed by workers compensation carriers on manufacturers such as myself, a scandal which I believe is far greater than the scandals have been mentioned heretofore at this meeting.

As an example, in 1998, when I was trying to figure out why my experience mods were going way out of whack, I received a loss run, and I believe mistakenly also a check run, from my insurance carrier. It was shocking. Four losses for $152,000 they claimed to the State of North Carolina actually amounted to less than $6,000. And one claim which they claimed they spent $70,072 on, they actually only spent $86.88. Now naturally this through my company into the high risk pool. It’s cost me hundreds of thousands of dollars. And my question is, are they trying to pull the same stunt on Berkshire Hathaway companies, especially in labor-intensive operations such as Dairy Queen? Because I have not in the intervening years been able to get one single copy of a negotiated check out of these insurance companies. They will not give it up, even under subpoena, and their behavior is entirely consistent with criminal fraud. Now my question relating to the Berkshire Hathaway problems, or companies, is, are your managers attuned to this, and are they receiving the actual copies of the negotiated, negotiated checks that the insurance companies claim that they are spending to settle workers compensation injury cases? Thank you.

Warren Buffett [01:52:39] Well, I would say that there’s plenty of fraud in various aspects of insurance, in auto insurance, for example. I mean, obviously we have fraud units. But I know you’re directing your question more to the insurance carriers than actually what takes place with policyholders and, and doctors and, and lawyers and various other parties. But we find that for every dollar we spend on fraud prevention, we, or detection, I think we get back well over $10. In the comp field, workers comp, you know, mike’s, you know, we have lost more money in workers compensation insurance, I would guess, maybe wrong on this, but I would, I would guess, than, than just about any line, not necessarily as a percentage of premiums, but in terms of aggregate dollars. It’s been a, it’s been a very tough period. So from the standpoint of a, we have one small workers compensation direct operation in California called Cypress, and then Gen Re had written a lot of workers comp reinsurance, and it’s been a bit of a bloodbath. The rates have not covered the losses, and I would say that there’s a fair amount of fraud that enters into the losses we’ve experienced, or at least the, the industries experienced, particularly at the direct level. But in terms of here, the dispute with an insurance company, I don’t know what, what company that would be. But, but I would say that most, many companies have been in the workers compensation business, particularly in California in recent years, wish they hadn’t been in the business. I mean, they have not been making a lot of money off of, off of defrauding policyholders, that I know about. But Charlie, do you have anything to say on them?

Charlie Munger [01:54:48] Well, they’ve, the experience may be related. If a fraud practiced on it by lawyers, doctors and claimants, and its own affairs are disrupted by fear and agony, that company is likely to start behaving badly with its own policyholders, in order to lay the troubles off on somebody. I think that’s just human nature. And, but I don’t think the main fraud in workman’s comp is by the carriers against the small businessmen. It’s by the claimants, the attorneys and the doctors against the whole system.

Warren Buffett [01:55:29] Now that, that really would be our experience. I was a sideline, I noticed you were from Morganton, North Carolina. We had a, we have a business there, Carolina Shoe. We made work boots. And I gave a talk at the University of North Carolina some time ago. In fact, that, I think they have a tape of it still. And afterwards, I mentioned in the talk that we had a, we had this business in Morganton, and one of the students came up to me afterwards, and there were, there were a number of them, and I shook his hand, and making idle conversation, I said, “Where are you from?” And he said, “I’m from Morganton.” And I said, “Oh,” I said, “do you know Carolina’s Shoe?” And he thought of saying, he said, “I don’t know her, but I think I know her family.” (Laughter) Never forgotten that fellow. Number 5.

[01:56:27] Shareholder (Andrew Soule, New York City): Good morning. Andrew Soule from New York City. I just want to preface my question by saying that I have a deep admiration and affection for both you men, and in that spirit, I had got a golden retriever puppy a few months ago, and he’s been proudly named Munger, is the house. Charlie, you’d be very proud. He’s just like you. I bring him to Central Park, and hundreds of women flock over to pet him.

Warren Buffett [01:56:59] He’s well named. He’s well named.

[01:57:01] Shareholder (Andrew Soule, New York City): But in my serious, that’s serious, but this is also serious. My question has to do with the Public Utility Holdings Company Act, which obviously affects MidAmerican’s businesses. You’ve spoken that if it were repealed, you’d be able to commit billions of dollars into the energy infrastructure for the country. And despite the fact that there was a massive blackout in this country over the last summer, the act has not been repealed. And I’m curious as to what effect it might have if PUHCA wasn’t repealed for MidAmerican.

Warren Buffett [01:57:42] The Public Utility Holding Company Act was passed in 1935. It was a reaction, and a justified reaction, to some real wild antics that had taken place in the ’20s in, in the public util, utility field, that were most dramatic in the case of Sam Insull, but, but occurred with a lot of other companies, Associated Gas and Electric and various other companies. And there was pyramiding of utility capital structure. There were a lot of things that, that were wrong that were addressed in that act. And in our view, that, that act is long outmoded. And I think that, I mean, the SEC, which has responsibility for administering it, I, I think there’s a lot of feeling there that it’s, that is long been unneeded. And I think there have been various energy bills that have been, included the repeal of it, but there was no energy bill passed last, in the last year. And so we live with the Public Utility Holding Company Act, and it does restrict what we do.

It’s an interesting question, though, if it were repealed, whether that necessarily would open up lots of opportunities, because if it were repealed, it’s quite conceivable that a number of other companies would also be competing with us in terms of possibly buying utilities that might have been difficult to, for us to acquire or for them to acquire back when the law was in existence. So I don’t want you to think that if it gets repealed that Berkshire Hathaway is necessarily worth a lot more money. But I do think it should be re…, I mean, I think it’s logical. It’s, it’s, it’s, there are lots of, there’s plenty of appropriate regulation in the public utility field, and there are advantages to having strong companies like, bob, like Berkshire Hathaway, pouring money, it, energy requires enormous sums of money, and, and to extend we can use capital advantageously in that business, we’re ready to do it, and it should not be impeded. If I had to bet, that act will probably go off the books at some time, but it doesn’t seem to be, you know, in the immediate future. It will not necessarily mean we get a lot richer. Charlie?

Charlie Munger [02:00:07] Yeah, but if we had a wonderful opportunity in the field now, we would find a way to do it, probably through MidAmerican, right?

Warren Buffett [02:00:15] Well, we’d find a way to do it. Yeah, if there’s been nothing that’s been presented to us that we couldn’t get done so far. Now it might involve a more awkward structure, but we have not, you know, there’s been, there’s been nothing that, that we wish we could have done, and when we got to the finish line, or yard from the finish line, we said, “Well, we can’t do this because of the Public Utility Holding Company Act.” So now there might have been other things presented if that act hadn’t been on the books, but it will, it will be no bonanza for us at all if it goes away. It, it may make life simpler on some very large transaction. Number 7. I’m sorry, number 6. I skipped 6. Number 6.

[02:01:07] Shareholder (Andy Lewis Charles, Miami): All right. Good morning. My name is Andy Lewis Charles from Miami. I think I speak for everyone, and I wish both you gentlemen continued health. I would wish you continued wealth, but I think you have that covered.

Warren Buffett [02:01:22] We could use more.

[02:01:24] Shareholder (Andy Lewis Charles, Miami): A beach. Speaking of MidAmerican Energy, a unit company underneath it, HomeServices, I see as a great opportunity. I would love to see and hear your thoughts about the future growth potential for it, especially against large consolidators like Cendant Corporation. Thank you.

Warren Buffett [02:01:47] HomeServices will grow. HomeServices, as you know, owns a number, I can’t recall how many, but probably in the area of 15 or 16, maybe, controls a number of local real estate firms, and they retain all of their local identity. In that way it’s somewhat akin to the whole Berkshire Hathaway model, where, where we, we, we leave our subsidiary companies quite autonomous, and they operate as if they were, as the managers operate as if they own them themselves. Well, HomeServices is somewhat along the same line, and that we have no national identity, where Cendant works under a couple of big names. We’ve acquired one company in, in North Carolina here in the last month or six weeks, Prudential of North Carolina, and we will, we will end up, there’s unquestionably in my view, we’ll end up buying either a few or a whole lot of additional companies over the next 10 years. We will, we’ve got great management, we like the business, we hear about opportunities from time to time.

Last year, you know, we participated in roughly $50 billion of transactions, and I think, I’m really vague on this one, but I, I, I better not give you a percentage of the national total that is, but it’s a very small percentage. It’s a lot of, it’s a lot of transactions, a couple hundred thousand transactions. We’re very big in Southern California, for example. We’re very big in Minnesota. We’re very big in Iowa. Very big right here in Omaha and Lincoln. But there’s an awful lot of places where we aren’t at all. We like to buy leading firms as we go around, and we sometimes like to buy more than one, and more than one in a community. It’s a good business. It’s a very cyclical business. Right now it’s very good. We will go through periods in the next five years, I’m sure we’ll go through a period where it’s very slow, but we’ll, but we’ll keep buying. We’ll buy when business is slow, we’ll buy when business is good, depending on the price of the institution and the kind of business we’re buying.

I don’t know how, how big it can become. It will become bigger than it is now. Relative to Berkshire’s total market value, it may not be that, a huge factor, but it’s conceivable, as we buy more operations, we’ll find other things to do with them too. I mean, that the purchase of a home is a big deal to people. You know, often they’re buying furniture at the same time, and maybe we can make a suggestion or two. Charlie?

Charlie Munger [02:04:29] I’ve got nothing to add about that business.

Warren Buffett [02:04:31] Number 7.

[02:04:32] Shareholder (Jim Hayes, Alexandria, Virginia): Good morning. I’m Jim Hayes from Alexandria, Virginia. Um, I hate to, he, beat a dead horse, but I really like the charitable plan. Suppose you brought it back and then personally opted out, and then we voted you a bonus equal to what you might otherwise be. Would you consider that?

Warren Buffett [02:04:57] Are you done like renewing the shareholder designated contribution program?

[02:05:01] Shareholder (Jim Hayes, Alexandria, Virginia): Yeah. Yes, and then personally opting out, and then we could have a shareholders vote to grant you an option bonus or some kind of tax advantage bonus.

Warren Buffett [02:05:15] I think that might get a little complicated. And additionally, I wasn’t the only one giving money at all, nor was Charlie, to organizations, primarily pro-choice organization. In fact, over, I don’t know of any other than pro-choice organizations that, that the people that were causing harm to the Pampered Chef representatives. We had dozens and dozens, maybe even hundreds, giving money on, on both sides of the issue. Um, I mean, if you looked at one class, well, the largest classification of gifts went to churches. Probably the largest classification with in that one positive were Catholic churches. And, and we had people giving money to everything in the world, which is exactly the way we wanted it. I mean, whatever, it’s the shareholders money. So even if you had the two of us opt out, we would have organizations, and that, that would get violent about the fact that some money was going to pro-choice organizations. And rather than take it out on us, whom they can’t hurt, they’ve taken out on some very innocent people. And neither Charlie nor I like the idea of somebody, you know, some, some woman that’s developed a living, you know, in, in Dubuque, Iowa, and Casper, Wyoming, having her livelihood destroyed because of what we’re doing.

So reluctantly we gave up the practice. I mean, we actually, I received a letter one time from somebody, some organization was monitoring, said they, they didn’t give, they didn’t care if we were giving $10 million to pro-life organizations and $1 to pro-choice organizations, they were still going to boycott our people. Well, boycotts don’t bother me. We, we had some of that right along, always on a small scale, but because they can’t, they basically can’t, they can’t hurt us in any significant way. But they can hurt individuals very badly, and we’re not going to have something around Berkshire that’s hurting a bunch of people that have devoted their lives to working with us. And so we reluctantly gave it up. Charlie?

Charlie Munger [02:07:32] Well, as I said, it’s a dead horse, and I miss it too.

Warren Buffett [02:07:37] Number 8, please.

[02:07:38] Shareholder (Jay Lieber, Houston, Texas): Good morning. I’m Jay Lieber from Houston, Texas. Mr. Buffett, since I’m older than you, and maybe even as old or older than Charlie, I feel like I can ask this question, and I’ll ask it as delicately as possible. When the time comes that you, I and Charlie have gone to that big stock market in the sky, I, I understand that you planned, or at least I have read that you plan, to give the bulk of your Berkshire Hathaway stock to your charitable foundation, along with your 30% of the votes of the company. If this is correct, and if it’s not correct this question is moot, but if so, what assurance do the Berkshire Hathaway shareholders have that the company will continue to be run as honestly and straightforward as is, is now, such as only 15.8 employees or so at headquarters, and no huge salaries are, our other ridiculous giveaways to dilute and weaken the equity of the shareholders at that time?

Warren Buffett [02:08:58] Well, for a short while that’ll only be 14.8, actually. But it’s a good question, and a very good question since you’re older than I. Apparently, I hope we don’t go at the same time. The, there’s one slight twist to the, the estate plans we have. If I die first, all of my Berkshire goes to my wife, and if we died simultaneously, it would all go to the foundation. But all the stock will end up in the foundation. In fact, if I died first, she might put my stock in the foundation before her death, but that would be up to her. But it will end up in the foundation, all of the stock. As you mentioned, it has 30-odd percent of the votes, although under the tax law, once it’s in the foundation, within five, convert to B some of it, or it would have to get down to 20% of the vote, that’s required under foundation law.

In terms of how it would be run in the future, I think it has a far better chance than any company, any major company I know in the country, of maintaining the culture, because it, it has, it will have people running it who have grown up in the culture. Earlier it was, the criticism was made about my wife and, and my son being on the board, but they are guardians of the culture. They’re not there to profit themselves. They’re there to profit is the other shareholders profit, but also to keep the company in the same way as previously. One great example of that, of course, has been at Walmart, where when Sam Walton died, a not too dissimilar amount of stock was left among the family, and essentially the Walton family has, in my opinion, done a magnificent job, not only of selecting successors to run the place, but having successors who, if anything, reinforce the culture of Walmart. And it’s been an enormously successful arrangement. The, the Waltons are there in case anything goes wrong, to make a change if needed, but they’re not there to run the business. And that’s exactly the pattern that we hope to have at Berkshire, and I think we, we have it. I think, I, you know, I can’t give you a 100% guarantee, but I would far rather bet on the integrity of the family that succeeds me, plus the managers that succeed me at Berkshire, remaining true, than I would any other company, and for a long, long time, any other company I can think of. Charlie?

Charlie Munger [02:11:45] Well, I would have a reason to fret about this subject just as you would. And I, of course, have known the members of the Buffett family that would be here after Warren has gone for decades. Don’t worry about it.

Warren Buffett [02:12:02] You should be so lucky. That’s a question we don’t wish to have an instant answer for. Number 9, please.

[02:12:12] Shareholder (James Eastern, Durham, North Carolina): Good morning. James Eastern from Durham, North Carolina. My question, my statement is, you have often written in reference to aggregate corporate profitability remaining fairly consistent in the long run, such that return on equities are in the 12% range for U.S. companies, and after-tax profits as a percentage of GDP is sticky in the 4% to 6.5% range. And the question is, given the advances in technology that brought the inventory-to-sales ratios down to historic lows, given the widespread adoption of the EVA principles by companies, might you think that might change over time?

Warren Buffett [02:12:56] Yeah, I don’t think any of the factors that you mentioned will act to, to move corporate profitability out of the, out of the range that has historically existed. It’s going to bob around, obviously, some. But I certainly don’t think EVA will, will do a thing for American corporations in terms of making them receive a greater share of GDP in profits. Technology, know that, that’s just as likely to reduce profits as to, as to increase profits. I mean, as the economic machine of the United States works better and better over time, um, the main beneficiaries are going to be consumers. If you took whoever you think is the best business manager in the United States, and you put a clone of that person in charge of each one of the Fortune 500, the profits of the Fortune 500 would not necessarily go up, because there’s, there’s this competitive nature to capitalism, where the improvement you get one day, your competitor gets the next day, and it very much tends to, to work to the benefit of consumers, but not to increase overall profitability.

We see that in the industries we’re in, every, we were in the textile business for a long time, and, and various new products and various new machinery would come along, and it would promise to deliver a 40% internal rate of return and get rid of 43 employees or something like that. And, you know, we just did one after another of those, and when we got all through, we didn’t make any money, because the other guy was doing the same thing. And I liken to, you know, to everybody to pray, you know, a huge crowd watching it, and somebody stands up on tiptoes, and, you know, everybody on the crowd is up on tiptoes, and they’re not seeing any better, and their legs hurt. Well, that was the textile business. And there’s an awful lot of self-neutralizing things in, in, in capitalism. So I don’t really expect any of the factors you named, or any other factors that I can think of, that will move profits up as a percentage of, of GDP. And, and indeed, I think that if you’re looking at GDP as being the national pie, and profits being what investors get out of it, and, and the rest belonging to people who are out there working for a living every day, I don’t think, I don’t think the, the relative, the proportions are, are inappropriate. Charlie?

Charlie Munger [02:15:42] I’ve got nothing to add to them.

Warren Buffett [02:15:45] Number 10.

[02:15:46] Shareholder (Mark Rabanov, Melbourne, Australia): Good morning. I’m Mark Rabanov from Melbourne, Australia. Mr. Buffett and Mr. Munger, I’d like to ask you, when you assess a business and derive its intrinsic value, how do you estimate the future growth of the business, and how do you decide what margin of safety to use? Thank you.

Warren Buffett [02:16:11] The future growth and what joy? Well, I have difficulty understanding that question fully.

Charlie Munger [02:16:19] He’s talking about how do we combine our estimates of future growth with our passion for having a margin of safety. Surely you can handle that.

Warren Buffett [02:16:31] Well, I certainly handle as well as you can. Every time he laterals him off to me, you know, he calls those audibles. The, you calculate, I think you take all of the variables and calculate them reasonably conservatively, but you don’t try and put too much windage in at every level, and then when you get all through, you apply the margin of safety. So I, I would say don’t focus too much on taking it on each variable in terms of the discount rate and the growth rate and so on, but try to be as realistic as you can on those numbers, but with any heirs being on the conservative side, and then when you get all through, you apply the margin of safety. Ben Graham had a very simple formula he used for just the most obvious situations, which was to take working capital, that working capital, and try and buy it at a third off working capital, and overall that worked for him. But that, that method sort of ran out of steam when the sub-working-capital stocks disappeared.

But it’s the same thing we do in insurance. I mean, if we’re trying to figure out what we should charge for, we’ll just say, the chances of a 6.0 earthquake in California. Well, we know that in the last century, I think, if there have been 26 or so 6.0 or greater quakes in California, and let’s forget about whether they occur in remote areas. Let’s just say we were writing a policy to paid off on a 6.0 or greater quake in California, regardless of whether it occurred in the desert and did no damage or any. Well, we would look at the history, and we’d say, well, there have been 26 in the last century, and, and we would probably assume a little higher number in the next century. That’d just be our nature. But we wouldn’t assume 50. If we did, we wouldn’t run any business. So we would, we might assume a little higher. I would, if I was pricing it myself, I’d probably say, well, I’ll assume they’re going to be 30, or maybe 32, or something like that. Then when I get all through, I’ll want to price the, I want to put a premium on it that now puts in a margin of safety. And I was at the, if I figured the proper rate for 32 is $1 million, I would probably want to charge something more than $1 million to build in that margin of safety. But I don’t want to, I don’t want to hit it. I want to be conservative at all the levels, and then I want to have that significant margin of safety at the end. And I guess that, as I understand the question, that’s, that’d be my answer. Charlie, you want to add to that?

Charlie Munger [02:19:14] Yeah, that book “Deep Simplicity” that I recommended to you says that you can predict, out of those 26 earthquakes, how the size will be likely to be allocated. In other words, there’s a standard power law that will tell you the likelihood of, of earthquakes of varying sizes, and of course the big earthquakes are way less likely than the small ones. So you count the math, and you know the applicable power law, and you guess as to how much damage is gonna…

Warren Buffett [02:19:51] It’s not that difficult. If somebody says they really want to protect, to get against a 9.0 or something like that, and then, you know, is it one, is it one in 300 years, is it one in 1,000 years, you know, well, you get really off the data points. But that is not what you’re looking at in investments. You don’t want to look at the things that are, that, you don’t want to come up with companies where you make the assumptions that they get that extreme, and you don’t have to. That’s the beauty about investments. You only have to look at the ones that you feel capable of evaluating, and you skip all the rest. Number 11.

[02:20:37] Shareholder (James Tarkenton, Durham, North Carolina): Good afternoon. James Tarkenton of Durham, North Carolina. Current examples, including discussion of media ownership rules, FCC regulation of the telecom industry, and proposed oversight changes for mortgage giants Fannie Mae and Freddie Mac, are all examples of the legislative, regulatory and lobbying process as an influence in shaping and reshaping economic moats. We would be interested in your comments on those, these and other examples of how competitive advantages are shaped by government in general. How do you incorporate the impact of regulation on the size and voracity of economic, economic moats for various businesses?

Warren Buffett [02:21:21] Well, that varies enormously by the business. I mean, there’s some businesses that we think that it’s not a very big factor, and there’s other businesses, we’re in the energy business, the insurance business, where regulatory change could have a, have a huge impact. And, you know, we, we don’t have any one-size-fits-all type arrangement. That we just try to think intelligently about any business we’re in, and it, if it’s, when we bought GEICO in 1995, or about that, last half of it, or whichever year it was, the question, you know, whether the regulatory climate would change in some major way, you nationalize auto insurance. Well, all of those things go through our mind, and we evaluate them. But there is no, there is no formula, you know, for, if we’re, for furniture retailing, you know, that, that is not something we’re going to worry about. We’re going to worry about plenty of things in terms of competition. But there are different variables that apply with different intensity to each business we’re in, and it’s up to Charlie and me to try and think about any of the variables that might, that might hit those businesses, and to weigh them appropriately, and crank that into our evaluation. Charlie?

Charlie Munger [02:22:45] I think it would be fair to say that in our early days we tended to overestimate the difficulties from regulation. We refrained from buying television station stocks for a long, long time, because it seemed like such a peculiar asset, when anybody could just ask to have your license jerked away from you each year, and they could ask a government agency to do it. And, and, but it turned out, the way the system evolved, that almost never happened.

Warren Buffett [02:23:17] Yeah, Tom Murphy figured that one out before we did.

Charlie Munger [02:23:21] Yeah, and we, we, we had, we were slow on the learning curve. Murphy was way better at it than we were.

Warren Buffett [02:23:30] Microphone 12, please.

[02:23:30] Shareholder (Vivian Pine, Tarzana, California): Hello, gentlemen. My name is Vivian Pine, and I’m from Tarzana, California. And my question is, for a new investor buying stocks today, would you recommend that they buy a low-cost S&P index fund or Berkshire Hathaway, and why?

Warren Buffett [02:23:51] Well, we never, we never recommend buying or selling Berkshire. But I would say that among the various propositions offered you, a very low-cost index fund, where you don’t put all your money in at one time. I mean, if, if you accumulate a, a low-cost index fund over 10 years with fairly regular sums, I think you will probably do better than 90% of the people around you that take up investing at a similar time. That, Charlie?

Charlie Munger [02:24:26] I would agree with that totally. It’s awkward for us sitting here at these annual meetings, where we have a sampling of some of the most honorable and skillful stock brokers around, who’ve done a wonderful job for their own clients and families. But the stockbroking fraternity in total can be guaranteed to do so poorly that the index fund is better option.

Warren Buffett [02:24:59] We’ll go to number 1 again.

[02:25:02] Shareholder (John Bailey, Boston): John Bailey from Boston. As of last week, my house is almost totally covered with Benjamin Moore now. But more, more seriously, you’ve spent a fair amount of time talking about the low-probability transformative events. I recall a discussion on the probability of a nuclear event not occurring in any given year, for say 50 years, at which point it begins to look like, over the time period, it’s pretty darn likely, and therefore the expected value is a pretty big negative. There are some other things that, that could be happening that somebody might expect. For instance, perhaps there is in fact a ceiling on consumer debt coverage ratios. If, if they, if they quit falling there, that could be a big change. The, if, if you even listen to the United States Geological Survey, they’re now saying that sometime in the next 50 years there could be a fall in the production of oil. And so I’d like you to address how you conceive of the portfolio of businesses in the context of these possible transformative events, especially given that all over this same time period of maybe the next 50 years, at some point you’re not going to be able to personally revise the portfolio.

Warren Buffett [02:26:53] Yeah, I think it’s a fair statement that over the next 50 years, at some point, Charlie and I will not personally be able to participate in portfolio revisions. The, we are, quite correct that people tend to underestimate low-probability events when they haven’t happened recently, and overestimate them when they have happened recently. That’s, that is the nature of the human animal. You know, Noah ran into that some years back, but he looked pretty good after 40 days. The, um, what you mentioned on the, on the, on the nuclear question, it’s a matter, you can do the math easily. What you don’t know is whether you’re using the right assumptions. But if, for example, if there is a 10% chance in any given year of a, a major nuclear event, the chance that you’ll get through 50 years without it happening, if the 10% is correct, is a half of 1%. I mean, 99.5% of the time, a 10% event per year will catch up with you in 50 years. If you can reduce that to 1%, there’s a 60% chance you get through the next 50 years without it happening. That’s a good argument for trying to reduce the chances of it happening.

In terms of our businesses, I think Charlie and I are, I mean, we think, we, we think about low-probability events. In fact, in insurance, we probably think about low-probability events more than most people who have been insurance executives throughout the year. It’s just our nature to think about that sort of thing. But I would say if you talk about transforming events, or, or really talk about major events that could have huge consequences that are low probability, they’re more likely to be in the financial arena than, than in the natural phenomena arena. But we’ll think about them in, in, in both cases. But we, we do spend a lot of time thinking about things that can go wrong in a very big and very unexpected way. And, and financial markets are, they bought, they have vulnerabilities to that, that, that, you know, we try to think of, and, and, and we try to build in ways that protect us against it, and perhaps even build in some, some capabilities that, where we think we might profit in a huge way from it. Charlie?

Charlie Munger [02:29:35] Yeah, that temporary collapse in the junk bonds, where they got down, many of them, to 35 and 40 yields, that’s a strange thing, and they have all those things pop back, you know, quadrupling in a short time. There was absolute chaos at the bottom of that, and that isn’t as much chaos as you could have. And of course it can happen in common stocks instead of junk bonds. So I think if you’re talking about, about the next 50 years, we all have to conduct ourselves so that we, it won’t be all that awful if a real financial crunch of some kinds could come along, either inflationary or a typical deflationary crunch of the time that people used to have a great many decades ago.

Warren Buffett [02:30:29] Probably the most dramatic way in which we are, cog, give evidence of our, of, of your worries, we just don’t believe in a lot of leverage. I mean, you could have thought junk bonds were wonderful at 15, because they eventually did go to 6%, you would make a lot of money. But if you owed a lot of money against them in between, you know, you wouldn’t have been around for the party at the end. So we believe almost anything can happen in financial markets, and the only way smart people can get clobbered, really, is through leverage. If you can hold them, you have no real, real problems. So we, we have a great aversion to leverage, and we would predict that a very high percentage of the smart people operating in Wall Street, at one time or another, are likely to get clobbered through the use of leverage. It’s, it’s, it’s the one thing that enforces you, or it’s one thing that, that ends or can prevent you from playing out your hand. And, and all of the hands we enter into look pretty good to us, but you do have to be able to, to play them out.

And the fascinating thing to me is that, just take the junk bond situation in 2002. You had people with a terrific IQ, tens of thousands of them, operating in Wall Street. You had the money was available. They all had a desire to make money. And then you see these extraordinary things happen in markets, and you say to yourself, you know, can these be the same individuals that two years later, or two years earlier, were, were buying these things that at prices that were double or triple or quadruple what they sunk to in between? And did they all go on vacation? You know, did they lose their, their ability to raise money? You know, the money was, you know, Wall Street was awash in money, and it was a washing talent, and yet you get these absolutely extraordinary swings. I mean, it doesn’t happen with apartment houses in Omaha, or, you know, with McDonald’s franchises or farms or something. But, but it, and it’s just astounding what can happen in the marketable securities department. And the big thing you want to do is, as, at a minimum, you want to protect yourself against that sort of insanity wiping you out, and, and, and better yet, you want to be prepared to take advantage of it when it happens. Now it’s about noon, so we will come back and begin at microphone 2, about, I don’t say, a quarter of one. The movie…

is showing continuously in the other room. We still have a few bargains over there for those of you who have any money left, and we’ll welcome you back at about a quarter of one. Thank you.

[02:33:32] Shareholder: After reading this story on Enron, I would like to ask you the following question. How does an entry level employee in a large company find out if her employer operates with a long-term perspective and with honesty and integrity?

Warren Buffett [02:33:52] Well, that’s a very good question. I’m not sure I’m going to have an equally good answer. You know, you pick up signals, or frequently you can pick up some signals about what is going on at the top of a business if you’re at a lower level, but I would say it would be very easy to be, it’d be easy to be fooled on that subject. Charlie and I would tend to be looking at things that they do in public in relation to their investors and the promises they make and all of that sort of thing, but I think that might be tough for people and it wouldn’t always give you a great guide.

We’ve been suspicious of companies, for example, that place a whole lot of emphasis on the price of their stock. I mean, when we see the price of a stock posted in the lobby of the headquarters or something, you know, things like that make us nervous. But I’m not so sure that’s, you know, that would be enormously helpful. So I guess you just have to sort of pick up from co-workers, publications, pronouncements of the leaders, the sort of culture that was being presented to them in the world, and, you know, you might get suspicious about it. But I don’t think I have a really good answer for that. Do you, Charlie?

Charlie Munger [02:35:32] No. It’s obviously easy when you’ve got a caricature of a person like Bernie Ebbers or Kenny Lay. I think it’s easy to say that you’ve got almost a psychopath in charge. But what, but what fools you is a place like Royal Dutch. If I’d been asked to guess major companies with sound long-term cultures and good engineering values and so forth, Royal Dutch would have been near the top of my list. And to have the oil reserves phonied for years, and internal reports of people were tired of lying. And if it can happen at Royal Dutch, believe me, it can happen a lot of other places.

Warren Buffett [02:36:14] Charlie and I would not have spotted at Royal Dutch by any of the means that we normally use. In fact, Charlie said we might have used that as an example of some place that was almost certainly above her approach.

Charlie Munger [02:36:27] And then, then you do read the emails and all that. But we don’t learn, because I would still expect that Exxon’s figures were fair.

Warren Buffett [02:36:39] Yeah, I think what was trans, what transpired in the 1990s, you know, was this gradual, and later on not so gradual, embracing at the top of the feeling that anything goes. You know, I don’t, I’m not going to speculate as to the motives at the top of Shell, but there was so much, there’s so much going on where people saw the fellows, in most cases fellows unfortunately, that were at their clubs, that they saw in other corporate meetings, or respected business leaders, they saw just one after another that we’re really cutting corners in one way or another. And, you know, situational ethics can take over in that people, people do, I think they sink faster to a lower prevailing morality than they rise to a higher prevailing morality, but they do move in the direction of what they perceived to be the prevailing morality of those around them in many cases. And certainly the corporate world in the late 1990s particularly was, it was extreme on that.

And that leads me into, I ran into the friend in the, at the lunch break, who’s involved in these matters, and he suggested, and I’m delighted to put in a plug, to encourage all of you to write your congressmen and senators to give… should be expensed, or whether in the, indeed whether Congress has got any business legislating on the question of what proper accounting is. It was a disgrace some 10 years ago when the United States Senate essentially threatened the Accounting Standards Board with extinction and bludgeoned Arthur Levitt, then running the SEC, at the behest of a lot of rich contributors, to declare that, to override the Accounting Standards Board’s pronouncement that options should be treated as expense. And it was, and I think in a very significant way it accelerated the anything goes mentality of the 1990s. At that point, when Congress says it’s more important to have stock prices go up than it is to tell the truth, and they voted 88 to 9 in order to do it, as I remember, I think that, I think there was a shift in morality among many corporate executives.

You may remember that the FASB then backed off, but still said that expensing was preferable. And having said it was preferable, 498 out of the 500 companies in the S&P took the less preferable method. All of the big auditing firms at that time endorsed their big clients’ views in order to report higher earnings. Now all four accounting firms says you should count them as expenses. Well, they’re right now, but it just shows what was going on in that period, when on a question of accounting principles, and when really nothing has changed, when what were then five, the Big Five, have shifted 100% to where the Big Four are now, and now they say options should be expense. So if you are inclined to write your congressman or senator, telling me, really think the FASB knows more about accounting than they do, and I think you’ll be right.

If you want to have some fun, go to Google and type in two words, type in the word Indiana and type in the word pie, that’s the mathematical symbol pi. And when you do that, you’ll see a number of stories come up, and they relate how in 1897, at the instigation of one legislator who was responding to a constituent, the House of Rep, the House in Indiana voted almost unanimously, may have even been unactually, it says what it was on Google, to change the value of pi to, you know, I’m not making this up, it’s checkable. And it seems that there was a fellow that had thought he discovered some new relationship between circumference in diameter in the area and a few things, and it came out to 3.20 if you work through his formula. And he offered to give this royalty free, as he put it, to the state of Indiana to teach its children, so that they would have not only the truth, but they’d have an easier number to work with than the long decimal that heretofore had been thought of as pie.

Well, that passed the Indiana legislature, and it passed, it passed the House, and by the time it got to the Senate, there were a few people that were still clinging to the old values who managed to shoot it down. But I would submit that in the night, in 1993, that the U.S. Senate cleansed the record of the Indiana legislature by outdoing them in attempting to change the rules on something, on a subject they knew nothing about. And I think some of the excesses of the 1990s that followed came about through the fact that they knew 88 senators were willing to declare the world was flat if constituents who had contributed enough money to them wanted it thus. That’s, we pause now, we’ll get back to our schedule here. Number three. Oh, Charlie, do you have anything to say about the Indiana legislature?

Charlie Munger [02:42:50] Well, I, the current members of Congress that want to retain the former abusive accounting, which are probably a majority of the House of Representatives, are way worse than the people who wanted to round pie to an even number. Those people were stupid. These people are mostly not stupid, but dishonorable. I mean, they know it’s wrong and they want to do it anyway. (Applause)

Warren Buffett [02:43:28] Let’s go to number three.

[02:43:30] Shareholder (Nate Anthony, Hinsdale, Illinois): Hi, my name is Nate Anthony from Hinsdale, Illinois. First, I would like to venture a response to an earlier question about the future of Berkshire. I believe it is our responsibility as shareholders to think for ourselves and ensure that Berkshire is run as respectably in the future it has been until now. You both have had a lot to say, both today and in the past, about how mutual funds should be run, but to my knowledge we do not directly have a fund management business. What do you think about putting your words in action and offering to have a Berkshire company manage the assets of funds where the directors are dissatisfied with present management?

Warren Buffett [02:44:12] Yeah, the problem would be there would be too many conflicts. You know, we’re managing so much of our own money at Berkshire that to take on the responsibility for managing another group of people to whom we would owe our best efforts, and handling that situation of wearing two hats ethically, I wouldn’t know how to do it. I certainly wouldn’t want to start a fund management company and be prorating all purchases between, personally wouldn’t want to start a fund management company and be pro-rating all purchases between Berkshire and that fund management company, or sure in that fund management company or the funds that it managed. I’ve, we’ve thought about it plenty. I mean, we’ve had all kinds of propositions put to us, and obviously we could sell it big time, but when we got through selling it, then we’d have the problem of administering it fairly, and I don’t know how we would do it. Charlie, you?

Charlie Munger [02:45:25] No, that’s why we don’t do it. But I must say it’s an attitude that doesn’t seem to bother many other people.

Warren Buffett [02:45:37] Microphone four, please.

[02:45:39] Shareholder (Norman Rentrop, Bonn, Germany): Norman Rentrop from Bonn, Germany. Two thanks and one question. My thanks go to both of you for allowing us investors to participate on equal terms with you. No management fees, no performance fees, no transaction fees. (Applause) My thanks also go to the people of Omaha for building this very fine new convention center.

Warren Buffett [02:46:15] Our thanks too. I’ll interrupt you for just one second. We wouldn’t be able to hold this meeting if we’ve been limited to the facilities we had last year. Last year we had the biggest facility in town, and I was told that we have at least 19,500 people here, and that would have been many, many thousands beyond what we could have had last year. And this is, this facility really does the job. Incidentally, it’s known as the Qwest Center. If you read about it in the paper, they have a, they seem to have some unwritten rule, or maybe it’s a written rule, that they can’t use the name, and so you will not, you will not see that name in the paper, for reasons that absolutely baffle me. But this is the Qwest Center, and they’ve done a wonderful job with it, and almost 19,500 people here today that otherwise might have to go to Kansas City. So thank you for thanking them, and now your question, please. (Applause)

[02:47:17] Shareholder (Norman Rentrop, Bonn, Germany): My question is your outlook on buying companies. You have taught us, when stocks are priced high and companies are priced low, than by companies. In the 1960s and 70s, we did see the rise of the conglomerates, then came in the pure industry place. Now we see a huge amount of money in private equity, and somehow private equity is competing for buying companies. So my question is, what is your outlook on the future of the buy out and the buying company industry?

Warren Buffett [02:47:56] Yeah, you’re absolutely correct that the private equity funds are a form of competition with Berkshire and buying businesses. We don’t really seek to buy businesses cheap, because you’re not going to get the chance to do that. We haven’t been able to do that. We do get occasional chances to buy them at what we would regard as fair value. You’ll never buy companies as cheap as stocks sometimes get. I mean, sometimes stocks sell for very low compared intrinsic value. Businesses just don’t do it. I mean, the reason is that stocks are, the prices of stocks, like those junk bonds we talked about earlier, are set in an auction market, and that market can do extreme things. But businesses are sold in a negotiated transaction, and that doesn’t get as extreme.

Nevertheless, our preference, our strong preference, is that we would rather buy businesses at fair prices than stocks even a little cheaper, and the private equity funds our competition. On the other hand, we have bought a reasonable number of businesses in recent years, and we’ll buy more in the future if somebody wants what we are offering. You know, we are somewhat one of a kind in that we can, we will buy a business, and the people that sold it to us, if they built that business, are really able to run it as if it’s their own indefinitely in the future. So they, if they have a tax reason, if they have a family situation or whatever, where they want to sell some business they love, and they don’t want to auction it off like a piece of meat, and they don’t want some guy buying it and then leveraging it up and then reselling it a couple years after, changing the accounting or something of the sort, they come to us and they know they’ll get the result they want.

And that happens periodically. It doesn’t, it doesn’t enable us to buy super bargains or anything like that. It just doesn’t work that way. But it does let us put the money to work at a sensible rate. There will be more people like that. Unfortunately we need big businesses, and, you know, they don’t come every day. But as I’ve said, when they, if you find that kind of an owner, if I owned a business that was big and that my, maybe my father started, my grandfather started, and I’d worked a long time for, but for one reason or another I had to monetize it, you know, I would sell the Berkshire. It’s very simple, because I wouldn’t regard the carving up of it to get perhaps the highest, a higher price, which might or not might not be higher, but I wouldn’t regard that as the ultimate goal in life. I think it’s kind of crazy, you know, to spend, I think it’d be kind of silly to auction off your daughter to whatever, you know, what, whatever man is willing to pay the most for, and I feel the same way about a business you’ve created lovingly over decades and decades and decades.

And we will buy some more. It’s a matter of luck whether it happens in any given quarter or even any given year, but there, there’s really no one else can quite make the promises that we can make. I mean, the degree of ownership that I have in Berkshire and the way I’ve got it set up for the future, where none has to be sold, you know, my promises will probably be about as good as you can get in that arena.

Most big companies simply can’t do that. If their board of directors, you know, decides they wanted to have a pure play, as you put it, in something, you know, what, what can be done about it? I tell prospective sellers, basically, I’m the only one that can double cross you. I mean, and I can double cross them. I mean, if I, the next day, want to pull something out of my… It’s not contractual what I’ve said to them at all, probably, but nobody else can. We’re not going to get some management consultants in and say, they say you ought to rearrange the business, or we’re not going to get Wall Street dictating to us. And that’s, I think, a significant advantage over time. I think it will enable us to buy businesses, but we do have a lot of competition, as you point out. Charlie?

Charlie Munger [02:52:19] Yeah, it’s been interesting, though, that we’ve had this private equity competition for a long time, and one way or another we’ve managed to buy a few things.

Warren Buffett [02:52:30] Okay, we’ll go to number five.

[02:52:32] Shareholder (Dan Cunningham, Boston, Massachusetts): Hello, my name is Dan Cunningham, and I’m from Boston, Massachusetts, home of the 2004 world champion Boston Red Sox. Thank you, Warren and Charlie, for providing this forum and teaching over the years. It’s much appreciated. In a recent New York Times Magazine cover story titled Up and Smoke, David Sokol, who runs Berkshire’s MidAmerican Energy business, was cited as a prominent CEO actively working to roll back the United States Clean Air Act, which 80% of Americans view as crucial to our public health. MidAmerican itself was cited as a major mercury polluter, among other things. With this in mind, could you see a role for a type of indep oversight committee charged with the purpose of auditing for shareholders the social responsibility of Berkshire’s businesses? This committee would monitor costs that Berkshire’s businesses incur for our society but do not show up anywhere in an income statement. Maybe in Berkshire’s case this would be a fraction of a person instead of a committee. Thank you.

Warren Buffett [02:53:58] Dave here? I can’t, it’s hard for me to see here. Did you see Dave? Mark, has David here? If you’ll go to it. Yeah, he might. I’d like to have David respond to that, because, you know, I have seen MidAmerica actually lauded in many, a great many respects. I did not see that particular article, but I know that if there were anything being done that had been judged wrong, I would have heard about it. So maybe David can address that if he will. Well, there’s a mic. Either come up here or go to the microphone that’s nearest. Yeah, more on this, David.

DSDavid Sokol [02:55:07] Okay. The article actually does not criticize MidAmerican for any error missions. It criticized me for, two years ago, being a Ranger in President Bush’s election. For what it’s worth, I’m no longer a Ranger. But that was the, the focus of the article was energy CEOs trying to influence legislation. That’s not why I was a Ranger. And frankly, MidAmerican’s environmental policies, I think, rank among the best in the industry, industry.

Warren Buffett [02:55:49] Thanks, David. I, yeah, I’ve never seen any criticism of MidAmerica. Matter of fact, David, could you tell them what happened with that J.D. Power study just recently?

DSDavid Sokol [02:56:04] Yeah, we were ranked nationally number two in the country for enviro, environmental, reliability, availability and customer satisfaction, number one in the Midwest, out of 55 utility companies.

Warren Buffett [02:56:18] Thanks, Dave. Number six, please.

[02:56:21] Shareholder (Van Argyrakis, Omaha): Good afternoon, Mr. Buffett and Mr. Munger. My name is Van Argyrakis. I’m from Omaha. Many U.S. multinational corporations depend on the importation of foreign workers. What is your opinion on the current state of U.S. immigration law as it applies to the employment of highly skilled permanent workers?

Warren Buffett [02:56:54] Charlie, you want to comment on that?

Charlie Munger [02:56:58] Well, of course that’s a subject on which reasonable minds disagree. My personal view is that I’m almost always glad to have very talented people come into the United States, and I’m almost never pleased when the very bottom of the mental barrel comes in.

Warren Buffett [02:57:23] We may differ just a bit on that one. (Laughter) The, this country has certainly benefited enormously over the decades, you know, by my immigration. We started out with 4 million people in 1790. China had 290 million at that time, just about what we have now. Europe had well over 75 million. So he had 70 times as many people in China, you had probably 20 times as many people in Europe. We had the same degree of intelligence in China or in Europe as we had here. We had similar natural resources. And now this country has well over 30% of the GDP of the world. So it’s, it’s a pretty remarkable story, and how to attribute or how to quantify the various components that entered into that is very, very difficult. But we’ve certainly been a country characterized by lots of immigration, and whether that, whether that is responsible in any way for the incredible record of this country, I don’t know, but I suspect that it was. And I think what Charlie would like to do is perhaps be the admitting officer, and it would work, it would work pretty well, Charlie was, but in the absence of that, I think, I don’t think net this company, country has been hurt by immigration over time. Number seven.

[02:59:00] Shareholder: Good afternoon, Mr. Buffett and Mr. Munger. I would like to thank you for being here. My question pertains to price discovery and liquidity. It is a common perception that unless there is adequate liquidity, price discovery is hurt. Now, if liquidity helps price discovery, then does it make sense to split the stock of a company which has a low liquidity problem? As a corollary, why do you consider stock splits and bonus issues to be bad for shareholders in the long run? Thank you.

Warren Buffett [02:59:34] Stock splits and what else, Charlie?

Charlie Munger [02:59:37] Bonus issues.

Warren Buffett [02:59:37] And what’s the relation? I don’t get it.

Charlie Munger [02:59:40] He didn’t indicate a relation. He just asked you to describe what’s wrong with both.

Warren Buffett [02:59:46] It’s two questions, then. Yeah. Well, we have explained how we think about stock splits, that there’s no religious view against them. We don’t think companies do them or evil or anything of the sort. We do think we’ve got the best group of shareholders in the world, and I think that a meeting like this to some extent is evidence of it. We’ve got people that are more in sync, I think, with the policies of the company. We certainly have people who are more long-term in their view of Berkshire, or their intentions regarding Berkshire. I think we have people that understand their investment in Berkshire better than, well, really better than any other large American corporation. We got the lowest turnover for any large American corporation.

Now, why is that? Well, people can buy stock in any company they want to. I mean, you could have bought stock and Berkshire or something else. But there’s this self-selection process of who comes in, and there’s a self-selection process of the people that just say, you know, that’s company doesn’t interest me. And I would say that people who say they aren’t interested in a stock that sells in the thousands of dollars a share simply because it’s thousands of, thousands of dollars a share, are not, would not as a group be as intelligent and informed and long-term in their outlook and as in sync with the managed policies and management as this group. It’s not a killer of a thing, obviously, but, but it’s a sign, it’s a, it’s a symptom of people with a somewhat different attitude toward the stocks they own.

Now, somebody is going to, if we have a million and a half Class A equivalent shares, we have a little more net outstanding, somebody’s going to own them all. So it’s just a question of who is attracted and who has repelled your, from your shares. And I think not splitting, and some other things we do at Berkshire, a number of other things we do at Berkshire, has attracted a group of shareholders that really come the closest to an investment-oriented group as, as almost possible in a widely traded and widely available company. And we like the group we’ve got. We’re not looking for the people who think it would be a more attractive stock if, instead of selling it $90,000 a share, it’s sold at $9 a share. Nothing wrong with those people, but, but they are, if we were choosing partners, we would choose the group we have over the people who think a $9 stock is a wonderful thing. Charlie?

Charlie Munger [03:02:25] Yeah, and on the second part of that question, I think the notion, which is taught in so much of modern academia, that liquidity is this, of, of tradable common stock, is a great contributor to capitalism, I think that is mostly twaddle. The GNP of the United States grew at very good rates long before we had highly liquid markets for, for common stock. I don’t know where people got that silly notion. I think the liquidity gives us these crazy booms, which have many problems as well as virtues. And in England, if you’ll remember, after the South Sea Bubble, England banned tradable common stocks for decades. It was absolutely illegal to have a company so widely held you got a liquid market in the shares, and England did fine during that period when you didn’t have a stock. If you think that liquidity is a great contributor to civilization, why, then you probably believe that all the real estate in America, which is relatively illiquid, hasn’t been developed properly. The, Keynes actually commented on the perversions brought about by liquidity.

Warren Buffett [03:03:49] But of course the truth is that Berkshire trades on average $50 million or so of stock a day, so very few people are going to have any problem with Berkshire, the liquidity in the stock. But we’re trying to create more of them, more people who have this big liquidity problem because they own so much stock. Let’s go on to number eight, please.

[03:04:18] Shareholder (Michelangelo, San Francisco): Hello there. This is Michelangelo from San Francisco. My general question is about how ethical concerns enter into your asset allocation decisions. So, for example, I think there’s some strong arguments that can be made that say Classic Coke should never be part of anyone’s diet. If such an argument could be made and you were convinced of it, would that change the way that you viewed Coca-Cola Company as part of your portfolio?

Warren Buffett [03:04:50] Well, I think that’s a hypothetical that simply wouldn’t happen. I mean, it, I’ve been drinking five of them a day, you know, and maybe it’s the combination of that and peanut brittle, you know, that does the job, but I just feel terrific. The… (Applause) We passed one time on the chance to buy an extraordinarily profitable company because Charlie and I met the people that ran it, and they were, they’re perfectly decent people, too, and we went down in the lobby of the hotel that, that we met him in, and we just decided that in the end we didn’t want to be involved in that. On the other hand, I would have bought stock, as a publicly traded stock, in the same company. Charlie will give you his view on that later.

So I do not have a problem, stock in companies, marketable securities, the bonds of those, of companies in the market, that, that engage in activities that I wouldn’t probably endorse myself. I would have trouble owning outright and actually directing the activities of some of those companies. But, you know, the, any major retailer in this country is virtually, is going to be selling cigarettes, for example, with, and if they’re not declared illegal, it does not bother me to own, would not bother me on those retailers outright, or does not bother me to own the stock.

Charlie Munger [03:06:29] Yeah, but you wouldn’t buy a company that made the tobacco and concocted the advertisements.

Warren Buffett [03:06:34] No way. And, you know, I can’t tell you perfectly why that, I mean, I can’t tell you that’s the perfect line, or I can’t tell you precisely why that’s where I draw it, but I will tell you that is where I draw it. We would not be in the manufacture of it, but I, we owned stock at one time in our JR rentals, before it, before it had the LBO. We owned bonds in it. And, you know, I would still be doing it if I liked either the bonds or the stock. We would not buy, we would not buy the manufacturer. And like I say, we walked on one that, you know, and we went down to the hotel to talk about it, though, too, so you’d have to say that, that, that we were thinking about it, but we decided not to do it. Charlie didn’t think very long.

Charlie Munger [03:07:37] The, we don’t claim to have some kind of perfect morals. You can draw these lines where you wish, but at least we’ve got a huge area of things which is perfectly legal to do that we think beneath us, so we won’t do them. And we see more and more in America a culture where just anything that’s unlikely to send you into prison, which looks like it’ll make money, is okay. And that is a very bad development.

Warren Buffett [03:08:08] But I think, I think it’s a little crazy myself to say that it’s terrible if people eat hamburgers or eat or drink Coca-Cola or eat candy or anything like that because they’re likely to gain weight. That is a perfectly optional decision, and who knows whether somebody has lived a happier life that lives to 75 and overweight condition causes them to die a little sooner, they live to 85 and lived on carrots and broccoli, you know, has lived a better life. I know which one I prefer. Okay, number nine, please.

[03:08:45] Shareholder (Allan Maxwell, Omaha): Hi, Mr. Buffett. I’m Allan Maxwell. My wife and I are shareholders from Omaha. I’m going to keep things simple so you can understand them.

Warren Buffett [03:08:55] Good. Allan’s a friend of mine, so he can get away with that.

[03:09:01] Shareholder (Allan Maxwell, Omaha): Thank you, Colonel. Excluding the Buffett’s stake, I’m going to combine A and B shares, and there are approximately 1 million A shares outstanding. Correct?

Warren Buffett [03:09:14] That’d be about right.

[03:09:16] Shareholder (Allan Maxwell, Omaha): Okay. About your salary, is approximately, or is $100,000 a year.

Warren Buffett [03:09:23] It’s been stuck there for a while, and we’ll talk about the board.

[03:09:30] Shareholder (Allan Maxwell, Omaha): Well, you’ll be happy with my question. In other words, we’re paying you 10 cents a share to manage a $90,000 investment. That’s remarkable in today’s corporate culture. Thank you, Mr. Buffett.

Warren Buffett [03:09:44] Thank you. Yeah, thanks, Allan. Thank you. But I have to tell you, as I did last year, I would pay to have this job. I mean, it, it doesn’t get any better than this.

[03:10:00] Shareholder (Allan Maxwell, Omaha): Well, rather than you doing something for us, I would like to suggest that we the shareholders do something for you. As a shareholder, I would be willing to pay you 25 cents and a share, so that way you could save a little extra money for your retirement. Would you support such an idea?

Warren Buffett [03:10:29] Allan, I’m getting Social Security now, and that really pretty well takes care of things. My family would go crazy if I made any more money. I appreciate that. I appreciate the offer.

[03:10:44] Shareholder (Allan Maxwell, Omaha): However, my heart’s with you. Thank you.

Warren Buffett [03:10:47] Okay, thanks, Al. Let’s go to number 10 and see if we can get 50 cents. How about a dollar?

[03:10:54] Shareholder (David Winters, Mountain Lakes, New Jersey): David Winters, Mountain Lakes, New Jersey. Thank you, Warren and Charlie, for a fabulous weekend, and for the discussion about governance in the mutual fund industry in the shareholder letter. Specifically, have you altered the compensation potential for the insurance underwriters to make sure, as Charlie has described, the incentive caused bias creates an environment that encourages writing new policies, that when the tide goes out again in the property and casualty business, Berkshire Hathaway minimizes losses, maximizes float, while compensating underwriters for not writing business?

Warren Buffett [03:11:31] Well, thank you. That, that feeds into an interesting set of slides I’ve got, if I can find them here, to tell the projector what to put up, because that’s a very important, a very important point you raise. I mean, we are very big in insurance, and having the wrong incentives in place could be very harmful. So let’s put up a couple of slides. Let’s put up slide number one, if we would, please. Slide number one is the situation at Berkshire, and Charlie, I’ll give you one of these, but that’s the situation at Berkshire shortly before we bought National Indemnity. There’s our balance sheet there, and as you’ll notice, we just had a few million dollars extra. We had about $20 million tied up in the textile business.

And then I heard that, you know, Jack Ringwalt wanted to sell his company. Some of you here in the audience know him. He, for, for 15 minutes every year, Jack would feel like selling his company. He would get mad at something or other than, and so my friend Charlie Heider knew Jack pretty well, and I said to Charlie, Charlie, next time Jack is in heat, have him, you know, get him over here. And so Jack, early in 1967, came by, came by and 11:30, 11:45 in the morning, and said he’d had it with insurance and with the insurance regulators and everything, he liked to sell. So we bought it. Now, we bought, that was, this made a major, that’s when we really embarked on what has happened subsequently. As you can see from that slide, the following year the textile business made all of $55,000, so sticking with textiles would not have been a great idea. We spent $8.5 million to buy National Indemnity.

Now, in the next slide, slide two, record like there’s never been. I don’t think there’s another insurance company in the world that has a record like this. That’s the premium volume of National Indemnity’s traditional business, and you will see a company that went from $79 million in that first year, premiums, if you go all the way back to the time we bought it, it was $16 million, but, but by 1980 we’re up to $79 million. And you will see that in what was known as the hard market of the mid-80s, we got up to $366 million, and then we took it down, not intentionally, but just because the business became less attractive, all the way from $366 million down to $55 million. And now the market became more attractive in the last few years, and it soared up to six, almost $600 million. I don’t think there’s a public company in America that would feel they could survive a record of volume going down like that year after year after year after year.

But that was the culture of National Indemnity. It was the culture starting with Jack Ringwalt, and it was the culture all the way through several other managers, Phil Liesche, and Rolly Miller, to Don Wurster, has done a fabulous job, and we don’t worry about premium volume. But if you’re not going to worry about premium volume, then you have to take a look at slide three, because if the silent message had gone out to our employees that unless you write a lot of business you’re going to lose your job, they would have written a lot of business. You could, National Indemnity can write a billion dollars worth of business in any month they wanted to. All it does, it has to do is offer silly prices. If you offer a silly price, brokers will find you in the middle of the ocean at four in the morning. I mean, that, you cannot afford to do that.

So what we have always told people in our insurance businesses generally, specifically at National Indemnity, is that if they write no business, their job is not in jeopardy. We cannot afford to have our, our unspoken message to employees that you right business or your job, or the guy sitting next to you, you know, may be lost. So when we bulged up to $366 million, we, employment went up modestly, and when we went all the way down, you’ll see it trickled downward, but that was all by attrition. We never had a layoff during that period. Other people would have, but we didn’t. And now we’re going back up some, and we’ll go back down again at some time in the future.

Now, if you go to the next slide, you’ll see that that created an expense ratio that went, went up dramatically, up as high as 41% in 1999 as volume shrunk back, and when we were riding a lot of business our expense ratio was as low as 25.9%. Now, some companies would feel that was intolerable, but what we feel is intolerable is writing bad business. And again, we can take an expense ratio that’s out of line, but we can’t afford to write bad business. For one thing, if you get a culture of writing bad business, it’s almost impossible to get rid of. So we would rather suffer from the stand of having too much overhead than we would want to teach our employees that to retain their jobs they needed to write any damn thing that came along, because that’s a very hard habit to get rid of once you get hooked on it.

Now, if we’ll move on to slide number five, you will see what the result has been of that policy, and it’s been that we had a few years, bad years in the early 80s. That’s what led to that hard market. But even with a high expense ratio, you’ll see that we made money underwriting in virtually every year. You’ll see the year 2001 at 108.4, but that will, in my view, that will come down. I think that will turn out to be quite a good year. These are the, that year is not fully developed yet. Now, you’ll see in 1980, in 86, we had this incredible year when we wrote it 69.3. That’s a 30% underwriting margin. And the nice thing about it is we did it with the most volume we ever had to that point, $366 million. So we coined money when we wrote huge amounts of business, and we made a little money when we wrote small amounts of business.

So it’s absolutely imperative in our view, and I think we’re almost the only insurance company like this, certainly public, in the world, that sends the absolutely unequivocal message to our, the people that are associated with us, that they will never be laid off because of lack of volume, and therefore we don’t want to write one bit of bad business. And we’ll make mistakes, and we’ll have a high expense ratio when business is slow, but will win the game. And that’s what National Indemnity has done over a period of time. National Indemnity was a no-name company running through a general agency system, which everybody said was obsolete. It had no patents, no real estate, no copyrights, no nothing that distinguished it essentially from other insurance, dozens of other insurance companies could do the same thing. But they have a record almost like no one else’s, because they had discipline. You know, they really knew what they were about, and they’ve stayed with that. In fact, they’ve intensified it over time, and their record has left, you know, other people in the dust.

It wouldn’t be a record you would point to Wall Street, you know. If you went to Wall Street with that record alone in 1990 or 1995, they’d say, what’s wrong with you? But the answer is nothing’s wrong with it. And you put your finger on, on having the incentives in place to write the right kind of business for the shareholders at Berkshire, and we try to think those things through. I mean, you can’t run a, you can’t run an auto company without having layoffs. You know, you can’t run a steel company this, this way. But this is the way to write, the right way to run an insurance company. And that’s why these cookie cutter approaches to employment practices or bonuses and all that are nonsense. You have to think through the situation that faces you in a given industry with its given competitive conditions and its own economic characteristics. Charlie, you want to come into that?

Charlie Munger [03:19:56] Well, the main thing is that practically nobody else does it, and yet to me it’s, it’s obvious it’s the way to go. There’s a lot in Berkshire that is like that. It’s just a little different from the way other people do it. Partly the luxury of having a controlling shareholder of strong opinions that accounts for this. It would be hard for a committee including a lot of employees to come up with these decisions.

Warren Buffett [03:20:29] We go to number 11.

[03:20:30] Shareholder (Andy Peake, Weston, Connecticut): Good afternoon. My name is Andy Peake, and I’m from Weston, Connecticut. As a keen China watcher, I was very interested in your PetroChina investment. Could you please tell us more about your thought process on investing in a complicated, opaque country like China, and PetroChina?

Warren Buffett [03:20:51] Yeah, PetroChina itself is not a complicated or opaque company. You know, the, the country, you know, has obviously different characteristics in many respects than the United States, but the company is, is very similar to, very similar to big oil companies in the world. I, and I, PetroChina may have been, it may have been the fourth largest, fourth most profitable oil company, united, in the, in the world last year. I may be wrong on that. But they produce 80% or 85% as much crude daily as Exxon does, as I remember, and it, it’s a big, big company. And so, and it’s not complicated. I mean, you know, obviously a company with a half a million employees and all that, but a big integrated oil company, it’s fairly easy to get your mind around the economic characteristics that, that will exist in the business.

And in terms of being opaque, actually their annual report may well tell you more about that business, you know, than you will find from reading the reports of other oil giants. And they do one thing that I particularly like, which other oil companies don’t, at least to my knowledge, is that they tell you they will pay out X percent, I think it’s 45% of their earnings, absent some change in policy. But I like the idea of, of knowing, in a big enterprise like that, the 45% of what they earn is going to come to Berkshire and the remainder will be plowed back.

It was bought not because it was in China. It was, but it was, but, but it was, it was bought simply because it was very, very cheap in relation to earnings, in relation to reserves, in relation to daily oil production, in relation to refining, whatever metric you wanted to use. It was far cheaper than Exxon or BP or, or Shell or companies like that. Now, you can say it should be cheaper, because you don’t know what will happen with it, 90% owned by the government in China, and that’s obviously a factor that you stick in valuation. But I did not think that was a factor that accounted for the huge differential in the, in the price at which it could be bought. And, you know, so far it looks okay on that basis.

We weren’t, we aren’t there because it’s China, but, but we’re not avoiding it because it’s Chinese. We just, we stick in a fairly appropriate number. But if you read the annual report of PetroChina, I think that there’s no, you will have as good an understanding of the company would if you read the annual report of any of the other big oil majors. And then you would factor in your own thinking about whether there could be some huge disruption in Chinese American relationships or something of the sort, where you would lose for reasons other than what happened in terms of world oil prices and that sort of thing. But we’re happy with it. Charlie?

Charlie Munger [03:23:52] I’ve got nothing to add. Everything is cheap enough, obviously you can afford a little more country risk or regulatory risk or whatever. This is not complicated.

Warren Buffett [03:24:04] Yeah, you can, Yukos, as you know, is a very big Russian oil company, and in evaluating Russia versus China in terms of country risk, you know, you can make your own judgments. But in our view, something like PetroChina was both cheaper and had less risk. But other people might see that differently. We’ll go to number 12.

[03:24:30] Shareholder (Hugh Stephenson, Atlanta, Georgia): Good afternoon, gentlemen. My name is Hugh Stephenson. I’m a shareholder from Atlanta, Georgia. This question is for both of you. If you would both comment on the subject of tort reform, specifically asbestos torts, and if you could construct an optimal solution, how would you construct it, balancing the interests of, of legitimate plaintiffs versus the attorneys versus the opportunists?

Warren Buffett [03:25:00] Okay, Charlie’s the lawyer, so he’s going to get to answer this one.

Charlie Munger [03:25:06] As a matter of fact, that is an easy question. What’s happened in asbestos is that a given group of people get mesothelioma, that came, which is a terrible form of lung cancer that kills people, really only from asbestos. And those people got it from somebody’s asbestos, and that’s one group of claimants. Then there’s another group of claimants, and these are people who’ve smoked two packs a day of cigarettes most of their lives, and they’ve got one little spot here or there and an elderly lung, and God knows what the spot is. But an enterprising lawyer can get an enterprising physician who just happens to find that every damn spot in any lung must be asbestos caused. And once you’ve got one expert witness whom you can bribe, in effect, to say that, you’ve got a claim that can be filed. And so you get millions of claims on behalf of people who have no symptoms, and who say that, I’m worried about getting cancer from this spot that my attorney’s doctor says was causes asbestos.

There isn’t enough money in the companies that made the asbestos to pay off everybody. And what happens is that a huge percentage of the money does not go to the people that got the cancer, or another group of people who got terrible lung impairment that is obvious, but that’s another small group, relative to these people who just have one little spot on her and now say they are worried about getting cancer. And they can file those cases where they say they’re worried in some state, usually a southern state, where they’ve got a jury pool that just hates all big corporations. And so it’s, you’ve got an industry, and of course the lawyers who are representing the people that aren’t heard are really stealing money from the people who are hurt. And the guy who gets mesothelioma doesn’t get as much as he should, and all these other people are getting money they’re not entitled to. It’s a bonker system.

But with federalism the way it is, there’s just no way to stop it. And the United States courts, the United States Supreme Court refused to enter it and just grab hold and make a decision. And so it just goes on and on and on, and the claims come in. I think the Manville Trust had more new claims come in last year than in any year in history.

Warren Buffett [03:27:57] And that’s correct. And they have mined and sold asbestos for the last time what, 35 years ago, or…

Charlie Munger [03:28:05] Yeah. And it just never stops. The people who are trying to buy these people off, it’s like trying to douse a fire by pouring gasoline on it, because word processing, processing machines can grind out these phony claims, and the doctors can ground up, grind out these phony opinions. And so a huge proportion of all the money that’s available to pay people who suffered from a spec goes to lawyers, experts, doctors, contingent visa lawyers, defense lawyers. I think is it something like 20%, 25% of the money is flowing through the people who were injured. So it’s a total national disgrace.

The only people who have the power to fix it would be the Supreme Court of the United States or Congress. The Supreme Court, some people would say rightly, other people would say and to chicken a fashion, duck the issue. That means the only party that has the power to fix it is Congress, and Congress so far, given the politics, has not, has not fixed it. Once you get wrongdoers so rich, they get this enormous political power to prevent change in the laws that are enriching them. I mean, it means that we should all be more vigilant about stepping on these wrongs when they’re small, because when they get large they’re very hard to stop. But it would be easy to fix this. The right way to fix it, we’re just not going to pay off on these tiny claims.

Warren Buffett [03:29:48] The John, Johns Manville, but we own Johns Manville. They went bankrupt. They were the first, at least big one, that asbestos took into bankruptcy, and probably, on the history of things, they somewhat deserved it, I think. Charlie, isn’t that right?

Charlie Munger [03:30:06] Their behavior was among the worst in the history of American corporations. Yeah, they knew this stuff was causing terrible injury, and they deliberately covered it up, time after time and year after year, to make more money. There’s no doubt about the guilt of the original management at Johns Manville.

Warren Buffett [03:30:26] So they went bankrupt in the early 80s, and out of that bankruptcy was formed something, as Charlie mentioned, called the Manville Personal Injury Trust. We’ve got, have no connection with that. I mean, this is a new company that we bought a few years ago, and this company has no connection with that except the historical history. The, but the Manville Personal Injury Trust was established and had, over time, had a couple billion dollars in it. And as Charlie said, last year, it’s been around for now for almost, I would say close to 20 years, and last year they had a record number of claims introduced. They didn’t have a record number because of the incidence of asbestos compared to the ones that were prevailing at the time it was established or something of the sort. It’s just, it’s become a honeypot.

And as a result, the Manville Personal Injury Trust is now paying out 5%, because their $2 billion will only go so far. They’re paying 5% of claims. So, Charlie says, the guy that’s got a, that has really been drastically injured by asbestos gets this tiny fraction, and the tens of thousands of climates for whom it’s a gleam in the eye, or rather a gleam in their lawyer’s eye, perhaps, also get their 5%. And it’s, you know, it’s not the right way to do it, but it’s very hard to correct. We’ve observed the asbestos legislation, over the proposed legislation over the last year, and in the end what they came up with we did not support, because it, it didn’t, it didn’t get the answer that, that’s needed. And Charlie’s, you know, my view, that the Supreme Court, when they ducted, I mean, they left open a can of worms which will be around for decades and decades and decades, and the right people will not get compensated.

Charlie Munger [03:32:30] And those of you who want to be cynical ought to look into it and see the perjury. What’s happened, of course, is that all the really horrible people pretty well are broken, gone, and maybe there’s some money left in a trust here or there, but by and large there isn’t enough money. But now they’re like three sovereign people left. You’ve got some little spot or something or other, and by a strange coincidence, every one of those people can only remember three names of products that you might have some household that might have caused it. And it’s an amazing coincidence, the three that are left solvent are the only names he can remember. And so you, it’s obvious you have a vast amount of pergy, perjury being so borned by practicing lawyers. It’s not a pretty picture.

Warren Buffett [03:33:23] Okay, let’s go to microphone one.

[03:33:25] Shareholder (Charlie Rice, St. Louis, Missouri): Hi, my name is Charlie Rice, and I’m a stockholder from St. Louis, Missouri. I appreciate hearing your comments on publicly held companies using their cash for dividends versus stock buybacks.

Warren Buffett [03:33:40] Well, we, the equation is pretty simple, but the practice doesn’t necessarily follow logic. The, it’s obviously, as long as you’re telling the truth to your shareholders about what’s going on, so that you aren’t manipulating the stock downward or something, when a stock can be bought well below its business value, that probably is the best use of cash. It’s something the Washington Post did on a huge scale back in the 1970s. Teledyne may have bought 90% or something, or close to it, of their stock back. And that was the reason a very significant percentage of companies bought stock back in the past, because they actually thought it was selling for less than it was worth. Like I say, that, that can be abused if you do various things to bury your stock in one way or another, but, but that wasn’t the usual case.

Stock repurchases were relatively unpopular in those days. They’ve become quite popular now, and to the extent that I’ve been around a good number of them, and been able to pick up on what I thought was the underlying rationale, if not the professed rationale, you know, I think it’s often done for people that, that are hoping that it causes their, their stock price not to go down, and they’re, you know, and often done at prices that don’t really make a lot of sense for continuing shareholders. If we wanted to return a bunch of cash to shareholders, we would, if our stock was undervalued, we would, we would, we would go to the shareholders and say, we think it’s cheap, and we think that this cash can be better used by you than by us, and we will therefore have, be repurchasing at what we think is a discount intrinsic value, and the people that remain will be better off, and the people that get out will get out at a little bit better price than they would otherwise.

In terms of dividends, you get into an expectational situation, and for most companies that follow a, that pay a cash dividend, it doesn’t make sense to be, to bounce around the dividend from year to year, although private companies frequently do that, and we do it ourselves with our subsidiaries. They, some subsidiary can pay us a lot of money one year and not so much money the next year. But with public companies, people do, a lot of people do buy stocks to obtain dividends, and they hope for regularity, and that there’s a signaling aspect to it and everything. So I would, I would say that once you establish a dividend policy with a public company, you should think a long time before you change that policy in a material way. But I think the best use of cash, if you don’t have a good use for it in the business, if the stock is under price, is to repurchase it. And if it’s overpriced, you’ve got no business buying in a single share, but a lot of companies do it. Charlie?

Charlie Munger [03:36:43] Yeah, the dividends are a very interesting subject. If you count the unnecessary stock trading and the cost of investment advice and the cost of making a lot of errors and the trading costs in and out, I don’t think would be too extreme to say that now the total amount that’s paid out in dividends is roughly equal to the amount that is wasted in all this trading and investment advice, so that the net dividends that come to the shareholders are approximately zero. This is a very peculiar way to run a republic, and very few people comment about it.

Warren Buffett [03:37:22] Yeah, actually I did in an article some time ago, and fortunate, the frictional cost to American shareholders in sort of changing shares, for all American businesses as a whole, those frictional costs are probably not much different than the entire amount paid out by American corporations. So, but getting to the individual corporation level, a company that expects to regularly earn more than it, than it can profitably employ in its business should be paying out dividends. Take a subsidiary of ours like See’s Candy. We would love to expand See’s Candy to double or triple its present size, but it doesn’t work. We’ve tried it a lot of different ways. So it should be paying out attorneys if it was a public company, and it was at one time. You know, you could argue that something approaching a 100% payout would, would make sense there. But most managements, worrying about earnings falling off at some time in the future, would rather establish a lower level, and therefore ensure regularity of dividends, by, by going with, with a conservative level.

I, you know, we, it’s obviously something we think about at Berkshire. When we have $30-odd billion around, if we can’t figure out a way to employ that over time, you know, it’s, it’s a mistake to keep it in corporate form. But we have this expectation, and I think it’s a reasonable expectation, that we get to put it to work. If we ever came to the different conclusion, if our stock, we thought our stock was significantly undervalued, we’d probably figure in terms of dispersing it through repurchases, particularly we’re now, dividends and capital gains are, are neutral for, for individuals. And if our stock was not underpriced, and we felt we would, we would probably do something by a dividend. It’s not going to happen soon, however. Number two.

[03:39:30] Shareholder (J.P. Tan, Orlando, Florida): Good afternoon. My name is J.P., as a justice of peace, or jello pudding. My last name is Tan, as in sun tan. I flew in from the suntan city of Orlando, Florida, where an elderly man told me J.P. Tan stands for just perfect 10. Mr. Buffett, allow me to give you a big thank you before I asked my question. Some time ago I sent you my business analysis of your investment in Scott Fetzer Company. I was not sure if you even bored to read it, yet you were very kind to write me that my analysis of Scott Fetzer Company is very much on the money. You also invited me to my first annual meeting, where I had the privilege of meeting Mr. Andrew Kilpatrick, who was kind enough to include my analysis of Scott Fetzer Company in his book, Of Permanent Value: The Story of Warren Buffett. I want to thank you for making this possible.

Here comes my question. Mr. Buffett, you have said that the nine most important words ever written about investing are these nine words: investment is most intelligent when it is most business-like. Mary Buffett said that you have built your entire business success upon these nine words, investment is most intelligent when it is most business-like. For this reason, I started businesslight.com, looking up to GEICO and Dell as direct marketing models, since they have the lowest cost structure. Please kindly share with us in elaborate details the direct marketing methods of GEICO and your friend Michael Dell. We want you to analyze the marketing methods of GEICO, the direct marketing methods of GEICO and Dell.

Warren Buffett [03:42:15] Yeah, well, I’m not as familiar with Dell as I am with GEICO. The, the idea of direct marketing in auto insurance at GEICO came from Leo Goodwin, who, and his wife Lillian, who had come from USAA. And USAA was set up some years, and GEICO was set up in 1936. USAA was set up, I believe, in the early 20s, because military personnel moved around a lot and they had trouble getting auto insurance, and a great organization was established. Leo Goodwin took that idea and decided to broaden it beyond the officer ranks of, of the military, and first went to government employees generally, and now that’s been extended dramatically over the years to the American public as a whole. It’s a better system.

You know, if you go back a hundred years, auto insurance, when the auto first came in, was sold by the casualty affiliates of the big fire companies. That’s where, at that, in the 1800’s, the, the major insurance companies were fire companies, and casualty insurance was something that came along later. And it was sold through a system whereby the agent got large commissions, where there were sort of cartel like rates established through something called the bureau, and that system prevailed for several decades. And then State Farm came along, formed in the early 1920s, farmer from Illinois in his 40s, all the background in insurance, no capital, but he came in with the idea of having a captive insurance agency force, and that brought down costs somewhat. And State Farm in time became the largest auto insurer in the country, and Allstate, which followed that system, became the second largest. And that was a better system, a better mousetrap. And then USAA, followed by Leo Goodwin at GEICO, came along with a direct marketing operation that, that bypassed the agent and brought down costs further.

Now, every American family virtually wants to have a car. They don’t want to have insurance, but they can’t drive the car without insurance. So they’re buying a product they really don’t like very well. It costs them a significant part of their family budget, and cost therefore becomes very important. It’s not a luxury item, it’s a mandatory item, virtually. And saving significant money makes a real difference in a lot of household budgets. So the low cost is going to win. And our direct operation, Progressive has a wonderful direct operation competing with us, we’re the, we’re the two that will be slugging it out over the years, is the, is a better system, and better systems win over time.

Now, again, I’m not familiar, that familiar with Dell, but I have the impression that Dell is a very low-cost operation, enormously efficient, you know, very low amounts of inventory, and, you know, I would, I would hate to compete with them. The, if they can, if they turn out a decent competitive product at the best price, you know, that system, that system will win. You know, Charlie is a director of, of Costco, and Costco and Walmart figured out ways to do things at lesser costs that people needed, where people spent money in big quantity, and those two companies are winning. So we have a terrific marketing operation, a traffic insurance operation, in GEICO, and in my view it will grow very, very substantially. And we have a very tough competitor and Progressive, because they’ve seen how well our model works, and they in effect have shifted over. I mean, they’re not totally shifted over, but they’ve moved towards a direct operation and away from an agency operation. It’s always a good idea to go with a low-cost producer over time. I mean, you could, you can mess it up in other ways, but, but being a low-cost producer of something that’s essential to people can, going to be a very good business, usually. Charlie?

Charlie Munger [03:46:54] Yeah, you’ve chosen a wonderful field, and if you fail in it, it’s your own fault.

Warren Buffett [03:47:00] I should say also that, that those nine words, they came from Ben Graham. They didn’t come from me. But Ben, Ben said those, and they, they are very important words, although they tie in with some other that he said. But they were, they are very important words.

Charlie Munger [03:47:17] Warren, I want to make an apology, too, because last night I said that some of our modern business tycoons, and I remembered particularly Armand Hammer, were the type that when they were talking they were lying, and when they were quiet they were stealing. And, and some people got the impression that that was my witticism. That was said a great many decades ago about one of the robber barons.

Warren Buffett [03:47:45] Well, if we start confessing here to the number of quotations we’ve stolen, we’ll be here all afternoon. So let’s, let’s go on to microphone three.

[03:47:56] Shareholder (Matt Lynch, Palo Alto, California): Good afternoon. My name is Matt Lynch, and I’m from Palo Alto, California. Mr. Buffett, a couple of times today you alluded to Google and its co-founders. I was hoping you could share with us your thoughts and reactions to the owner’s manual the co-founders included in Google’s S-1 filed last week, especially in light of the similarities and differences between it and that of Berkshire Hathaway.

Warren Buffett [03:48:24] Well, that’s a real softball for me. The, obviously, I’m, I’m, I’m very pleased that, that the Google, the fellows at Google decided, and they say they, it was, I think they used the word inspired by the, by the Berkshire owner’s manual. And, you know, it obviously pleases us enormously that, that other people think that it’s a good idea to talk to their owners, or in their case their perspective owners, in a very straightforward manner. If you buy into Google having read their owner’s manual, you know, you will, I think you’ll know the kind of people you’re associating with. You’ll know what they will do and won’t do. It’s the kind of thing that one person would say to another if you were setting up a partnership, and you would, you said, you know, I’d like you to join me in a partnership, I need your money, and here’s the way we’re going to do business. And I, I think more companies, obviously I think more companies ought to do it. It’s been simple for us at Berkshire. We’ve had these principles in mind for a long time, and we really want people to understand those principles before they join with us. And the Google fellows, in a very straightforward manner, I, you know, I liked, I like their pros. You know, doesn’t mean I agree with every idea they have, but I, you know, I do know what ideas they do have, and I, I hope, I hope more companies sign on for that sort of thing. Charlie?

Charlie Munger [03:49:56] Well, you know, but most of the world does not in any way imitate Berkshire Hathaway. This is a quirky few. It may look, there may be 19,500 of you that came, but it’s still a quirky few by the standards of the country. And what’s interesting about Google is the, those two guys who created that are two of the smartest young men in the whole country, and it’s much more fun to be copied by people that smart than… We even think they were smarter than we thought they were last week. We now think they’re a lot smarter. It could be a lot of fun to watch that. I would, and my guess is that their annual reports are going to make very good reading. They’re actually going to alternate the two of them in writing the reports, and I think you’ll know a lot about them and a lot about their business if you read it. Although they had an interesting, as I remember, they had an interesting sentence or two in there which I admired also, where they said that, you know, certain of the things that might affect their business prospects really would be better left unsaid in terms of competition and so on, and if so, they weren’t going to tell you. I kind of enjoyed that.

Warren Buffett [03:51:17] Number four, please.

[03:51:18] Shareholder (Chad Bliss, Lincoln, Nebraska): Thanks, Warren. Thanks. My question, my name is Chad Bliss, Lincoln, Nebraska. My question pertains to MidAmerican Energy in the Home Service division. You said earlier that you would continue buying, you know, companies in the real estate industry. Given the growth and for sale by owners, discount brokers, also maybe even banks now, do you think the current business model of Home Services is sustainable, or do you think commissions need to be lowered?

Warren Buffett [03:51:48] Yeah, I really do think it’s sustainable. It’s a good question. In fact, I forget where I saw the article a few weeks ago, maybe on the Sunday New York Times, about Barry Diller’s interest, I think through LendingTree, on the internet, and there have been a lot of real estate sales related operations that have been on the internet, and the internet is a threat to any business, including real estate brokerage. But, you know, when I think about the process of buying a home and the degree of personal involvement involved in that, you know, that for sale by owner, they call them FSBOs in the business, I remember talking with my friend Chuck Peterson about that 50 years ago, and FSBOs were with us then and FSBOs are with us now.

But my guess is that a very significant percentage of home transactions 30 years from now will be done through a pipeline that, and through a distribution mechanism or brokerage mechanism like exists now. I do not see it changing dramatically, although there are people, they’re going to try and change it dramatically, so you’ve got competitors. But I love the idea of expanding Home Services. Charlie?

Charlie Munger [03:53:20] Well, you tried to change it once yourself dramatically, right here in Omaha, and you fell on your ass.

Warren Buffett [03:53:28] His memory is better than mine.

Charlie Munger [03:53:31] He tried to take away the, a good part of the home advertising business from the World-Herald to, you know, your then little newspaper, right?

Warren Buffett [03:53:44] It was very thin. Yeah, yeah.

Charlie Munger [03:53:47] And it didn’t work worth a damn.

Warren Buffett [03:53:50] Yeah. I, that’s the last time I call on him. The, let’s go to number five.

[03:53:58] Shareholder (Tim Medley, Jackson, Mississippi): Mr. Buffett, Mr. Munger, I’m Tim Medley from Jackson, Mississippi. Recently Mr. Philip Fisher died. At this meeting many years ago, you, Mr. Buffett, mentioned your fondness for chapters 8 and 20 of The Intelligent Investor, the first edition of Security Analysis, and you said Phil Fisher’s first two books. And you, Mr. Munger, have also been complimentary of Mr. Fisher’s writings and investment approach. I wonder if the two of you would tell us of your experiences with Mr. Fisher, the circumstances of your meeting, etc., and did his writings or your discussions with him starts you thinking about the idea of the great business or the franchise company, or was it simply an affirmation of thoughts which you had already begun to have? And anything else you would like to say about Mr. Fisher.

Warren Buffett [03:55:00] Yeah, Phil Fisher was a great man. He died maybe a month ago or thereabouts, and well into his 90s. His first book, and I believe it was Common Stocks and Uncommon Profits, was written in 1958, and the second book was written a few years later. Those two books were terrific books, and as with Ben Graham, you could really get it all by reading the books. I met Phil Fisher just once, and it was great. I enjoyed it, I loved it, it was nice to me. But similarly, actually, to my experiences with Ben Graham, where I worked for him, I took his class and everything else, it was in the books.

I mean, they were such good writers and their thoughts were so clear that you didn’t need to meet him personally. I enjoyed meeting him personally, obviously, but they got it across in words. And the only time I met Phil was sometime after that 1962 book or whatever it was, ’61 or ’62, and I was in San Francisco, I think it was in the Russ Building, I may be wrong on that, and I just went there. I used to do that all the time when I was younger, and I’d go to New York and I just dropped in on all kinds of people, and I guess they thought because I was from Omaha that, you know, one time and they’d be rid of me. So, and I would usually get in to see him. And Phil, I did that with Phil, and it was extraordinarily nice to me. But it wasn’t, I gained new ideas, though, however, by meeting him, because I’d already read it in his books.

And Charlie, actually, I met Charlie in 1959, and Charlie was sort of preaching the Fisher doctrine also to me, a little different form, but his ideas paralleled those of Phil. So I was sort of getting it from both sides. That made a lot of sense to me. I don’t know what Charlie’s experiences were with feldman.

Charlie Munger [03:57:09] Well, I always like it when somebody who’s attractive to me agrees with me, and therefore I’ve got very fond memories of Phil Fisher. The basic idea of that, it was hard to find good stocks and it was hard to find good investments, and you wanted to be in good investments, and therefore you just find a few of them that you knew a lot about and concentrate on those, seemed to me such an obviously good idea. And indeed it’s proved to be an obviously good idea. Yet 98% of the investing world doesn’t follow it.

Warren Buffett [03:57:49] That’s been good for us. It’s been good for you. We’ll go to number six, please.

[03:57:56] Shareholder (Stan Leopard, Menlo Park, California): Good afternoon. My name is Stan Leopard, and I’m from Menlo Park, California. I’m very pleased to be here, Warren and Charlie. I first heard about you, Warren, in the late ’80s and began reading your writings. Unfortunately, I didn’t invest until the late ’90s. You have shaped my business thinking, and as I listen to you and as I continue to read what you write and the things you recommend to read, it continues to shape my thinking. My questions about compensation, and I’ve seen your writing and I heard the earlier comments today, and they still leave me as a guy who is a business owner not quite sure how to act to design compensation for managers.

For most of my career I’ve been the senior manager in my businesses, but now I’m in a situation where I’m looking to own a majority interest of businesses that I don’t manage every day directly, and I’m very concerned with this compensation issue. I think about things like return on equity or growth or risk or like that, but if you could speak a little more towards the specific of how you approach the getting it to the right things to measure and incent, I’d appreciate that.

Warren Buffett [03:59:15] Yeah, it’s a very good question, and it’s, you know, there is no formula that applies across all industries or businesses. You take something like return on equity. You know, if you pay way too much for the business that you buy, the person who runs it’s going to get a lousy return on your equity, and they may get a good return on the tangible assets employed in the business, but your purchase price may defeat them in terms of earning good returns if you based it on earnings on tangible equity. You know, there are businesses, like a network television station, where, you know, if you have an idiot nephew, you can put them in charge and they’ll earn huge returns on equity as long as they manage to stay away from the office.

So it’s, and there are other business where you have to be a genius turn 7% or 8% returns on equities. So there is no single yardstick. To have a fair compensation system, both you and the manager have to really understand the economics of the business. In some businesses the amount of capital employed is all important. In some businesses the amount of capital employed doesn’t mean anything. So we have certain businesses where we have charges for capital and all of that, and where we have other businesses where that would just be an exercise to go through and it wouldn’t really change any results anyway. We have a great preference for making them simple. I mean, we concentrate on the variables that count to us, and then we try to put that against the backdrop of the competitive nature of the economic, the true economics of the business they’re in, and really reward where they’re adding value, even if that value is from a very low base in a lousy business, and we make it the base very high if they’re in a very easy business.

And it hasn’t been a problem, but I would say it would have been an enormous problem if we brought in some compensation consultants, because they would have wanted something that would spread across the whole group, and it would have all kinds of variables, and they particularly would have wanted something that they would have had to come in every year and redo in some ways so that they would have had a continuing stream of income. You know, if I knew what kind of a business you were, we’re looking at, it’s easier to talk about what kind of a system to have. If you had a group of television stations, just to pick an example, let’s say they were network television station, all of a reasonable size, you know, you would probably figure that a chimpanzee could run the place and have 35% pre-tax margins, and you might want to pay for performance above some number like that.

But there’s, it’s silly to have something that starts at 10% or 15% when you do that, and a lousy manager will always suggest an arrangement like that. Charlie and I’ve seen all kinds of compensation arrangements where basically you get paid for showing up, but they try to make it look, by constructing some mathematics around it, like you really had to achieve something. But in the end, if you get a great manager, you want to pay them very well. You know, we’ve got great managers, for example, at a place like MidAmerican, and somebody mentioned that there’s a big carrot out them, out there for them if they achieve the results that we’ve set out, and that will be a check I’ll be very happy to write. Charlie?

Charlie Munger [04:02:56] Yeah, if you want to read one book that will demonstrate really shrewd compensation systems in the whole chain of small businesses, read the autobiography of Les Schwab, who had a bunch of tire shops, has a bunch of tire shops all over the Northwest, and he made a huge fortune in one of the world’s really difficult businesses by having shrewd systems. And he can tell you a lot better than we can, and he worked that out himself. I mean, it’s an interesting book. And, you know, selling tires, how do you make any money doing that? And hundreds of millions selling tires.

Warren Buffett [04:03:37] Yeah, yeah, it’s, and people like Sam Walton. I mean, the compensation system, I will guarantee you, at Walmart, or Charlie’s involved in Costco, they’re going to be rational, because you had very rational people running them, and they wanted, they wanted to get the best, they wanted to attract good managers and they wanted to get the best out of them, and they had no use in paying for mediocrity. And that, but that doesn’t require a knowledge of the business. I mean, you don’t want to let, if you don’t understand a business, you don’t, you’re going to have a problem with both the manager and the consultant in terms of getting flim-flammed on how you pay people. Number seven.

[04:04:26] Shareholder (Martin Krawitz, Sydney, Australia): Good day. My name is Martin Krawitz. I’m a shareholder from Sydney, Australia, and thank you so much for some of your wonderful hospitality. How we, we’ve had a chance to get on some of Omaha’s 65 golf courses, and it’s just great being in the second best country in the world. My question to you, sir, is regarding to IPOs. We had one of the authors about a book on yourself visit us in Sydney last year, and apparently you dislike IPOs. My question is, there are some really poor businesses that try and get passed off, but there are some good ones. There’s some government privatisations or decentralizations, the demographics of baby boomers, and we have some friends wanting to exit some really good businesses.

Could we as investors and Berkshire Hathaway not apply some of your disciplines to look at investing in some of these? And finally, would you answer be different in its applicability to Berkshire Hathaway as a company as opposed to us as investors? Thank you, sir.

Warren Buffett [04:05:48] Charlie?

Charlie Munger [04:05:49] The first question, is it entirely possible that you could use our mental models to find good things to buy among IPOs? The answer is sure. There are a zillion IPOs every year, and buried in those IPOs, I’m sure there’s a, there are a few senses that a really intelligent person could find and pounce on. So welcome on the, but the average person buying IPOs is going to get creamed. So if you’re talented enough, why, sure, that will work. The second question, I forget, about the government offering services, about government spin-offs, given the spotlight again. What was the second question?

[04:06:45] Shareholder (Martin Krawitz, Sydney, Australia): It was just, would the attitude of Berkshire Hathaway be different as opposed to investors? Thank you.

Charlie Munger [04:06:54] Yeah, because the IPOs are normally small enough so that they won’t work for us, or they’re high-tech where we couldn’t understand them. And so, by and large, if Warren is looking at them, I don’t know about it.

Warren Buffett [04:07:13] Yeah, they, I mentioned earlier how you, an auction market prevailing in the stock market will offer up extraordinary bargains sometimes, because somebody will sell a half a percent or 1% of a company at a price that may be a quarter of what it’s worth, whereas in negotiated deals you don’t get that. An IPO situation more closely approximates a negotiated deal. I mean, the seller decides one to come to market in most cases, and they don’t pick a time necessarily that’s good for you. So it has, I think it’s way less likely that in scanning a list of 100 securities that are trading in the auction market, well, in the 100 IPOs, if you scan 100 IPOs, you’re going to come up with something cheaper than scanning 100 companies that are already trading in the auction market.

It is more of a negotiated sale, and negotiated transactions are very hard to get bargains. If you take the houses in Omaha, you know, somebody that lives next door to somebody who sold their house for 80,000 or dollars, and their house is more or less comparable, they’re not going to sell it for 50. It just doesn’t happen. People are, it’s too important an asset and they’re cognizant of what it brings, what is being brought for similar properties. That’s what happens in negotiated sales. Now, if on the other hand there was some, a whole bunch of entities that owned 1% of each house in Omaha, and you had an auction market in those one percentage points, they might sell it damn near anything, and occasionally they sell at crazy prices. So you’re way, in my view, you’re way more likely to get incredible bargains in an auction market. It’s just the nature of things. The IPO is closer. Sometimes there will be IPOs in terrible markets and they may come very cheap, but by and large that is not when IPOs come. They come when the seller thinks that the market is ready for them, and they come, they come with an informed seller thinking it’s a pretty good time to go public. And, you know, that you’ll make better buys, in my view, in an auction market. Number eight.

[04:09:29] Shareholder (Mark Stender, San Francisco): Good afternoon, Mr. Buffett, Mr. Munger. My name is Mark Stender from San Francisco. My question involves, if you live in California, which I understand you do some time of the year, it’s almost mandatory that you shop at Whole Foods Markets. They sell a lot of organic food there, and I was wondering if anyone ever tried to feed you organic food or organic food stock.

Warren Buffett [04:10:00] I’ve never been near the place, but Charlie, Charlie I’ve never thought of as a health nut, but he may have some comment to make on this, being a Californian.

Charlie Munger [04:10:14] No, my idea of a good place to shop is Costco. Costco has these heavily marbled fillet steaks in the finest grade, and the idea of eating a little whole grain whatever, or washing it down with some carrot juice, has just never appealed to me.

Warren Buffett [04:10:35] We don’t have a lot of arguments between the two of us about where to eat. Number nine.

[04:10:42] Shareholder (Sherman Silber, St. Louis): Hello, thank you. I’m Sherman Silber from St. Louis. I’m a fertility doctor in Saint Louis. We kind of view ourselves as the Berkshire Hathaway of infertility treatment. We don’t know anything really about business, we’re doctors and scientists. And so first I’d just like to say I really appreciate the people that you have on your board and would like to keep it that way, because we do know a lot about character, and I’m happy to have our savings safe with you and the people of character that represent the company.

I just had an opportunity a couple of weeks ago, I was talking to one of the former managers of the Fidelity Magellan Fund, managed huge amounts of money, and he never really met you, and I was saying I may have a chance to ask Warren Buffett and Charlie Munger a question. What would that question be? I wanted to have some idea of something intelligent I could ask business-wise. And he thought, if he had the opportunity to talk to you, the best thing is to give you what would sound like a softball question, because you could maybe bring more profoundness to this than we hear usually. What, in view of the Iraq war, consumer debt that’s increasing, declining job growth, declining pay in the jobs that are growing, prospects of increased interest rates, he has this view that the next five to ten years are going to be very difficult. What would your view be about this, the investment future for the next five to ten years, in view of all these negative factors going on?

Charlie Munger [04:12:35] That’s too soft for me. I think Warren should. (Laughter)

Warren Buffett [04:12:39] Well, I would say that at any given point in history, including when stocks were their cheapest, you could find an equally impressive number of negative factors. I mean, you can, you could have sat down in 1974, when stocks were screaming bargains, and you could have written down all kinds of things that would have caused you to say, you know, the future is just going to be terrible. And similarly at the top, you know, or anytime, you can write down a large list of things that would be quite on the bullish side. We don’t pay, we really don’t pay any attention to that sort of thing. I mean, we have, you might say that our underlying premise, and I think it’s a pretty sound underlying premise, is that this country will do very well, and in particular it will do well for business. Businesses done very well.

You know, the Dow went from 66 to 10,000-plus in the 100 years of the 20th century, and we had two world wars and nuclear bombs and flu epidemics and, you name it, Cold War. There’s always, there’s always problems in the future. There are always opportunities in the future. And in this country the opportunities have won out over the problems over time, and I think they will continue to do so. Absent weapons of mass destruction, which is another question, and business won’t make much difference anything really drastic happens along that line. So we don’t, I don’t, I can’t remember any discussions, Charlie, that I’ve had, ever, going back to 1959, that where we would have come to the conclusion at the end of them that we would have passed on a great business opportunity, a business to buy, because of external conditions. Nor did we ever buy anything that we thought was mediocre simply because we thought the world was going to be wonderful.

It won’t be the American economy, in my view, the dozen investors over a 5- or 10- or 20-year period. It will be the investors themselves. If you look at the record of the 20th century, you’d say, how can anybody have missed, you know, and owning equities during that time? And yet, you know, we had all kinds of people wiped out. You know, in the ’29-’32 period, we had all kinds of things that were bad. But you, if you would just own stocks right straight through, didn’t leverage them, you know, you would, you’d have gotten a perfectly decent return. So we’re unaffected, in essence, by the variables you mentioned. Just show us a good business tomorrow and we’ll jump at the hook. Charlie?

Charlie Munger [04:15:38] Yeah, I think, but it’s also true that both of us have said at various times over the last three years that we wouldn’t be at all surprised if professionally invested money in America had a pretty modest result over a fairly extended period of the future, compared to the very dramatically high returns that it had achieved up to about three years ago. And so far that’s been proved out to be pretty much right. Certain stretches are easier than other stretches.

Warren Buffett [04:16:08] Yeah, our expectations were more modest than most people’s a few years ago. We didn’t say the world was coming to an end or anything. We just said that people have gone crazy in certain sectors, and that anybody that thought that you could, you know, sit at home and day trade and make double-digit returns over time, or do anything that you were entitled to that, you know, by just sticking a little money in your 401(k) or something, was really living in a fool’s paradise. But that was never accompanied by any predictions of disaster for the American economy as a whole or for American business as a whole. It’s, people get crazy notions from time to time in financial markets, and we’ve commented on this earlier, but they just believe things that there’s, it’s hard to understand how they can believe. Now, so some extent they get sold out by other people. But American business really is, has never let investors down into the group, but investors have done themselves in quite frequently. Number 10.

[04:17:19] Shareholder (Sam Kidston, Cambridge, Massachusetts): Sam Kidston from Cambridge, Massachusetts. I’d like you to ask to discuss the similarities and differences between what you do in your reinsurance operations and what Gen Re did in its securities division, as it would seem that reinsurance is often a form of weather derivative. I would also like to ask you why you are so comfortable writing what appears to be one type of derivative and so uncomfortable writing another. Thank you.

Warren Buffett [04:18:01] Yeah, the derivative contracts that Gen Re wrote in Gen Re Securities, I would say war very little, more very little relation to the insurance business as we see it. I mean, we are ensuring against events that people either can’t or aren’t willing to take on the risks themselves. In the derivatives business, a lot of that was speculative activity of one short or another. The more complex the arrangements were, the easier it was to claim that large profits were being made, when maybe large losses really awaited you over time. They were created transactions without much economic necessity in a great many cases. They were just facilitating speculation. Insurance deals with taking on risks that people incur in their business or personal life that they don’t want to bear themselves or that they’re unable to bear themselves. I, it was very little connection between the business.

Charlie Munger [04:19:21] I think that in going into the business they dreamt up a lot of reasons for it. You know, they said they’re both in the risk business and their clients were going to demand it. It is chock full of clauses saying that if one party’s credit gets downgraded by a rating agency, they have to start posting collateral, and that’s just like a margin account. And when you sign pieces of paper like that, you can go absolutely broke into default and catastrophe and having other people liquidating your positions under distressed conditions, etc., etc. So there’s a lot of irresponsible mechanics. In attempting to protect themselves, they’ve introduced this enormous instability into the system through all these clauses about collateral posting, and nobody seems to recognize what a disaster of a system they’ve created in an attempt to make each party feel safer. It’s a demented system. And you don’t get properly paid in most cases for playing the game, and therefore we’re not in it.

Warren Buffett [04:20:34] Absent the ability to raise new capital at the time, and who knows whether that would have been, they’ve been able to or not, Gen Re, which had been rated triple-A, it still is because Berkshire’s involved, but which had been traded AAA, could well have run into really terrible financial difficulty post September 11th, particularly if they’d fully recognized the liabilities that they’d already incurred but not fully recognized at that time, because their capital would have shrunk. They would have had way more inequities, which would have shrunk further, and who knows how far, you know, at the time, how far it would have gone. Plus they would have had, in my view, they would have been downgraded quite significantly, and that might well have triggered things in their derivatives activities which would have required coming up with loads of cash. It was not built to last, and it is now built to last.

But I would say that that threat exists with other financial institutions as well. But I think many of the CEOs, or some of them anyway, I should say, don’t really fully comprehend that when you get margin calls for huge amounts of money, you know, it only has to be one day when you can’t meet it. That almost happened, if you go back to October of 1987. There was a large wire transfer that didn’t make it to the, for a while didn’t make it to the clearinghouse at the, in Chicago, and that came close to hauling the whole system at the time, and we were very close to closing the exchange, and a lot of things would have unraveled. The money finally showed up, but it’s dangerous to have a system where people are depending on billions of dollars coming in from other people.

Well, we had that on Salomon on that Sunday in 1991. If Salomon had gone bankrupt the next day, you would have had people on the other side of 1.2 trillion of notional amount of something like that of derivatives who would have had a contract with the party that, where they would have been dealing with a bankruptcy court. You would have all kinds of security settlements that wouldn’t necessarily have settled. You would have all kinds of confusion, and believe me, it would have been huge at that time, between what was going on in Japan, what was going on in the UK and what was going the United States, because the counts were all intermingled. As a matter of fact, Salomon was a, was banking, was running a bank in Germany, where, which took on large amounts of deposits from individuals and just loaned it all to Salomon. So it would have had a receivable from a bankrupt company and owed money to I don’t know how many German depositors.

There are all kinds of things that would have come out at that time, and who knows what the effect would be on the system. You don’t need to put more and more of those kind of linkages and strains on an economic system that already is pretty damn leveraged. Charlie, got any further thoughts? We love talking about disaster, so you don’t, don’t stop us.

Charlie Munger [04:24:17] It’s simply amazing what goes on in these seemingly rational places. Salomon was at least as disciplined and honorable and rational as the other leading investment banks, and yet toward the end of our pleasant period, Salomon was begging for new invest, investment banking business from Maxwell, and his nickname was the Bouncing Czech. Now, and of course it wasn’t very much after that then he committed suicide after massive embezzlements of pension funds and a huge collapse. And now, you think of a guy’s nickname was the Bouncing Czech, you wouldn’t be madly seeking his investment banking business, but all the leading investment banks were.

Warren Buffett [04:25:03] Yeah, I’m fuzzy on it now, but actually the morning of the day was discovered to be bobbing around in the ocean, the, I think at Salomon we had transferred a bunch of money to somebody over in Germany or Switzerland, and we were supposed to get some more money back that afternoon. And this is basically correct, I may be a little bit off on the details, but the money that got sent got sent, but the money that was to be received did not get received. And then we went over to England and tried to collect it from his sons, and we gets stiff-armed in one way or another. I mean, we got what we deserved, frankly, in a transaction like that. But to the investment banker involved, his earnings that year was, were going to be affected in a significant way by whether he wrote a ticket or two more with Maxwell, and, you know, in the end, that carried the day.

And it’s very hard to control people when their income depends on bringing in dubious people into the door. They care enormously about it, and you’ve got this big system that doesn’t quite pick up on it. And Charlie’s mentioned before, you know, one of the underwriting clients that came forth that Salomon took on, that professed to be doing wonderful things with money, and it turned out to be a huge fraud. Well, it’s tough to stop. You got dozens and dozens of people running around out there, all thinking about whether, how big their bonus is going to be at the end of the year, and, you know, they are not, they are not inclined to run more hourly checks on who they do business with.

Charlie Munger [04:26:50] That was a wonderful experience. Warren and I and Lou Simpson are all directors of the company, and we are by far the biggest shareholder, and we all said, we should not be doing business with this guy, this is a very dangerous transaction. And they told us it had been approved by the underwriting committee, and of course that settled matters.

And this guy had a neon sign that said “crook” on him, as far as we were concerned. He was waving it vigorously.

Warren Buffett [04:27:19] Yes, but it had been through the underwriting committee. They, the transaction closed, but not financially. I mean, they had the underwriting, but that, but they hadn’t had the financial closing. They caught them on the way to the bank.

Charlie Munger [04:27:32] You’re right. They pulled back just from the edge of the precipice, and this big fraudulent, and of course they got egg all over their faces. That phrase reminds me of, oh, one of the leading lawyers of your, and he said, “Captain of my soul,” he says, “the captain of my fate,” he says, “hell, I don’t even pull an oar.” I mean, here we are, all three of us on the board, are the biggest shareholder, and we can’t even stop one stupid little underwriting.

Warren Buffett [04:28:07] He did go to jail, though, I think, didn’t he?

Charlie Munger [04:28:12] Yes.

Warren Buffett [04:28:12] He claimed to, incidentally, be a huge shareholder, Berkshire Hathaway, and made all this money, and I went to the shareholders list, and admittedly he could have had a street name someplace, but it was a big quantity claimed. We, I couldn’t find any record in any place. But he did have some kind of a letter from an accounting firm that was backing him up. Didn’t back him up all the way, though, it turned out. Number 11, blazing.

[04:28:39] Shareholder (Manuel Fernandez, Mexico City, Mexico): Good afternoon. I’m Manuel Fernandez from Mexico City, Mexico, and I want to thank you for your valuable lessons on how to be good partners, you, and for exporting some good ideas and principles to the world for free. My simple question is, do you think it makes sense for individual investors to invest a part of their capital in hedge funds or fund of hedge funds, somewhat like the $600 million investment Berkshire made in Value Capital?

Warren Buffett [04:29:08] Yeah, I would say that people that are now investing in hedge funds in aggregate are going to be disappointed. You don’t get smarter because you’re running something called a hedge fund, or something called private equity, or something, you know, called anything, an LBO fund. But what you do gain periodically is the ability to merchandise those things. I mean, they’re, there are fads in Wall Street, and Wall Street will sell what it can sell. Just remember that. You know, that may be as good as what the fellow quoted up in the upper levels there. And the hedge fund right now is in the midst of a fad. It’s distinguished not neces, not by the ability to make more money, it’s distinguished by the extraordinary amount of fees that are collected.

And believe me, if the world on $600 billion of money is paying 2% fees and a percentage of the profits, and the losers go out of existence and the winners continue for a while and take money off the table, it is not going to be a great experience in aggregate for investors. There, obviously, there are a few smart, honest people out there running funds, and they can, they will do quite well. But if you buy the, buy them across the board, in my view, you’re going to get a bad result. Charlie?

Charlie Munger [04:30:34] Yeah, why would you want to invest with a guy whose basic thought process runs something like this: if a second layer of fees on top of a first layer of substantial fees is good for an investor, then a third layer of fees must be better yet? Why would you invest with somebody with a proposition like that?

Warren Buffett [04:30:58] Just the idea of taking 2%, you know, plus percentages on top of that. I mean, that reflects, you know, it may be what the traffic can bear, you know, Collis P. Huntington style, but that reflects an attitude toward people that we tend to regard as partners, investors. I just, I think it’s a basically unfair type of arrangement, and I don’t like getting in, in general. I think it’s a mistake to get in with people who propose unfair arrangements that, you know, they in effect, they’re getting, probably getting four times standard fees to begin with, and then on top of that they say, we want part of the action. And I would guess in many of those cases that they don’t have all of their own money in the fund themselves. Maybe they have a substantial sum outside.

Charlie and I both run, ran partnerships in the ’60s and ’50s with me, and into the ’70s with him, that would generally be classified as hedge funds. They had the compensation arrangement somewhat similar to, although not like they are now, and we did some, they had some similarities. But I don’t think, I don’t think we had quite the attitude toward the people were trying to, that were asking to join us, that the present managers have. It’s, as Charlie says, the fund of funds types stuff, I mean, it’s really sort of unbelievable, just piling on layer after layer on cost. It doesn’t make the companies that are underlying these stocks they buy any better. I mean, it, and believe me, people don’t become a genius because you walk into some office and it says hedge funds on the door. I mean, they’re, what they may be very good at is marketing. In fact, if they’re good at marketing, they don’t have to be good at anything else. Number 12.

[04:33:02] Shareholder (Arturo Brulenborg, Washington, D.C.): My name is Arturo Brulenborg. I’m from Washington, D.C. I’ll be graduating from Harvard College in June and beginning a career in value investing, so I sure hope we’re all right and thinking that this century will be just as good as the last for value investors. You’ve been doing this since you were my age, if not younger, so I’m wondering what habit or habits have contributed most to your ability to continue learning and improving your investment decisions in a changing business and financial environment.

Warren Buffett [04:33:32] I would say that, at least in my case, I haven’t been continually learning in terms of the basic principles. You always learn a little more about given techniques, or we learn, you know, I learned more about some industries over time, and therefore maybe I’ve widened the universe in which I can operate, although more funds narrows it back down, unfortunately. But I know more about businesses than I knew 20 years ago or 40 years ago. I haven’t really changed the principles. The last change, the basic principles are still Ben Graham. They were affected in a significant way by Charlie and Phil Fisher in terms of looking at the better businesses, but they, but I didn’t leave any of, I didn’t leave Graham behind on that, and I really haven’t learned any new fundamental principles. But I may have learned a little bit more about how business operates over time.

And there’s really nothing, I mean, you ought to get a investment framework that comes straight from, in my view, from The Intelligent Investor and from Phil Fisher, more from The Intelligent Investor, actually. And then I think you ought to learn everything you can about industries and businesses that, where you think you have the ability to get your mind around them if you work at them. And with that arsenal, you’ll do very well, and if you’ve got the temperament for the business. Charlie?

Charlie Munger [04:35:01] Yeah, of course, I’ve watched Warren all these decades, and he’s learned a hell of a lot, even the last 20 or 30 years. So it’s a game of continuing to learn. And he can denigrate this little frou-frou that enables him to pick the biggest oil company in China, or this or that, but those basic principles alone that he knew a long time ago wouldn’t have given him the ability to make the recent investment decisions as well as he’s made them. It’s a lifelong game, and if you don’t keep learning, other people will pass you by.

Warren Buffett [04:35:39] I would say temperament so still is the most important one, of course.

Charlie Munger [04:35:44] Yeah, but temperament alone won’t do it.

Warren Buffett [04:35:47] No.

Charlie Munger [04:35:47] Temperament, you have to have the temperament and the right basic idea, and then you have to keep at it with a lot of curiosity for a long, long time.

Warren Buffett [04:35:58] But you don’t have to be blindingly, and have any blinding insights, or have a high IQ to look at a PetroChina, for example. And you know it, I mean, it’s a, when you get a, you know, a company that is doing 2.5 million barrels a day, that’s 3.5% of the world, 3% of the world’s oil production, you know, and they’re selling based on U.S. prices, using WTI, you know, as West Texas Intermediate, as a base price, and where they have a significant part of the marketing and refining in a country, the tax rates 30%, they say they’re going to pay out 45% eu in dividends, don’t have unusual amounts of leverage. If you’re buying something like that at well under half, what, maybe a third of what comparable oil companies are selling for, that’s not high level stuff. I mean, you have to read some, you have to be willing to read the reports, and, but I enjoy doing that. But you wouldn’t say that requires any high level insights or anything. Charlie?

Charlie Munger [04:37:09] Well, when you were buying that block of stock, nobody else to speak of was buying.

Warren Buffett [04:37:14] Thank heavens.

Charlie Munger [04:37:15] The insights can’t have been all that common.

Warren Buffett [04:37:17] No.

Charlie Munger [04:37:18] I think that takes a certain amount of what an old Omaha friend used to call uncommon sense. He used to say there is no common sense, when people say common sense, they mean uncommon sense. Part of it, I think, is being able to tune out folly, is distinguished from recognizing wisdom. And if you just got whole categories of things you just bat away, so your brain isn’t cluttered with them, then you’re better able to pick up a few sensible things to do.

Warren Buffett [04:37:51] Yeah, we don’t consider many stupid things, you know, and we get rid of them fast. And in fact, people get irritated with us because they’ll call us, and when they’re in the middle of the first sentence, we’ll just, don’t, forget it, you know. And we don’t, we can see it coming. You know, that’s the way, actually, the mind was. There was a great article in The New Yorker magazine 30 years ago or so, a little more than that was when the Fischer-Spassky chess matches were going on, and it got into the speculation of, with the humans being able to take on computers in chess. And, you know, here were these computers doing hundreds of thousands of calculations a second, and they said, how can the human mind, when all you’re really looking at is the future, you know, the results from various moves in the future, how can a human mind deal with a computer that’s thinking at speeds that are unbelievable?

And of course they examine the subject some, and a mind like, well, in fact all minds, but some much better than others, but a Fischer or Spassky essentially was eliminating about 99.99% of the possibilities without even thinking about it. So it wasn’t that they could out-think the computer in terms of speed, but they had this ability in what you might call grouping or exclusion, where essentially they just got right down to the few possibilities, out of these zillions of possibilities, that really had any chance of success, and getting rid of the nonsense. I mean, just figuring that, you know, people start calling you and saying, I’ve got this great wonderful idea. Don’t spend 10 minutes, you know, once you know in the first sentence that it isn’t a great wonderful idea. Don’t be polite, go through the whole process. And Charlie and I are pretty good at that. We can hang up very fast.

Charlie Munger [04:39:49] Well, there you have it. All you’ve got to do is go at it in the way that Vasily Smyslov did when he was the world champion and of chess, and just do the same thing in investments.

Warren Buffett [04:40:03] Okay, microphone one.

[04:40:04] Shareholder (Richard Azar, Trinidad, West Indies): Good afternoon, Mr. Buffett, Mr. Munger. My name is Richard Azar. I’m from Trinidad in the West Indies. You guys have been very generous with your intellect over the years, and it’s been a huge help to me in my personal and financial life. I weathered if it was appropriate for me to describe the methodology in which I’m trying to determine the range of Berkshire’s intrinsic value, and if you can guide me on if my mythology is flawed or is reasonably accurate.

Warren Buffett [04:40:51] If it doesn’t take too long, we’ll be glad to, although I think I know the answer already.

[04:41:02] Shareholder (Richard Azar, Trinidad, West Indies): Okay. We ended 2003 with about $5.422 billion of operating earnings. I estimated our look-through earnings to be approximately $915 million, so in total that was about $6.337 billion of estimated look-through earnings. I knew that we spent a billion two on capex, and our net depreciation on tangible assets was $829 million, so there’s a difference there of $173 million, and we spent more on capex over the appreciation over the last few years. But in extrapolating out 20 years, I thought I might be kidding myself to ascertaining the differences between capex and depreciation, and I’m using look-through earnings as a rough proxy for distributable earnings.

And I’ve assumed that Berkshire can grow its look-through earnings at 15% per annum from years one to five, and at 10% per annum from years six to twenty, and the business will stop growing after year twenty, resulting in a 7% coupon from year 21 onwards. I discounted the cumulative flows in years 1 to 20 by 7%, and I discounted the terminal value by 7%. I added the two together to get what I thought was the intrinsic value of Berkshire’s cash stream. I knocked off a $103 billion of liabilities and minority interests. I divided by 537,000 shares to arrive at what I thought was a conservative calculation of the range of Berkshire’s intrinsic value. Am I off the mark, or is that the sort of mythology you might use yourself?

Warren Buffett [04:43:10] Well, you’ve done your homework. (Laughter) The line of thinking is correct. It just depends on what variables you plug in, and then we might have different ideas on variables, and neither one of us knows. But the approach in general, the approach of trying to figure out distributable cash over a period of time, the business today is worth the present value at some number, you’re using 7%, but the question, what number to use, but it’s worth the present value of all the cash it can distribute between now and judgment day. And if cash can be retained and it’s at a rate higher, it produces at a rate higher than your discount rate, obviously you’ll get some benefit from that retention.

But, you know, I would say that your assumptions about capex, and related to depreciation, I would expect capex to be on average a little more than depreciation unless we run into highly inflationary times. But of course we have to keep buying businesses and using the capital in the business that we retain. If we retain those earnings, we have to use that to buy more businesses, and then the question is what kind of returns can we expect on those. I don’t, I don’t quarrel with, I don’t quarrel with the approach you’re using, but, you know, everybody has to do their own equation and plug in some numbers. And I think we might settle for lower numbers on earnings gains than you’ve postulated, because we’re very large and it’s, it gets harder all the time to deploy the kind of funds that keep flowing into Omaha. Charlie?

Charlie Munger [04:45:02] Yeah, and you shouldn’t necessarily get overly excited about last year, as it was a very unusual year when everything worked together pretty darn well.

Warren Buffett [04:45:16] Except interest rates on…

Charlie Munger [04:45:18] Yeah, well, but a lot worked together very well. The interesting thing about Berkshire’s present valuation is how much cash and cash equivalents it has to do something, and that is a very interesting question: how well are we going to do with this massive amount of investable cash and cats, cash equivalents?

Warren Buffett [04:45:41] Yeah, we should be out working now. That is the test. I mean, we’ve got a bunch of good businesses, we’ve got a lot of money that we’d like to use to buy more good businesses. We may get lucky and deploy that quite rapidly. We may wait a long time. Cash may pile up faster than we can use it, in which case we’ll have to rethink the whole game. But our hope is, and so far we’ve, we feel okay about what’s happened in that, our hope is that we can read, can deploy the money that flows in at, in businesses that are, come close to being as good as the ones that we’ve fought over the years. Number two.

[04:46:28] Shareholder (Whitney Tilson, New York City): Hi, I’m, Mr. Buffett, Mr. Munger, Whitney Tilson, a shareholder from New York City. It’s past three o’clock, and we’ve heard almost nothing about how these great businesses are doing right now, or at least in the first quarter. And I recall at last year’s annual meeting you took the fairly unusual step, at least from my recollection, of putting up slides and actually giving us a preview of how phenomenally the businesses were doing. And I can imagine that if you had the wind to your back a year ago, the situations in the first quarter of this year, you must really, really have the wind at your back. And I was wondering if you can share with some, with us what you can.

Warren Buffett [04:47:08] Well, we can’t give you the speed of the wind. The, we’re going to have the 10-Q out when, Martin, it’s going to be out in a few days, and if we throw out any numbers now or make any commentary, we’d have to put that up on the website, and perhaps even try to cover the nuances in my voice. So I think you’ll just have to wait a few days, and they’ll go up, the figures will go up at that time. And if there are any surprises, there will be surprises then, and everybody will get them at the same time.

Incidentally, we’re going to have a little more trouble in the next year or two, because the, we like to publish everything, all the figures or anything important, if we can do it, we like to do that on Friday night after the close or Saturday morning, so that everybody has an opportunity to look at them and have a maximum amount of time to digest them before trading begins. And the SEC is shortening up reporting times, so that we’re gonna be scrambling just to meet whatever day of the month it is that recording requirements are met. And so we may not, we won’t have the luxury, although we’ll try to do when we can, we won’t have a luxury of picking the Saturday before the due date and being, and targeting that as our release date.

We, you know, when we had 45 days, or what was it, 45? Yeah, 45 days to report, we could pick the Saturday before the 45 days. If that gets down to 30 days, you know, if the 30th day is on a Tuesday, we’re going to be hard put, probably, to get it done by that Tuesday. So we’ll obviously put it out after the close, so people have between four o’clock and the next morning to digest it. But we won’t be able to follow the procedure that we followed today, which we regard as the best procedure of all, giving people close to two day, two days to digest whatever is in the figures. And, but I can’t help it, Whitney, on how the first quarter looks, sir. And Charlie, I don’t think you’ll want to add anything on that way. Okay, number three.

[04:49:27] Shareholder (Justin Fong, California): Hello, Mr. Buffett and Mr. Munger. My name is Justin Fong. I’m 14 years old, from California. This is my fourth consecutive meeting attendance. I write in a book that you prefer talking to young people about life and financial concepts because we still have time to implement them. Can you please share some of the concepts with us? Thank you.

Warren Buffett [04:49:53] I didn’t catch the last product. There’s something about sharing concepts. You want to repeat it?

[04:50:01] Shareholder (Justin Fong, California): You please share the life and financial concepts that you prefer talking to young people.

Charlie Munger [04:50:08] Well, sure. He wants to know your life concepts and financial concepts that are useful to young people.

Warren Buffett [04:50:17] Well, that’s a fairly broad question. But I think the financial concepts, you know, we’ve obviously spelled out in the reports. Charlie’s probably better on the life concepts than I am. It is true that I do believe in spending the time that I spend giving talks or answering questions, doing it with young people. I do, I’m sure, well over a dozen a year. And I just think that obviously young people are more receptive to change, or actually even forming habits that are going to be useful in life. And I think that people underestimate, until they get older, they underestimate just how important habits are, and how difficult they are to change when you’re 45 or 50, and how important it is that you form the right ones when you’re young. But Charlie, what do you have to say on that?

Charlie Munger [04:51:18] Well, all the trite stuff is what works. I mean, you avoid doing the really dumb things, like racing moving trains to the crossing, experimenting with cocaine, risking getting AIDS or other unfortunate ailments. They’re just a lot of standard things that take people down, and you just give those a wide berth. And then you want to develop a good character and good mental habits, and you want to learn from your mistakes, every single one, as you go along. It’s pretty obvious, isn’t it?

Warren Buffett [04:51:58] Yeah, we would say, even though we issue lots of credit cards, I think we’d say, if probably, if I had one piece of advice to give to young people, you know, that across the board, it would be just don’t get in debt. It, the game plays a lot easier if you’re a little bit ahead of the game than if you’re behind the game. And Ben Franklin said that long ago in better terms, which Charlie can recite. But there’s a real difference. I get letters every day from people that are in all kinds of financial trouble, and often it’s health related, which is tragic, but very often it’s, it relates to debt. I mean, they get behind the game and they’re never going to catch up.

And often, it may surprise you, but often I write these bills, they’re very decent people, they’ve just made mistakes, and I just tell them the best course is bankruptcy. I mean, they are not going to catch up, and they should start all over again, and they should never look at a credit card the rest of their life. And, but it would have been better if they’d gotten that advice a little earlier. But it’s very tempting to spend more than you earn. I mean, I, you know, it’s very understandable, but it’s not a good idea.

Charlie Munger [04:53:23] And of course you particularly want to avoid evil or seriously irrational people, particularly if they are attractive members of the opposite sex.

Warren Buffett [04:53:36] Charlie knows more about this. The expert. They, yeah, the, you know, it’s better to hang out with people better than you. I found that very easy to do over the years. But if you, if you’re picking associates, pick out those whose behavior is somewhat better than yours, and you’ll drift in that direction. And similarly, if you hang out with a bad bunch, you’re very likely to find your own behavior worse over time. But all, like Charlie says, that the trite advice, which Ben Franklin was handing out a few hundred years ago, really works. The, you know, just, we’ve said it, but look at the people you like to associate with. You know, what qualities do they have that you can’t have? If you want to look at the people that you can’t stand to be around, what qualities do you have that they have? Can you get rid of them? You can do all of that at a young age. It gets harder as you go along, but it’s not, it’s not very complicated.

Charlie Munger [04:54:38] And my final word of advice would be, if this gives you a little temporary unpopularity in your peer group, the hell with them.

Warren Buffett [04:54:47] And his advice, a little more applicable to me and Charlie, I was reading about a woman that was 103, and they said, “What do you like about being 103?” And she says, “No peer pressure.” We’ll go to number four. (Laughter)

[04:55:11] Shareholder (Mike McGowan, Pasadena, California): Good afternoon. My name is Mike McGowan. I’m from Pasadena, California. Everything you just said seems to apply to precious metals, specifically…

Warren Buffett [04:55:24] I’m sorry, I missed that.

[04:55:27] Shareholder (Mike McGowan, Pasadena, California): Precious metals.

Warren Buffett [04:55:28] Oh, sure.

[04:55:29] Shareholder (Mike McGowan, Pasadena, California): Specifically silver. As I recall, Berkshire Hathaway bought 129.5 million ounces of silver, and at the time you said supply demand fundamentals were good, you saw inflation kicking back, and lots of, lots of other reasons. I’m assuming you still own at least 90 million ounces of that. The problem would be the pricing mechanism. Apparently the COMEX, or at least certain of the managers of the silver price on the COMEX, are in debt, the New York banks and financial institutions are short 400-plus million ounces, and it doesn’t look as if they really want the price to go anywhere. So, given that Berkshire has all of this silver, do you see the price of silver actually trading in a free market at some point, or would you look at shares instead of the physical metal? And otherwise, we’re kind of at the point, I guess, where John Maynard Keynes said the market can remain irrational a lot longer than we can remain solvent.

Warren Buffett [04:56:46] The, we have no comment at all to make on our present position in silver, if any. We may, we could own more, we could own the same, we could own less, we could own none. So, and we won’t comment. We commented one time because the Bank of England asked us to comment, and since it was the only time the Bank of England had ever talked to me, I felt quite flattered. And they, but I would say this: I would disagree very much with your thoughts that the market is in some way rigged or something of the sort. The, I find that most of the people that write, or many of the people that write on gold and silver, tend to have various theories, and some of which are conspiratorial, and there’s always, you know, the selling forward, just doing this and that to the market, or that somebody’s short.

You know, the answer is that there’s plenty of silver above ground, and whether there’s more or less than there was a few years ago in terms of the supply demand since then, I’m not, I’m not 100% sure. It’s tough to figure out what goes on and shine in a lot of things. But I, there’s nothing flawed, in my view, about the market for silver or copper or gold or really any commodity that I can think of that trades in real quantity. Charlie?

Charlie Munger [04:58:21] Yeah, I think it also should be pointed out that you’re asking for the opinions of people who have not particularly distinguished themselves in this arena.

Warren Buffett [04:58:33] He was pointing at me, with good reason. We’ll go to number five.

[04:58:39] Shareholder (Travis Keith, Dallas, Texas): Good afternoon. Travis Keith from Dallas, Texas. The OCC’s quarterly report on bank derivatives shows that Wells Fargo has one of the largest derivatives portfolios of any U.S. bank. In spite of your high profile criticism of derivatives, Berkshire added to its position in Wells Fargo last year. What about Wells Fargo’s derivatives portfolio did you find less objectionable, and what disclosure did you examine in considering the risks of Wells Fargo’s derivatives portfolio?

Warren Buffett [04:59:11] I don’t, I don’t have their report here, but without looking at it, I would be willing to bet that JP Morgan Chase has a derivatives portfolio that’s far, far greater than Wells. I do not think of Wells, I mean, maybe wrong, I do not think of Wells as being a big player. Now, all the big banks have various derivative positions, but I don’t think of Wells as being a big player in the derivative game. And I, you can’t, there is no perfect measurement of the size of a derivative position. I mean, you hear all these huge numbers thrown around, and they sound great, but they tend to exaggerate things in a huge, in a very dramatic way, in terms of trillions of this or that. But so, you know, there can be, you could talk about a billion-dollar notional amount of one kind of derivative, and it could have less danger in it than a $50 million position of, in some other type.

But I really don’t think you’ll find that Wells, particularly compared to a JP Morgan Chase or a Citibank or something of the sort, is a really big derivatives player. And Charlie and I, at least I, and I think Charlie will agree, Wells, I think, is an extraordinarily well-managed bank. I disagree with them violently on expensing of stock options. I mean, Dick Kovacevich, who runs that, and I would have a entirely different opinion. He’s written about it in the last couple of annual reports, and much as I, and I really admire the management, I think he’s done a great job, but much as I admire the management, I voted the other, our Berkshire stock the other way, and for expensing options. And I noticed that 57% of the stock, this, at this meeting just the other day, voted to expense options. But even though I disagree with him on that particular accounting point, Wells has a, an absolutely terrific record. Dick is a terrific business person, and I think in terms of taking risk, or handling the risk that he necessarily takes, I think that I would rank him very way up there in terms of bank managers. Charlie?

Charlie Munger [05:01:37] I’ve got nothing to add to that.

Warren Buffett [05:01:41] Okay, well, you’re gonna take one more from number six.

[05:01:44] Shareholder (Michael Stopski, New York): Thank you very much, Mr. Munger and Mr. Buffett. My question regards, Michael Stopski from New York. My question regards financial institutions and the potential of collapses, and how is Berkshire protected, and how can the individual investor protect themselves against potential bank failures, stock brokerage failures, and things like that?

Warren Buffett [05:02:07] Well, I think as a depositor with large banks, or as somebody that leaves their securities with large brokerage firms, I really don’t think you need to worry very much. We have a too-big-to-fail doctrine operating in this country relative to what you might call the innocent parties in big financial institution failures. We don’t have it in respect to the equity holders, nor should we have it. But I would not, I don’t worry about leaving my securities, my personal securities, or for that amount of Berkshire securities, with the large securities firms. I don’t worry about my bank accounts at that big bank. So…

Charlie Munger [05:02:55] But you’re talking cash accounts.

Warren Buffett [05:02:57] Yeah, yeah, yeah, cash accounts.

Charlie Munger [05:02:59] Margin.

Warren Buffett [05:03:00] Yeah. And the, but if you, in terms of owning the equities of companies like that, or in terms of the fallout, the big thing that will really, the only way a smart person that’s reasonably disciplined in how they look at investments can get in trouble is through leverage. I mean, it, if somebody else can pull the plug on you during the worst moment of some kind of general financial disaster, you go broke. And Charlie and I both have friends that have, where that’s happened to them. But absent leverage, and absolutely just kind of going crazy in terms of valuation on things, the world, the world won’t hurt you over time in securities. I mean, you won’t, you won’t be subject to the financial cataclysms that they don’t need to do in, if you have any more money during periods like that.

You buy Berkshire, I think, is an extraordinarily strong position in respect to any kind of a financial cataclysm. I think we would be definitely the last man standing, and then some. And while we don’t go around, you know, like undertakers looking for a plague or anything like that, you know, we would probably do very, very well in the end. And that’s happened a couple of times, actually, in the past, where we’ve had cash and we’ve had courage when the world was panicking, and it’s, and we’ve done reasonably well during that period. We’ve never gotten, we’ve never gotten hurt by what was happening in the world around us, at least in the last 30 or 40 years. Charlie?

Charlie Munger [05:04:54] Well, I think that’s plainly right.

Warren Buffett [05:04:56] Okay, well, with him saying that after I’ve made a comment, I think we can happily disband. We’ll see you next year, and we’ll see the international people at four o’clock. Thank you.