2001 年股东大会 · 下午场

"Insurance float has been a huge asset to Berkshire"

WARREN BUFFETTOK. I hope you've all had a cholesterol free lunch. And — (laughter) — we will move on. And when we stopped, we were about to go to zone 3.

AUDIENCE MEMBERHi, my name is Jason Tank from Traverse City, Michigan. I've got one kind of quick question that I'm sure you can answer relatively quickly, if you're not interested. I know that Walter Scott's on the board of directors and he's also on the board of directors of a company called Level 3 Communications that is in an industry that's — well, there's been a lot of change happening and stock prices have been plummeting. I wonder if you’ve ever — You've probably spoken to him at great length about the economics of that business. And have you ever expressed any interest that business, especially at the prices today? That's the first question. The second question is — if you look at Berkshire Hathaway as a portfolio, you've got wholly owned subsidiaries as operating businesses, marketable securities, common stocks and bonds. If you strip out — and if my premise is wrong, just please tell me. If you strip out the leverage effect of the cost of the float being, you know, nearly zero or negative throughout the years — if you look at the portfolio minus that leverage piece, how fast do you think your book value would've grown over the last 30-plus years? Are we talking about 5 percent or 6 percent due to just the leverage piece on the insurance float?

WARREN BUFFETTI don't think it would run as much as 5 or 6 percentage points, but the float has been very useful to us. And actually, I've never made the calculation. So you could well be correct that if it was 5 or 6 points, that would be a quarter of our book value gain over the years being attributable to insurance float. And I think that's probably maybe on the high side but — and you can’t make it — We don't look at insurance float 100 percent the same as we would look at equity, but we've looked at it a good bit, you know. It's largely tantamount to equity because we've had so much equity, we could afford to do it that way. So I — you'll have to make that calculation yourself. We think insurance float has been a huge asset to Berkshire. We think it'll continue to be a huge asset. And we look for every way possible to increase the amount of low-cost float. On a small scale, we added US Liability last year, an excess surplus lines carrier based in Philadelphia. And so far, that's working out extremely well. Got a terrific guy running it. And, you know, in a small way, we add float there. I just looked at the first quarter on it, and we had a significant underwriting profit and we had float added. And, you know, that's the best of all worlds. So we'll keep working on it, and it will add — it's a big asset that Berkshire has that a great many companies — I mean, virtually no other company has it to the degree that we have that also invests in other businesses and uses it as a source of money to invest in other businesses. The question about Level 3, I obviously can't answer. I just — I can tell you that you have two enormously smart and high-grade guys in Walter Scott and Jim Crowe in that business. But it's not a business I know a lot about. And if I did, I wouldn't talk about it. Charlie?

CHARLIE MUNGERI cannot talk just as well as you can. (Laughter)

WARREN BUFFETTNot always. (Laughter)

Accounting "shenanigans" and "gamesmanship"

WARREN BUFFETTOK. Section 4.

AUDIENCE MEMBERJohn Golob from Kansas City. I have a follow-up question to your comments about how financial statements can be distorted by making over-optimistic assumptions about returns for the pension portfolio. If you believe accounting statements, as published in annual reports, returns on equity for U.S. businesses are amazingly high — higher than in Europe, higher than they've been historically, higher than Japan. Are these highs, do you think, completely attributable to accounting shenanigans? Or are there any fundamental reasons in addition that might make returns in the U.S. higher than in Europe or higher than they've been historically?

WARREN BUFFETTWell, I would say that they certainly — to the extent that American returns have been higher than those around the world, at least in developed countries, I would say that they are not solely due at all to accounting shenanigans. I think that the absence of honest accounting for option costs and — has been a factor. But American business has done very well, excluding — very well — excluding any accounting activities that Charlie and I might differ with. You know, I'm no expert on exactly what returns have been around the world in developed countries, but my impression definitely is that American business is well above averaged — average — for the developed world, in terms of profitability. And, you know, I don't have the answers as to why that's occurred. I think that American business, and I think the whole American system, has reflected more of a meritocracy than exists in many countries. And I think that a meritocracy works best. I think — and I think that mobility between classes, which is the flip side of a meritocracy, you know, does tend to get the Jack Welches into positions of — whether they run a General Electric or an Andy Grove or an Intel or, you know, go with Sam Walton at Walmart. I think if you'd taken those same individuals and dropped them down in most countries, they would've done very well. But I don't think they would've done quite as well as here. And I think that what they have done well has spilled over, in a big way, to benefit the American economy. So I would not lay it all on the accounting shenanigans. And the pension funds accounting, that applies very heavily at some companies. And, of course, most newer companies don't have pensions. Companies that have started in the last 20 or 30 years are much more inclined to have various kinds of profit sharing or 401(k)s. The older industries that took on pensions spurred, to a great degree, I think, by World War II, when you got excess profits taxes that ran to 90 percent. And there was a huge incentive to start pension plans and fund them heavily because the government, in effect, was funding 90 percent of your pension obligation. So there was a great boon — boom period in the inauguration of pension funds. And, of course, that meant steel and auto and all of those big industries of that time. Charlie?

CHARLIE MUNGERYeah. It isn't so much accounting shenanigans as it is deliberate financial practice. Take General Electric. There's been a deliberate increase in financial leverage, which was made possible by the wonderful and deserved reputation. There's been a deliberate increase in repurchase of stock, which General Electric has done even when they're paying huge multiples of book value. That sort of thing does wonders for returns on equity as reported, as does the process of writing off everything in sight and various extraordinary charges, removing the burden of past costs from future earnings. You put all those things together, and American returns on equity are higher partly because the management has deliberately set out to paint the company as unusually efficient in its use of capital, meaning that it earns a high return on shareholders' equity. Think of how high we could drive our return on equity at Berkshire. I mean, we could make it almost any number you want if we just used enough leverage.

WARREN BUFFETTYeah, we could run it with no (inaudible).

CHARLIE MUNGERWe could run Berkshire with no equity. And then people could say, "Gosh, these guys have finally learned how to manage the damn thing." (Laughter) It's not been an objective around here to reduce the equity to zero. But at other places, in order to make the reported return on equity good, they deliberately pound on the net worth as much as they can.

WARREN BUFFETTYeah. The questioner may have seen — if you look at the S&P figures of the last 15 years, they report them both before special charges and after special charges. And there's been a very significant difference between those two figures. American business likes to frequently write off things and say that doesn't count. And, of course, that takes the equity down. And it actually frequently benefits future earnings because you remove costs that would otherwise hit the income statement in future years.

CHARLIE MUNGERThe truth of the matter is you have — part of this is shrewd and correct management of the companies' financial structure and operations. And part of it can drift into gamesmanship.

Save money in your teen years and be very curious

WARREN BUFFETTRegion 5.

AUDIENCE MEMBERHi, Mr. Buffett. My name is Mallory Marshall (PH). I am 11 years old and I am from Kearney, Nebraska. I have 2 questions. First, my dad would like to know if you have any grandsons my age. (Laughter)

WARREN BUFFETTAny what her age?

CHARLIE MUNGERShe wants to know if you have any grandsons her age.

WARREN BUFFETTHow many shares of stock do you have? And I'll tell you. (Laughter)

AUDIENCE MEMBERAlso, what investment advice do you have for young people of my generation?

WARREN BUFFETTYeah. Well, I've got a grandson fairly close to your age and he probably would go for a younger woman anyway, so — (laughter) — I will mention him to you. Mention you to him. The — well, if you're interested in financial matters, A, you've got to have something to work with. I mean, I was fortunate in that respect because my dad paid for my education. If he hadn't, I probably wouldn't have become educated if I had to pay for it myself, but — So I was able to save $10,000 by the time I was 21. And, you know, that was a huge, huge head start. If I hadn't have been able to do that and, you know, my first child came along when I was 22. So it's much easier to save in those teenage years if you're lucky enough to be in a family where you don't have — where your parents are taking care of your financial obligations. Every dollar then is, you know, worth making $10 or $20 later on. And, so if you are interested in financial matters, getting a stake early is very useful, and getting knowledge early is very useful. So, you know, I would say you're well on the way if, at 11, you're even interested in coming to a meeting like this. And I would — if that interest is maintained, you know, I would read financial publications. I would read whatever was of interest to me. I'd be curious about how the businesses around the town of Kearney operated. I would — to the extent that you can get people to talk to you — and people usually like to talk, you know — learn about who's got good businesses in Kearney and why they're good businesses. And learn about the businesses that went out of business and why they went out of business. And just keep accumulating knowledge. That's one of the beauties of the business that Charlie and I are in, is that everything is cumulative. The stuff I learned when I was 20 is useful today. Not in necessarily the same way and not necessarily every day. But it's useful. So you're building a database in your mind that is going to pay off over time. But you have to have a little money to work with. So there's nothing like getting a few dollars ahead. Stay away from credit cards. And you can have a lot of fun, if your mind goes along that track as you get older. Charlie?

CHARLIE MUNGERWell, I'm glad to see somebody that has, so early, shown an interest in getting ahead. There's nothing wrong with getting ahead. (Laughter)

WARREN BUFFETTAnd actually, she may have the best idea about getting ahead by learning the name of my grandson, too. (Laughter)

CHARLIE MUNGERWell, there, I can give the young lady some advice. Before your feelings totally take over, you should look carefully at both parents and all four grandparents. (Laughter)

WARREN BUFFETTWrite Charlie and let us know how it works out. (Laughter)

GEICO policy retention rates

WARREN BUFFETTArea 6.

AUDIENCE MEMBERI'm Jack Hurst (PH), Philadelphia, Pennsylvania. Three notes of thanks. First, for American Express for the terrific job they've done the last three times in scheduling reservations for me. The second is thanks for the care you take with your annual report. There is nothing more accessible than the statistics in that report, and the text is just absolutely marvelous. The third one is the care and feeding you give to troubled businesses like World Book, which I'm glad has survived, and Dexter Shoes. They're closing the plant in Milo, Maine, which is advantageous for the shareholders. But they gave the people enough time that, because of the additional — Jackson Labs expanded, they're hiring, and Fidelity brought 6,000 jobs into the area. So those people will have better chance for jobs than they had to — if they were kicked out right away. The second point is a question about GEICO. You have a wonderful table in your annual report showing the number of policies issued and the policies in force at the end of each year, for the last seven or eight years. In general, at the end of one year, the policies in force are equal to 95 percent of the policies in force at the beginning of the year, plus 60 percent of those that have been issued in the year. And that's been constant, up until this last year, when the amount in force at the end of 2000 is 24 percent of the policies issued in 2000 and 95 percent of those that were in force at the end of 1999. I'm curious if Mr. Nicely has asked, first, "Why is there such a large difference in lapse between the first year policies and the renewal policies?" and, "Why is there such a discontinuity in the year 2000?"

WARREN BUFFETTThe — I'll answer the last one first, about GEICO. The retention rate is affected overwhelmingly by two factors. One is the mix between the below-standard business, the standard business, and the better business, in terms of risk. In other words, we have — just making a calculation here — we have 75 percent or so of our business, plus, in the preferred category. But we have grown faster up till the last year or so — in the last three or four years before that — up till the last year in the standard and the non-standard business. Those latter two categories have far greater lapse — or non-retention ratios — or lapse ratios — than the preferred business. They're two different businesses almost. So any change in the mix between preferred and the other two categories will change the aggregate retention ratio very substantially. The second thing is that the first year has a much higher retention — lapse ratio — than the second year of a policy. And, in turn, than the third, and so on. In other words, if you get to preferred business that's been with you five or more years, you have a very, very high retention ratio. In the last few years, we've added more new business than we were adding in the years before that. So we have had a higher percentage of new business and we've had a higher percentage of non-preferred business, both of which would make the aggregate lapse ratio look higher, even though the lapse ratio, when categorized by class of business and age of business, really hadn't changed very much. Now, it's true, however, our retention ratio in the preferred business has fallen by a point or so. But that's the big difference. And now, unfortunately, you know, our new business is not as strong. So you’ll actually see, and — but, our preferred business is running stronger than our standard and non-standard. So you are seeing the mix go back in the other direction, right now. I mean, currently, that's going on. Through right to date this year, our preferred business is up in aggregate policy holders. And our standard and non-standard is down. So what you've deduced from those figures reflects changes in mix and age of business far more than it does retention ratio, although there was a minor change in the retention ratio. And that will be true. And maybe I should explain that better in the annual reports in the future. I touched on it once a year ago, but we can make that clearer in future reports. What you said about the American Express people, I echo. I mean, they have just done a fabulous job with people. We sort of turned the problem over to them of how people get here and where they stay and all of that. And we've had wonderful help from the local American Express office. And frankly, they've been so good, we don't even think about it. We just refer people on to American Express. And I congratulate them for the job they've done. Thank you. (Applause)

"True synergy" between General Re and Berkshire's reinsurance operations

WARREN BUFFETTArea 7, please.

AUDIENCE MEMBERI'm Chip Mann (PH) from Minneapolis, Minnesota. Thanks again for this open format and your direct answers to our questions. You've talked a bit about the super-cat class level of risk that you write. Could you share your thoughts about expanding the competitive advantage and the scale advantages at General Re, referring more to their traditional or historical franchise and the type of contracts they would write?

WARREN BUFFETTYeah. General Re was a — is a — and General Re and Cologne are a very different operation than the historical reinsurance business of National Indemnity. National Indemnity had nothing like their distribution system. And they have a — and a knowledge base for a whole different form of reinsurance than we could ever accumulate at National Indemnity. General Re did not — nor Cologne — did not take —retain — as much risk as we're quite willing to retain because their financial profile was different before they joined Berkshire. So it's an opportunity for us, for two reasons, to make more money in that respect than General Re might've made on its own. One is we can retain much bigger portions of what they would write in the first place, and which they've been writing over the years, but which they've laid off with other companies in what has the fancy name of retrocessionals. And a second point is that they have a distribution capacity that may well have the ability to deliver to us a lot of big risks that we might not otherwise see. And that, in the past, they might not otherwise have had a good outlet for. So there is — there’s really true — I hate the word — but there's really true synergy in General Re Cologne being married to Berkshire Hathaway. And you've put your finger on, really, one point that has two aspects to it. And we haven't fully exploited that. We probably won't fully exploit it, you know, 10 years from now. But it's very much in my mind and the minds of the managers at General Re and Cologne that we have expanded opportunities, simply because Berkshire is willing to take on more risk than just about anybody in the world knowingly takes on. Although we think some other people take on a lot more risk, unknowingly. But in terms of writing a specific contract, we are both bigger and faster, I think, than anybody in the world. In effect, we have some of the abilities that used to be associated with going to a Lloyd's of London. I mean we can — now, I don't know how true all that was over the years, because I wasn't around there then. But we really can give an answer on something in an hour that other companies wouldn't know what to do with in a month. And that should be a plus for us in the world. Charlie?

CHARLIE MUNGERNothing to add.

Why Buffett doesn’t like to buy a new car

WARREN BUFFETTOK. Zone 8.

AUDIENCE MEMBERMy name is Ethan Berg. I'm from Cambridge, Massachusetts and I'd like to thank you for the education you've provided, particularly with the annual reports. I've got three brief questions. Years ago, you wrote to your friend Jerry Orans that you were applying to Columbia's Business School because they had a pretty good finance department and a couple of hot shots in Graham and Dodd. If you were considering graduate or business school today, with which individuals or professors would you want to study? The second question is, a friend who wants to know your thoughts on the concrete, cement and aggregates business. And the third question is from my wife. You mentioned earlier if someone were buying a parachute, they wouldn't buy based on lowest bid. We saw you tooling around in a car this week that, were it to be bought today, could probably be bought at a relatively low bid. As someone interested in your health, she's wondering whether you've considered a newer automobile, possibly one with lots of airbags. (Laughter)

WARREN BUFFETTActually, I picked out the car I have based on the fact that it had airbags on both sides. So that was a factor. It may be the first car of its type ever made with airbags. But I think my car actually — it's both heavy and has airbags, and those are two primary factors in safety. I don't think any — I don’t think a safer car is necessarily being made. It might be safer to drive around in a big, heavy duty truck or something but I'm not ready for that. Incidentally, on a car, I look at that like anything else. It would take me, probably, a half a day to go through, you know, the exercise of buying a car and reading the owner's manual and all that. And that's just a half a day I don't want to give up in my life for no benefit. You know, if I could write a check in 30 seconds and be in the same position I'm in now with a newer car, I'd be glad to do it this afternoon. But I don't like to trade away when there's really no benefit to me at all. I'm totally happy with the car. I just don't want to trade away the amount of time I'd have to spend fooling around to get familiar with and get title to and do all the rest of the things, pick one out, so a new car. But if there's a safer car made, you know, I'll be driving in it.

Concrete, cement, and aggregates are understandable

WARREN BUFFETTThe aggregates business, concrete, all of that, those are businesses that — and Charlie probably knows more about them than I do. We've looked at businesses like that. In fact, we've even owned a few shares at one time or another, because it's an understandable business. And it's a business that — particularly if you get into concrete, cement, I mean, you know, there have been periods of substantial overcapacity, particularly on a regional basis. But those are fundamental businesses. And at a price, you know, for low-cost capacity and advantageously located raw materials and so on, you know, we would do it. In fact, Charlie and I talked about one probably 10 or 15 years ago —

CHARLIE MUNGERYes.

WARREN BUFFETT— quite a bit. And he's had a fair amount of familiarity with it. And what was the other one? I jotted it down here. Let's see.

Business schools are "pathetic" at teaching how to invest

CHARLIE MUNGERHe wanted to know what business school a young man should —

WARREN BUFFETTOh, business schools.

CHARLIE MUNGER— go to.

WARREN BUFFETTYeah. Well, I would say this, that I think Bruce Greenwald's class at Columbia is very good. He gets in a lot of people that are practitioners. So there's a lot of practicality to the course. And I think Bruce is good. He's got a new book coming out probably within the next six months or so that will deal with that. And then there also has been endowed, at the University of Florida, certain courses relating to value investing. And I think there's been one at the University of Missouri. So I would suggest you at least check out the curriculum at the University of Missouri and Columbia and Florida. And do a little comparison and maybe check with a few graduates — recent graduates — as to what kind of experience they had. If you can find them, I think that's the best system for evaluating a place. But those three, at least, have courses that, based on the catalogue, sound like they might be of interest to you. Charlie?

CHARLIE MUNGERYeah. A huge majority of the business school teaching on the field of investment of (inaudible) portfolios of securities is not what we believe and not what Warren was taught years ago by Ben Graham. There're just little pockets of our attitude left. There's one at Stanford. Jack McDonald?

WARREN BUFFETTYeah, sure. Yeah, that's graduate school. But yeah.

CHARLIE MUNGERIt's graduate school. And what's interesting about that is I think it's the most popular course in the whole Stanford Business School. They've got some kind of a bidding system. And yet, I asked Jack how he felt and he said he felt lonely. He's got the most popular course, but in the whole professoriate, dealing with investment matters, the Jack McDonalds are a little clan of their own in a side pocket, so to speak. Now, they're right. And they can take whatever consolation they get from that. But mostly, if you go to business school you will learn a lot of things we don't believe. (Laughter)

WARREN BUFFETTJack — Bob Kirby comes in and works with Jack sometimes, too. And Bob has got a terrific mind, in terms of investment. I mean, there's no question about that. You know, it's not the easiest school in the world to get into and it is at the graduate level. But there are these occasional little anomalies, as they would say, in the teaching world. I mean, what you really want a course on investing to be is how to value a business. That's what the game is about. I mean, if you don't know how to value a business, you don't know how to value a stock. And if you look at what is being taught, I think you'll see very little of how to value a business. And the rest of it is playing around, maybe, with numbers or, you know, Greek symbols or something of the sort. But it doesn't do you any good. I mean, in the end, you have to decide, you know, whether you're going to value a business at $400 million or $600 million or $800 million. And then you compare that with the price. And that's what investing is. And I don't know any other kind of investing, you know, basically to do. And there — that just isn't taught. And the reason it isn't taught is because there aren't teachers around, you know, who know how to teach it. I mean, they don't know themselves. And since they don't know themselves, they teach something that says, "Nobody knows anything," which is the efficiency market theory. (Laughter) And if I didn’t know how to do it — and if I ever teach physics, I'm going to come up with a theory that nobody knows anything, because it's the only way I can get through the day, you know? But — (Laughter) It's fascinating to me how, you know, the really great universities operate in this respect. If you get a sacred writ, I mean, you get in the finance department because you sign on, you know, to whatever the present group thinks. And if they think the world is flat, you'd better think the world is flat too, you know? And your students better answer that the world's flat when they get it on exams. I would say investment — finance — teaching in this country, in general, is kind of pathetic.

CHARLIE MUNGERWell, I think the business schools do a pretty good job when it comes to accounting —

WARREN BUFFETTOh, accounting, sure, sure.

CHARLIE MUNGER— or personnel management, or — there're a whole lot of subjects I think they do quite well with. But they miss one enormous opportunity. If you learn to think intelligently about how to invest successfully in businesses, you'll become a much better business manager than you will if you aren't good at understanding what's required for successful investment. So they're missing a huge opportunity to improve the management profession by doing such a lousy job in teaching investment.

WARREN BUFFETTYeah, see, Charlie and I see CEOs all the time who, in a sense, don't know how to think about the value of businesses they're acquiring. And then, you know, so they go out and hire investment bankers. And guess what? The investment banker tells them what to do, tells them to do it because they get 20X if they do it and X if they don't do it. And guess how the advice comes out. So it’s a — when a manager of a business feels helpless, which he won't say out loud, but inwardly feels helpless in the question of asset allocation, you know, you've got a real problem. And there aren’t — they have not gone to business schools that have given them any real help, I think, in terms of learning how to think about valuation in businesses. And, you know, that's one of the reasons that we write and talk about it some, because there's a gap there.

Credit card advice: "It's crazy to get in debt

WARREN BUFFETTOK. Number 1.

AUDIENCE MEMBERMy name is Martin Mitchell (PH). I'm from Bakersfield, California. My question, a two-part question, is concerning debt. We know that individual debt can be devastating. Do you — are you concerned that the American consumer is so far in debt, as a whole, as to be a problem? And part two is, do you feel that our trade deficit with other countries is of concern to you?

WARREN BUFFETTWell, the first question about debt, I think it's very hard to answer about the consumer as a whole. I get letters every day from people who have problems in life. And they revolve — I mean, they're either health or debt. And usually — frequently — the debt is connected with health, you know? But they — it's been very easy for them to borrow money, and they're in over their heads, and it's all over then. And there's no question that the American consumer is somewhat more indebted, in aggregate. But it's a very hard thing, I think, to come into conclusions about whether it poses a serious problem. You know, most people have had assets, directly or indirectly, that have gained in value enormously, particularly in real estate and some in securities. So there's a greater capacity to carry debt as earning power increases and assets held increases. I don’t — I can't give you a useful answer, in terms of the world as a whole. But I constantly give advice to young people, and those are the only people I talk to, aside from our shareholder group: just don't start out behind the eight ball. I mean, it's crazy to get in debt because it's so hard to get out of debt. And, I mean, the idea of having credit card debt — and we issue credit cards in all our businesses and, you know, so does every other retailer. But the idea of trying to borrow money at 18 percent, you know, and thinking you're going to get ahead in life, it isn't going to work. And I urge people — they can use their credit card, but I urge them to pay it off before it starts revolving because it's just — it’s too expensive. Charlie and I can't make money with 18 percent money. I mean, we're looking around for float because we don't want to pay 5 percent for money. And, so I'm very sympathetic to people get in debt. But once you get in it, it is hell to get out. I mean, Charlie will have a few Ben Franklinisms to quote on that subject. In fact, you want to give a few from Ben now? (Laughter)

CHARLIE MUNGEROh, no.

WARREN BUFFETTHe'd love to, but I led him into it the wrong way.

Long-term trade deficit is "a significant minus for the country"

WARREN BUFFETTAnd the second question about the trade deficit, that's a very interesting thing. Because when you run a trade deficit, what you're doing is you're trading assets of one sort or another for goods, beyond what you're sending abroad. So in effect, you are selling off a tiny bit of the farm so that the country can consume more than it's producing. If you run a net trade deficit, the country, in aggregate, is consuming less than — or consuming more — than it's producing. And if you're a very rich country, you can't even see it because if you run a trade deficit of a few hundred billion dollars, you know, compared to an economy that's maybe worth, what, 40 trillion or something like that, you don't see it. But you're trading off a tiny bit of the farm every year to live a little bit better than if you just lived off the produce of the farm that year. And you can do it with IOUs if you've got a good record. You can't do it with IOUs if you're a country that's got a terrible record. So they have to denominate their debt in dollars. And, of course, they don't have the ability to denominate a lot of dollars, and people don't want to accept a weak currency. So a weak country can't get away with doing that, unless it's getting special-type loans from agencies set up to do that. We can do almost anything we want in this country, because we don't confiscate property and we don’t — we haven't destroyed a currency that the people have accepted, in terms of payment for their goods, over the years. But I basically think a significant trade deficit over a long enough time is a significant minus for the country. You won't see it though, day-by-day, or week-by-week, or month-by-month. But eventually, if you trade for trinkets or whatever you're getting beyond what you're sending, and you trade away your assets — Fortunately, some of the assets we traded not that many years ago, like movie studios and some of those things, the other people got the short end of the bargain on. But by and large, it's not a good policy for the country to run large trade deficits year after year. Charlie?

CHARLIE MUNGERWell, it’s — that's certainly true if what you're trading for is trinkets, or consumer goods, or something. But, of course, a developing country that ran a trade deficit to put in power plants and what have, that might be a very smart thing to do. In fact, the United States once did that.

WARREN BUFFETTYeah, we did it with railroads in a huge way, you know, and —

CHARLIE MUNGERBut under modern conditions, do we look like a twosome that would love a big trade deficit? (Laughter)

WARREN BUFFETTNo. It's one thing to build railroads with the process, but it's another thing, you know, to buy radios and television sets. I mean, it depends what you're getting. But by and large, we run a trade deficit on consumption goods. And that's not a big plus over time.

Satisfied sellers are a "recruiting force"

WARREN BUFFETTArea 2.

AUDIENCE MEMBERGood afternoon. I'm Jim Hays (PH) from Alexandria, Virginia. I'd like to thank you and Mr. Justin for bringing his masterpiece into the Berkshire family. But the question arises, will you soon run out of privately-held firms that meet the criteria for acquisitions of sufficient size to continue the returns to Berkshire?

WARREN BUFFETTWell, that's a good question because people who sell to us have the option of —private business — selling elsewhere or going public. There seem to be enough people that have built businesses lovingly over 50 or 100 years, and their parents before them and grandparents, that really do care about the eventual disposition of them in some way beyond getting the last dollar that day, that we have a supply from time to time of those businesses. And I think we'll continue to see them. You do raise an interesting question. How many businesses like that are worth, you know, a billion dollars or more in the whole economy? There seem to be — you know, I wish there were more, but there are enough. So I think we will probably buy, on average, maybe two a year, something of that sort. The really big ones — I mean, what we'd love to make is a 10- or $15 billion acquisition. And there would be very few private companies that would be in that category. And then, from the ones that are in that category, you have to find somebody that is not going to conduct an auction. We don't — we just are not interested in auctions. If somebody wants to auction their business, we're not that excited about getting in with them because we need people to run it after we buy it. And, if that's the way they look at their business, we may get more unpleasant surprises than we've tended to get in the past with the kind of criteria we've used. Charlie?

CHARLIE MUNGERYeah. There're two aspects of that situation. One is, are there going to be enough businesses? And two, how much competition are we going to get from other buyers? One thing we do have going for us is that if you are the kind of a business owner that likes the culture that's in this room today, there isn't anybody else like us. Everybody else is off on a different path with a different culture. (Applause) So — and look at all you. I mean, this culture is popular, at least with a certain group. And surely, there'll be other people who like this culture in the future, as in the past, and will feel right about joining it with their companies.

WARREN BUFFETTWe haven't had any luck internationally so far, but we would hope that that could change. I was over in Europe about a month ago and I got asked the question a lot of times about whether we would be a prospect for businesses in Europe, for example. The answer is yes. And then they say, "Well, you know, why haven't you bought anything?" And I said, "The phone's never rung." I don't know whether they thought that was a brilliant answer or not, but they — (Laughter) But I left my phone number a lot of places, you know? Every time I got a chance, I gave that answer. And maybe the phone will ring. I've got to believe that, if we were on the radar screen the same way in Europe over the last five years that we have been in the United States, we would've bought a couple of companies. It's just, they don't think of us. And a lot of people don't think of us in the United States, either, but more do now than did five or 10 years ago. And we have, actually — a reasonable percentage of our acquisitions come, directly or indirectly, because we've made another acquisition in the past where the seller was happy. It's very hard to find anybody that's been unhappy dealing with us. And they're friends with other people in their industry, or whatever it may be. So, we hear about things now more often, because we actually have what you might call a recruiting force out there of people that have already done business. It's very much like NetJets that way. I mean, we spend a lot of money advertising at Executive Jet, the NetJet service. But still, 70 percent or so of our business comes from owners who are with us. They're, by far, the best salespeople we have. And incidentally, that's the way I was introduced to the business. Frank Rooney, who's in this room today, told me about his good experience with NetJets back in January or so of 1995. And that's when I joined in. And if Frank hadn't told me, I might — six years later, I might not have ever looked into it. I mean, you know, I might've just turned the pages past the ads and — But when Frank said, "You ought to look into this," I did. Well, that's what we hope we have going for us on the acquisition front. And I think we do, to some degree. But we'd like it to be greater, and we would like it to be more widespread, geographically, than it is.

CHARLIE MUNGERWhen I was a lawyer, I used to say, "The best business getter any lawyer has is the work that's already on his desk." And similarly, probably the best business getter that Berkshire Hathaway has is the business practice that's already on our desk. That's what's driving the new businesses in, right, Warren?

WARREN BUFFETTSure. Sure.

CHARLIE MUNGERSo it's a very old-fashioned idea. You just do well with what you already have and more of the same comes in.

Why Berkshire sold its Freddie Mac and Fannie Mae stakes

WARREN BUFFETTZone 3, please.

AUDIENCE MEMBERMy name is Steve Sondheimer. I live in Chicago and I'm 14 years old. I'm a third generation shareholder and my question is, I noticed that you sold our position in Freddie Mac. What risks do you see in that industry?

WARREN BUFFETTAre you Joe's granddaughter?

AUDIENCE MEMBERYeah.

WARREN BUFFETTOh, good. We have an amazing number of second and third and even fourth generation shareholders, which I'm delighted with. I mean, I don't think lots of companies — big companies on the stock exchange — are in that position. It is true, we sold the Freddie Mac stock last year. And there were certain aspects of the business that we felt less comfortable with as they unfolded — and Fannie Mae, too. And the consequences of what we saw may not hurt the companies, I mean, at all. But they made us less comfortable than we were earlier, when, actually, those practices or activities didn't exist. We did not — I would stress — we did not sell because we were worried about more government regulation of Freddie and Fannie. If anything, just the opposite, so — It was not — it was not — Wall Street occasionally will react negatively to the prospect of more government regulation and the stocks will react sometimes short-term for that reason. But that was not our reason. We were — we felt the risk profile had changed somewhat. Charlie?

CHARLIE MUNGERYeah, but that may be a peculiarity of ours. We are especially prone to get uncomfortable around financial institutions.

WARREN BUFFETTWe're quite sensitive to —

CHARLIE MUNGERYeah.

WARREN BUFFETT— risk in — whether it's in banks, insurance companies or in what they call GSEs here, in the case of Freddie and Fannie. We feel there's so much about a financial institution that you don't know by looking at just figures, that if anything bothers us a little bit, we're never sure whether it's an iceberg situation or not. And that doesn't mean it is an iceberg situation, in the least, at banks or insurance companies that we pass. But we have seen enough of what happens with financial institutions that push one way or another, that if we get some feeling that that's going on, we just figure we'll never see it until it's too late anyway. So we bid adieu without — and wish them the best — without any implication that they're doing anything wrong. It's just that we can't be 100 percent sure of the fact they're doing things that we like. And when we get to that situation, it's different than buying into a company with a product or something, or a retail operation. You could spot troubles usually fairly early in those businesses. You spot troubles in financial institutions late. It's just the nature of the beast. Charlie?

CHARLIE MUNGERYeah. Financial institutions tend to make us nervous when they're trying to do well. (Laughter) That sounds paradoxical, but that's the way it is.

WARREN BUFFETTFinancial institutions don't get in trouble by running out of cash in most cases. Other businesses, you can spot that way. But a financial institution can go beyond the point — and we had banks 10 years ago that did that, en masse — but they can go beyond the point of solvency even while they still have plenty of money around.

Debating whether it's good moats are harder to find

WARREN BUFFETTArea 4, please.

AUDIENCE MEMBERGood afternoon, Mr. Buffett, Mr. Munger. My name is George Brumley from Durham, North Carolina. We often consider evaluating companies in the context of Michael Porter's model of position relative to competitors, customers, suppliers, substitute products. You state that much more simply when you say you seek for companies with the protection of wide and deep moats. To complete the valuation of a company, we all seek to choose the appropriate future cash flow coupons. A qualitative assessment of the protected competitive position is required to precisely forecast those future coupons. In your opinion, are the dynamic changes in the nature of competition, distribution systems, technology, and even changes in customers, making it more difficult to accurately forecast those future cash flow coupons? Are good, protected businesses going to be more rare going forward in — than they have been in the past? And if so, does that make the few that do exist more valuable?

WARREN BUFFETTWell, you've really described the investment process well. I can't see from here, but which George are you? Are you the — are you Fred's brother-in-law or are you one generation down?

AUDIENCE MEMBERGeorge III. My father is here as well.

WARREN BUFFETTOK, good. The questions you ask are right on the mark. And we do think, to the extent I understand what — or have read what Porter has written, we think alike, basically, in terms of businesses. And we do call it a moat. And he makes it all into a book, but that's the difference between the businesses we're in. (Laughter) I — and Charlie may have a different view on this. I don't think that the quantity or sustainability of moats in American business has changed that dramatically in 30 or 40 years. Now, you can say that Sears and General Motors and people like that thought there were some very wide moats around their businesses, and it turned out otherwise when, in the case of Sears, Walmart, for example, came along. But, I think — the businesses we think about, I think the moats that I see now seem as sustainable to me as the moats that I saw 30 years ago. But I think there are many businesses — industries where it's very hard to evaluate moats. There — those are the businesses of rapid change. And are there fewer businesses around where change is going to be relatively slow than previously? I don't think so, but maybe Charlie does. Charlie?

CHARLIE MUNGERNo, I would argue that the old moats, some of them are getting filled in. And the new moats are harder to predict than some of the old moats. No, I would say it's getting harder.

WARREN BUFFETTWell, there you have it. (Laughter) Unanimity at Berkshire. OK. I think it's a very good question. And I really don’t — you know, Charlie may be right, I may be right. I think it's a very tough one to figure. But regardless of whether there are fewer or that — harder to find, that's still what we're trying to do at Berkshire. I mean, that is what it's all about. Our instructions to our managers — we don't have budgets and we don't have all kinds of reporting systems or anything else. But we do tell them to try and not only protect, but enlarge, the moat. And if you enlarge the moat, everything else follows.

How derivatives become "potential dynamite"

WARREN BUFFETTArea 5?

AUDIENCE MEMBERBill Graham (PH) from Los Angeles. Warren, you've made it possible for outside shareholders to understand Berkshire's financial businesses. But there is one that seems, to me, anyway, hard to understand, which is the financial products business, which I guess, involves trading of derivatives. And for the same — given the same kind of concerns that you and Charlie voiced in relation to financial businesses, can you help us out on that and why you're comfortable with it?

WARREN BUFFETTWell, I think you put your finger on it, Bill. It is a hard business to understand. And it's a hard business to understand if you own it, let alone read about it in somebody else's annual report. And I would guess that most people who own complicated or extensive derivatives businesses, I would say that most of the CEOs probably don't understand it. And how many of them stay awake at nights over that, I don't know. Actually, in financial products, what you see on that one line of income on that, and also what you see in the balance sheet items, is a combination of several things. It's General Re Securities, which used to be GRFP, General Re Financial Products. It’s — and it's a couple of other operations. It actually had our — it has our — structured settlement business in it, which is quite predictable and a very easy business to understand. And it actually has some trading business that I do that falls in there. It's not our normal investment business, but it may involve, what I think are — it tends to be fixed-income related. It might involve arbitrage or semi-arbitrage of various types of fixed-income securities. It wouldn't involve any equity arbitrage. That would not be in there. But I would say that it would be a fair criticism to say that neither Charlie nor I know fully, or even in large part, what goes on in the derivatives business. Now, we have a fellow who is both smart and trustworthy running that in Mark Byrne. So we feel very good about the individual. We do not feel the instinctive understanding of everything that's going on that we do, probably, in most of the businesses that we're in. I think we've probably got 17,000 outstanding tickets at General Re Securities. And those interplay in all kinds of ways. And I don't think that Charlie or I have my mind — our minds — around that book of products. That means we want to be very comfortable with the fellow whose job it is to have his mind around those products. And I will tell you that, you know, there's nobody that I'd feel more comfortable with than Mark Byrne. But it is — it's not a natural-type business for us. The other things in that area, and we made a fair amount of money in some things that aren't related to the derivative business last year. And those are under my direct control. So I feel OK about that. The structured settlement business is a minor profit area. But it's made us some money. And right now, it's not attractive. But it could be again in the future. And there could be other financial-type things we would stick in there. But if we stuck in anything, it would be something that I would be running. Charlie?

CHARLIE MUNGERYeah, that mix includes what I would call oddball pastimes of Warren Buffett — (laughter) — outside —

WARREN BUFFETTThe ones that are publishable. (Laughter)

CHARLIE MUNGER— outside the common stock field. That I'm quite comfortable with, although I'm sure the results will be irregular. The rest of it — and I think we also have what might be called oddball personal ideas of Mark Byrne, and I'm quite comfortable with those. As you get away from that, into what might be called more standardized derivative trading businesses, I think it's fair to say I like them less than most of the people do who are in them.

WARREN BUFFETTQuite a bit less. (Laughter)

CHARLIE MUNGERYeah.

WARREN BUFFETTYeah, we regard that area as potentially being dynamite because if you get a group — a large group — of people that, in many cases in that business — although we've tried to go away from it ourselves — but in many cases in that business are getting paid based on front-ending potential profits, you can get — I mean, that's a dangerous situation to place a hundred people in. You're going to find people who will crack under that, in terms of what they will do. You know, they had — we had a case of it, actually, in the electric utility industry a year or two ago, when Edison in California, through a subsidiary, compensated people based on projecting the profitability of the business they were putting on the books that day. That's Wall Street practice and it was brought to the utility industry. And it produced I'd say predictable results. So it's dangerous to pay people to make deals where you won't know the outcome for 15 or 20 years and give them a lot of money upfront for doing it. And that's fairly standard practice in the business. I mean, it was standard practice at Salomon when I was there. And as I say, people occasionally crack under that. It isn't exactly analogous, but it's worth reading Roger Lowenstein's book entitled “When Genius Failed,” because it touches on some of the problems we've described that Charlie and I are apprehensive about.

CHARLIE MUNGERYeah, the derivatives business has the very significant problem that the accounting profession sold out. The accounting is improper. It front-ends way too much income. It's irrationally optimistic because that's the way the denizens of the field want it because it creates bigger compensation. This is intrinsically an irresponsible system. And it's another case where the accounting profession has failed the wider civilization.

WARREN BUFFETTWe found — Charlie was on the audit committee at Salomon — and we found positons — single positions — mismarked by close to $20 million, for example, didn't we, Charlie?

CHARLIE MUNGEROh, yeah. But deliberate mismarkings was not the main problem. The main problem is the whole system of accounting is wrong. The whole system of accounting is too optimistic. It would be like going into the taxi cab business with a 30-year depreciation rate.

WARREN BUFFETTYeah. Or it'd be like writing long, very long-tail insurance, and paying a big commission upfront based on the expected profit of that insurance over a 10-year period or something, with that prepared by the guy who wrote the policy. There are certain activities that are really just dangerous in the financial world. And when you get close to that kind of situation, you just have to be very careful. Now you — actually, Mark has been implementing a system that compensates — that accounts for this — significantly differently than occurs at many institutions. So, you know, you can try to attack it. But it's also hard to get too far away from industry norms and still do business. I mean —

CHARLIE MUNGERYeah. Our accounting is way more conservative than the standard derivative accounting of the country, thank God.

GEICO's Lou Simpson manages "autonomously"

WARREN BUFFETTOK. Area 6.

AUDIENCE MEMBERMy name is Scott Tilson (PH). I'm from Owings Mills, Maryland. Gentlemen, you have stated many times that Lou Simpson manages the GEICO investment portfolio on an independent and autonomous basis. What unique or superior qualities does Mr. Simpson possess as an investor that has earned him this tremendous vote of confidence? Secondly, Berkshire invests in privately-held businesses as well as publicly-traded securities. While the skillset required to value public and private businesses may be the same, does Mr. Simpson also have the additional experience and skills necessary to negotiate a private transaction, if called upon to do so?

WARREN BUFFETTYeah, I think he could. But I hope he doesn't get called on to very soon. (Laughter) Lou is smart, and careful, and high-grade, and experienced. So he does manage a couple billion dollars autonomously. He will buy things. I won't know about them until I either look at a monthly sheet or sometimes read it in the paper. And that's fine, you know? He doesn't know what I'm doing. I don't know what he's doing. Every now and then, we're in the same security, so we try and coordinate if we're buying or selling under those circumstances. And incidentally, you will occasionally read a headline, not a very big headline, but in the financial press that says, "Buffett buying X, Y, Z." Well, sometimes it should say, "Simpson buying X, Y, Z." They — the reports we file would not necessarily tell the reader which one of us made the decision, because even if the reports show that something was bought in GEICO, that could be bought in — by me and placed in GEICO for various reasons. Or conceivably, Lou can buy something and place it in National Indemnity or some other Berkshire company also for perfectly good reasons. But some of what gets reported as done by Berkshire is done by Lou entirely independent of me. And most of it, in terms of dollars, is done by me. But Lou's record is just as good as mine, so. And Lou would know how to evaluate businesses, whether private negotiations or public securities, and — but I'm in no hurry to turn it over. (Laughs)

Berkshire's investment in Finova

WARREN BUFFETTSeven.

AUDIENCE MEMBERGood afternoon. My name is Scott Croy (PH). I'm from Chicago, Illinois. Mr. Buffett, could you please describe the situation — the extent, if any, of Berkshire Hathaway's investment in Finova Group earlier this year? Finova's back appears to be against the wall.

WARREN BUFFETTYeah. It's worse than against the wall. They're in Chapter 11. (Laughter) But that was all contemplated, obviously. Finova is the old Greyhound leasing company, and grew to about 13 or $14 billion in assets. And then just about a year ago, now, ran into funding difficulties. And when you run a highly leveraged finance business and you run into funding difficulties, they compound on you very quickly. You know, confidence is a real coward. I mean, it runs when it sees trouble. And in a finance business, you're constantly faced with refinancing old obligations, and you have commercial paper out and all of that. So there's no honeymoon period when you get in trouble in the finance business. And we've even seen big ones in the past, like Chrysler Financial and all of that. I mean, it can strike anywhere when confidence disappears. And so that hit Finova about a year ago. And it became clear not that many months later that Finova would have to either be sold or reorganized. And I think there were attempts made to sell the company to other finance companies, and even a couple of little portions of the portfolio were sold. But they didn't make a sale. And when the bonds started selling down to prices that I thought were very attractive, in the fall or whenever it was of last year — and by attractive, I mean, I thought that if they went into bankruptcy that the assets were considerably greater in relationship to the liabilities than indicated by the market — we started buying bonds. And we bought — we publicly announced it. We bought $1,428,000,000 face amount of bonds or bank debt. So we, out of 11 billion of aggregate debt at Finova, we own $1,428,000,000 face value. And we bought those at prices that looked attractive then and look attractive now. And it became clear — it was somewhat — it was clear all along that they were either going to sell or go into bankruptcy. And it became clearer that they weren't finding a buyer as time went by. And so it became very likely that they would declare bankruptcy sometime earlier this year. One of the reasons being is they didn't want to use the available cash to pay out the creditors whose money was coming due tomorrow, and thereby shortchange creditors whose claims were due at later dates. We thought, perhaps, somebody would come in with a plan of reorganization. And it got very close to where they —in our view — they were going to default. And so we jointly, with Leucadia, in a joint venture called Berkadia, put forth our own plan and made a — and arranged a transaction. But they are now in Chapter 11, and there will be plans presented to the — a plan or plans — presented to the court in short order. And then the court will determine — I’m not — Charlie may know more about exactly how bankruptcy works than I do, although I don't think he's had any personal experience — that a plan gets submitted to creditors for approval. And we will have a plan, which will be — which has been outlined in the press, and will be submitted to the court, almost certainly within a week, and when you can read about it at that time. And then we will see whether anything else happens. I mean, it may be that somebody else comes in with a plan. It may be that our plan is approved. And if our plan is approved, it involves a significant additional investment so that an initial payment can be made to the present debt holders. And then we'll see what happens. We feel very good about Berkadia. I — we think Berkadia — well, we think the Leucadia part of Berkadia brings a lot to the party, in terms of efficiently managing the assets that are there. It makes it — when an entity gets in bankruptcy, it makes a lot of difference how it's handled. I mean it, you can — there can be a lot of wastage of assets in bankruptcy. Or there could be a reasonably efficient way of handling it. We think that the Berkadia arrangement will maximize the value of the assets. And we think that's important. But we'll see what happens. I think our position is going to work out fine. Charlie?

CHARLIE MUNGERYeah. I think it's —

WARREN BUFFETTMicrophone.

CHARLIE MUNGER— a very interesting transaction. And you would hope there would be more of it.

WARREN BUFFETTThere will be. (Laughter)

CHARLIE MUNGERNo, I mean, not more bankruptcy, but more cures of bankruptcy following this model. I think it's a very intelligent model and a very clean, simple, prompt way of cleaning up a corporate mess. And I hope the rest of the world feels about it the way I do, and that the judge and other people concerned will say, "Thank God," and we want this one to go through and we want more like it to happen.

WARREN BUFFETTThat's what we tried to do in Salomon, incidentally. I mean, we tried to behave in a somewhat different way, in terms of a corporate crisis, than typical. And we hoped that if that got a good result, that that might become a model that people might gravitate toward in future problems, because there will be future problems. We are the largest creditor of Finova now. So we have more money on the line than anybody else, and we don’t have an interest — You know, our interest is not primarily in getting fees or extending the bankruptcy or, you know, any of that sort of thing. We want to get the greatest realization of assets as possible. And the swing in that between doing it right and doing it wrong, you know, could be measured in the billions.

GEICO's Lou Simpson bought Berkshire's Gap shares

WARREN BUFFETTArea 8.

AUDIENCE MEMBERGood afternoon. I'm Claudia Fenner (PH) from Long Island, New York and I have two questions. The first is, as a big fan of the Gap, I'd like to know why at this time you feel that the Gap is undervalued. And the second question, if you could direct your answer to my husband, as a shareholder, would you agree that buying a large present at Borsheims this afternoon is like taking money out of one pocket and putting it back in another? (Laughter and applause)

WARREN BUFFETTI'll let Charlie handle the second one. (Laughter) He's our expert on consumption at Berkshire. The Gap is a good illustration of what I talked about earlier, because I think the world assumes that I made a decision to buy Gap at Berkshire. And actually, that's totally, 100 percent a Lou Simpson portfolio investment. I don’t think I've read the annual report of the — I know — I haven't read the annual report of the Gap ever. And I don't know anything about it. I mean, you probably know a lot more about it than I do, and I hope Lou knows a lot more about it than I do. (Laughter) It's not a company I've ever looked at. And Lou operates — and he has people that help him — Lou operates in somewhat — he can look at smaller securities, in terms of aggregate market caps, than I can, because I'm investing $2 billion. He can work with $200 million positions or even $100 million positions sometimes. And I will do that occasionally, just because I happen to bump into them, in effect. But I'm really looking for things that we can put a billion or 2 billion or more in. And Lou's universe of possible candidates for purchase is a bigger universe than mine. And that may be a good thing, I mean, having two of us in there. Because he just is going to see things that I'm not going to see. So you'll have to ask Lou about the Gap.

Buffett's never regretted buying jewelry

WARREN BUFFETTBut, well, Charlie, give her a little advice on Borsheim's. (Laughter)

CHARLIE MUNGERWell, I think when you're buying jewelry for the lady you love, it probably shouldn't get too much financial calculation into it. (Laughter and applause)

WARREN BUFFETTI will say this. And this is true. And you're talking to a guy who does not normally go down this path, but I would say this: I've never bought a piece of jewelry that I've regretted, in terms of what has happened subsequently, so it — (Laughter) Well, if that isn't a sales pitch, I don't know what is. (Laughter)

Why GEICO can't give everyone a better deal

WARREN BUFFETTZone 1.

AUDIENCE MEMBERYou're a tough act to follow. I'm Matt Richards. I'm from Parkton, Maryland. Last year at this meeting, a gentleman stood up and implored you, Mr. Buffett, to invest in some technology stocks to juice our returns. I would like to this year thank you for having not done that. (Applause) My question is regarding GEICO. I've been a USAA preferred risk customer for something like 15 years now.

WARREN BUFFETTYeah. You'll do very well with USAA. They're a perfect —

AUDIENCE MEMBERYes, well —

WARREN BUFFETT— company.

AUDIENCE MEMBER— I'd prefer to be a customer of the company that I own part of. Unfortunately, due to an accident and two speeding tickets in the last five years, they will not accept me as a preferred risk. And I wonder if this isn't an untapped group of people who are preferred risks with their own company. Couldn't GEICO possibly take their current preferred risk status into account when determining whether to accept them as a customer?

WARREN BUFFETTYeah, I would — USAA, incidentally, is a terrific company. And Leo Goodwin, who started GEICO, which was then called Government Employees Insurance Company in 1936 — Leo actually was a key employee of USAA, as was his wife, Lillian. They both came from USAA. And, they felt that — I mean, USAA as you know, limits its clientele — at that time, they limited their clientele to the officers in the armed services. And Leo wanted to extend — and that was a preferred class, and history has shown it to be a preferred class. Leo wanted to extend that to other classes that he felt also had similar characteristics that USAA was not interested in. And that's the reason he formed Government Employees Insurance. He felt that the preferred characteristic that could be determined by employment in that area as to their propensity for accidents would extend beyond the officer ranks of the armed services. And he was right. It's a fascinating story. And there's a good book about USAA that came out about two or three years ago, tells the whole story. It's hard for us to take away the preferred customers of USAA. It's hard for them to take away our preferred customers, too. But USAA has some of the same qualities that we have talked about in terms of State Farm. It has, as I remember, maybe a $6 billion, maybe larger now, surplus. It's slightly different than State Farm. It's not a true mutual. It's a reciprocal, as I remember. But, it's tantamount to a mutual. So the 6 billion that has been accumulated over the years is working for present policy holders, which is a terrific asset for them. And the fact that they keep you as a preferred risk probably means you are a preferred risk. I mean, their underwriting judgment is very good. You know, we have various categories that relate to speeding tickets or accidents and all of that sort of thing. And in aggregate, they are a good predictor of future accident potential. But it's only in aggregate. I mean, it's like saying, you know, "Because I'm 70, that I have X percent chance of dying," but it doesn't say what's going to happen to me specifically. But it does mean if you're insuring 100,000 70-year-olds, you'd better get this sort of price. We have these predictors, too. And past driving history is an important predictor. But you've got this long history with USAA. And they, probably for very good reason on that total history, keep you in the preferred class. And we, based on criteria that are developed from looking at 5 million policy holders, we can’t make the determination — we can't come out and actually observe you driving, or anything of the sort. We have to look at the information that comes to us, which if it says speeding tickets or accident, it does result in various scores being applied. So I really can't offer you a better deal. I'd like to. I have a feeling you'd be a good client. If USAA ever gets mad at you, come over and see us.

"We regard volatility as a measure of risk to be nuts"

WARREN BUFFETTArea 2.

AUDIENCE MEMBERI'm Bob Kline (PH) from Los Angeles. Wall Street often evaluates the riskiness of a particular security by the volatility of its quarterly or annual results. And likewise, evaluates money managers by their volatility — measures their risk by volatility, I should say. And I know you guys don't agree with that approach. I wonder if you could give us some detail about how you come at the concept of risk, how you measure it, and just in general how you approach risk.

WARREN BUFFETTYeah, we regard volatility as a measure of risk to be nuts. And the reason it's used is because the people that are teaching want to talk about risk. And the truth is, they don't know how to measure it in business. I mean, that would be part of our course on how to value a business. It would also be, how risky is the business? And we think about that in terms of every business we buy. And risk with us relates to — Well, it relates to several possibilities. One is the risk of permanent capital loss. And then the other risk is just an inadequate return on the kind of capital we put in. It does not relate to volatility at all. Our See's Candy business will lose money — and it depends on when Easter falls — but it'll lose money in two quarters of the four quarters of the year. So it has a huge volatility of earnings within the year. It's one of the least risky businesses I know. You can find all kinds of, you know, wonderful businesses that have great volatility and results. But it does not make them bad businesses. And you can find some very — you can find some terrible businesses that are very smooth. I mean, you could have a business that did nothing, you know? And its results would not vary from quarter to quarter, right? So it just doesn't make any sense to translate — (laughter) — volatility into risk. And Charlie, you want to add anything on that?

CHARLIE MUNGERWell, it raises an interesting question, which is how can a professoriate that is so smart come up with such silly ideas and spread them all over the country? (Laughter) It is a — it’s a very interesting question. If all of us felt that — (Laughter)

WARREN BUFFETTCharlie, your Dilly Bar's arrived.

CHARLIE MUNGEROh, good.

WARREN BUFFETTYeah. You've heard of getting a second wind.

CHARLIE MUNGEROh, fine.

WARREN BUFFETTThank you. (Laughter and applause) You tip him. (Laughter) I didn't think our cracks were that funny. (Laughter)

CHARLIE MUNGERRight, right. But I've been waiting for this craziness to pass for several decades now. I do think it's getting dented some. But it's not passing.

WARREN BUFFETTIf somebody starts talking to you about beta, you know, zip up your pocketbook. (Laughter)

Zen Buddhism and the value of low expectations

WARREN BUFFETTArea 3.

AUDIENCE MEMBERBrian Zen (PH) from China. As a Coke addict myself, I'm excited to report to you — (laughter) — our worldwide promoter-in-chief, that the Cokes in Beijing taste just as wonderful as in Omaha. As a ex-Zen monk, today I feel like visiting the Buddha of the financial world. (Laughter) We have an investment club, but with a name that ends in .com, believe it or not, which tells you that the frenzy — .com frenzy — even seduced Zen monks when we tried to follow you. We find that Mrs. Susan Buffett used to send Zen Buddhism books to her sorority sisters. That's probably why she always has a peaceful smile due to her low expectation of life which, according to Buddha, is full of sufferings. But Mr. Munger would tell me that Susan's smile is because you, as the husband, exceeded her low expectations.

CHARLIE MUNGERThat's right. (Laughter)

WARREN BUFFETTYeah. And her father's even lower expectations. (Laughter)

CHARLIE MUNGERRight, right.

AUDIENCE MEMBERAnyway, my question is, did Susan also send those Zen books to your office or your bedroom? And if you have read those books, what are the key ideas that contributed to your investment tao, which even made sense to secluded, narrow-minded Zen monks like me? Thanks for the financial enlightenments you've given us today.

WARREN BUFFETTThank you. I sent those books on to Charlie so I'll let him answer. (Applause)

CHARLIE MUNGERActually, I tend to be a follower of Confucius. (Laughter) And I think this room is full of Confucian values, you know? If the first law of Confucianism is filial piety, particularly toward elderly males, you can see why I like that system. (Laughter)

Capital and opportunity costs

WARREN BUFFETTArea 4. (Laughter)

AUDIENCE MEMBERGood afternoon, Mr. Buffett and Mr. Munger. My name is Kevin Truitt (PH) from Chicago. I have three questions for you. Mr. Munger, at last year's shareholder meeting, you stated that you didn't feel that the concept of the cost of capital made true economic sense. Would you explain why you felt this way and what you would do to replace it with anything? My second question is to Mr. Buffett. You've stated the importance of an occasional big idea. How were you able to, in fact, tell when you had a big idea? And my third question, Mr. Buffett, you have talked about the importance of the franchise and sustainable competitive advantage. Companies like Kellogg and Campbell's Soup are companies that most people would have said had those qualities. However, over time, those qualities were lost as a result of a change in consumer taste. What gives you confidence that the same things won't happen to Coke or Gillette?

WARREN BUFFETTCharlie?

CHARLIE MUNGERWell —

WARREN BUFFETTCost of capital.

CHARLIE MUNGERCost of capital, first. Obviously, considerations of cost are important in business. And obviously, opportunity costs, which is a doctrine of economics, really a doctrine of lifesmanship, are also very important. And we've always had that kind of basic thinking. Of course, capital isn't free. And, of course, you could figure cost of capital when you're borrowing money. Or at least you can figure cost of loans. But the theorists had to develop some theory for what equity cost. And there, they just went bonkers. They said if you earned a hundred percent on capital because you had some marvelous business, your cost of capital was a hundred percent. And therefore, you shouldn't look at any opportunity that delivered a lousy 80 percent. That is the kind of thinking, which came out of the capital assets pricing models and so forth, that I've always considered inanity. What is Berkshire's cost of capital? We have this damn capital. It just keeps multiplying and multiplying. What is its cost? You have perfectly good, old-fashioned doctrines like opportunity cost, you know? At any given time when we consider an investment, we have to compare it to the best alternative investment we have at that time. We have perfectly good, old-fashioned ideas that are very basic to use, but they weren't good enough for these modern theorists. So they invented all this ridiculous mathematics, which concluded that the companies that made the most money had the highest costs of capital. Well, all I can say is, it's not for us. Now, the other half of that question I leave for Mr. Buffett.

WARREN BUFFETTYeah, what you find, of course, is that the cost of capital is about a quarter percent below the return promised by any deal that the CEO wants to do. It's — (laughter) — very simple. You know, we have three questions on capital — with capital, throughout — leaving aside whether we want to borrow money, which we generally don't want to do. And one is, does it make more sense to pay it out to the shareholders than to keep it within the company? A sub-question on that is if we pay it out, is it better off to do it via repurchases or via dividend? The test for whether we pay it out in dividends is, can we create more than a dollar of value within the company with that dollar than paying it out? And you never know the answer to that. But so far, the answer as judged by results is yes, we can. And we think that prospectively, we can. But, that's a — you know, that's a hope on our part. And it's justified to some extent by past history, but it's not a certainty. Once we've crossed that threshold, then do we repurchase stock? Well, obviously, if you can buy your stock at a significant discount from conservatively calculated intrinsic value, and you could buy it in reasonable quantity, that's a use for capital. Beyond that, then the question becomes, if you have the capital, you think you can create more than a dollar, how do you create the most with the least risk? And that gets to business risk. It doesn't get to any calculation of the volatility. I don't know the risk in See's Candy as measured by its stock volatility because the stock hasn't been outstanding since 1972. Does that mean I can't determine how risky a business See's is, because we don't have a daily quote on it? No. I can determine it by looking at the business, and the competitive environment in which it operates, and so on. So once we cross the threshold of deciding that we can deploy capital so as to create more than a dollar of present value for every dollar retained, then it's just a question of doing the most intelligent thing that you can find. And, you know, that is — The cost of every deal we do is measured by the second best deal that's around at a given time, including more — doing more of some of the things we're already in. And I have listened to cost of capital discussions at all kinds of corporate board meetings and everything else. And, you know, I've never found anything that made very much sense in it except for the fact that it's what they learned in business school and that's what the consultants talked about. And most of the board members would nod their head without knowing what the hell was going on. And that's been my history with the cost of capital.

How Buffett knows when he's had a "big idea"

WARREN BUFFETTNow, moving onto the big ideas, you know when you've got a big idea. And I can't tell you, you know, exactly what happens within your nervous system or brain at that time. But we've had relatively few big ideas, good ideas, over the years. I don't know how many you think we've had in aggregate, probably, career, maybe 25 each or something?

CHARLIE MUNGERIf you took the top 15 out of Berkshire Hathaway, most of you people wouldn't be here. (Laughter) So, roughly one every two years.

WARREN BUFFETTYeah, one every year or two. And sometimes there'll be a bunch of them, like in 1973 and -4. But the problem is, for us is that big, now, really means big. I mean, it has to be billions of dollars to move the needle very much at Berkshire. But I would say that when I would turn those pages, 50 years ago in the Moody's Manuals, I would know when I hit a big idea. I've got half a dozen of them that I keep the Xeroxes from those reports around from 50 years ago just because it was so obvious that they just — they were incredible. And that happens every now and then. When I met Lorimer Davidson, you know, in end of January, 1951, and he spent four hours or five hours with me explaining GEICO, I knew it was a big idea. Eight months later, no, probably 10 months later, I wrote an article for The Commercial and Financial Chronicle on "The Security I Like Best." It was a big idea. When I found Western Insurance Securities, I knew it was a big idea. I couldn't put billion — millions — of dollars into it, but I didn't have millions so it didn't make any difference. And I — we've seen things subsequently. And we’ll see, you know. If we have a normal lifespan, we'll see a few more before we get done, but I can't tell you that —exactly how — I can’t tell you exactly what transpires in my mind that says, you know, flashes a neon sign up that says, "This is a big idea." What happens with you, Charlie? (Laughter) Actually, one of my — I've have a real system. (Laughter) My idea of a truly big idea is, one I get it and I call Charlie and he only says no, rather than, "That's the worst idea I've ever heard of." But if he just says no, it's a hell of an idea.

CHARLIE MUNGERYou know, the game in our kind of life is being able to recognize a good idea when you rarely get it, and — or when it rarely is presented to you. And I think that's something you have to prepare for over a long period. What is the old saying? That opportunity comes to the prepared mind? And I don't think you can teach people in two minutes how to have a prepared mind. But that's the game.

WARREN BUFFETTThings we learned 40 years ago, though, will help and recognize the next big idea.

CHARLIE MUNGERAnd on opportunity costs, going back to that, the current freshman economics text, which is sweeping the country, has right in practically the first page. And it says, "All intelligent people should think primarily in terms of opportunity cost." And that's obviously correct. But it's very hard to teach business based on opportunity cost. It's much easier to teach the capital assets pricing model where you could just punch in numbers and out come numbers. And therefore, people teach what is easy to teach, instead of what is correct to teach. It reminds me of Einstein's famous saying. He says, "Everything should be made as simple as possible, but no more simple."

WARREN BUFFETTWrite that down. (Laughter)

Big retailers are attacking big brand-name moats

SPEAKERYou asked an interesting question about franchises, too, and mentioned Campbell's Soup and Kellogg. And, you know, I'm no expert on that but I would say that, just based on my general observation over the years, is that the problems there came from two different things. I think that the problems with cereal — ready-to-eat cereal — were not so much changes in taste or consumption patterns. But I think they maybe just pushed their pricing too far to the point that they lost market share without getting — without having — the moat that they thought they had, as opposed to the General Mills cereals, and the General Food cereals, and all of that sort of thing. I mean, if you're pricing really gets out of whack and people regard Wheaties or Grape-Nuts in the same category as they regard Kellogg's Corn Flakes, you know, you're going to lose share. And once you start losing share, it's hard to get back. The problems with soup I think relate more to lifestyle. I think it’s become — it’s a little less — it fits in a little less well with current lifestyles, maybe, than 40 years ago. Soft drinks, — the consumption of soft drinks — I don't have the figures here, but I would wager that in 110 years, the per capita of soft drinks has gone up virtually every year throughout that history. I mean, it's now 30 — close to 30 percent — of U.S. consumption of liquids. So, if the average American has about 64 ounces of liquids a day, you're talking about, say, 18 ounces of that being soft drinks and 43 percent of that 18, or almost 8 ounces a day, of being Coca-Cola products. In other words, 1/8th of all the liquid man, woman and child in the United States take in comes from Coca-Cola products. But that has gone up, virtually — well, throughout the world it's gone up on a per capita basis, you know, almost since soft drinks were discovered. I would say that that trend is almost impossible to reverse on a worldwide basis. I mean, there's so much potential in countries where per capita consumption is like — well, I think it's, you know, maybe 8 per capita, which is — 8-ounce servings they talk in terms — 64 ounces a year. So you have 1/50th of the consumption, per capita, on Coke products in many — in some important countries — that you have here. I don’t — I just don’t see it as being — Now, you can push pricing too far. I mean, there comes a point — it depends on the country in which you're doing it, but that depends even on areas within the country in which you do it. But if you establish too wide a differential between Coke and a private label product, you will change consumption patterns somewhat. Not huge, but enough so that you don't want to do it. But I don’t think you’ll see — It's interesting. Coffee's gone down every year. People talk about Starbucks and all that, but if you look at coffee consumption in this country, if you look at milk consumption in this country, you know, per capita, it just goes down, down, down, down, year, after year, after year, after year. And I think it's pretty clear what people like to drink once they get used to it, and with the price right. Interesting thing about Coca-Cola is, when I was born in 1930, a 6 1/2-ounce Coke cost a nickel and you put a two cent deposit on the bottle. But forget about that, just take the nickel. Now you buy a 12-ounce can or a larger product, and you're paying, if you buy it on the weekends in the supermarket special or something, you're paying maybe a little more than twice per ounce what you were paying in 1930, 70 years ago. And compare that to the price behavior of almost any product, you know, that you can find except raw commodities. But compare it to cars, housing, anything. And there's been very, very little price inflation in it. And I think that's a contributor, of course, to the growth in per capitas over time. Charlie, how about cereals and soup?

CHARLIE MUNGERWell, I think those are examples where the moats got less hostile for the competitors. Part of the trouble was the buying power got more concentrated and tougher. I mean, the big grocery chains now have a lot of clout. And then you add the Walmarts and the Costcos and the Sam’s and the — it's a different world faced by the Kelloggs than the one they had 30 or 40 years ago.

WARREN BUFFETTYeah, there will be a battle, always, between brands and retailers, because the retailer would like his name to be the brand. And, to the extent that people trust Costco or Walmart more than they — or as much as — they trust the brand, then the value of having the brand moves over to the retailer from the product itself. And that's gone on for a long, long time. You know, the first — I would — cases I know about in any real quantity were back with A&P in the '30s. And A&P, I believe, was the largest food retailer in this country. And they were also a big promoter of private labels. Ann Page I think was a big private label with them, for example. And they felt they could convince the consumer in the '30s that their brand meant more than having Del Monte on it or Campbell's or whatever it might be in the different categories. And people thought they were going to win that war for a while. And who knows? I mean, I don't know all the variables that went into A&P's decline, but it was dramatic. I mean, it was one of — it was a great American success story for a while, and then it was a great American failure. Charlie, you —?

CHARLIE MUNGERThe muscle power of the Sam's Clubs and the Costcos has gotten very extreme. A little earlier this morning, when I was autographing books, a very good looking woman came up to me and said she wanted to thank me. And I said, "For what?" And she said, "You told me to buy this pantyhose I'm wearing from Costco." And I'd evidently made some previous comment about how amazing it was that Costco could get Hanes, of all people, to allow a co-branded pantyhose, Hanes-dash-Kirkland, in the Costco stores. That wouldn't have happened 20 years ago.

WARREN BUFFETTShe must've been pretty desperate if she was consulting with you on where to buy pantyhose, Charlie. (Laughter)

Selling short is "tempting" but "very painful"

WARREN BUFFETTOK, let's move to area 5.

CHARLIE MUNGERYeah, right.

AUDIENCE MEMBERHi, I'm Dave Staples from Hanover, New Hampshire and I've got two questions for you. First, I'd like to hear your thoughts on selling securities short and what your experience has been recently and over the course of your career. The second question I'd like to ask is how you go about building a position in a security you've identified. Using USG as a recent example, I believe you bought most of your shares at between 14 and $15 a share. But certainly, you must've thought it was a reasonable investment at 18 or 19. Why was 14 and 15 the magic number? And now that it's dropped to around 12, do you continue to build your position? How do you decide what your ultimate position is going to be?

WARREN BUFFETTWell, we can't talk about any specific security, so — our buying techniques depend very much on the kind of security we're dealing in. Sometimes, it's a security that might take many, many months to acquire. And other times, you can do it very quickly. And sometimes, it may pay to pay up. And other times, it doesn't. And the truth is, you never know exactly what the right technique is to use as you're doing it, but you just use your best judgment based on past purchases. But we can't discuss any specific one. Short selling, it's an interesting item to study because it’s, I mean, it's ruined a lot of people. It is the sort of thing that you can go broke doing. Bob Wilson, there're famous stories about him and Resorts International. He didn't go broke doing it. In fact, he's done very well subsequently. But being short something where your loss is unlimited is quite different than being long something that you've already paid for. And it's tempting. You see way more stocks that are dramatically overvalued in your career than you will see stocks that are dramatically undervalued. I mean there — it's the nature of securities markets to occasionally promote various things to the sky, so that securities will frequently sell for five or 10 times what they're worth, and they will very, very seldom sell for 20 percent or 10 percent of what they're worth. So, therefore, you see these much greater discrepancies between price and value on the overvaluation side. So you might think it's easier to make money on short selling. And all I can say is, it hasn't been for me. I don't think it's been for Charlie. It is a very, very tough business because of the fact that you face unlimited losses, and because of the fact that people that have overvalued stocks — very overvalued stocks — are frequently on some scale between promoter and crook. And that's why they get there. And once there — And they also know how to use that very valuation to bootstrap value into the business, because if you have a stock that's selling at 100 that's worth 10, obviously it's to your interest to go out and issue a whole lot of shares. And if you do that, when you get all through, the value can be 50. In fact, there's a lot of chain letter-type stock promotions that are sort of based on the implicit assumption that the management will keep doing that. And if they do it once and build it to 50 by issuing a lot of shares at 100 when it's worth 10, now the value is 50 and people say, "Well, these guys are so good at that. Let's pay 200 for it or 300," and then they could do it again and so on. It's not usually that — quite that clear in their minds. But that's the basic principle underlying a lot of stock promotions. And if you get caught up in one of those that is successful, you know, you can run out of money before the promoter runs out of ideas. In the end, they almost always work. I mean, I would say that, of the things that we have felt like shorting over the years, the batting average is very high in terms of eventual — that they would work out very well eventually if you held them through. But it is very painful and it’s — in my experience, it was a whole lot easier to make money on the long side. I had one situation, actually, an arbitrage situation when I was in — well, it was when I moved to New York in 1954, so it would've been about June or July of 1954 — that involved a surefire-type transaction, an arbitrage transaction that had to work. But there was a technical wrinkle in it and I was short something. And I felt like a — for a short period of time — I felt like Finova was feeling last fall. I mean, it was very unpleasant. It — you can’t make — in my view, you can't make really big money doing it because you can't expose yourself to the loss that would be there if you did do it on a big scale. And Charlie, how about you?

CHARLIE MUNGERWell, Ben Franklin said, "If you want to be miserable, you know, during Easter or something like that," he says, "borrow a lot of money to be repaid at Lent," or something to that effect. And similarly, being short something, which keeps going up because somebody is promoting it in a half-crooked way, and you keep losing, and they call on you for more margin — it just isn't worth it to have that much irritation in your life. It isn't that hard to make money somewhere else with less irritation.

WARREN BUFFETTIt would never work on a Berkshire scale anyway. I mean, you could never do it for the kind of money that would be necessary to do it with in order to have a real effect on Berkshire's overall value. So it's not something we think about. It's interesting though. I mean, I've got a copy of The New York Times from the day of the Northern Pacific Corner. And that was a case where two opposing business titans each owned over 50 percent of the Northern Pacific Company —the Northern Pacific Railroad. And when two people each own over 50 percent of something, you know, it's going to be interesting. And — (laughter) — Northern Pacific, on that day, went from 170 to a thousand. And it was selling for cash, because you had to actually have the certificates that day, rather than the normal settlement date. And on the front page of The New York Times — which, incidentally, sold for a penny in those days. It's had a little more inflation than Coca-Cola — front page of The New York Times, right next to the story about it, it told about a brewer in Newark, New Jersey who had gotten a margin call that day because of this. And he jumped into a vat of hot beer and died. And that's really never appealed to me as, you know, the ending — (laughter) — of a financial career. And who knows? You know, when they had a corner in Piggly Wiggly, they had a corner in Auburn Motors in the 1920s. I mean, there were corners. That was part of the game back when it was played in kind of a footloose manner. And it did not pay to be short. Actually, during that period — you might find it interesting — in the current issue of The New Yorker, maybe one issue ago, the one that has the interesting story about Ted Turner, there's also a story about Hetty Green. And Hetty Green was one of the original incorporators of Hathaway Manufacturing, half of our Berkshire Hathaway operation, back in the 1880s. And Hetty Green was just piling up money. She was the richest woman in the — maybe in the world. Certainly in the United States. Maybe some queen was richer abroad. But Hetty Green just made it by the slow, old-fashioned way. I doubt if Hetty was ever short anything. So as a spiritual descendent of Hetty Green, we're going to stay away from shorts at Berkshire. OK, area 6. Hetty, incidentally — this story, it's a very interesting story. As I read the story, it's almost conclusively clear to me that she forged a will to try and collect some significant money from, I believe, her aunt. And it was a very, very famous trial back in whenever it was, 1860 or '70. And they found against Hetty when it got all through, but she still managed to become the richest woman in the country.

The value of Berkshire's "loyalty effect"

WARREN BUFFETTArea 6.

AUDIENCE MEMBERYeah, hi. I'm James Halperin from Dallas, Texas. And I've been a shareholder since 1995. And I feel great about it, so thank you. This question has to do with Berkshire's so-called permanent holdings and whether, when making investment decisions, you somehow mathematically calculate a value to Berkshire's reputation for loyalty to its public investees. Let's say you are confident enough that Pepsi or Procter and Gamble would grow cash flow faster than Coke or Gillette would. And that the replacement value of the stock was less expensive enough to more than make up for the taxes. Would you then sell Coke, for example, to buy Pepsi? And if not, why not? And how do you value this reputation for loyalty aspect in those decisions?

WARREN BUFFETTWell, I think that's a very good question. I don't think we would ever — I think it's very unlikely we would come to the conclusion that we were that certain that — you mentioned P&G and Pepsi versus the ones — but that some major consumer products company would do better than the ones we're in. We might very well decide that some other one is going to do quite well and buy that additionally. As a practical matter, if I'm on the board of a company, or Charlie were to be, representing Berkshire, it's very difficult — I would say it's almost impossible for us to trade in their securities. It just — it creates too many problems. People would think we knew something we didn't. Or, you know, particularly if we were selling it, you know, we would have people questioning very much whether we had detected something within the company that was not available to the rest of the world. So we really give up an enormous amount of investment mobility when we go on a board. And so I don't even think about doing what you're suggesting, although I might very well if I were just a money manager running the business. We certainly, and we've laid it out in the ground rules in the back of the — in our Owner's Manual back in the annual report — we've certainly said, in terms of businesses we buy control of, that they just aren't for sale. And a fancy price will not tempt us. And that we lay out that exception relating to businesses where we think there's a permanent loss of cash for as far as the eye can see, or businesses where we have labor troubles, which we — I described earlier in the day, we might've had at The Buffalo News at that one period. But otherwise, simply because we can use the money better someplace else, we're not interested in it. You know, I can't really dig into my psyche and tell you how much of that is because I think that will help us buy businesses in the future if we behave that way, or how much is just my natural inclination that when I make a deal with somebody and I'm happy with how they behave with me, that I want to stick with them. It's probably both, you know? And I wouldn't want to try and weight the two. I'm happy, you know, with the results of the first and I'm happy with the way I feel, essentially, about the second. I just think it's crazy — I know if I owned all of Berkshire myself, I wouldn't dream of trading around businesses with people that have trusted in me and that I like and have been more than fair with me. I wouldn't dream of trading around businesses so that my estate was 105 percent of some very large number instead of 100 percent of some large number. I just would regard that as a crazy way to live. And I don't want the fact I run a public company to cause me to behave in a way that I would be uncomfortable behaving if we were a private company. But I also feel that you, as shareholders, are entitled to know that that's an idiosyncrasy of mine. And therefore, I lay it out, and have laid it out for 20 years, as something that you should understand, as an investor or before you become an investor. I'm sure it helps us in acquisitions over time. But whether that in any way compensations the opportunity costs that Charlie talks about of making an occasional advantageous disposal, I don't know and it's something I'll never calculate. Charlie?

CHARLIE MUNGERWell, I do tend to calculate it, at least roughly. And so far, I think that the loyalty effect is a plus in our life.

WARREN BUFFETTWould you regard that as true though in both public — I mean, both marketable securities and owned businesses?

CHARLIE MUNGEROh, no. I don't think the loyalty effect in lots of public companies is nearly as important as it is with the private companies.

WARREN BUFFETTYou can say it's a mistake for us to be directors of companies, because we give up huge amount of flexibility in investment because we are directors. I — and there's no question that we do. It’s — if you're thinking solely of making money, you do not want to be a director of any company. So there's just no question about that.

Confidence that Berkshire's culture will endure

WARREN BUFFETTArea 7.

AUDIENCE MEMBERTom Harrison (PH) from Claremore, Oklahoma. Good afternoon, gentlemen. And thanks for a wonderful weekend. This question's for Mr. Buffett. Being somewhat pessimistic by nature, I have a recurrent nightmare of a Wall Street Journal headline proclaiming, "Buffett kicks bucket."

WARREN BUFFETTThey may phrase it a little more elegantly than that — (laughter) — but someday, the headline will be there. (Laughter)

AUDIENCE MEMBERAnd, of course, Charlie's no spring chicken either. (Laughter) In light of these concerns, could you please go into a little more detail than that presented in your annual report regarding the succession issue? And my apologies for the morbid nature of the question.

WARREN BUFFETTOh, there's no reason to apologize. I mean, it's a question I ask our managers, incidentally, every couple of years. I — about every two years, I send them a letter and I say, you know, "If you die tonight, what will you — what will I wish you had told me tomorrow morning?" You know, because I have to make that same decision and I'm not conversing with them every night. So I want them to put in writing to me, once every couple of years, what they think about the subject, who they think should succeed them, or whether there are several candidates, or what the strengths and weaknesses are. And I have that information available. And, you know, you're entitled to the same sort of answer about succession. It's a part of buying into this business. And it — I can tell you that no one has more of an interest in it than I do. And Charlie has a similar interest, because, we have a very high percentage of our net worth in the business. Plus, we've got a lifetime of effort in the business. And we want it to succeed for both, in our cases probably, at least my case, the ultimate reward, the foundation I have. But also because we just want — we like what's happened so far and we want to prove that it can — it's not dependent upon a couple of guys like us, but that it can be institutionalized, in effect. And we have, and Charlie and I, we know who will succeed me in what are likely to be two jobs, one marketable securities and one business operations. We want to be very sure that the culture is maintained. And I think it's so strong that I think it'd be very hard to change it. But in addition, the stock ownership situation with me is such that it can — if there were any inclination to change it, it can be prevented from happening. I don't think it would, anyway. Now, in terms of who succeeds me, that depends when I die. I — and there's no sense telling you who it would be today. There'd be no plus to that, and it might not be the same 20 years from now. I mean, 20 years ago, it would've been Charlie, obviously. But it won't be Charlie now because of his age. And it'll be somebody else. But 20 years from now or 15 years from now it might be some third party. But we’ve got —we feel very good about the succession situation. We feel very good about the stability of the organization, in terms of the stock ownership situation, because that is insured for a very, very long time to come. We couldn't feel better about the managers we have in place and the culture we have in place. And, you know, the individual will be named. I think I've mentioned, though, that when they open that envelope — all of the contents of that envelope are already known to the key people — but when they open that envelope, the first instruction is, you know, take my pulse again. (Laughter) But if I flunk that test, there will be somebody very good in place. Charlie?

CHARLIE MUNGERThe main defense, of course, is to have assets that will do well, more or less, automatically. And we have a lot of those. And to the extent you improve that further by having very good managers in place and very good individualized systems for bringing new managers into the places, there's a lot of momentum here that would go on very nicely with the present management gone. And now, I don't think our successors are going to be as good as Warren at actually — (applause) — allocating the money. (Louder applause and laughter)

WARREN BUFFETTNo, we ran a little test case 10 years ago because for nine months and four days, I took another job at Salomon. And things went fine at Berkshire. We’ve got — the managers don't need me. We have to allocate capital. We have to make sure they're treated fairly. And — But we are not making decisions around the place, except in the allocation of capital. And that will be important. But some of that is semiautomatic. And others, you know, it does require, you know, some imagination sometime or something of the sort. But for nine months and four days in 1991, you know, Salomon was primarily on my mind and Berkshire wasn't. And everything went on just as before. And we are far, far, far stronger now than we were 10 years ago. So I'm very comfortable with 99 percent of my estate being in Berkshire shares. And I think it's an intelligent holding, eventually, for the foundation. And knowing that, you know, I won't be around at some point before the foundation gets it.

"We don't want to talk about silver"

WARREN BUFFETTOK, area 8.

AUDIENCE MEMBERHello, Mr. Buffett, Mr. Munger. My name's Matt Ahner (PH). I'm from Tucson, Arizona. It's a tremendous pleasure to be here today. This question probably falls into Charlie Munger's realm of oddball investment activities. But considering Berkshire's previous experience in silver, what are your thoughts on the silver market today? How do you analyze this market? Have you determined an equilibrium price for silver? And if so, would you share that price, or explain to us how you determined it?

CHARLIE MUNGERThe short answer is we don't want to talk about silver. (Laughter)

WARREN BUFFETTYeah. We're not going to comment, you know, on oil or the prices of anything in terms of making any forecasts about it. The equilibrium price though I can tell you is whatever it's selling for today. But there will be a different equilibrium price a year from now or five years from now. But we can't tell you what it'll be.

Electricity deregulation led to damaging shortages

WARREN BUFFETTArea 1.

AUDIENCE MEMBERHello, Mr. Buffett, Mr. Munger. My name's Bob Odem (PH) from Seattle, Washington. Considering the political climate, and what seems to be a more regulated environment than not in the electric utilities market, and politicians that seem to be pacifying their constituents rather than the common sense of price and quantity — Is it not a risky venture to participate in these markets more than what has already been done with MidAmerican, considering that, even with a possible repeal of the PUHCA laws, that they may be reinstated some years later, with the addition or subtraction of any other legislation that a politician may dream up, and then put the investment at risk?

WARREN BUFFETTCharlie, you're a resident of California. (Laughs)

CHARLIE MUNGERWell, the production of electricity, of course, is an enormous business. And it's not going away. And the thought that there might be something additional that we might do in that field is not at all inconceivable. It's a very fundamental business. Now, you're certainly right in that we have an unholy mess, in California, in terms of electricity. And again, it reflects, I would say, a fundamental flaw in the education system of the country, that is many smart people of all kinds, utility executives, governors, legislators, journalistic leaders, they have difficulty recognizing that the most important thing with a power system is to have a surplus of capacity. Is that a very difficult concept? (Laughter) You know, everybody understands that if you're building a bridge, you don't want a bridge that will handle exactly 20,000 pounds and no more. You want a bridge that'll handle a lot more than the maximum likely load. And that margin of safety is enormously important in bridge building. Well, a power system is a similar thing. Now, why do all these intelligent people, you know, ignore the single most obvious and important factor and just screw it up to a fare-thee-well? So I'm giving you a response which is, of course, another question. As the — my old professor used to say, "Let me know what your problem is and I'll try and make it more difficult for you." (Laughter)

WARREN BUFFETTWell, to me, the interesting thing is that you had a system — I mean, Charlie's obviously right in that you’ve got about three goals in terms of — from a societal standpoint — you've got perhaps three goals in what you would like your electric utility business to be. One is you would like it to be reasonably efficiently operated. Secondly, since it does tend to have, in many situations, monopoly characteristics, you would want something that produced a fair return, but not a great return for capital. But enough to attract capital. And then third, you'd want this margin of safety, this ample supply. Now, when you've got a long lead time to creation of supply, which is the nature of putting on generation capacity, you have to have a system that rewards people for fulfilling that obligation to have extra capacity around. A regulated system does that. If you give people a return on the capital employed, if they keep a little too much capital employed so that they have this margin of safety on generation, and they get paid for it, they stay ahead of the curve. They always have 15 or 20 percent more generating capacity than needed. And one of the disadvantages of that regulation and the monopoly nature is that it doesn't have the spur to efficiency. They try to build it in various ways, but it's difficult to have a spur to great efficiency if somebody can get a return on any capital they spend. So utility regulators have always been worried about somebody just building any damn thing and getting whatever the state-allowed return is. But I would say that the problems that would arise from, say, a little bit of sloppy management are nothing compared to the problems that arise from inadequate generation. So here you have in California — my view as an outsider — you had a situation under regulation where the utilities had the incentive to have a little extra generating capacity because they got allowed to earn a decent return on it, a return that would attract capital. Then you had, I think, the forced sell-off of half of their generating capacity or something like that. And they sold it at multiples of book value to a bunch of people who were now just generators who were deregulated. They’ve got — they don't have an interest in having too much supply. They've got an interest in having too little supply. So you've totally changed the equation because the fellow that now has the deregulated asset, for which he paid three times book, now has to earn a return on a three times book what the fellow was formally earning under the regulated environment at one times book. And so, he is not going to build extra generating capacity. That — all that does is it brings down the price of electricity. You know, he hopes things are tight. So you've created, in my view, a situation where the interests of the companies in the business have diverged in a significant way from the interests of society. And I — it just doesn't make any sense to me. And I really think that the old system made more societal sense. Let people earn a good return, not a great return, but a return that attracts capital, on an investment that has built into it the incentives to keep ahead of the game on capacity because you can't fine tune it that carefully. And you do have this long lead time, so. Now, what you do with the scrambled eggs now, you know, is something. And with all the political forces back and forth, I think that you'd better have a system that encourages building extra capacity. Because you don't know how much rainfall there will be in the Pacific Northwest and, therefore, how much hydro will be available. And you don't know what natural gas prices will do. And therefore, you know, whether it's advantageous for a gas-fired turbine to be operating. And it — the old system really strikes me as somewhat better than this semi-deregulated environment that we've more or less stumbled into. But Charlie, what do you think on that?

CHARLIE MUNGEROf course, even the old system got in some troubles in that since everybody had the NIMBY syndrome — "Not In My Back Yard" — everybody wanted any new power plant to be anyplace not near me. And if everybody feels that way, and if the political system means that the obstructionists are always going to rule, which is true in some places in terms of zoning and other matters, you get in deep trouble. If you let the unreasonable, self-centered people make all the decisions of that kind, you may well get so you just run out of power. That was a mistake. And we may make that mistake with oil refineries. It is — you know, we haven't had many new, big oil refineries in the last, well, period. So you may get to do this all over again.

WARREN BUFFETTAll of that being said, there will be need for more generation capacity. I mean, the electric utility industry will be — will grow. It will need lots of capital. And there should be ways to participate in that where we get reasonable returns on capital. We would not expect to get great returns on capital. But we would, you know, we would be happy to do that. We generate a lot of capital and we would be comfortable in that business. We would not feel the risks were undue, as long as we didn't go around paying incredible prices for somebody else's capacity and then have people get very upset at what that meant in terms of their electric rates. You can’t go out and — If you've got a utility plant in this country that was put in place at X and then you go out and encourage entrepreneurs to buy in at 3X, you cannot expect utility prices — electricity prices — to fall. And that was, in my view, a very basic mistake. I may not understand it fully.

Can a good business make up for bad management?

WARREN BUFFETTArea 2.

AUDIENCE MEMBERGood afternoon. My name is Pavel Begun. I am from Minsk, Belarus. And I have two questions. And before I'll have questions for you, I'd like to say thank you for recommending to read “Intelligent Investor.” It's a terrific book and it reshaped me tremendously, literally, overnight. So I'd like to thank you for that. And now the question. Say I'm an owner of the business. And the business has a durable competitive advantage and superior business model and is run by able people. And then, you know, I start noticing that, basically, management starts doing things which are far from intelligent. So what should I do as an owner, as an investor? Should I try to tell them how they should run the business? Or should I just sit back and do nothing because superior business model should overcome poor management? That's the first question. And the second question is, how important is nominal experience in the business of investing? And by saying nominal, I mean the number of — the actual time you've been in the business, as opposed to real experience that also includes experience you acquire from, say, Ben Graham, or you, or Peter Lynch, when you read books? So those are the questions.

WARREN BUFFETTOn your first question, did you assume that you had control of the business, or you just owned a marketable security?

AUDIENCE MEMBERYes, if I own, say, 20 percent of marketable securities.

WARREN BUFFETTAll right. Well, the situation you described is not hypothetical, in the first case. (Laughter) And I would say that the history that Charlie and I have had of persuading decent, intelligent people, who we thought were doing unintelligent things, to change their course of action has been poor. Would you agree with that, Charlie, or no?

CHARLIE MUNGERWorse than poor.

WARREN BUFFETTYeah. (Laughter) So I would say that if you really think you're in with people that have got a good business, but they're going to keep doing dumb things with your money, you'll probably do better to get out and get in with people who've got a good business and you think they're going to do sensible things with it. I mean, you've got that option. Now, you also have the option of trying to persuade them to change their mind. But it's just very, very difficult. I mean it is, you know, that's been something we've faced for 50 years. And initially, we faced it from a position where nobody even knew who the hell we were, or anything of the sort. So we've acquired a certain stature over time, perhaps in talking on the subject. And we've written on the subject. And we still don't get very far. I mean, when people want to do something, they want to do something. And they didn't rise to become the CEO of a company to have some shareholder tell them that their most recent idea is dumb. I mean, that is just not the type that gets to the top. So I would say that, as a matter of investment technique, and maybe as a matter of, you know, avoiding stress in your life and all of that sort of thing, that it’s — and dealing with smaller quantities of stock so it's easier to sell and buy and all that sort of thing — I would say that it's better to be in with a management you're simpatico with, than simply to be in a great business with a management that's bent on doing things that don't make much sense to you. Charlie?

CHARLIE MUNGERWell, I certainly agree with that.

Having "your head screwed on right in the first place"

WARREN BUFFETTSecond question — (laughs) — I gather is, sort of, how much does our actual business experience versus book experience help us?

AUDIENCE MEMBERWell, it's, you know, if you look at a person who has just made two years of being in the business of investing, versus a person who has been for 10 years in the business of investing. And say the person who has been for two years, you know, has read a lot about, you know, Ben Graham's techniques, and your techniques, and, say, Peter Lynch's techniques. So would you say that the person who has only two years of experience may do much better than the second person?

WARREN BUFFETTWell, if everything else is equal, I mean, everything else is equal, except the amount of experience you have, I think the experience is probably useful. But it isn't going to be equal. And I don’t think that — I don't think that the — I think it's way more important what you've thought about for two years than what you've practiced for 10 years. If you're — if the direction — if there's a divergence in techniques applied, I would rather be with the one that I'm philosophically in sync with. If I'm philosophically in sync with both and one's had 10 years of experience, the chances are they will know a little bit more about more businesses if they've been around for 10 years, looking at them, than if they've been around for two years. But the biggest thing is that, you know, basically they've got their head screwed on right in the first place, in terms of how they value businesses and how they look at stocks. Whether they look at them as pieces of businesses or whether they look at them as little things that move around, and that you can tell a lot by looking at charts or listening to strategists on or something of the sort. We have — Charlie and I have learned a lot about a lot of businesses over 40 or 50 years. But I would say that, in terms of the new things that would come to us, at the end of the second year, we were probably about as good judges of them as we would be today. But I think there's a little plus to having seen — more in terms of human behavior and that sort of thing — than knowing about the specifics of a given business model. Charlie?

CHARLIE MUNGERYeah, I think that — I've watched Warren for a long time now, and I would say he's actually getting better as he gets older. Not at golf or — (Buffett laughs) — many other activities, but —

WARREN BUFFETTStay with generalities.

CHARLIE MUNGER— as an investor, he's better — (laughter) — which I think's remarkable. It shows that scale of experience matters.

WARREN BUFFETTYeah, it helps somewhat to have seen a lot of business situation — I mean, Charlie talks about models and you construct your models as you go along based on observation. And your models will — if you're paying attention, your models will be somewhat better the more years you've spent really observing and not just trying to make everything fit into what you saw the first few years.

Berkshire stock recommendations would be "big mistake"

WARREN BUFFETTArea 3.

AUDIENCE MEMBERHi, my name is Richard Marvel (PH) from Washington, D.C. And my question has to do with the intrinsic value of Berkshire Hathaway. You've stated several times that you would prefer the stock to be neither overvalued nor undervalued so that the time people spend owning the security represents a gain from what the security — the results during that period of time. However, it's a very difficult security to value because of the disparate pieces. And, as we saw last year, when you provide a little bit of guidance — in last year's annual report you said that when the stock price hit $45,000 a share, you considered buying, but thought it was unfair until the annual report came out so everyone had the same information. And while I also realize that you don't feel there is a particular quote-unquote "correct" number, would you ever consider giving any guidance in this direction?

WARREN BUFFETTYeah. The answer is we really wouldn't. I mean, to the extent that we were going to repurchase shares, you could certainly interpret that as indicating that we thought it was attractive from the standpoint of remaining shareholders to do so. And we certainly wouldn't be paying over intrinsic value, at least in our judgment, and benefiting the exiting shareholders to the disadvantage of the continuing shareholders. So you might draw that conclusion at that point. But other than that, we’ve — you know, we would prefer Berkshire's shares to fluctuate far less than they do. Because we would like the — ideally — we would like the experience of every investor during the time they held the shares to be exactly proportionate to the progress, or lack thereof, of the business. And I think we've come, over the years, reasonably close to that, compared to most companies. But the nature of markets is such that reasonably close is as, you know, probably as good as it's going to get. We don't know the exact intrinsic value of Berkshire, obviously. And if you looked at the figures, we — if we had written down secret figures over the — ever since 1965 — they would — some of them would look silly now, in terms of what has actually transpired. But we try to give you — I think Berkshire is easier to value than most businesses, actually, because we give you all the information that, at least, is important to us in valuing it. And then the biggest judgment you have to make is how well capital will be deployed in the future. Because it's easy — it's relatively easy — to figure out the present value of most of our businesses, but the question becomes, "What do we do with the money, as it comes in?" And that will have a huge impact on the value 10 years from now. And that will depend a lot on the environment in which we operate over the next 10 years. There'll be a lot of luck in it. I think — you know, I think there's a reasonable chance of good luck. But who knows? It would be a mistake for us to do anything — I mean, a big mistake — to ever recommend buying or selling the stock. I mean, how would you tell everybody to do it at once? You know, you would negate your own advice. You're certainly not going to tell one person, you know, to the advantage or the disadvantage of somebody else. So there's really no way for us to ever talk about whether we think the stock — whether we think it's a buy or a sale, except to the extent, like I say, on repurchases where there's obviously an implicit judgment being given the shareholders. Charlie?

CHARLIE MUNGERYeah. I rather like the way it's worked out. If you average out the period that we've been through, we've come within hailing distance of the objective of having our stock track its intrinsic value. It gets a little ahead sometimes and a little behind other times, but averaged out, it's worked pretty well.

Would Benjamin Graham's "cigar butt" strategy work now?

WARREN BUFFETTArea 4.

AUDIENCE MEMBERGood afternoon. My name is Martin O'Leary (PH) and I'm from Houston, Texas. My question to you is this. In your annual report this year, in the letter to the shareholders, you indicated that it was 50 years ago that you met Benjamin Graham, and that he had a major impact in your life, especially in your investment success. Moreover, you've stated in the past that “The Intelligent Investor” is, by far, the greatest book ever written on investing. One of the central tenants in the book was that if you bought a group of stocks, say, 10 or 20, that traded at two-thirds or less than net current assets, that you would be assured of a margin of safety, coupled with a satisfactory rate of return. Today, if you were to find 10 or 20 stocks that trade at two-thirds of net current assets, would you be inclined to purchase those stocks for your own personal portfolio, not for Berkshire Hathaway? And the second question, since I've mentioned the book, I was wondering which books that you and Mr. Munger have been reading lately and would recommend. Thank you.

WARREN BUFFETTYeah, in respect to your first question, you could probably — if you found a group like that — and you won't, I don't think — you'd probably do all right buying the group. But not because the businesses themselves worked out that well over time, but because there would probably be a reasonable amount of corporate activity in a group like that, either in terms of the managements taking them private, or takeovers, or that sort of thing. But those sub-working capital stocks are just almost impossible to find now. And if you got into a market where a lot of them existed, you'd probably find wonderful businesses selling a lot cheaper, too. And our inclination would be to go with a cheap, wonderful business. I don’t think you’ll get — in a high market or something close to it — I don't think you'll get a lot of sub- working capital stocks anymore. There's just too much money around to promote deals before they really get to that point. But that was a technique. It was 50 years ago. And is Walter Schloss here still? Walter, are you here? Stand up if you're here. I met Walter 50 years ago when I met Ben Graham. I know Walter’s — came out this year, but he already knows everything I've been talking about, so he may have left. But Walter, actually, has practiced in securities, much closer to the original — he's run a partnership now for 46 years, I guess it is. And he's done it much more with the type of stocks that Ben was talking about in those days. And he has a record that is absolutely sensational, that is far better than people who get promoted and go on television shows and do all of that sort of thing. And he's done it in, you know, what I tend to call cigar butt companies. You know, you get one free puff and that's about it, but they don't cost anything. And that’s — that was the sub-working capital type situations. Walter's had to extend that somewhat, but it's been a great, great record over a considerable — I mean, 46 years — a very considerable period of time. So I think, if you found that kind of a group and did it as a group operation, and Ben always emphasized a group operation because when you're dealing with lousy companies but you expect a certain number to be taken over and all that, you'd better have a group of them. Whereas if you deal with wonderful companies, you only need a couple. But I think, if you see that period again, we'll be very active. But it won't be in those kind of securities. Charlie?

CHARLIE MUNGERYeah. And there's another change. In the old days, if the business stopped working, you could take the working capital and stick it in the shareholders' pockets. And nowadays, as you can tell from all the restructuring charges, when things really go to hell in a bucket, somebody else owns a lot of the working capital. The whole culture has changed. If you have a little business in France and you get tired of it, as Marks & Spencer has, the French say, "What the hell do you mean trying to take your capital back from France? There're French workers in this business.” And they don’t care. They don't say, "It's your working capital. Take it back," when the business no longer works for you. They say, "It's our working capital." The whole culture has changed on that one. Not completely, but a lot from Ben Graham's day. There're a lot of reasons why the investment idiosyncrasies of one era don't translate that perfectly into another.

WARREN BUFFETTThat list that was published, I forget whether it was published in the 1951 edition of “Security Analysis” or the '49 edition of “Intelligent Investor,” but there were a list of companies. There was Saco-Lowell, there was Marshall-Wells, there was Cleveland Worsted Mills, there was Foster Wheeler, and all those companies were sub-working capital companies selling at three or four times earnings. And there was a — if you bought a group of stocks like that, you were going to do well. But, you know, I — you certainly don't see that in companies of any size today. And I've seen a few lists of tech companies selling below cash. But they're determined to use that cash. And it may not be there in a year or two. It was a different breed of animal, to some extent, in Ben's list at that time.

Book recommendations

WARREN BUFFETTDid you ask a second question?

CHARLIE MUNGERBooks you've read.

WARREN BUFFETTOh, books I've read. Well, tell him what books you've read, Charlie. (Laughter)

CHARLIE MUNGERWell, I mentioned that one book “Genome.” I have a hell of a time putting the accent on the first syllable. But that is a marvelous book. And some shareholder sent me a book that not many of you will like, by Herb Simon I think, “Models of My Life.” And it's a very interesting book for a certain academic type. But that "Genome," you know, which is the history of a species in 23 chapters, and it's a perfectly amazing book, and very interesting.

WARREN BUFFETTI may have recommended it before, but if you haven't read “Personal History” by Katharine Graham, I think you'd find that it's a fascinating story. And more amazing yet, it's an honest story. You know, if I ever write my autobiography, I'm going to look like Arnold Schwarzenegger, but — (Laughter) But she is compulsively honest about what's happened. And it's really quite a saga.

CHARLIE MUNGERIt is a good book. That Janet Lowe book about me I find has had a very interesting sub-chapter, so to speak, in its distribution. I notice a considerable number of people buying that book and sending one copy to each descendant. They believe that if they just do that, the descendants will behave more like the parents. It'll be interesting to see if that works. If it does, it's going to outsell the Bible. (Laughter)

WARREN BUFFETTHold your breath — (Laughter)

Congress should loosen capital restrictions for utilities

WARREN BUFFETTArea 5.

AUDIENCE MEMBERGood afternoon. I'm Laura Rittenhouse (PH) from New York City. And I want to say it's a great pleasure to be here. You talked earlier about companies that monetize greed. And it's great to be with people and with leaders who monetize values. You — a couple years ago, you spoke very passionately about campaign finance reform, and I wondered if you could comment on your views of this, given recent developments related to another question in Washington. What's your expectation for the passage of the repeal of PUHCA? I know there was some recent activity in a Senate sub-committee. And lastly, a question for Charlie. How would you, or do you, apply the principles of intrinsic investing to real estate?

WARREN BUFFETTOK. In respect to PUHCA, it's hard for me to — you know, I have no great record of handicapping legislative action. But I would say that the awareness of the public problems in the electric utility industry under current circumstances, you know, has mushroomed. I mean, it's ballooned. And so I think that — I think it's likely that Congress is more receptive to the idea that they need to do something that ensures that the power supply is adequate. And I think that there's probably a number of them that would think that PUHCA is a barrier to capital entering the industry from a lot of sources where capital is available. And that it's going to take capital to solve this problem. Now, they don't have to solve it by letting Berkshire do more things. But it's not a crazy approach to say that if Berkshire has billions of dollars to invest, that it might be a net plus for the availability of electricity down the road. So I think that certainly the chances of repeal or major change are far higher now than they were a couple of years ago. And, I mean, politicians do not like to face major brownouts. I mean, they can try and blame it on someone else and they may well be accurate in blaming it on someone else. But the public is going to at least partially blame political leaders if this country runs out of electricity, because it hasn't run out of the ability to build generators. You know, we could create all the generators we needed to have plenty of electricity. And we could create the transmission lines and all of that. But you do need a flow of capital to the industry. And PUHCA restricts that flow to quite a degree, I would say.

More regulation needed for campaign contributions

WARREN BUFFETTCampaign finance reform, you've read about it as much as I have. You know, I happen to admire enormously what McCain and Feingold have done. I don't think it's a panacea. I mean, money is going to find its way into trying to buy political influence one way or another. But the present situation, in my view, has gotten totally out of control and, incidentally, totally out of sync with what the American Congress, even, as well as the public, intended, because in 1907, Congress said, and it's never been changed, that corporations shall not contribute money to federal elections. And in 1947, they said the same thing about labor unions. And then they enacted campaign legislation in the early '70s which, when later interpreted by the Federal Election Commission, enabled corporations and unions to do on an unlimited scale, what Congress had said they shouldn't do at all. And politicians did not really understand the potential in that, initially. I remember the first guy that called me, Senate candidate, called me for a soft money contribution probably in 1985, or so. And he was kind of embarrassed about it and sort of danced around the subject about how this money was going to find its way into his campaign and everything. And he was asking me for an amount of money that was illegal under the law, except if I did it via soft money. And that has developed to the point where I have literally had people, where I have firsthand knowledge, of requesting million dollar contributions or larger, which would never be reported. We'd never be required to report it. And I regard that as a perversion of the system. But I think we're going to get some significant improvement. I think it was only possible because of the credibility that McCain built up with the public and the fact that he just wouldn't let go of this issue. So I’m — but I'm not hopeful about it changing the whole course of American democracy or anything of the sort. But I am hopeful that the system of government where access is sold to the highest bidder, and where the bidding starts at a higher level, by a material amount, in every election cycle, will at least be checked for a while. Charlie, she had a question for you.

CHARLIE MUNGERWell, my trouble with campaign finance reform is that I fear career politicians just staying on and on just about as much as I fear special interests protecting themselves with money. And I never know exactly how the reform is going to work. When I came to California, we had sort of a semi-corrupt, part-time legislature dominated by race tracks and saloons and liquor distributors, and so on. And people went up and entertained the legislators with prostitutes and what have you. And I really sort of prefer that government, in retrospect — (laughter) — to the full-time legislators I have now. So I just am more skeptical about my ability to predict which reform I'm going to like the results of and which I would like to trade back in for my former evils.

Munger has moved on from real estate investing

WARREN BUFFETTLaura, you had one more, did you on —? Was it for Charlie?

AUDIENCE MEMBERIt was a question about the principles of intrinsic value investing applied to real estate.

CHARLIE MUNGEROh, that period of my life involved the remote past. And I much prefer business investment to real estate investment.

Q&A concludes

WARREN BUFFETTOK. It's 3:30. We're going to have a directors meeting here, we do that once a year, following this meeting. And so I'll ask the directors to stick around.