Annual Meetings

Afternoon Session - 1996 Meeting

Warren Buffett and Charlie Munger discuss why they think portfolio diversification is a "protection against ignorance," explain why they're fearful of change, and argue that people rewarded by capitalism have an obligation to help people who don't do as well.

Mon, May 6 1996 • 1:00 PM EDT
Key Chapters —
1. Investing with "the two wealthiest guys"

WARREN BUFFETT: OK, if we've got a monitor over in zone 1, we're ready to start.

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AUDIENCE MEMBER: Yes. Thank you very much. My name is Maria Nicholas Kelly (PH). I'm from Tacoma, Washington.

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And my husband and I have rather different investment approaches. And in 1988, he bought me one share of Berkshire, so that I could learn something about investing. We both started about that same time.

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And he has chosen to invest in, let's say, about 40 different stocks and buying and selling, and doing rather well for us, frankly.

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My approach is more simple. And basically, I finally figured out last year that I should invest in the companies of the two wealthiest men in the world.

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So — (laughter) — I decided we should buy, monthly, more Berkshire and Microsoft. So, then this year — and so, we've been able to do that.

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This year, we read in your report that Berkshire is selling "at a price at which Charlie and I would not consider buying it," so my husband has challenged my investment strategy. (Laughter)

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I know that you are an honest man. And while you may not — (laughter) — you may not recommend to "my partner, Charlie," to buy more Berkshire at this time, do you recommend that I continue — (Buffett laughs) — my rather automatic investment buying of Berkshire?

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And I wanted — I think I know the answer. But I wanted my husband to hear it from the horse's mouth. (Laughter)

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WARREN BUFFETT: I think you're using me here. (Laughter)

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AUDIENCE MEMBER: But —

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WARREN BUFFETT: Well, I — we don't recommend selling it, but we don't recommend buying it, either. We are neutral on that subject.

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And I hope you continue to be in with the two wealthiest guys. I like the other fellow, too. (Laughter)

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AUDIENCE MEMBER: Thank you.

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WARREN BUFFETT: Yeah.

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2. American Express has "slipped" in credit cards

WARREN BUFFETT: Zone 2?

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AUDIENCE MEMBER: Mr. Buffett, I am Harriet Morton from the Emerald City [Seattle], the same area, the land of Microsoft. And I have a couple small questions.

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The first one is, recognizing your lack of interest in technology or sense of familiarity with it, I'm wondering if you'd give a few comments on Bill Gates as a manager.

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But the second one, dealing with a business that you're familiar with, has to do with American Express.

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Would you comment on American Express' strategy to deal with their declining market share in the credit card industry and the rising importance of debit cards? Thank you.

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WARREN BUFFETT: I'm not sure I got that entirely, Charlie. Did you? I mean, I got the part about American —

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CHARLIE MUNGER: She wanted you to comment on Gates as a manager and American Express as — with the problems in declining in market share.

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WARREN BUFFETT: Well, the first part is very easy. You know, Bill Gates is, you know, one of the great managers of all time and is an exceptional business talent who loves his business.

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And when you get that combination and a high energy level and, now, an heir to leave it to, I don't think you do much better than that.

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American Express has, you know — has slipped over from where they were 20 years ago, obviously, in the credit card business. And I think they may have taken their customer a little bit for granted for a while.

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I think [CEO] Harvey Golub is very focused on correcting that and has made some progress. But the credit card business is a very different competitive struggle now than it was 20 or 25 years ago.

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Interestingly enough, American Express, itself, backed into the business. Because they were worried about what was going to happen to their traveler's check business, originally.

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And they saw Diners Club come along. A fellow named Ralph Schneider and — started it. And they saw the inroads that were being made. So, the credit card was a reactive move. And for a while, they really dominated the field. And of course, they still dominate the travel and entertainment part of it.

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But credit cards are going to be a very competitive business over time. And you need to establish — American Express needs to establish — special value for its card in some way, or it gets more commodity-like.

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It's not an easy business. But their franchise — they've got a strong franchise. It is not what it was 20 years ago, relative to the competition.

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3. "A lot of mediocrity" among CEOs

WARREN BUFFETT: Zone 3?

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AUDIENCE MEMBER: Good afternoon. My name is John Weaver. I'm a shareholder from Bellingham, Washington.

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You have discussed what a wonderful business is. One of the criterias in your acquisition, page 23 of your annual report, is management.

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Could you discuss how you decide what good management is and how you decide whether you have a good manager?

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WARREN BUFFETT: The really great business is one that doesn't require good management. I mean, that is a terrific business. And the poor business is one that can only succeed, or even survive, with great management. And —

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But we look for people that know their businesses, love their businesses, love their shareholders, want to treat them as partners. And we still look to the underlying business, though. We —

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If we have somebody that we think is extraordinary, but they're locked into one of those terrible businesses, because we've been in some terrible businesses, and you know, the best thing you can do, probably, is get out of it and get into something else.

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But there's an enormous difference, frankly — there’s an enormous difference in the talent of American business managers.

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The CEOs of the Fortune 500 are not selected like 500 members of the American Olympic track and field team. And it is not the same process. And you do not have the uniformity of top quality that you get with the American Olympic team in any sport. You do not get that in top management in American business.

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You get some very able people, some terrific people, like a Bill Gates, that we just mentioned. But you get a lot of mediocrity, too.

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And the test — I think, in some cases, that it's fairly identifiable, who has done an extraordinary job. And we like people that have batted .350 or .360, in terms of predicting that they're going to bat over .300 in the future.

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And some guy says, you know, "I batted .127 last year. But I've got a new bat or a new batting coach," you know, some management consultant has come in and told them how to do it, supposedly.

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We're very suspicious of that. So we don't like banjo hitters who suddenly proclaim that they can become power hitters.

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And then we try to figure out what their attitude is toward shareholders. And that isn't uniform, either, throughout corporate America. It's far from uniform.

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We still want them to be in a good business, though. I would emphasize that.

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We feel that — I mean, I gave the illustration of Tom Murphy in the annual report.

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I mean, no one had either the ability — no one could top his ability or integrity, in terms of the way he ran Cap Cities for decades. I mean, and you could see it in 50 different ways.

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I mean, he was thinking about the shareholders. And he not only thought about them, he knew what to do to forward their interests, and —

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In terms of building the business, he only built it when it made sense, not when it did something for his ego or to make it larger alone. He did it when it was in his shareholders' interests.

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And they're not all Tom Murphys. But when you find them, and they're in a decent business, you want to bet very heavily and not make the same mistake I made by selling out once or twice, too. (Laughter)

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4. "Diversification is a protection against ignorance"

WARREN BUFFETT: Zone — was that zone 3 or —? Yeah, zone 4.

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AUDIENCE MEMBER: Yeah, my name is Mark Hake (PH). I'm from Scottsdale, Arizona.

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And I am very interested in your policies on diversification and also how you concentrate your investments.

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And I've studied your annual reports going back a good number of years, and there's been years where you had a lot of stocks in your marketable, equitable securities portfolio. And there was one year where you only had three, in 1987.

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So, I have two questions. Given the number of stocks that you have in the portfolio now, what does that imply about your view of the market in terms of, is it fairly valued, that kind of idea?

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And second of all, whenever you — it seems that, whenever you take a new investment, you never take less than about 5 percent and never more than about 10 percent of the total portfolio with that new position. And I wanted to see if I'm correct about that.

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WARREN BUFFETT: Yeah. Well, on the second point, that really isn't correct.

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We have positions which you don't even see, because we only listed the ones above 600 million in the last report. And obviously, those are all smaller positions.

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Sometimes, that's because they're smaller companies, and we couldn't get that much money in. Sometimes, it's because the prices moved up after we'd bought them. Sometimes, it's because we may be selling the position down, even. So there's nothing magic.

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We like to put a lot of money in things that we feel strongly about. And that gets back to the diversification question.

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You know, we think diversification is — as practiced generally — makes very little sense for anyone that knows what they're doing.

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Diversification is a protection against ignorance.

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I mean, if you want to make sure — (laughter) — that nothing bad happens to you relative to the market, you own everything. There's nothing wrong with that. I mean, that is a perfectly sound approach for somebody who does not feel they know how to analyze businesses.

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If you know how to analyze businesses and value businesses, it's crazy to own 50 stocks or 40 stocks or 30 stocks, probably, because there aren't that many wonderful businesses that are understandable to a single human being, in all likelihood.

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And to have some super-wonderful business and then put money in number 30 or 35 on your list of attractiveness and forego putting more money into number one, just strikes Charlie and me as madness.

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And it's conventional practice, and it may — you know, if you all you have to achieve is average, it may preserve your job. But it's a confession, in our view, that you don't really understand the businesses that you own.

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You know, I base — on a personal portfolio basis — you know, I own one stock. But it's a business I know. And it leaves me very comfortable. (Laughter)

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So you know, do I need to own 28 stocks, you know, to have proper diversification, you know? It'd be nonsense.

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And within Berkshire, I could pick out three of our businesses. And I would be very happy if they were the only businesses we owned, and I had all my money in Berkshire.

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Now, I love it — the fact that we can find more than that, and that we keep adding to it. But three wonderful businesses is more than you need in this life to do very well.

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And the average person isn't going to run into that. I mean, if you look at how the fortunes were built in this country, they weren't built out of a portfolio of 50 companies. They were built by someone who identified with a wonderful business. Coca-Cola's a great example. A lot of fortunes have been built on that.

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And there aren't 50 Coca-Colas. You know, there aren't 20. If there were, it'd be fine. We could all go out and diversify like crazy among that group and get results that would be equal to owning the really wonderful one.

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But you're not going to find it. And the truth is, you don't need it. I mean, if you had — a really wonderful business is very well protected against the vicissitudes of the economy over time and the competition.

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I mean, you know, we're talking about businesses that are resistant to effective competition. And three of those will be better than 100 average businesses.

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And they'll be safer, incidentally. I mean, there is less risk in owning three easy-to-identify, wonderful businesses than there is in owning 50 well-known, big businesses. And it's amazing what has been taught, over the years, in finance classes about that.

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But I can assure you that I would rather pick — if I had to bet the next 30 years on the fortunes of my family that would be dependent upon the income from a given group of businesses, I would rather pick three businesses from those we own than own a diversified group of 50.

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Charlie?

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CHARLIE MUNGER: Yeah, what he's saying is that much of what is taught in modern corporate finance courses is twaddle. (Laughter and applause)

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WARREN BUFFETT: You want to elaborate on that, Charlie? (Laughter)

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CHARLIE MUNGER: You cannot believe this stuff. I mean, it’s modern portfolio theory and — yeah, it’s —

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WARREN BUFFETT: It has no utility. But you know, it will tell you how to do average. But, you know, I think anybody can figure out how to do average in fifth grade. I mean, it's just not that difficult, and —

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It's elaborate. And you know, there's lots of little Greek letters and all kinds of things to make you feel that you're in the big leagues. But it — (laughter) — there is no value added. (Laughs)

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CHARLIE MUNGER: I have great difficulty with it because I am something of a student of dementia — (laughter) — and I have —

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WARREN BUFFETT: And we hang around a lot together. (Laughter)

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CHARLIE MUNGER: And I get ordinarily — classified dementia, you know, on some theory, structure of models. But the modern portfolio theory, it involves a type of dementia I just can't even classify. (Laughter)

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Something very strange is going on. (Buffett laughs)

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WARREN BUFFETT: If you find three wonderful businesses in your life, you'll get very rich. And if you understand them — bad things aren't going to happen to those three. I mean, that's the characteristic of it.

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CHARLIE MUNGER: By the way, maybe that's the reason there's so much dementia. If you believed what Warren said, you could teach the whole course in about a week. (Laughter)

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WARREN BUFFETT: Yeah, and the high priests wouldn't have any edge over the laypeople. And that never sells well. (Laughter)

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CHARLIE MUNGER: Right.

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5. Downsizing is sometimes needed to correct excessive hiring in the past

WARREN BUFFETT: OK, zone — what, 5, are we over there?

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AUDIENCE MEMBER: Yes. Good afternoon, Mr. Buffett, Mr. Munger, board of directors.

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Wanted to ask, in looking ahead, do you see the trends of extensive outsizing, the offshoring, the downsizing, the expendable workforce, the rightsizing, the diminished commitment to company loyalty, and the greater emphasis on the short term, quick buck, bottom line versus your commitment to the long-term investment affecting your pool of investment possibilities and your decision processes?

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And do you possibly think of creating new companies on your own?

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WARREN BUFFETT: Well, I think that the trends you talk about, and the attention devoted to them, could have some effect, just in terms of how the public and Congress may feel toward business.

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Historically, you know, every industry, at all times, is interested in downsizing or becoming more efficient.

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Now, if the industry is growing, you can achieve efficiency by doing more work, or turning out more output, with the same people.

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But you know, if you go back 150 years and look at the percentage of people in farming, for example, farming has downsized from being a very appreciable percentage of the American workforce to a very small percentage. And essentially, that's released people to do other things.

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So, it's in the interest of society to get as much output in anything as it can per unit of labor input. It's very difficult on the individual involved.

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And you know, it’s no fun — I guess it's no fun being a horse when the tractor comes along, or a blacksmith, and when the car comes along. But the —

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So, I don't quarrel with the activities. I quarrel, sometimes, with how it's done. And I do think there's been a certain lack of, in certain cases, some empathy or sensitivity in terms of the way it's being done.

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You should try to make your businesses more efficient. We hope we're not in businesses that will require us to lay off people over time, because we hope that physical output grows, and that we become more productive and can keep the same number of people to get greater output.

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Dexter Shoe has done a great job of that over time. They've become more and more productive. But they've sold more shoes instead of selling the same number of shoes and letting people go. But sometimes, industry trends —

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I mean, at World Book, we have fewer people than we had a year or two ago. And we didn’t — we don't have any answer to that.

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Over time, we got out of the textile business. I wish we didn't have to. But we did not know how to run a textile company in New England and compete effectively.

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Like I say, I would — I love avoiding those businesses. And to the extent we can, we will.

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I mean, GEICO is going to add people over time. And I think Berkshire Hathaway's going to add people over time.

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But I can’t — but it is in the interest of society to do jobs more effectively. It's also in the interest of society, it seems to me, to take care, in some way, of the people that are affected by that activity. And either — in some cases, it may be retraining.

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But in other cases, you know, it doesn't work so well if you're 55 years old, and you've been working in a textile mill all your life, and all of a sudden the guy that runs the place can't make any money out of selling your output. I mean, that's not the fellow's fault that's been working at the textile mill for 30 years.

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So, there's a balance in that. I think that the attention that's come about lately, I think there's — to some degree, it was a media fad based on some particularly dramatic examples at a couple of companies.

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I don't think there is more displacement going on now, as a percentage of the labor force, annually, than there was 10 years ago, in terms of reconstituting what people do. But it's gotten a lot of attention lately.

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There could be a backlash on that, in terms of corporate tax rates or a number of things. And we might feel it in that direction.

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We want, at Berkshire, to do everything as efficiently as we can. Part of that, in a big way, is not taking on a lot of people we don't need.

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A lot of the mistakes that are being corrected now are because people got very fat. And their businesses got very fat in the past and took on all kinds of people they don't need. We see that in a lot of businesses that we're exposed to.

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And as long as they're very prosperous, really, no one does very much about it. And then when the time comes, they all of a sudden find out they can get way more output.

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The oil companies are a classic example. You know, the people, probably, actually needed to produce, refine, and market oil probably hasn't changed that much. But if you look at the employment relative to barrels produced, refined, and marketed, it's gone down dramatically over 20 years ago.

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To me, it just means that they weren't being run that well 20 years ago. And it never should've occurred in the first place.

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We don't want to take on more people than we need in any of our businesses, because we don't want to lay people off, either.

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Charlie?

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CHARLIE MUNGER: Well, if you put it in reverse, you'd say, name a business that has been ruined because it was over-downsized. I cannot think of a single one.

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But if you asked me to name businesses that were half-ruined, or ruined, by bloat, I mean, I could just rattle off name after name after name.

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It's gotten fashionable to assume that downsizing is wrong. Well, it may have been wrong to let the business get so fat that it eventually had to downsize.

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But if you've got way more people than are needed in the business, I see no social benefit in having people sit around half employed or unemployed.

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WARREN BUFFETT: You're very likely to compete against some guy, at some point, who doesn't have more people around than needed in the business, too. But it doesn't change. For the people involved, they've got real problems, and —

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CHARLIE MUNGER: Warren, can you name one that has been ruined by over-downsizing? There must be one, but —

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WARREN BUFFETT: Well, it's like Eisenhower said about Nixon. Give me a week, and I'll come up with something. (Laughter)

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6. No layoffs at insurance operations due to reduced volume

WARREN BUFFETT: How about zone 6?

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AUDIENCE MEMBER: Mr. Buffett, Mr. Munger, I'm Walter Kaye of New York City.

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WARREN BUFFETT: We're glad to have you here, Walter.

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AUDIENCE MEMBER: What?

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WARREN BUFFETT: We're glad to have you here. Walter's been a good friend of ours.

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AUDIENCE MEMBER: Thank you very, very much. You just make me more of an egomaniac, a humble egomaniac, by saying that.

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I don't know if Mr. Munger's wife is here and Mrs. Buffett is here, but back East, where I come from, in New York, they say, "When people — when men are successful, it's their wife's doing. But if they're a failure, it's because they're lazy." (Laughter)

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But anyhow, I just wanted to, again, thank you very much. You've done such great things for our family. It's absolutely incredible.

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And to those of you who don't know these two gentlemen, besides being financial geniuses, and you all know Mr. Buffett and, somewhat, Mr. Munger, too, they're the finest human beings you'll ever meet. I mean, just the way they explained this downsizing is the most intelligent thing that I've ever heard.

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And eventually, like, you know, these people eventually find work. They have to be reeducated and everything like that.

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But one point of business I'd like to ask you, if you don't mind. I have been noticing that there has been a tremendous amount of new capital going into reinsurance carriers.

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And I was wondering if you could make a few comments about that, if you think that will affect the reinsurance business — have any effect on the insurance business in general, because, as you know better than I, we're still in a very soft market.

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And there isn't a month that goes by that I don't hear of some new reinsurance carrier, whether in Bermuda or London or somewhere. Thank you.

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WARREN BUFFETT: OK. Walter knows more about insurance than I do. But I'll, nevertheless, comment on that.

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There has been a fair amount of capital. And there was a rush of it about, I'd say, maybe three years ago into the reinsurance business.

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But there has been capital come in, and that is negative for our business. I mean, because any capital that's brought in, basically, will get employed.

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We are willing, at Berkshire — and we do it — we are willing to sit on the sidelines in the reinsurance business.

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We'll offer quotes. But somebody that — will cut those prices substantially, if they've got a lot of capital and want to keep busy. And if you've got a lot of capital in this business, or if you attracted a lot of capital, you will do something. You might like to do something smart, but if need be, you'll do something dumb.

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You'll rationalize it, so you think it's smart. But you will do it. You won't just sit there and write the shareholders at the end of the year and say, you know, "We asked you for $300 million last year. And we'd like to report that it's all safely in a bank account at Citicorp." It just doesn't work that way.

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So they will go out and do something. People don't like to sit around all day and do nothing.

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And that means that prices will get cut under certain circumstances. And those circumstances — that's happening now.

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We will — at Berkshire, we do have a rule about downsizing on that. We have promised people, at all of our insurance operations, that we will never have layoffs because of a drop in volume. We do not want the people who run our insurance business to feel they have to write X dollars in order to keep everybody there.

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We can afford some overhead around that's costing us a little money for lack of using it at full capacity, because it isn't that much, relative to the size of our insurance operation.

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What we can't afford are people feeling some internal compulsion to keep writing business in order to keep their job. So, we have a strong policy on that.

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And if the business falls away, in terms of price, we won't be doing business. But we will be around to do business in a big way when the circumstances reverse.

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They reversed in the casualty business for a while in 1985 or thereabouts. And we did a terrific amount of business.

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They reversed in catastrophe reinsurance four or five years ago, and we became very active in that, and —

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We will have times that are very good for us in insurance. It's a lot like investments. If you feel you have to invest every day, you're going to make a lot of mistakes. It just — it isn't that kind of a business. You have to wait until you get the fat pitch.

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And in insurance, it's similar. You do not — if we had a budget for premium volume for our insurance companies, it would be the dumbest thing we could do, because they would meet the budget.

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They could meet any budget I set out. I could tell some operation that wrote a hundred million last year to write 500 million this year, and they would meet it, you know, and I would be paying the bills for decades to come, so —

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It's a very illogical way to try and plan 8 or 10 percent-a-year growth.

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Now, GEICO is a different story in that GEICO is a business that is the low-cost operator and can attract, from a huge pool, business at, I think, a very good rate of growth simply by letting people know what's available out there. So that is a business that I see growing under almost any circumstances.

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But our reinsurance business will swing around enormously, in terms of volume, based on what the competitor is doing. And what the competitors are doing depends, to a great extent, on how much money they've got burning a hole in their pocket.

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And right now, it's going one direction. But it will change, I mean, just like investment markets change, you know. I've been through at least a half a dozen periods where people think, you know, they're never going to get a chance to buy securities at intelligent prices. And it always changes.

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In the insurance business, people that misprice their policies will pay the price for it. And the world will still need insurance. And we will still be there.

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7. International expansion for GEICO would be dangerous distraction

WARREN BUFFETT: Zone 7? Oh, we don’t have any. I guess we have everybody in here now, so we'll go back to zone 1.

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AUDIENCE MEMBER: Mr. Buffett, salutations from Portugal. I am from Portugal. My name is Herculano Fortado (PH). I have been a shareholder of your company since it was traded on the NASDAQ.

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And I hold the shares and went on accumulating year after year, whenever funds were available and were at my disposal.

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Now, a little bit about my history. As a student, I am from India. I was born in India, of Indian parentage. And my parents were very modest and could not afford me higher education. I started my school —

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WARREN BUFFETT: I think maybe you'd better just get to the question, though, if you will, please.

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AUDIENCE MEMBER: Yes. And then started writing insurance, life insurance, for a company which was a subsidiary of American Life.

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My question now is this. I am now living in Portugal, and I see that the European market is developing and Berkshire Hathaway is having a very big slice of insurance investments.

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They don't seem to be operating in the new markets that are emerging in Europe, and as well as in countries like India or the Pacific area, where the human — two-thirds of human beings are living.

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Is there a policy or a plan, on the part of Berkshire Hathaway, to diversify and internationalize their insurance business? This is my only question.

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WARREN BUFFETT: Thank you.

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The reinsurance business of Berkshire Hathaway is totally international. I mean, we deal with risks all over the world. We deal with companies all over the world.

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And that's the nature of the reinsurance business, generally, although there might be some that would be more specialized to this country, but —

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We are quite willing to take on risks around the world, although they have to be risks with a large premium. I mean, that's the nature of our reinsurance business. We're not in the retail end of the business.

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But we do that worldwide. And we'll continue to do that worldwide, because there are huge risks that exist for primary insurers around the world. And they need somebody to lay them off on.

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Now, whether they will pay the proper price is another question. And it may be a little more difficult, in a few jurisdictions, to do business than in others. But that's an international operation.

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GEICO has two-and-a-fraction percent of the U.S. auto market. We have about 2 1/2 million policyholders. There are over a hundred million in the country.

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And there is such an opportunity here that it would be diversionary to go into other countries with GEICO.

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There's been a firm that was very successful over in England that introduced a somewhat GEICO-like operation about 10 years ago. And they did very well. They are now encountering more competition. And their results are falling off somewhat, but —

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There's a huge potential for GEICO in this country. And I would not want the management of GEICO to be going off in other directions now, when there's so much to be done here.

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I mean, three percentage points on our growth rate here, for example, you know, would be 75 million or so of volume. And that, in turn, would keep compounding over time. Well that — there's too much to do here before we set up some startup operation around the world.

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And there are actually various problems in a lot of jurisdictions in — to run a GEICO-like operation — although I wouldn't say that that prevails every place. I mean, there could be opportunities. But the opportunity here in this country is huge. And the management of GEICO is focused.

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I love focused management. The management of — if you read the Coca-Cola annual report, you will not get the idea that Roberto Goizueta is thinking about a whole lot of things other than Coca-Cola.

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And I have seen that work time after time. And when they lose that focus — as, actually, did Coke and Gillette both, at one point 20 to 30 years ago somewhat — it shows up.

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I mean, it — two great organizations were not hitting their potential 20 years ago. And then they became refocused. And what a difference it makes. It makes tens of billions of dollars' worth of difference, in terms of market value.

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GEICO actually started — they started fooling around in a number of things in the early '80s, and they paid a price to do it. They paid a very big price.

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They paid a direct price, in terms of the cost of those things, because they almost all worked out badly. And then they paid an additional price in the loss of focus on the main business.

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That will not happen with the present management. Tony Nicely thinks about nothing else but doing — carrying the GEICO message to people who — that 97 1/2 percent or so that are not policyholders. And that will work very well for us over time.

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Charlie?

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CHARLIE MUNGER: We are indirectly in all of these emerging markets through Coca-Cola and Gillette. So, it isn't true that we're totally absent.

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WARREN BUFFETT: No. Well, at Coca-Cola the international markets are 80 percent of profits — actually, a little more.

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Gillette, I think they're about 70 percent or so. So, the — we love the international aspects of the Coca-Cola or Gillette businesses. And that's a very major attraction.

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But the management of those companies is focused on that. But they are doing — they have distribution systems, and they have recognition, and they've got a lot going for them over there. But the beauty of it is that they're maximizing what they do have going for them, which was not the case 20 years ago.

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They just sort of let it go more by default, and they started fooling around with a lot of diversification. And you know, basically, that has not worked that well. So, we like focus. We love focus.

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CHARLIE MUNGER: Yeah, and doing it indirectly, as we've done, one can argue that we, thereby, do it a lot better. (Laughter)

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WARREN BUFFETT: We won't explore the implications of that. (Laughter)

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8. Shareholders boost Borsheims sales

WARREN BUFFETT: Zone 2?

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AUDIENCE MEMBER: My name's George Olson (PH). I'm from Atlanta, Georgia. I have a couple quick questions for you.

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First of all, I'd like to have your comments on the USAir preferred that were — they're several quarters in arrears on.

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And secondly, I was wondering about the Borsheims report from yesterday. You usually comment on that. (Laughter)

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WARREN BUFFETT: Well, Susan Jacques, who runs Borsheims, called me this morning. And her voice was hoarse but happy, and — (Laughs)

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Borsheims — that comparable day last year was the biggest day of the year. And it was about 60 percent up this year, so — I’m — you've done your part. (Applause)

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CHARLIE MUNGER: We are starting a new custom at Berkshire Hathaway's annual meetings. A shareholder came up to me and asked for my autograph on his sales slip from Borsheims — (laughter) — which was a $54,000 watch.

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Now, that is the kind of autographs we like to give. (Laughter and applause)

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And so our message to you all is, "Go thou and do likewise." (Laughter)

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WARREN BUFFETT: It wasn't a member of Charlie's family, incidentally. (Laughter)

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9. USAir investment has improved, but was still a mistake

WARREN BUFFETT: The USAir preferred, as I mentioned in the annual report, it looks considerably better than it did 18 months ago or thereabouts.

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But their fundamental problem — and Steve Wolf has said this — the new CEO of USAir — the fundamental problems are there. And they either address and correct those fundamental problems, or those problems will address and correct them. (Laughter)

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And the — you know, their costs are out of line. Their costs are those that are relics of a regulated, protected environment. And they are not in a regulated, protected environment. And so far, they have not had any great success in correcting the situation.

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Knowing Mr. Wolf, I'm sure he is, you know, focused entirely on getting that changed. And he will need to get it changed. And he — his record has been pretty successful at that.

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So, we're a lot better off with our US Air preferred than we were 18 months ago, but it still is a mistake I made.

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And we would've been a lot better off if I'd just, as Charlie says, gone out to a bar that night instead. (Laughter)

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You got any comments, Charlie, on USAir? He doesn't want to comment. It may sound like it's his deal. (Laughter)

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CHARLIE MUNGER: It's, plainly, worth a lot more than it was last year. (Laughter)

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10. Newspapers may evolve, but won't disappear entirely

WARREN BUFFETT: And with that, we'll move to zone 3. (Laughter)

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AUDIENCE MEMBER: Hi, David Winters, Mountain Lakes, New Jersey.

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Without ruining my fun, can you give me a few hints about how I should think about calculating the intrinsic value — (Buffett laughs) — of the insurance businesses?

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And secondly, I'm wondering about, not that you can foretell the future, either one of you, but with regards to newspapers, is there any concern that it goes the way of the printed World Book and Blue Chip Stamps?

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WARREN BUFFETT: It could — I think it’s very — I'll answer the second part first.

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I think it's very unlikely — very, very unlikely, you know, down to a few percentage points, that newspapers will go the way of Blue Chip Stamps.

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World Book is a different story. World Book has got — they have a reasonable shot at a decent future. But it's not automatic.

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But the newspaper, it may be configured somewhat differently. It may get a different percentage of its revenue from circulation and advertising than it does. I mean, there may be some evolutionary-type changes in it. But it's still a bargain.

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It is a bargain to anybody that is interested in their community. It's still a bargain to a great many advertisers.

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We spend a lot of money advertising in newspapers in our various businesses. And we feel we are getting our money's worth, obviously. And it works.

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But it just doesn't have the lock that it used to have on the business.

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11. Why $7B of insurance float is better than $7B of cash

WARREN BUFFETT: Now, what was the other question about?

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Did you want to repeat the first one?

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AUDIENCE MEMBER: (Inaudible)

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WARREN BUFFETT: Oh, yeah, the question about the insurance business, the intrinsic value.

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I would say this. We have — I'm not going to give you a precise answer, but I will tell you this.

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We have 7 billion, presently, of float. That's the money we're holding that belongs to someone else but that we have the use of.

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Now, if I were asked, would I trade that for $7 billion and not have to pay tax on the gain that would result if I did that, but I would then have to stay out of the insurance business forever — total forever non-compete clause of any kind in insurance — would I accept that? And the answer is no.

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Now, that is not because I would rather have 7 billion of float than 7 billion of net proceeds of free money. It's because I expect the 7 billion to grow.

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And if I'd made that trade — that I'm just suggesting now — if I'd made that 27 years ago and said, "Will you take 17 million for the float you have, no tax to be paid, the float for which you just paid 8-million-7 when we bought the companies, and gotten out of the insurance business," I might've said yes in those days, but it would’ve —

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CHARLIE MUNGER: Oh, you would've?

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WARREN BUFFETT: Yeah. (Laughter) Yeah.

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CHARLIE MUNGER: No, he keeps learning. That's one of his tricks. (Laughter and applause)

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WARREN BUFFETT: That's probably true in this case. I'm not sure about other cases.

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But it would've been a terrible mistake. It would've been a mistake to do it 10 or 12 years ago with 300 million.

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It is not worth $7 billion to us to forego being in the insurance business forever at Berkshire Hathaway.

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Even though it would all be, you know, it would be — if it were nontaxed profits, so we got the full 7 billion, pure addition to equity — we would not take it. And we wouldn't even think about it very long. So as Charlie says, that is not the answer that we would've given some time back. But it's a very valuable business.

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It has to be run right. I mean, GEICO has to be run right. The reinsurance business has to be run right, National Indemnity, the Homestate Company. They all have to be run right. And it's not automatic.

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But they have the people, the distribution structure, the reputation, the capital strength, the competitive advantages. They have those in place. And if nurtured, you know, they can become more valuable as time goes by.

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12. Keeping more mortgages has increased Freddie Mac's risk a "tiny bit"

WARREN BUFFETT: Zone 4?

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AUDIENCE MEMBER: Yes. I'd like to ask the chairman and Mr. Munger about Freddie Mac.

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A few years ago, I think they were earning most of their money from the guarantee fees and the float. Now, they've got the huge balance sheet, a lot of short-term liabilities.

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Do you think that's a more risky business now and that the spread might go away in some, you know, less-than-foreseen event?

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WARREN BUFFETT: Charlie, I think he aimed that one at you. (Laughter)

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CHARLIE MUNGER: It's probably slightly more risky, but I don't think they're taking horrible risks. It's still a very good business.

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WARREN BUFFETT: Yeah, what the question referred to is that, formerly, Freddie Mac emphasized, normally, just the guarantee of credit and then passed all interest rate risk onto the market.

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Now, they've retained, for their portfolio, a greater percentage of the mortgages that come through their hands.

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I think they've structured the liabilities quite intelligently to handle what they call in the investment world "the convexity problem," but — which is that the borrower has the option of calling off the deal tomorrow or retaining it for 30 years. And that is a very disadvantageous contract to enter into, if you lend money.

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They have done quite an intelligent job of attacking that by callable debt and various things. But you can't address a problem like that totally. There is no way to set up some model that satisfies that entire risk.

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They've done a good job. But as Charlie says, the larger the portfolio, as compared to guarantee fees — because you've still got the — you got the credit risk on the portfolio, and you've added a little interest rate risk at the extremes.

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And it doesn't keep us up nights, but it's a tiny bit riskier than it used to be.

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13. Don't wait for downturn to buy a great company

WARREN BUFFETT: Zone 5?

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AUDIENCE MEMBER: (Inaudible) — I’m the guy who asked you my question, my family last year — (inaudible) — my mom. This guy said fine, so I — (inaudible) — (laughter).

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I know you said do what you want. I just wanted to let you know that —

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WARREN BUFFETT: Well, you did what you wanted. I mean, you followed my advice. (Laughter)

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I'm batting 1.000. We'll see what you're batting next year. (Laughter)

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AUDIENCE MEMBER: I had one quick question — (inaudible) — you said, if you have three great companies, wonderful businesses, they could last you a lifetime.

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And I have — one thing that struck me in a way that — (inaudible) — great businesses get pounded down. And then you bet big on them, like American Express and Disney at one time.

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And my question is, I have capital to invest, but I haven't yet invested it. I have three great companies, which I've identified: Coca-Cola, Gillette, and McDonald's.

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And my question is, if I have a lifetime ahead of me, where I want to keep an investment for more than 20 or 30 years, is it better to wait a year or two to see if one of those companies stumble, or to get in now and just stay with it over a long time horizon?

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WARREN BUFFETT: Yeah. Well, I won't comment on the three companies that you've named.

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But in general terms, unless you find the prices of a great company really offensive, if you feel you've identified it —

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And by definition, a great company is one that's going to remain great for 30 years. If it's going to be a great company for three years, you know, it ain't a great company. I mean, it — (Laughter)

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So, you really want to go along with the idea of something that, if you were going to take a trip for 20 years, you wouldn't feel bad leaving the money in with no orders with your broker and no power of attorney or anything, and you just go on the trip. And you know you come back, and it's going to be a terribly strong company.

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I think it's better just to own them. I mean, you know, we could attempt to buy and sell some of the things that we own that we think are fine businesses. But they're too hard to find.

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I mean, we found See's Candy in 1972, or we find, here and there, we get the opportunity to do something. But they're too hard to find.

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So, to sit there and hope that you buy them in the throes of some panic, you know, that you sort of take the attitude of a mortician, you know, waiting for a flu epidemic or something, I mean — (laughter) — it — I'm not sure that will be a great technique.

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I mean, it may be great if you inherit. You know, Paul Getty inherited the money at the bottom, in '32. I mean, he didn't inherit it exactly. He talked his mother out of it. But — (laughter) — it's true, actually.

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CHARLIE MUNGER: Close enough.

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WARREN BUFFETT: Yeah, close enough, right?

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But he benefitted enormously by having access to a lot of cash in 19 — in the early '30s — that he didn't have access to in the late '20s. And so, you get some accidents like that.

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But that's a lot to count on. And you know, if you start with the Dow at X, and you think it's too high, you know, when it goes to 90 percent of X, do you buy?

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Well, if it does, and it goes to 50 percent of X, it gets — you know, you never get the benefits of those extremes anyway, unless you just come into some accidental sum of money at some time.

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So, I think the main thing to do is find wonderful businesses.

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Is Phil Carret here? We’ve got the world —there's the hero of investing. Phil, would you stand up?

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Phil is 99. He wrote a book on investing in 1924 ["Buying a Bond"]. (Applause)

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Phil has done awfully well by finding businesses he likes, and sticking with them, and not worrying too much about what they do day to day.

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There’s going to be — I think there's going to be an article in the Wall Street Journal about Phil on May 28th, and I advise you all to read it. And you'll probably learn a lot more than by coming to this meeting, but —

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It's that approach of buying businesses — I mean, let's just say there was no stock market. And the owner of the best business in whatever your hometown is came to you and said, "Look it, you know, my brother just died, and he owned 20 percent of the business. And I want somebody to go in with me to buy that 20 percent.

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"And the price looks a little high, maybe, but this is what I think I can get for it. You know, do you want to buy in?"

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You know, I think, if you like the business, and you like the person that's coming to you, and the price sounds reasonable, and you really know the business, I think, probably, the thing to do is to take it and don't worry about how it's quoted. It won't be quoted tomorrow, or next week, or next month.

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You know, I think people's investment would be more intelligent, you know, if stocks were quoted about once a year. But it isn't going to happen that way, so —

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And if you happen to come in to some added money at some time when something dramatic has happened — I mean, we did well back in 1964, because American Express ran into a crook.

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You know, we did well in 1976, because GEICO's managers and auditors didn't know what their loss reserves should've been the previous couple of years.

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So, we've had our share of flu epidemics. But you don't want to spend your life — (laughs) — waiting around for them.

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14. "Change is likely to work against us"

WARREN BUFFETT: Zone 6.

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AUDIENCE MEMBER: I'm Joe Condon (PH) from London.

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Both Mr. Buffett and Mr. Munger have addressed my question in annual reports and at previous meetings here. This is my first time. It has to do with investment in a few great, high-technology stocks.

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I know your answer has been that, if you don't understand it, and I can't, after this performance, can't really believe that both of you don't understand most of the high-technology questions. But I'm thinking about not only Microsoft but, say, Pfizer and J&J.

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All three companies, which have already proven that not only do they have a great product, proven management over 10 to 15 years, great market share positions, which are not easy to get into.

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And I, frankly, don't see a big difference in the P/E ratios, for example, you could say, Coca-Cola, or, you know, against Johnson & Johnson or Pfizer, which are very powerful companies. I wonder if either or both of you would address that question again.

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WARREN BUFFETT: Charlie, why don't you? (Laughter)

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CHARLIE MUNGER: If you have something you think you understand that looks very attractive to you, we think it's smart to do what you understand. If — we've been unable to find companies that fit our slender talents.

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We well might have been in the Pfizers and Microsofts and so forth. But we've never had to revert to it.

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We don't sneer at it. Other people with more talent have found that a wonderful course of action.

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WARREN BUFFETT: We generally look at businesses — we feel change is likely to work against us. We do not have great ability — we do not think we have great ability to predict where change is going to lead.

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We think we have some ability to find businesses where we don't think change is going to be very important.

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Now, at a Gillette, the product is going to be better 10 years from now than now, or 20 years from now than 10 years from now. You saw those earlier ads going back to the Blue Blade and all that. The Blue Blade seemed great at the time. But they keep — the shaving technology gets better and better.

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But you know that Gillette — although they had that little experience with Wilkinson in the early '60s — but you know that Gillette is basically going to be spending many multiples the money on developing better shaving systems than exist now, compared to anyone else.

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You know, they've got the distribution system. They've got the believability. If they bring out a product, and they say, "This is something that men ought to look at," men look at it.

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And they found out here a few years ago that the same thing happened when they said to women to look at it in the shaving field. They wouldn't have that same credibility someplace else. But in the shaving field, they have it.

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Those are assets that can't be built. And they're very hard to destroy.

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So change — we think we know, in a general way, what the soft drink industry or the shaving industry or the candy business is going to look like 10 or 20 years from now.

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We think Microsoft is a sensational company run by the best of managers. But we don't have any idea what that world is going to look like in 10 or 20 years.

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Now, if you're going to bet on somebody that is going to see out and do what we can't do ourselves, I'd rather bet on Bill Gates than anybody else.

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But that — I don't want to bet on anybody else. I mean, in the end, we want to understand, ourselves, where we think a business is going. And if somebody tells us the business is going to change a lot, in Wall Street, they love to tell you that, you know, that's great opportunity.

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They don't think it's a great opportunity when Wall Street itself is going to change a lot, incidentally. (Laughter)

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But they — you know, it's a great opportunity. We don't think it's an opportunity at all. I mean, we — it scares the hell out of us. Because we don't know how things are going to change.

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We are looking, you know — when people are chewing chewing gum, we have a pretty good idea how they chewed it 20 years ago and how they'll chew it 20 years from now. And we don't really see a lot of technology going into the art of the chew, you know? (Laughter) So, that —

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And as long as we don't have to make those other decisions, why in the world should we? I mean, you know, if I — all kinds of things, we don't know. And so, why going around trying to bet on things we don't know, when we can bet on the simple things?

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Zone 1? (Applause)

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I can see the shareholders like us sticking with the simple ones. They understand us, yeah.

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15. We don't reveal more about our stocks than we have to

AUDIENCE MEMBER: Good afternoon, Warren. Jerry Zucker (PH), Los Angeles, California.

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In the annual report, the second-largest holdings of unsecured securities are labeled, "Others."

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Could you please expand on some of the holdings there? Like, do we still own PNC? And are we supposed to be buying Big Macs, as the press has reported?

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WARREN BUFFETT: Yeah, well, actually, it's a very descriptive title, "Others." (Laughter)

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We do that for several reasons. But one is that we have no interest in people buying Berkshire or looking at the Berkshire report or anything else, in order to generate investment ideas for themselves. Some people may do it, but we are not in that business.

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Berkshire Hathaway shareholders are not being paid for that. There is no way it benefits the owners of the company.

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So, we will not disclose, in the way of our security holdings, more than we feel we have to disclose in order to be fair about things that can be material to the company.

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And we certainly have no interest in disclosing them to people who, essentially, want to use the information to try and figure out where our buying power may be, subsequently, or something of the sort.

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So, we will keep raising the cutoff level. And you may see more and more in others.

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And I will say this. There's a lot of speculation about what we do, in the press, and I'd say about half of it's accurate and about half of it's inaccurate.

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And again, we leave to you the fun of figuring out which half is right. (Laughter)

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Yeah, we hope you get a lot for your money in buying a share of Berkshire. But we don't want to act as an investment advisory service.

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16. Buffett isn't worrying about the Y2K computer problem

WARREN BUFFETT: Zone 2?

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AUDIENCE MEMBER: David Coles, Appleton, Wisconsin.

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Earlier, you made reference to the vicissitudes of time. What are the plans to ensure that all the computer systems and companies in which Berkshire has an interest will function correctly with dates of January 1st of the year 2000 and beyond?

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And what will you do to reassure shareholders that we will not suffer serious business loss or failure due to incorrect handling of these dates by computer systems?

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WARREN BUFFETT: Well, actually, I've got a friend that's quite involved in the — (laughter) — question of — no, I'm serious about that — the 2000 question with computers. But that's the kind of thing I don't worry about.

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I mean, I will let the people who run the operating businesses work on that. And I'll work on capital allocation. And I have a feeling, one way or another, we'll get through it.

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But like I say, we have — there are a lot of things at Berkshire we don't — (applause) — we don't spend a lot of time on a lot of things at the headquarters that other companies have whole departments on.

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And our managers have not let us down. I mean, I must say that we've got a group at one business after another. And they focus on their business. And they mail the money to us in Omaha. And we're all happy. (Laughter)

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Charlie?

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CHARLIE MUNGER: I have the feeling that our people will be quite good at keeping the computer systems in order and with backups. I also have the feeling that few companies could handle a big computer snafu better than we could.

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I have the feeling the Coca-Cola stock would be there. The Gillette stock would be there. The Nebraska Furniture Mart would be full of furniture and know the customers.

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I don't think a computer crash is going to do us in.

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WARREN BUFFETT: Yeah. You're correct, though, that that is a problem for the computer world. But as Charlie says, it'll hit other people a lot harder than it hits us.

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Most of the things — we try to be in businesses that are fairly simple and that can't get all messed up.

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And by and large, I think that we've got an unusual portfolio of those. And when it gets to our investees, you know, they're going to worry about those problems themselves.

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We really worry about allocating money around Berkshire and having the right managers in place. That — if we can do those two right, everything else'll take care of itself.

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17. Berkshire businesses are "way easier to predict"

WARREN BUFFETT: Zone 3?

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AUDIENCE MEMBER: My name is Peter Bevelin from Sweden.

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You have said that you like franchise companies, companies that have — that are castles surrounded by moats, companies that are possible to — you can have some prediction five, 10 years down the road.

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But aren't businesses like See's Candy, the furniture business, the jewelry business, the shoe business, businesses that are hard to predict the future, five, 10 years down the road?

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WARREN BUFFETT: What was that on the last part of that?

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CHARLIE MUNGER: Aren't these businesses hard to predict five or 10 years down the road?

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WARREN BUFFETT: Yeah, I think —

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CHARLIE MUNGER: Things like shoe business and —

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WARREN BUFFETT: I think they're far easier to predict than most businesses. I think I can come closer to telling you the future of virtually all of the businesses we have, and not just because we have them — I mean, if they belonged to somebody else — than if I took the Dow 30, excluding the ones we own, or you know, the first 100 companies alphabetically on the New York Stock Exchange.

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I think ours are way easier to predict. There are fair — they tend to be fundamental things, fairly simple. Rate of change is not fast, so I feel pretty comfortable.

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I think, when you look at Berkshire five years from now, the businesses we have now will be performing pretty much as we've anticipated at this time.

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I hope there are some new ones, and I hope they're big ones. But I don't think that we'll have had lots of surprises in the present ones.

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My guess is we'll have had one surprise. I don't know what it'll be. But I mean, you know, that happens in life. But there won't be a series of them.

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Whereas, if you — if we were to buy — if we owned a base metals business or many retailing businesses I can think of, or an auto business, I'm not sure I'd know where we would stand in the competitive pecking order five or 10 years from now.

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I would not want to try and come in and displace See's Candies, for example, in the business it does, or the Furniture Mart. It's not an easy job.

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So, I don't think you'll get lots of surprises with the present businesses of Berkshire, but the key is developing more of them.

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18. Eisner is "most important factor" in Disney's success

WARREN BUFFETT: Zone 4?

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AUDIENCE MEMBER: My name is Stafford Ordahl. I'm from Morris, New York.

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I was just wondering if the surprise could be coming from Disney. Because it seems to me they've been coasting, up until very recently, on the efforts of a person that's no longer with the company, [Jeffrey] Katzenberg, who is one of those rare geniuses, like [filmmaker Steven] Spielberg, that has his finger on the pulse of the American people.

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And that — they don't come along every day, even in Hollywood.

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They might be a very different company now that all of his efforts are, so to speak, out of the pipeline.

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WARREN BUFFETT: Yeah. Have you finished, or —?

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AUDIENCE MEMBER: Yes.

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WARREN BUFFETT: Yeah, I — Katzenberg is a real talent. I would say that, by far, I mean, by far, the most important person at Disney in the last 12 years, or whatever it's been, has been [CEO] Michael Eisner.

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I mean, if you know him and what he has done in the business, there’s no one — [former President and Chief Operating Officer] Frank Wells did a terrific job in conjunction with Eisner.

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But Eisner has been the "Walt Disney," in effect, of his tenure. He knows the business. He loves the business. You know, he eats and lives and breathes it. And he has been, in my view, by far, the most important factor in Disney's success.

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Now, they face competition. The money is in — you know, the big money is in the animated films and everything that revolves around that, because you go from films to parks to character merchandising and back. And I mean, it's a circular sort of thing, which feeds on itself. There's going to be plenty of competition in that.

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I mean, they’ve — you know, you've seen what MCA and Universal's going to do in the parks in Florida. And you know what DreamWorks is going to do in animation. And now, you've got new technology in animation, you know, through [Pixar CEO Steve Jobs.] And there's a lot of things going on in that field.

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So the question is, 10 years from now, what place in the mind — because it's a share of mind. You know, they call it share of market, but it starts with share of mind — and what place in the mind of billions of children around the world, and their parents, does Disney itself have, and their characters, relative to that owned by other organizations and other characters?

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And it's a competitive world, so there will be people fighting for that. But I would rather start with Disney's hand than anyone else's, by some margin. And I would rather start with Michael Eisner running the place than with anyone else, by some margin.

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So that does not mean that it can't become a much more competitive business. Because people look at the video releases of a "Lion King," and they salivate.

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You know, you sell 30 million copies of something at whatever it may be, 16 or $17, and you can figure out the manufacturing cost. And you know, it gets your attention. And it gets your competitors' attention.

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But going back, if I had to — if I thought the children of the world were going to want to be entertained 10 or 20 years from now, and I had my choice of betting on who is going to have a special place, if anyone has a special place, in the minds of those kids and their parents, I think I would probably rather bet on Disney.

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And I would feel particularly good about betting on them, if I had the guy who has done what Eisner has done over those years presiding in the future.

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Charlie?

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CHARLIE MUNGER: Well, I think it helps to do the simple arithmetic. Suppose you have a billion children of low-middle income 20 years from now. And suppose you could make $10 per year per child, after taxes, from your position. It gets into very large numbers.

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And — (laughter) — I don't know about your children and grandchildren, but mine want to see Disney. And they want to see it — (applause) — over and over and over again. They don't want to see Katzenberg. (Laughter)

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WARREN BUFFETT: Well I —

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CHARLIE MUNGER: I mean, in terms of the trade name. (Laughter)

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WARREN BUFFETT: It's a pretty good trade name. I mean, when you think about names around the world, it's interesting that, you know, it's very hard to beat the name Coca-Cola. But Disney's got a — it's very, very big name.

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And Charlie's point that they want to see them over and over again, and it's kind of nice to be able to recycle Snow White every seven or eight years. You hit a different crowd.

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And — (laughter) — it's kind of like having an oil field, you know, where you pump out all the oil and sell it. And then it all seeps back in over seven or eight years. (Laughter)

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19. Why Wall Street businesses are "tough" to manage

WARREN BUFFETT: Zone 5?

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AUDIENCE MEMBER: I'm Randall Bellows (PH) from Chicago. Thank you for this marathon question-and-answer period.

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WARREN BUFFETT: We enjoy it. Thanks.

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AUDIENCE MEMBER: Thank you. My question is on the security business, Wall Street firms, in general, and specifically, what you feel about Salomon at this time. Thank you.

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WARREN BUFFETT: Well, we know more about the security business than we knew 10 years ago. (Laughter)

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And it, you know, it is a tough business to manage.

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There's a lot of money made in the business and then — throughout Wall Street, I'm talking about. There's, you know, there's very big sums of money made. And then the question is, how does it get divided up between the institution and the people there?

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And you get to this question — I've often used the analogy of, you know, would you rather — if you're an investor, and you get a chance to buy the Mayo Clinic, you know, that is one sort of an investment. And if you get a chance to buy the local brain surgeon, that's another one.

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You buy the local brain surgeon and his practice for X millions of dollars. And the next day, you know, what do you own?

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And if you're buying the local brain surgeon, you would not pay any real multiple of earnings because he's going to have this revelation, several days later, that it's really him and not you there, with your little stock certificate, that's producing the earnings. And it's his reputation. And he doesn't care.

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Can you imagine Berkshire Hathaway advertising brain surgery, you know, how much business we would do?

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So — (laughter) — he owns the business, even though you've got the stock certificate.

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Now, if you go to the Mayo Clinic, no one can name the name of anybody at the Mayo Clinic, unless you live within 10 miles of Rochester [Minnesota].

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And there, the institution has the power. Now, it has to keep quality up and do all the things that an institution has to do. But whoever owns the Mayo Clinic has an asset that is independent of the attitude of any one person in the place the next day.

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Wall Street has a mix of both. And there are some businesses that are more — where the value resides more in the institution. And there are some where the value resides more in the individuals.

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We've got a couple of sensational people running Salomon. And they wrestle with this problem as they go along. And they seem to be wrestling considerably more successfully currently than was the case close to a year ago.

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But it is not an easy business to run. And it's not an easy business to predict, unless you have a business that's very institutional in character, and there aren't many of those in Wall Street.

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20. Not important if part of the market is "kind of screwy"

WARREN BUFFETT: Zone 6?

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Sorry we got a — the microphone’s over here.

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CHARLIE MUNGER: (Inaudible)

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WARREN BUFFETT: Yeah. Just raise your hand and the monitor will supply the microphone.

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AUDIENCE MEMBER: Thank you. Howard Winston (PH) from Cincinnati, Ohio.

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One question. Are you concerned about the rising valuations on the NASDAQ market, where companies trade at multiples of revenues instead of multiples of earnings?

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WARREN BUFFETT: The rising value of what, did you say?

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AUDIENCE MEMBER: The NASDAQ market —

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WARREN BUFFETT: Oh.

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AUDIENCE MEMBER: — where they trade at 10 times revenues or more, 30 times revenues, instead of 10 times earnings?

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WARREN BUFFETT: Yeah. Well, we don't pay much attention to that. Because throughout the careers Charlie and I have had in investing, there have always been hundreds of cases, or thousands of cases, of things that are ridiculously priced, and phony stock promotions, and the gullible being led in to believe in things that just can't come true.

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So that's always gone on. It always will go on. And it doesn't make any difference to us.

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I mean, we are not trying to predict markets. We never will try and predict markets. We're trying to find wonderful businesses. And the fact that a part of the market is kind of screwy, you know, that's unimportant to us.

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We tried, a few times, shorting some of those things in our innocence of youth. And it's very tough to make money shorting even the obvious frauds. And there are some obvious frauds.

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It really is — it's not tough — it’s not so tough to find the obvious frauds, and it's not tough to be right over 10 years. But it's very tough to make money being short them, although we tried a few times way back.

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It’s — we don't look at indicia from stocks in general, or from P/Es, or price-sales ratios, or what other things are doing.

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We really just focus on businesses. We don't care if there's a stock market. I mean, would we want to own Coca-Cola, the 8 percent we own of Coca-Cola, or the 11 percent or Gillette, if they said, you know, "We're just going to delist the stock and we're never — you know, we'll open it again in 20 years?"

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It's fine with us, you know. And if it goes down on the news, we'll buy more of it. So we care about what the business does. Yeah.

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21. A business is more important than where it's based

WARREN BUFFETT: Norton, did — why don't you give him the microphone there?

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AUDIENCE MEMBER: Thank you, Warren, for including me — (Buffett laughs) — out of order.

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WARREN BUFFETT: It's good to have you here. Norton [Dodge] represents a family that came in nineteen-fifty —

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AUDIENCE MEMBER: Six.

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WARREN BUFFETT: Six! Yeah, that joined up with the partnership and has been with us ever since. (Applause)

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AUDIENCE MEMBER: A very, very fortunate connection. (Laughter)

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WARREN BUFFETT: Both ways, Norton, both ways.

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AUDIENCE MEMBER: And —

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CHARLIE MUNGER: Careful, Norton. We don't want you mobbed on the way out. (Laughter)

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AUDIENCE MEMBER: But I might say that it all began with my father [Homer Dodge] discovering — thanks to a professor of finance that was also at the University of Oklahoma — Ben Graham, back in 1940.

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And then later, when Ben Graham was about to retire, we were trying to find his protégé. And clearly, that was Warren. And so he belongs to that long tradition.

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But the question I wanted to ask was, you've mentioned the very strong companies that Berkshire has that are really international companies, like Coca-Cola and the — Gillette.

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But are you considering, or have you ever thought of considering, the foreign companies that are undervalued? Or have you, for some reason, not included that in your universe of companies to consider?

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WARREN BUFFETT: We've looked at companies domiciled in other countries. And we continue to look at companies domiciled in other countries.

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We wouldn’t — you know, we're happy for the U.S. and for Atlanta that Coca-Cola's domiciled in Atlanta. But would we pass on it if it happened to be domiciled in England? No, we'd love it, if it were domiciled in England, too.

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And we feel that the important thing is the business, not the domicile. Although, it’s — A, we're more familiar, in a general way, with domestic companies that are domiciled here, although they make — they may make their money internationally.

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And we feel a tiny bit more comfortable, just a tiny bit, in terms of understanding the nuances of taxes, and politics, and shareholder governance, and all of that in something where we've been reading and thinking about it daily than someplace where we've had a little less experience.

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But we would love to find a wonderful business that is domiciled in any one of 30 or so countries around the world.

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We look some. We don't look as hard as we look at domestic companies. We're not as familiar with them.

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But I have read hundreds of annual reports of companies spread around the world. And we've owned a few, just a couple.

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They're usually not as big, so just getting the kind of money in, in many cases, is more of a problem. But some of them are big.

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And we do not have such a surplus of ideas that we can afford to ignore any possibilities. And if we can find something with a market cap, probably, of at least $5 billion or greater, that strikes us as having our kind of qualities, and the price is right and everything, we will buy.

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22. We never reach "for an extra eight of a percent"

WARREN BUFFETT: Zone 1?

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AUDIENCE MEMBER: Good afternoon, Mr. Buffett. I'm Nelson Coburn (PH) from Silver Spring, Maryland. I have one question I want to ask that hasn't come up here yet.

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Where does the money sit that comes in, say, from dividends and whatever other income that comes into Berkshire, that you're waiting to invest someplace else? Is it get — someplace where it's taking in a profit? Or is it just sitting, gathering dust? (Laughter)

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WARREN BUFFETT: Well, we only have about four or five commercial paper names we accept. We're very picky about where we put — the money all gets invested. We do not have anything sitting around in a safe or anyplace else. So it's all invested.

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But we do not get venturesome, in the least, in terms of where our short-term money goes. So we only have, like I say, maybe four or five approved names on commercial paper, all of which I approve. I mean, if anything ever goes haywire on this, it's my fault.

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Right now, we have, maybe, a billion and something in relatively short-term Treasurys. And we have a little extra in some commercial paper, maybe.

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But you will never see us reaching for an extra eighth of a percent on short-term yields.

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Some of you may remember the fiasco in the — in Penn Central, in the commercial paper market. And Penn Central, around 1970 or thereabouts, was paying a quarter of a point, as I remember, more than other commercial paper issuers.

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And of course, they, one day, despite showing a positive net worth, I think, of a billion and a half or so, they said they had a lot of net worth but no cash. Turned out cash was more important. And so they defaulted.

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Now, the interesting thing about doing that is, if you're getting a quarter of a point extra, and you came over on the Mayflower, and you landed, and you said, "Well, I'm going to apply myself to getting a quarter of a point extra on short-term money," and you didn't make any mistake until you got to Penn Central, you would — aside from the compounding aspect — you would be behind at that point.

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And I don't like a business that you can do right for 300 years and then make one mistake and — (laughter) — be behind.

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So we are very picky about short-term paper. But it is all invested. And when it's large amounts, it probably will be in Treasurys. A couple firms' commercial paper, we take.

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23. Volatile earnings to be expected at Salomon

WARREN BUFFETT: Zone 2, please?

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AUDIENCE MEMBER: My name is George Gotti (PH) from Zurich, Switzerland. I've got a question with respect to Salomon.

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Salomon experienced quite a large volatility in profits and even revenues in the past years. What are your views on how this will develop in the future with respect to volatility in profits and revenues?

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WARREN BUFFETT: I didn't get a hundred percent of that, Charlie. Want to —?

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CHARLIE MUNGER: Yeah, well —

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WARREN BUFFETT: I can see, he can hear. We make a great combination. (Laughter)

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CHARLIE MUNGER: Well, you can see we aren't wasting much around the joint. (Laughter)

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Salomon's earnings have always been volatile, at least all the time I've been around the place. And I don't think that that volatility will — is likely to disappear.

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All that said, we very much like the people at Salomon. And they've done a ton of business with Berkshire over the years and in a whole lot of different capacities. And they've done it very well.

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So we're high on the firm, as a customer. And the firms we like, as a customer, we think, maybe, other people will like, as a customer. And generally, we love it, volatile or no.

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WARREN BUFFETT: If you — at Salomon, as well as other firms of that type, they mark their securities to market. And so the changes in those marks go through earnings daily, actually, but you see them quarterly.

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Interestingly, if you took Berkshire over the last 30 years, and marked to market, as we do now for balance sheet purposes, but not for income statement purposes, because the rules are different in that case — if you did that, you would see enormous volatility, quarter to quarter, in Berkshire's figures.

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You would — I don't think you'd necessarily have seen any down year. But you would've seen swings between a few percent and, perhaps, 50 percent or something.

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And if you looked quarterly, you'd have seen a number of quarters of losses. And you would've seen some great upsurges, too.

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The volatility would be extreme, if it had all been run through the income account. But accounting convention does not call for running it through the income account, in the case of Berkshire. And it does, in the case of Salomon.

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But the nature of their business is volatile earnings. The nature of most Wall Street businesses is going to be volatile earnings. Some may follow policies that tend to make it look a little less volatile than it might actually be, even.

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The real thing that counts is two things, really. I mean, it's running it so that the volatility never kills you in any way, and the second is having a decent return on equity over time. And I think that the people at the top of Salomon are very focused on that.

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CHARLIE MUNGER: I think it's illogical for the credit rating agencies to mark down Salomon as much as they do because the earnings are volatile. But they're in a style business. And it's their game.

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24. Very little interaction between Berkshire subsidiaries

WARREN BUFFETT: Zone — what are we? Zone 3 now? Yeah, zone 3.

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AUDIENCE MEMBER: Yes. I have three quick questions.

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Do you have any formal or informal way where the managements — I know that you don't interfere with the managements of the holdings — but where they can cross-pollinate ideas, for instance, you know, selling World Book through the GEICO channel or something like that?

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WARREN BUFFETT: I'll answer that right now. There's very, very, very little of that, I — you know, maybe once in two or three years, maybe some idea might strike me as worth passing along. But I — they're doing fine running their own operations.

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We don't do it within Berkshire, either. They really go their own way.

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Now, they know what businesses we're in. And so they can always go directly to somebody else. But they don't need me to communicate.

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25. Lloyd's of London reputation problems have helped Berkshire

WARREN BUFFETT: Zone 4?

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AUDIENCE MEMBER: My name is Mike Macey (PH) from Las Vegas, Nevada.

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My question is this. There have been some recent news articles on the problems at Lloyd's. What effect, if any, do you see the problems at Lloyd's having on an increase in the Berkshire insurance or reinsurance business?

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WARREN BUFFETT: Well, I think, probably, I think it's fair to say that the problems of Lloyd's have helped us because Lloyd's had a terrific reputation. It was the first stop and, usually, the last stop for all kinds of unusual risks and large risks 20 years ago.

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And the fact that they have lost some of their luster in that period has helped us. And, you know, we didn't do anything to contribute to it, but it obviously benefits us, as a competitor, when questions develop about an organization which has been a premier player in the industry.

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So, Berkshire probably possesses more capital than all of Lloyd's put together, and it has established a reputation for being willing to quote on very large risks very quickly and to do exactly what it says. And it might very well be that, in many cases, we would get a call before they would get the call now.

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So we've been a beneficiary and, probably, in a fairly good-sized way, from their problems. And it's more difficult for them to make inroads on us now than would've been the case 10 years ago.

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We have a — I don't like to lay it on too strong — but we do have a preeminent position in a certain area of really large-scale reinsurance that will be difficult for anyone else to replicate.

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Now, they may not like our prices. There may not be demand for some of the things we can do. But if there is demand, we are very likely to get some very significant business out of that position. And we've seen it some in recent years. And we'll see it more in the future.

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26. "We assume we'll be around forever"

WARREN BUFFETT: Zone 5?

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AUDIENCE MEMBER: Mike Assail (PH) from New York City with a question for Charlie about the hundred or so models we ought to have in our head —

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WARREN BUFFETT: Here we go.

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AUDIENCE MEMBER: — mentioned at the end of the excellent "Worldly Wisdom" speech.

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I'd like to know the most useful models on industry consolidation, on product extension, on vertical integration, and any models which explain the special cases when it makes sense to invest in retailing stocks. And if Warren has anything to add or subtract, I'd love to hear it. Thank you very much.

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CHARLIE MUNGER: Well, I'm glad to answer such a modest question. (Laughter)

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I spoke about having a hundred models in your head. But those are all great, big models of considerable generality that are useful over and over again.

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Now, you're down into very complex sub-modeling when you get into a separate model for what's going to happen in industrial consolidations and retail and so on, and I'm not up to all those sub-models. (Laughter)

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WARREN BUFFETT: The truth is, you know, we're up to a few. But we take the general models and, you know, plug them in. And sometimes, the light goes on. And sometimes, it doesn't. But if it does, they could be quite useful.

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If you focus, you do see repetition of certain business patterns and business behavior. And Wall Street tends to ignore those, incidentally. I mean, Wall Street really doesn't seem to learn, for very long, business lessons.

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It may not be to their advantage to learn it. Charlie would — that would probably plug right in to Charlie's model. It’s —

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CHARLIE MUNGER: You bet.

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WARREN BUFFETT: Yeah. It's better, if you're out selling the future, it may be better to forget the past, if you're getting paid on selling it and not on betting your life on it in some way.

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One situation at Berkshire that really is somewhat different than many companies: we assume, and unfortunately, it's in error, but we assume we'll be around forever.

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So when we — in our insurance business, we assume we're going to be here to pay every claim. And we're not going to retire at 65 and hand over something to someone else. And there wouldn't be any sense paying games on accounting because it would catch up with us later on.

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And whereas, in many businesses, I don't think they have quite the same horizon on things. They do at a Coca-Cola, or they do at a Gillette.

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But many companies are thinking about what kind of — I think, I'm afraid that, more than you'd like — are thinking about what little pictures they can paint for the next four quarters or so. And that's easy to do.

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But our problem is we're going to be around a lot longer, we think, than four quarters, so that's not an option available to us. And we have to — we really run it as if, in the year 2050 or something, somebody's going to look and say, "Did — how'd it work out?"

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27. Compensation plans must include cost of capital

WARREN BUFFETT: Zone, where are we, 5 or 6? Wherever the microphone is.

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Zone 5, we got a mic over there? Maybe that was — 6! OK, we'll go to 6.

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AUDIENCE MEMBER: You state, in your letter —

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WARREN BUFFETT: Could you have the microphone? Or do we have one in the — yeah. Want to bring him the microphone? Particularly for the people behind you, it’s a little difficult.

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AUDIENCE MEMBER: Glen Rollins (PH), Atlanta, Georgia.

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You state, in your letters to shareholders, that with your wholly owned companies, you reward them at a higher rate when they release capital to you. And you, likewise, charge them a higher rate when they need capital. Could you elaborate on that?

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WARREN BUFFETT: Well, we — some of our businesses don't need capital at all, or need so little that it doesn't make sense to build it into a formula.

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So we have certain businesses, those are the best businesses, incidentally, that take — to take, essentially, no capital because it means that, if you double the size of the business, you don't need any more capital. And those are really wonderful businesses. And we've got a few of those.

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But where our businesses do produce capital, we could have all kinds of complicated systems and have capital budgeting groups at headquarters and do all kinds of things.

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But we just figure it's simpler to charge people a fair amount for the money and then let them figure out, you know, whether they really want to buy a new slitter or whatever it may be in their business.

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And it varies a little bit. It varies on the history of when we came in. It varies on interest rates that they — but we generally will be charging people something in the area of 15 percent, in terms of working out compensation arrangements for capital.

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Now, 15 percent pretax, depending on state income taxes, is only 9 to 9 1/2 percent after-tax. So you can say that isn't even enough to charge people, but we find that 15 percent gets their attention.

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And it should get their attention, but it shouldn't be such a high-hurdle rate that things that we want to do don't get done.

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Our managers expect to be running their businesses for a long, long time. So we don't worry about them doing something that works for them in the next year but doesn't work five years out or vice — you know, where they don't make longer plans, because they see themselves as part-owners of the business. But we want them to be owners with a cost attached to capital.

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We think it's awful, frankly, the way businesses reward executives with absolutely no regard for the cost of capital. I mean, a fixed-price option for 10 years — you know, imagine giving somebody an interest-free loan for 10 years. You're not going to do it.

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And if a company is retaining a significant part of its earnings, and you give out a fixed-price option for 10 years, you know, they can do nothing with it but put it in a savings account, and they'll make some money off of it. So it — we like attaching a cost to the capital.

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If we had options for me and Charlie at Berkshire, which would not — it’s not going to happen, but it would not be illogical. We have responsibility for the whole place.

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You could have some kind of a compensation arrangement that worked in respect to how the whole enterprise fared, and it would make sense for the two of us.

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It wouldn't make sense for the rest of our managers because they work on specific units. And you should have compensation arrangements that apply to those units.

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But assuming you had it for the two of us — which we're not going to have, I want to assure you — but we would say the fair way to do that would be to have an option at not less than present intrinsic value.

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Forget what the market price is. Because, believe me, it — the idea of having the more depressed your market price be, the better your option price be, does not make any sense.

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So we would have it at not less than intrinsic value. And then we would have it step up yearly based on something relating to a cost to capital. Because we would say, "Why should we get free use of the shareholders' capital?" And we could work out a fair stock option.

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That would be perfectly appropriate. We won't do it, but it'd be a perfectly appropriate way to have us compensated that involved an issuance, then an initial price of not less than intrinsic value, and involve carrying costs.

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And then we would be in a position, still, not totally analogous to shareholders, because we wouldn't have a downside that you have, but we would at least have the carrying cost that you have of ownership.

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And we work that through into our unit compensation plans by having a cost of capital that, like I say, tends to run about that 15 percent area.

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And if people can give us money, we should be able to figure out a way to do something better than 15 percent pretax with it. That's part of our job, too. So we will pay them to give us back money.

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CHARLIE MUNGER: Well, we really invented a more extreme system. And that is the executives can buy Berkshire Hathaway stock in the market for cash.

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This is a — (laughter) — very old-fashioned system, but most of them — it doesn't take any lawyers, or compensation consultants, or — and most of them have done it. And most of them have done very well with it. I don't know why it doesn't spread more. (Laughter)

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WARREN BUFFETT: People say they want their management to think like shareholders. Management, you know, they're compensating them. We're going to have them think like shareholders. It's very easy to think like a shareholder. Become one, you know? (Laughter)

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And you'll think exactly like a shareholder.

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CHARLIE MUNGER: Right, right.

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WARREN BUFFETT: It's not a great — it’s not a huge psychological hurdle to get over, if you actually write a check. (Laughter)

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28. Unlike many movie companies, Disney makes money for shareholders

WARREN BUFFETT: Zone 1?

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AUDIENCE MEMBER: John Lichter from Boulder, Colorado.

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Are there some worthwhile books that you could recommend to us?

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And secondly, with respect to Eisner and Disney, how would you define Michael Eisner's circle of competence? And are you concerned that he might step outside it?

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WARREN BUFFETT: Well, I would say that he has proven himself very good at understanding what Disney is really all about.

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And you can look back to the predecessor management, between Walt and Eisner. And they didn't really do much with that, if you look at those years.

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What is special about Disney? And how do you make it more special? And how do you make it more special to more people? I mean, those are the things that you want to — and you've got wonderful ingredients to work with when you're working with something like Disney.

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I mean, it — you know, one of the advantages — we were talking about the Mayo Clinic and brain surgeons. The nice thing about the mouse is that he doesn't have an agent, you know. I mean, the mouse is yours. (Laughs)

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He is not in there renegotiating and, you know, every week or every month and saying, you know — (laughter) — "Just look at how much more famous I've become in China," you know, or something. (Laughter)

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So if you own the mouse, you own the mouse. And Eisner understands all of that very well. I would say he's been very skillful, in terms of how he's thought about it.

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I worry about any manager. It has nothing to do with Michael Eisner. But Charlie and I worry about ourselves in terms of getting out of our circle of competence.

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And we've done it. It is very tempting. And it's probably part of the human condition, in terms of hubris or something, that if, you know, that if you've — as Charlie would say, if you've — you know, if you're a duck floating on a pond, and it's been raining, and you're going up in the world, after a while, you think it's you and not the rain.

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You know, that there — that you're some duck. (Laughter) But —

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CHARLIE MUNGER: Right, right.

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WARREN BUFFETT: And we all succumb to that a little bit.

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But I think that Disney, Coca-Cola, Gillette — I think those companies are very focused. I think our operating units are very focused.

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And I think that gives us a huge advantages over the managers that are getting a little bored and decide that they'd better fool around with this or that to show just how talented they really are.

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Charlie?

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CHARLIE MUNGER: Yeah. Eisner is quite creative. And he also distrusts projections. And that is a very good combination to have in the motion picture business. (Laughter)

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WARREN BUFFETT: Yeah, Charlie was a lawyer for, what, 20th Century in the old —

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CHARLIE: Yes.

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WARREN BUFFETT: — days? Yeah, and he saw a little bit of how Hollywood operated. And it kept us out of buying any motion picture stocks for about 30 years. Every time I'd go near one, he'd regale me with a few stories of the past.

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So it's a business where people are — can trade other people's money for their own significance in their world. And that is a dangerous combination, where if I can buy significance in my world with your money, you know, there's no telling what I'll do. (Laughter)

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CHARLIE MUNGER: Part of the business reminds me of an oil company in California. And it was controlled by one individual. And people used to say, about it, "If they ever do find any oil, that old man will steal it." (Laughter)

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The motion picture business, it's only about half of it that has normal commercial morals.

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WARREN BUFFETT: Yeah, we're not applying that to Disney.

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CHARLIE MUNGER: No.

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WARREN BUFFETT: Disney is really — Disney's done an extraordinary job for the shareholders.

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And they make real money out of movies. Most movie companies have — they make money for everybody associated with it, but not a lot has stuck to the shareholders.

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Zone 2?

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AUDIENCE MEMBER: I —

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29. Book recommendations

WARREN BUFFETT: What? Oh, the books! Charlie, what are you reading these days? (Laughs)

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CHARLIE MUNGER: Well, I'm almost ashamed to report because I've gone back and picked up the part of biology that I put up — should've picked up 10 or 15 years earlier. And if any of you haven't done it, it's a total circus, what they figured out over the last 20 or 30 years in biology.

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And I — if you take [evolutionary biologist Richard] Dawkins, "The Selfish Gene" and "The Blind Watchmaker", I mean, these are marvelous books. And there are words in those books that are entering the English language that are going to be in the next Oxford Dictionary. I mean, these are powerful books. And they're a lot of fun.

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I had to read "The Selfish Gene" twice before I fully understood it. And there were things I believed all my life that weren't so, and I think it's just wonderful, when you have those experiences. We always say, "It isn't the learning that's so hard. It's the unlearning."

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WARREN BUFFETT: Yeah. I made the mistake of taking Charlie up to Microsoft in December. And he became friends with [Chief Technology Officer] Nathan Myhrvold.

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And they are corresponding back and forth with increasing fervor and enthusiasm about mole rats. And they copy me on all these communications. So I'm getting to see this flow back and forth on the habits of mole rats.

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I really haven't found a way to apply it at Berkshire. But I'm sure Charlie — (laughs) — has got something he's working on, on that. He's gotten very interested in biology lately.

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I like — you know, I've always liked reading biography, but since the — the computer has changed my life. I now find myself playing bridge on the computer about 10 hours a week. And unfortunately, I didn't want to give up sleep or eating or Berkshire. So the reading has been kind of light.

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On investment books, if you're asking about that, I would recommend the first two books that Phil Fisher wrote back around 1960, "Common Sense [Stocks] and Uncommon Profits" and the second one ["Paths to Wealth Through Common Stocks"]. They're very good books.

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You know, I obviously recommend, first and foremost, [Benjamin Graham's] "The Intelligent Investor," with chapters eight and 20 are the ones that you really should read.

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Two of the — well, all of the important ideas in investing, really, are in that book, because there's only about three ideas. And those — two of them are emphasized in those two chapters.

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Actually, I think John Train's "Money Masters" is an interesting book.

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I don't know. Can you think of any others, Charlie, that we want to tout? (Laughs)

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CHARLIE MUNGER: I don't know. We have such a fingers-and-toes style around Berkshire Hathaway. (Laughter) So you sort of count.

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WARREN BUFFETT: The three —

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CHARLIE MUNGER: I’ve never seen — you know, Warren talks about these discounted cash flows. I've never seen him do one. (Laughter and applause)

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WARREN BUFFETT: Yeah.

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CHARLIE MUNGER: If it ever —

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WARREN BUFFETT: There are some things you only do in private, Charlie. (Laughter)

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CHARLIE MUNGER: If it isn't pluperfect obvious that it's going to work out well, if you do the calculation, he tends to go on to the next idea.

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WARREN BUFFETT: Yeah, it’s sort of — it is true. You don't — if you have to actually do it on — with pencil and paper, it's too close to think about. I mean, it ought to just kind of scream at you that you've got this huge margin of safety.

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I mentioned the three ideas. The three ideas, I should elaborate on. One is that — to think of yourself — to think of investing as owning a business and not buying something that wiggles around in price.

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And the second one is your attitude, which ties in with that, the attitude toward the market, that's covered in chapter eight. And if you have the proper attitude toward market movements, it's an enormous help in securities.

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And the final chapter is on the margin of safety, which means, don't try and drive a 9,800-pound truck over a bridge that says it's, you know, "Capacity: 10,000 pounds." But go down the road a little bit and find one that says, "Capacity: 15,000 pounds."

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30. We'll do more in insurance, but we don't know what

WARREN BUFFETT: Zone 2?

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AUDIENCE MEMBER: Yes, Chip Tucker (PH), Minneapolis.

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Mr. Buffett and Mr. Munger, what market share does Berkshire have in super-cat insurance business? And what's your outlook for both the market growth in that business and the potential market share growth with — from Berkshire?

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You answered a related question regarding GEICO's auto opportunities. Are there other insurance businesses potentially worth expanding into? Or is your focus on super-cat and autos opportunity enough?

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CHARLIE MUNGER: You know, Warren can answer that question a lot better than I can.

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WARREN BUFFETT: I — we don’t — there wouldn't be any good market share figures in something like super-cat.

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We know that, a couple years, and last year, I think, too, we had to be the biggest in terms of premium volume.

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We simply take on so much more than anyone else will. And we were getting the calls on the big risks, you know, 400 million here or something of the sort. We had a quote we put out on a billion dollars on the New Madrid fault here a little while ago. Nobody else will be doing that.

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So we got market share by our willingness to do large volume, by the fact that people knew we would pay subsequently, but we don’t — while we know we were the largest, we can't give you any precise figures.

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We also know we're slipping in that now, but that makes no difference to us. We'd only be interested if we were slipping in profitable markets.

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And what was the second part of the question on that, Charlie?

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AUDIENCE MEMBER: What other opportunities —

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WARREN BUFFETT: Oh, what other opportunities in the insurance business?

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We — just this year, we bought a very, very small company [Kansas Bankers Surety], the managers of whom are here, a very fine insurance company. It has a little niche.

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It — I mean, it will never be huge or anything of the sort, but it's the kind of business that we can understand. And we like the people that run it. And we like the position they've achieved in the market. So we're delighted to be in it.

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We are willing to think about a whole variety of things to do in insurance. But most of them, we find, make no sense. We'll be — we’ll do other things in insurance over the next 10 or 15 years. It's just bound to happen, but I can't tell you what they will specifically be.

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The biggest single thing we will do in terms of value, though, probably, is grow GEICO. But we will do other things. And who knows what they might be?

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We have expanded some in the — it's a small business — the structured settlement business, from when we talked a year or two ago. And we are the preferred provider of structured settlements. Those are annuities, essentially, that are payable to people who are usually the victims of a very bad accident.

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So they're very severely injured people, with injuries that will probably last for life. And so we will be making payments to people who are incapable of earning a living, may incur substantial medical bills, for many decades, sometimes, 50 or 60 years.

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Those annuities are provided by our companies to other insurance companies and to these injured people, usually, with the approval of the injured person's attorney.

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And when the advisors to the injured person think, "Who is going to be around in 50 years to pay money to this person who's been incapacitated," they frequently, and in our view, logically, think of Berkshire. So we have become much better known in that over the last couple of years.

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It's not a big business. And it won't be a big business. But it's a perfectly decent business. And it's one where we have a competitive advantage over time.

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We don't obtain the competitive advantage by price. We obtain the competitive advantage from the peace of mind that the injured party obtains from knowing that that check will be in the mail 50 years from now.

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And that's the kind of business where we have some edge. And we'll find other things to do over time, but can’t — I can’t —

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It isn't like we're looking at some specific area and saying, "We're focusing on this." We're aware, generally, of what's going on in the insurance business. And we're very ready to move when the time comes, so that we can do something intelligent.

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31. People rewarded by capitalism need to help those who aren't

WARREN BUFFETT: Zone 3?

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AUDIENCE MEMBER: Mr. Buffett and Mr. Munger, my family's been associated with Berkshire since 1968. So I ask this question with a great deal of respect for your integrity and your wisdom.

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I work as an inner-city schoolteacher, where there is a rising and pervasive sense of hopelessness.

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When I ask my students, "What would make you happy?" their predominant response is, "A million dollars." As some of the richest men in the world, I wonder what your response to them might be.

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And as a second part of this question, the philosophical underpinnings of capitalism have largely ignored a systemic perspective involving issues of ongoing depletion of limited global resources exploited to sustain a market economy, widening gaps between the very wealthy and the severely impoverished, and an international view of America as a country whose primary values are greed and imperialism.

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As we move into the 21st century, do you see a need to re-envision capitalist premises towards original notions of democracy, justice, and humanitarian concerns?

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WARREN BUFFETT: I didn't get all of that.

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CHARLIE MUNGER: Well — (laughter) — I will say this. I am higher on the existing social order than you are. (Applause)

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I — there's always plenty wrong with a social order. And certainly, there are places where ours is a lot more broken than it used to be.

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I don't think Warren and I have any wonderful solution to all the problems of the world. But wishing for a million dollars instead of some more tangible short step is the wrong frame of mind. That isn't the way we got our million dollars.

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WARREN BUFFETT: But I don't — (Applause)

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CHARLIE MUNGER: Warren might give a different answer, by the way. He’s a —

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WARREN BUFFETT: No, I would agree with the — I, you know — wishing for a job makes a lot of sense to me and figuring out how to get one and then going from there. But it —

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There is and always has been — that doesn't mean it always should be — but there is a tremendous amount of inequality.

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What you don't want is an inequality of opportunity. There will be a lot of inequality in ability.

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A market system, like we have, churns out what people want. If they want to watch a heavyweight fight, and they want to watch Mike Tyson, they're going to pay him $25 million for getting in the ring for a few minutes.

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And it produces what people like. And it produces it in abundance. And it's done very well in terms of production.

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It is much better to be in the bottom 20 percent in this country now than it was 50 years ago. And it's better to be in the bottom 20 percent of this country than in any other country. But it still isn't very satisfactory.

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The market system does not reward — it does not reward teachers, does not reward nurses — I mean, it does not reward all kinds of people who do all kinds of useful things in any way comparable to how it will reward entertainers, or people who can figure out the value of businesses, or athletes, or that sort of thing.

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A market system pays very big for something that will entertain them. People want to be entertained a good bit of the day. And it pays better for people that will entertain than educate.

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I think — I don't want to tinker with the market system. I don't think I should be telling people what they should want to do with their lives.

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But I do think that it's incumbent on the people that do very well under that system to be taxed in a manner that takes reasonable care of anybody that is not well adapted to that system, but that is a perfectly decent citizen in every other regard.

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And that is — you know, I don't want to start getting into comparable worth in terms of how I tax. But I do think that somebody like me, that happens to just fit this system magnificently, but wouldn't be worth a damn in Bangladesh or someplace, you know, because what I have wouldn't pay off there — their system would not reward that.

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I think that we get from society — society provides me — this society provides me — with enormous rewards for what I bring to the game. And it does the same with Mike Tyson. And it does the same with some guy whose adenoids are right for singing or whatever it may be.

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And I don't want to tamper with that. But I do think those people who are getting all kinds of claim checks on the rest of society from that — I think there should be a system that people — where people who are not well adapted to that system, but that are perfectly decent citizens in every other respect, do not really, you know, fall through the slats on that.

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And I think progress has been made on that over the last 50 years. But I think we're far from a perfect society in that respect. And I hope, you know, more progress is made in the next 50 years.

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I don't think the wishing for the million dollars, though — you know, it doesn't work that way. I think —

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But if you are lucky enough to have something that the market system rewards, you do very well here. And if you're unlucky enough to have something it doesn't reward, you do better now than you would've 30 or 40 years ago. And you do better than in other countries.

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But I can see where it seems very unjust to look at somebody else who has just a little different mix of talents that can achieve claim checks in a way that keeps them and the next five generations of their family in a position where they don't have to do very much.

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CHARLIE MUNGER: I would say that I like a certain amount of social intervention that takes some of the inequality out of results in capitalism.

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But I hate, with a passion, rewarding anything that can be easily faked. Because I think then people lie, and lying works, and the lying spreads. And I think your whole civilization deteriorates.

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If I were running the world, the compensation for stress under workman's compensation would be zero, not because there isn't real stress. Because there's no way to keep the fakery out, if you reward stress at all.

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WARREN BUFFETT: There was a great article, and this applies — (applause) — to an earlier question.

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There was a very good article in Forbes about one issue ago that showed the occupational profile of the U.S. at a couple of different intervals, going back to 1900.

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And one problem you can see, just by looking at that profile, is that, if you assume 20 percent of the — the bottom 20 percent — however you measure it, in terms of employability — whether it's measured by IQ, or interest in working, or energy level, or whatever you want to do — they fit, very well, most of the jobs that were available a hundred years ago.

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In other words, you could do most of the jobs, of which there were many, with relatively unimpressive mental abilities. And as jobs have changed, the profile of people hasn't changed. So there are more people that end up on the short end.

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Now, the good part of that is the society produces so much more that it can take care of those people, one way or another. Now, the trick is to take care of them and make them not only feel, but be productive and be part of the act, and —

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We've got enough product to do that. But the country turns out way more output than 50 or a hundred years ago.

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We don’t have — we’re not perfect at figuring out how to make the bottom 20 or 30 percent, in terms of abilities, fit a new, changing job profile.

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I really recommend you look at that Forbes magazine. Because if you think through the implications of those charts, I think you'll see what social problems have to be attacked.

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32. "No magic" to running a bank — just don't do "something foolish"

WARREN BUFFETT: Zone 4?

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AUDIENCE MEMBER: Edward Barr, Lexington, Kentucky.

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Earlier, you led us through a discussion of the competitive position of Disney. And you also discussed share repurchase.

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I wondered if you could also lead us through a discussion of the competitive position of Wells Fargo, since they just effected such a large combination [with First Interstate], in addition with, perhaps, some discussion of their share repurchase, which is probably as large, in percentage terms, as any company I can think of at the present time.

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WARREN BUFFETT: Well, Wells should repurchase their shares, if they feel that they're repurchasing them below intrinsic business value. And that's a calculation that they make.

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And you should — have to ask the question of them what their calculus is of that. But that will determine whether that share repurchase program makes good sense or not.

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The advantages of an in-market merger are — can be dramatic. Sometimes, it just causes a bank to do what they should've done anyway.

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I mean, I'm not so — I’m not always as convinced that the economies come about through — totally through scale, as they are just from taking a hard look at how they run their business.

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We may have in the audience today — he was here earlier — the CEO of the Bank of Granite, which is in Granite, North Carolina. And that bank earned 2.58 percent on assets, I believe, in the most recent quarter, annualized, and had a 33 percent efficiency ratio.

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Now, that bank is 400 million or 500 million of assets. You know, it doesn't need to be 5 billion in order to get more efficient or anything of the sort.

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It's got — it’s so much more efficient than any of those larger banks that had to be put together to get those ratios that it makes you kind of wonder about the underlying rationale.

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But I'm sure that Mr. [John] Forlines, who runs that bank, just focuses on — and he's been focusing on it for a lot of years — just doing the right things day after day. And it didn't take any in-market merger or anything of the sort to cause him to do that.

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I recommend any of you in the banking business to get his report because there is nothing magic about the community of Granite, North Carolina.

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Nor does he work under laws that are way different than the rest of bankers or anything of the sort. He just gets a record that — achieves a record — that makes all the rest of the records look silly.

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We had a fellow over in Rockford, Illinois, in the bank we owned back in the '70s, Gene Abegg, whose brother is going to be 104. There was a fellow from Rockford here that got me to sign a note to Ed Abegg, who will be 104 soon. I wish Gene had lived to 104.

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But Gene ran a bank in Rockford that, when banks — the best banks were earning one percent on assets, he earned two percent on assets. And he did it with way less leverage than anyone else and lower loan losses and big investment portfolio.

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And there wasn't any magic about it. He just didn't do anything that didn't make sense.

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And there's a lot of room for improvement in the banking business with or without mergers.

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But I would say that Wells, on the record, has done an exceptionally good job of running their bank compared to other big banks. And I would say that those two operations put together will be run a whole lot more efficiently than if First Interstate had been run by — run on its own.

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It's a business that can be a very good business, when run right, as the Bank of Granite or Illinois National Bank in Rockford proved. There's no magic to it. You just have to stay away from doing something foolish.

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It's a little like investing. You know, you don't have to do anything very smart. You just have to avoid doing things that are ungodly dumb when looked at about a year later and — you know, airlines and that sort of thing. (Laughter)

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And you know, that's the trick. It is not some great crystal ball game where you look into the future and see all these things that other people can't possibly see. I mean, what's complicated about Coca-Cola or Gillette or Wells Fargo, for that matter?

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And that’s — we like businesses like banking, if we've got somebody in charge of them that is going to run them right. We’ve got a — I don't know whether Bob Wilmers is here. But he runs First Empire, which we have a good-sized investment in. Bob just runs it right, you know?

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I do not worry about surprises from Bob or First Empire. And he’ll do things — if he can grow, and it's logical, he'll grow. And if it isn't logical to do something, he'll pass. He has no ego compulsions forcing him into some sort of action. And he runs a terrific bank.

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Charlie?

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33. We do "whatever comes along that makes sense"

WARREN BUFFETT: OK. Zone 5.

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AUDIENCE MEMBER: Dorothy Craig (PH) from Seattle.

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And I noticed, in the annual report, that your recent acquisitions doubled the revenue for Berkshire Hathaway. And it seemed astounding for me. I'm wondering how that's possible.

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WARREN BUFFETT: Well, it’s — for one thing, we started from kind of a small base. The — but we — the GEICO acquisition, you know, added 3 billion or so of revenues, and — actually more than that, a little more than that, but not much more. And RC Willey and Helzberg’s probably added 600 million or so in the current year.

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And since we were working off a base of 3 1/2 or so billion, those three acquisitions did double the revenues. We won't have many years when that happens. It's not any goal of ours to double the revenues or increase them 20 percent, even, or anything.

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We just — we try to do whatever comes along that makes sense. And if there's a lot that comes along in one year that makes sense, we'll do a lot. And if there's nothing that comes along that makes sense, we'll do nothing.

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So it’s — there's a lot of accident in it. But last year, you know, a fair amount happened. And I'd love to see a lot happen next year. But we don't know at this point.

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Charlie?

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CHARLIE MUNGER: Nothing.

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34. GEICO's Lou Simpson has more investing options now

WARREN BUFFETT: Zone 6.

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AUDIENCE MEMBER: Oh me? Yes, my name is Victor Lapuma (PH). And I'm from the Virgin Islands. And my question is on the GEICO asset side.

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One of the things that makes Berkshire unique is the high percentage in equity as opposed to fixed assets. And GEICO, as of the end of the year, looked like a typical insurance company with four times the fixed assets as equity assets.

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And my question is, over time, will they have the same composite as Berkshire on the asset side?

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And the second part of that question is, how are the asset allocations decisions being made at GEICO after the merger as compared to before the merger?

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WARREN BUFFETT: The decisions at GEICO, which, as you say, is about 5 billion of marketable securities, have been made, and are being made, and will be made, by Lou Simpson. Lou has done a fabulous job of running the investments of GEICO since about 1979. And we're lucky to have him.

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There are very few people that I will let run money running businesses that we have control over. But we're delighted, in the case of Lou. I mean, that's one in a thousand or something. But Lou has done a terrific job, will do a good job.

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And the one thing we offer him, he has the ability to do whatever he wants to do with those assets now. He did not have that ability before GEICO became part of Berkshire. Because at that time, there were certain ratios that were necessary for — which were understandably necessary, that made sense.

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With GEICO as a standalone entity, with its own net worth of a billion and a half or 2 billion, and doing 3 billion of business, it would've been inappropriate for him to take on a different configuration, beyond a certain point, in equities.

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So he was constrained by the nature of the business he was in and its capitalization. That constraint no longer applies. So he, with that 5 billion, can do whatever he wants.

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Now, if he does certain things, we would need to provide backup to GEICO, so that their policyholders would be protected under the most adverse of circumstances. But that's no problem for us.

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We could do it by quota share reinsurance. We could do a lot of things. We could just guarantee their obligations. And we are in a position to do that.

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We haven't done it yet because it’s not — hasn't been necessary yet. But if it made sense — if Lou wanted to be 5 billion in equities and it made sense, we would arrange things so that the GEICO policyholders would be every bit as secure as under the most conservative of investment portfolios.

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So Lou has another string to his bow now. And there may be a time when it gets used. He's been great under the old system. And he may be better under this system.

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CHARLIE MUNGER: That's a very shrewd question. You're to be complimented.

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WARREN BUFFETT: That means it's something we thought about — (laughs) — before, but you are to be complimented, right.

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35. "Permanent holdings" probably won't be sold even if market overvalues them

WARREN BUFFETT: Let's see. Zone 1?

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AUDIENCE MEMBER: Neil McMahon (PH), New York City.

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Berkshire owns several companies — stock in several companies — which are called permanent holdings.

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In the early '70s, we had a two-tier market, the one-decision stocks, high P/Es — 50, 60 times earnings.

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If that were to reappear again, would Berkshire's companies still be permanent? Or is there a price for everything?

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WARREN BUFFETT: Well, there are things that we think there's no price for. And we've been tested sometimes and haven't sold them, but —

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You know, my friend, Bill Gates, says, you know, it has to be illogical at some point. The numbers have — at some price, you have to be willing to sell something that's a marketable security, forgetting about a controlled business.

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But I doubt if we ever get tested on — there's only a couple of them in that category.

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Actually, there — you know — I won't comment on that. (Laughs)

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We really have a great reluctance to sell businesses where we like both the business and the people. So I don't think I'd count on seeing many sales. But if you ever attend a meeting here, and there are 60 or 70 times earnings, keep an eye on me. (Laughs)

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Charlie?

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CHARLIE MUNGER: The so-called two-tier market created difficulties, I would say, primarily because a lot of people or companies were called tier one when they really weren't. They just had been, at some time, a tier one. If you're right about the companies, you can hold them at pretty high values.

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WARREN BUFFETT: Yeah, you can really hold them at extraordinary levels if you’ve got — it's too hard to find. You're not going to find businesses that are as good.

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So then you have to say, "Am I going to get a chance to buy back the same business at a lot lower price? Or am I going to buy something that's almost as good at a lot lower price?"

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We don't think we're very good at doing that. We'd rather just sit and hold the business and pretend the stock market doesn't exist.

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That actually has worked out way better for us than I would've predicted 20 years ago. I mean, that mindset is — or 25 years ago — that mindset is — there's been a fair amount of good fortune that's flowed out of that that I really wouldn't have predicted.

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CHARLIE MUNGER: But there, you're demonstrating your trick again, you know? Still learning. A lot of people regard that as cheating. (Laughter)

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36. Buffett doesn't expect Gates will join Berkshire's board

WARREN BUFFETT: Zone 2.

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AUDIENCE MEMBER: Yeah, Alan Rank, Pittsburgh, Pennsylvania.

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Knowing your aversion to technology but your close affiliation with Bill Gates, Microsoft, have you ever considered either inviting him to be part of the Berkshire through the board, or being involved to maybe solve some of the problems with World Book and taking it to the new technology and expanding it?

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And on the other end, you also love insurance and the float. Have you considered the other businesses that would have that similarity, such as cemeteries and funeral homes with their pre-need and their large cash reserves?

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WARREN BUFFETT: The — Bill and I talked about the encyclopedia business some years ago. But he was pretty far down the line at Encarta, quite far down the line at Encarta, actually, before I even met him. So it wasn’t — my guess is, if we had met earlier, that there might have been something evolve in that.

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But he had put a lot of chips on Encarta and had done a good job with it. So it really wasn't — it wasn’t a real option to work with him on World Book.

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Bill also is very focused on his business. And I believe he's on the board of some biotech company in which he's got a significant investment.

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But you will not see him on the boards of, at least I don't believe that you will, of American corporations — I think, if you look at the boards in the, say, up in the Pacific Northwest, where he had a lot of friends and knows the companies well and maybe grew up with some of the people.

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But I don't think you'll see him on anything which really doesn’t — which is just a business that doesn't grab him intellectually on something. I do think there's one biotech company that he's involved in that way. And you know, he'd be a terrific asset.

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But he really focuses on Microsoft. He has his board meetings, as I remember, on Saturday. They last, you know, all day. And then he goes after the business that way. He’s not —

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I don't think he'd be interested on being on a bank board or an insurance company board because he just figures he's got other things to do with his time. And I think he's probably right. (Laughs)

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37. Not all "float" businesses are attractive

WARREN BUFFETT: Zone 3? Oh, the question was about other kinds.

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We've always had an interest in float businesses of one sort or another, but —

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You know, Blue Chip Stamps was such a business, until it disappeared — (laughs) — one day, and we couldn't find it. We went — looked in the closet. We looked everywhere, out in the backyard. (Laughs) Where was it?

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So we like that sort of business. But most of the float businesses, the costs are pretty explicit. And like I say, we don't like most insurance companies as float businesses. We are not interested in buying the typical insurance business, because we think the float will end up costing us too much.

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We'd rather borrow money with an explicit cost attached to it rather than have the implicit costs of an underwriting loss with most companies.

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But we’re always — we are interested in businesses that provide cash rather than use up cash. We're willing to have them use cash, if the — if what they use will produce high enough returns. But we've got this bias toward things that throw off cash.

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Charlie?

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CHARLIE MUNGER: Well, if we go into the pre-need funeral home business, that'll be the day. (Laughter)

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38. Expect a "better" market for Class A than Class B

WARREN BUFFETT: Zone 3. (Laughter)

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AUDIENCE MEMBER: Charlie is a difficult act to follow. I'm Robert Keeley (PH) from Washington, D.C.

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I have a brief comment and a brief question. The comment is that I think you may be considerably underestimating the interest there will be in purchases of Class B stock later this week and next week.

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I have at least 10 friends in Washington who are aware that I'm a Berkshire shareholder and that I was coming to this meeting. And they've insisted that I report back to them tomorrow on just what happened with the Class B stock because they're very interested in buying some of it.

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Now, that's anecdotal, to be sure. But if you take that ratio of 10 people to even the shareholders who are present here today, you're talking about tens of thousands of people who are going to be in that market.

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And my question relates to liquidity. On page 18 of your annual report, you say, and I quote, "The prospect that most shareholders will stick to the A stock suggests that it will enjoy a somewhat more liquid market than the B."

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Could you explain that? It seems to me that if most shareholders keep their A stock, do not convert it or sell it, that the B stock will be much more liquid. Maybe I don't understand liquidity.

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WARREN BUFFETT: No, I think you do. You understand it. And I'll elaborate just a bit.

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The — certainly, in the first week, I would expect the B stock to trade far more, although I hope it doesn't trade like most new issues trade in relation to the amount sold.

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It's just the nature of a new offering that there's usually — there’s always some flurry of activity. Sometimes, I think it's quite excessive. And I don't think it will be with Berkshire. But there will be some flurry of activity.

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But longer range, let's just assume that there's $400 million worth of B stock. There will be 40 billion of A.

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Now, admittedly, you know, I'm not going to do anything with my stock. And many people in this room have a very low tax basis and, except under very unusual circumstances, have no intention of doing anything with their stock.

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So of that 40 billion, there's a very significant percentage that you might say is almost inoculated against reaction to market changes.

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But there still is a very significant dollar value. There's a fair amount held by funds, for example.

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And so the market value of what I would call the potentially tradeable A is likely to far exceed the market value of the potentially tradeable B. Now, it may be that all of the B is potentially tradeable, whereas, only a small portion of the A is.

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But that 40-billion-to-400-million ratio, I think, almost ensures that, after the initial flurry, that the better market — and when I say, "better market," I mean the ability to move large dollar amounts in both directions with minimal movement of price — the better market — not by a huge margin — but the better market is likely to be in the A. And frankly, we hope that it is. We still hope there's a good market in the B, obviously.

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But if you're talking 10 shares of the A, which is a $300,000 or so investment, I think that, two months from now — that it's likely to be that buying or selling $300,000 worth of A will have slightly less of a percentage impact than buying or selling $300,000 worth of B, but not by a significant amount.

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But that's what I meant by that comment of having a slightly better market in the A than the B. And that's important from our standpoint because, if that situation became reversed and the B became the better market, then people would have a real incentive to convert from A to B over time, and eventually the B market would dominate.

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We don't anticipate that happening. And I think the way we've arranged it, it won't happen. But it could happen.

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Charlie?

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CHARLIE MUNGER: Yeah, well, I think we've also created arrangements in the way we've written the prospectus and rewarded the selling brokers that tend to dampen demand, both individual and institutional. And we sometimes accomplish what we try to do. (Laughter)

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WARREN BUFFETT: Zone 4? Don't ask us for a list of those, what we've accomplished. (Laughter)

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39. Corporate return on equity will probably drop

AUDIENCE MEMBER: Dan Pecaut, Sioux City, Iowa.

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In the mid-'70s, you wrote an article on how inflation swindles the equity investor and that the average return on equity for corporate America would be like 12 or 13 percent.

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Last year, the average was more like 20. Have the laws of economics been repealed or modified? Or if not, what sort of calamities might occur as we revert to the mean?

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WARREN BUFFETT: Well, I have been surprised by returns on equity. There was a good article in Fortune about two issues ago. Well, it was in the "Fortune 500" issue, whenever that was. And it discussed the question of return on equity.

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And it made some good points about how the introduction of putting post-retirement health benefits on the balance sheet tends to swell equity returns subsequently. In other words, it moves down the denominator in terms of total equity employed.

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And there's been a lot of big-bath accounting, where there have been write-offs, so that counting that, I don't think it has gotten to 20 percent. But it's higher than — it’s certainly higher than I anticipated when I wrote that article.

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And I would say that it would seem very extreme to me, in a world of — like we're living in now — to have equity cap — returns on equity — close to the 20 — average close to the 20 percent rate over time. But it has surprised me, how high returns have been.

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Now, you have had situations like at Coke, for example, where 25 years ago, they would not have repurchased stock. And so, they'd have piled up more equity in the business. And Coke's return on equity, if it had been following the policies of 1970 or '75, would be far less than it is now.

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Coke really doesn't need equity. And so, it can earn extraordinary returns and very large dollar sums. To the extent that impacts the figures, that has some impact on them.

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To the extent that General Motors sets up many, many billions of a reserve for post-retirement health benefits, that tends to make the returns on GM look a lot better than it did in the past, when it wasn't even recognizing those costs and, therefore, had an equity that really was much larger than the true equity.

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So there have been some things happen like that. But all in all, I don't think, under any system of accounting, the 20 percent returns for American industry are in the cards.

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Charlie?

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CHARLIE MUNGER: Well, I agree. And I think that this business of having way more consolidation and the successful companies, like Wells Fargo, buying in stock, I think that's had a huge effect, too.

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I don't think it's actually gotten that much — obviously, we had a long period of real growth and so on. And I think that, on average, business has earned higher returns on equity. But I think a whole lot of things have combined to goose the results. And I don't see how it could go much farther.

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40. Buffett's investment doesn't reflect any real estate insights

WARREN BUFFETT: Zone 5?

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AUDIENCE MEMBER: Yes. My name is Ted Elliott (PH) from Connecticut.

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The press reported a recent investment you made in the real estate business. And I wondered if you would comment as to your outlook for that business.

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WARREN BUFFETT: Well, that's just sort of an asterisk. I've got virtually everything in Berkshire, and I own a few municipal bonds outside and a few other things, but I don't want to buy anything that Berkshire's involved in. It just complicates life. And all the best things I like — (laughs) — are in Berkshire.

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So every now and then, some little thing happens to hit the radar screen that is too small, really, for Berkshire. And I'd bought a hundred shares of that company back when I — it's called Property Capital Trust — I'd bought 100 shares of that back when we owned NHP, which had done a couple of deals with them. So I — my policy of reading every annual report in sight that can further my knowledge about anything, I bought 100 shares.

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And then I happened to see a year or so ago, where they said they were going to liquidate. So having some money around, I bought that. But it's not based on any feeling about the real estate business, any sophisticated analysis of the company, or anything else. It's a minor personal investment.

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I have no insights whatsoever. We've done a few things in real estate at Berkshire. But they've been large things. And there was a brief period when there were a couple things that were intelligent to do.

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If we'd started a little earlier, there might've been a lot more things. But we started a little late. So we're doing nothing now. But we listen to things, occasionally.

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But we're looking. We're basically looking for big things at Berkshire. And we haven't found anything in real estate in a long time. And we may never.

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But who can tell? I mean, we've got our oar in the water. And the couple things we're in are working out fine. But they're not significant relative to Berkshire's size.

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41. Berkshire's past growth not a yardstick for new investments

WARREN BUFFETT: We'll go to zone 6. And this is the last question because it's going to be 3 o'clock. And let's have zone 6.

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AUDIENCE MEMBER: Hi, my name's Mike Nolan from New Jersey. My wife and I have been shareholders since 1984, and happy ones. Thank you both. Two questions today.

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In the retail store industry, in light of Berkshire's outstanding 23 percent annual growth in book value per share and the industry's roughly 8 to 9 percent growth in equity over the last several years, we wonder, why would Berkshire exchange stock for securities such as these, when the growth and the net worth of the acquired companies, if they're anywhere near the industry average that you've acquired this year, are one-third or less?

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To quote Barnett Helzberg from the annual report, "The diamond business is a very competitive industry."

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WARREN BUFFETT: Well, all retail is competitive. And both of those companies have averaged a lot better returns on equity than the numbers you cite for the industry.

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And the second point, you know, we have no way of making 23.6 percent in the future. So we do not use our historical — if we used our historical average as a yardstick for new investments, we would make no new investments because we don't know how to make 23.6 percent in the future.

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But we like — we regard the retail business as a very tough business. We like the records of those companies, their market positions, and their managements. And when we find a business like that, and we feel very comfortable with the people running it, we will make the deal.

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But we won't expect to make 23.6 percent on our money over time doing that.

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I'd like to thank everybody for coming. You’ve, you know — (Applause)

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