(Video recording begins after meeting has started)

WARREN BUFFETT: … second or anybody would like to speak to that motion, might now work their way over to the microphone in zone 1. Could we have a spotlight on where that is? In that way, when we get to that point of the program —

If anybody that would like to speak to the motion that was in the proxy statement, if you'll work your way over to the microphone there then we'll be ready at the time — you can be ready at the time when it will be appropriate to talk about it.

And so we'll get there in just a minute and if you’ll all wander over there that are interested.

Also with us today are partners in the firm of Deloitte & Touche, our auditors. They're available to respond to appropriate questions you might have concerning their firm’s audit of the accounts of Berkshire.

Mr. Forrest Krutter, the secretary of Berkshire. He will make a written record of the proceedings.

Miss Becki Amick has been appointed inspector of elections at this meeting. She will certify to the count of votes cast in the election for directors.

The named proxy holders for the meeting are Walter Scott Jr. and Marc D. Hamburg.

We will conduct the business of the meeting and then adjourn the formal meeting. After that, we will entertain questions that you might have.

WARREN BUFFETT: Does the secretary have a report of the number of Berkshire shares outstanding entitled to vote and represented at the meeting?

FORREST KRUTTER: Yes, I do.

As indicated in the proxy statement that accompanied the notice of this meeting that was sent by first class mail to all shareholders of record on March 6, 2002, being the record date for this meeting, there were 1,323,707 shares of Class A Berkshire Hathaway common stock outstanding, with each share entitled to one vote on motions considered at the meeting and 6,290,415 shares of Class B Berkshire Hathaway common stock outstanding, with each share entitled to 1/200th of one vote on motions considered at the meeting.

Of that number, 1,103,455 Class A shares and 5,260,231 Class B shares are represented at this meeting by proxies returned through Thursday evening, May 2nd.

WARREN BUFFETT: Thank you. That number represents a quorum and we will therefore directly proceed with the meeting.

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

WALTER SCOTT: I move that the reading of the minutes of the last meeting of the shareholders be dispensed with and the minutes be approved.

WARREN BUFFETT: Do I hear a second? The motion has been moved and seconded.

Are there any comments or questions? Three second pause. We will vote on this motion by voice vote.

All those in favor say aye. Opposed? The motion’s carried.

WARREN BUFFETT: The first item of business of this meeting is to elect directors. The shareholders present who wishes to withdraw a proxy previously sent in and vote in person on the election of directors here, he or she may do so.

Also, if any shareholder that is present and has not turned in a proxy and desires a ballot in order to vote in person, you may do so.

If you wish to do this, please identify yourself to meeting officials in the aisles who will furnish a ballot to you.

Would those persons desiring ballots please identify themselves so that we may distribute these?

I now recognize Mr. Walter Scott to place a motion before the meeting with respect to election of directors.

WALTER SCOTT: I move that Warren E. Buffett, Charles T. Munger, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace, Ronald L. Olson and Walter Scott Jr. be elected as directors.

WARREN BUFFETT: Is there a second?

It has been moved and seconded that Warren E. Buffett, Charles T. Munger, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace, Ronald L. Olson and Walter Scott Jr be elected as directors. Sounds like a hell of a slate to me.

Are there any other nominations? Is there any discussion?

Nominations are ready to be acted upon. If there are any shareholders voting in person, they should now mark their ballots on the election of directors and allow the ballots to be delivered to the inspector of elections.

The proxy holders please all submit to the inspector of elections a ballot on the election of directors, voting the proxies in accordance with the instructions they have received.

I will have to say at this point, deviating from my script, that — in the spirt of disclosure which now permeates the corporate world — I have a tally here from yesterday as to the number of votes each director has received.

And the — I won't give the affirmative votes, but the total — basically negative vote is a withhold vote — Charlie and I and Howie came in last, by a significant margin.

Susie did the best. She only had 1,000 votes against her, but Charlie and I had 16,000-some votes against us.

So, I really suspect that Susie voted against us so that she could lead the ticket, but who knows? (Laughter)

Miss Amick, when you're ready you may give your report.

BECKI AMICK: My report is ready.

The ballot of the proxy holders in response to proxies that were received through last Thursday evening has not less than 1,139,672 votes for each nomine.

That number far exceeds a majority of the number of the total vote related to all Class A and Class B shares outstanding.

The certification required by Delaware law of the precise count of the vote, including the additional votes to be cast by the proxy holders in response to proxies delivered at this meeting, as well as any cast in person at this meeting, will be given to the secretary to be placed with the minutes of this meeting.

WARREN BUFFETT: Thank you, Miss Amick.

Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chace, Charles T. Munger, Ronald L. Olson, and Walter Scott Jr. have been elected as directors.

Next — (Applause)

The next item of business is the proposal put forth by a Berkshire shareholder, Gloria Jay Patrick, the owner of two Class B shares.

Miss Patrick’s motion is set forth in the proxy statement and provides that the shareholders request the company to refrain from making charitable contributions.

The directors have recommended that the shareholders vote against this proposal.

We will now open the floor to recognize Miss Patrick or her designee to present her proposal.

And I believe we have Mr. Mosher at the microphone in area one to speak to — to make the proposal and speak to it. Would you go ahead please, sir?

STEVEN MOSHER: Thank you, Chairman Buffett. I apologize if this is a little loud. I was told I would have to really project but I think you can hear me up there on the stage and I hope you can hear me up in the rafters.

My name is Steven Mosher. I'm the chairman of the Population Research Institute, a nonprofit organization dedicated to making the case for people as the ultimate resource, the one resource that we, as investors, cannot do without, and to debunking the hype about overpopulation, what the New York Times has called, and I quote, “One of the myths of the 20th century.” Of course, we're now living in the 21st century.

I've written about the coming depopulation — that's right, I said depopulation — in the Wall Street Journal and other publications.

I say all this to explain why Gloria Patrick, a Berkshire Hathaway shareholder, has asked me to present her action at this meeting, the following proposal.

And I do have one other qualification: I have nine children.

Now when people gasp at this, I remind them that my children will be paying their Social Security one day. Of course, if you invest in Berkshire Hathaway stock, you won't need Social Security.

I will present the proposal and then, with the chairman’s indulgence, spend a couple of minutes explaining why it's necessary.

Here is the resolution:

Whereas, charitable contributions should serve to enhance shareholder value.

Whereas, the company has given money to groups involved in controversial activities like population control and abortion.

Whereas, our company is dependent on people to buy the products and services of the various companies we own.

Whereas, our company is being boycotted by Life Decisions International and investment-related groups like Pro Vita Advisors because of these contributions.

Resolved: The shareholders request the company to refrain from making charitable contributions.

Let me take these very quickly, point by point.

You all know shareholder money is entrusted to the board of directors to be invested in a prudent manner for the shareholders.

I think you will all agree, as the resolution states, that charitable contributions should serve to enhance shareholder value.

Indeed, this is already Berkshire Hathaway policy with regard to its operating subsidiaries.

As Chairman Buffett explained in his Chairman’s Letter of last year, quote, “We trust our managers to make gifts in a manner that delivers commensurate tangible or intangible benefits to the operations they manage. We did not invest money in this company so it could be given to someone else’s favorite charity.”

I think you will also likewise agree that activities like population control and abortion are controversial.

In fact, some of the charitable money has been given to Planned Parenthood, a group that is responsible for almost 200,000 abortions a year in the United States — (applause) — and in countless more through its population control programs worldwide.

Now, we believe abortion is the taking of a human life, but even if you disagree on this fundamental point, you must concur that these ongoing boycotts of Berkshire Hathaway company products are not a good thing.

Next, it should be self-evident that Berkshire Hathaway, like the economy as a whole, is dependent upon people. It is people who produce the products and services of the various companies we own, and it is people who buy them.

Now, you may think that there is the superabundance of people in the world and that we will never run short, but this is not true.

Half of the countries of the world, including countries in Latin America, Africa, and Asia, now have birthrates below replacement.

Europe and Japan are literally dying, filling more coffins than cradles each year.

Dying populations may shrink the economic pie. We already see this happening in Japan and some European countries.

How much of Japan’s continuing economic malaise can be directly traced to a lack of young people to power the economy?

Dying populations may also make economic development nearly impossible. Russia is having trouble finding its feet economically. Why? Because of its ongoing demographic collapse, losing a million people a year.

These problems will spread to many more countries in the near future.

Charitable contributions to simple-minded population control programs, in which governments impose restrictions on childbearing, are not in Berkshire Hathaway's interest.

Such programs are not investing in humanity's future, they are compromising humanity's future and putting a roadblock in the way of future economic growth.

There is no global share buyback in store for those who fund population control programs, because such programs will rob the world of future consumers and producers and threaten to shrink the economic pie.

Let me give you a concrete example of what I mean. Berkshire Hathaway owns Dairy Queen.

Now, there are 103 Dairy Queens in Thailand. But Thailand, due to a massive population control campaign, now has a birthrate that is below replacement and falling.

This means that its cohorts of young children are shrinking. There will be fewer and fewer families in the years to come and its population will eventually fall.

Now, you may think Thailand has too many children. But is it possible for there to be too many children for Dairy Queen?

According to Dairy Queen, the Dairy Queen concept especially appeals to, quote, “young families.” But there will be fewer young families in Thailand’s future and Dairy Queen’s future because of population control.

So I urge you to vote yes on this resolution: let it be resolved that this company refrain from making charitable contributions.

One final point. Should you, on the other hand, both continue the current practice of making charitable contributions based on shareholder designations, I would urge you all to designate 501(c)(3)s, like the Population Research Institute, which are attempting to help the poor become the agents of their own development and not simply try to reduce their number through population control.

Thank you, Mr. Chairman for this opportunity to speak. (Applause)

WARREN BUFFETT: Thank you.

Do we have a — do we have a second to the motion?

Ok, we have.

And is there are any further discussion? Is there anyone there at the microphone that would like to talk?

OK. If there's no further discussion, we'll have Miss Amick report on the votes cast on that.

If anybody wishes to cast a vote in person, they can raise their hand and submit that, but we’ll have a preliminary report from Miss Amick.

BECKI AMICK: My report is ready.

The ballot of the proxy holders in response to the proxies that were received through last Thursday evening cast 28,452 votes for the motion, and 1,014,353 votes against the motion. (Applause)

As the number of votes against the motion exceeds a majority of the number of votes related to all Class A and Class B shares outstanding, the motion has failed.

The certification required by Delaware law of the precise count of the vote will be given to the secretary and placed with the minutes of this meeting.

WARREN BUFFETT: Thank you, Ms. Amick. The proposal failed.

WARREN BUFFETT: After adjournment of the business meeting, I will respond to questions that you may have that relate to the businesses of Berkshire but do not call for any action at this meeting.

Does anyone have any further business to come before this meeting before we adjourn?

If not, I recognize Mr. Walter Scott to place a motion before the meeting.

WALTER SCOTT: I move that this meeting be adjourned.

WARREN BUFFETT: Is there a second?

Motion to adjourn has been made and seconded. We will vote by voice.

Is there any discussion? If not, all in favor say aye. All say no? The meeting’s adjourned. Thank you. (Applause)

WARREN BUFFETT: Now, before we get on to the questions, and when we get to the questions we will move through various zones sequentially, there are just a few special guests that I would like to recognize, and because of the crowd, I've not had an opportunity to make sure all of these special guests are here, but we will find out here shortly.

The first guest, and I hope very much he’s here. He was planning to be here. It was — let’s see — 40 — 48 years ago this July or so — well about June — I got a letter from Ben Graham who I had been pestering for a job for about three years and getting no place, and then said the next time you're in New York, come in and talk to me.

So, I was there about ten hours later. I didn't have a NetJets plane, so it took a little longer.

And I went in to see Ben and he offered me a job and I took it on the spot. I didn't ask what the salary was, or anything else, and a month or two later the family joined me.

I had — my daughter was already born and Susie was pregnant with Howie. And we moved back there and I went to work for Graham-Newman Corp.

And, one of my three bosses — I had three bosses that — Ben Graham, Jerry Newman, and Mickey Newman. And Mickey was exactly ten years older than I was at that time and he's exactly ten years older now.

And Mickey was a major factor in a hugely successful — he ran the place — company that was not quite that successful yet in 1954 when I went back there: the Philadelphia and Reading Coal and Iron Company, as it was called then.

And after I'd been there maybe a year — Mickey was in charge of Philadelphia and Reading — and a fellow named Jack Goldfarb came into the office, and I really didn't know what was going on.

I had a good bit of my net worth in Philadelphia and Reading, so I was interested, but Jack Goldfarb and Mickey were behind closed doors, largely.

But when they emerged, the Philadelphia and Reading Company, which was controlled by Graham-Newman, had bought Union Underwear, which was the manufacturer of Fruit of the Loom product under a license at that time.

And, as I told in the annual report, was a very, very attractive buy, and Mickey made a number of good buys.

And when — Mickey and I have talked and seen each other over the years, some, not a lot, but we would see each other.

And when Fruit of the Loom entered bankruptcy a few years ago, Mickey called me and sort of said, what are you going to do about it? You should do something.

And he was very helpful, particularly helpful, in introducing me to John Holland, who runs Fruit of the Loom, and who is a tremendous asset to the company. And, Mickey gave me lots of insights on that.

And when I got discouraged with the bankruptcy procedure — and it is discouraging to try and buy a company out of bankruptcy — Mickey would gently prod me along.

And so I believe, today, we have with us Mickey Newman and his son, who I last saw when he was a little red-headed kid, Bill.

Mickey and Bill, if you're here, if you’d stand up, it’d be great. Now, let's see if they made it.

There they are. Let’s have a spotlight on them. (Applause)

I can’t see very well from here whether Bill is still redheaded.

But Mickey is 81, believe it or not. You won’t believe it if you meet him.

And he's been a tremendous help and a great friend over the years.

And he accomplished much for us in the past year. We — I don't think we would have Fruit of the Loom if it hadn’t been for Mickey, particularly nudging me along as we went through the process.

WARREN BUFFETT: I also hope we have today with us, and again, I didn’t get a chance to see them before the meeting, but are Ralph and Luci Schey here? Ralph and Luci? Did they — were they able to make it or not?

Yeah, there they are. (Applause)

Ralph is in the Berkshire Hathaway Hall of Fame. I mean, this is like being at Cooperstown, you know, and introducing Bob Gibson or Sandy Koufax.

Ralph, for a great many years, added tremendous value to Berkshire at Scott and Fetzer.

We wouldn’t be able to buy some of the things, like Fruit of the Loom, if it hadn’t been for the profits developed under Ralph’s management at Scott Fetzer.

So I’m delighted that he and Luci can join us. (Applause)

WARREN BUFFETT: I believe, and I hope we have Larry and Dolores Brandon. Are they here?

Show your — there they are. Let’s have a spotlight on them. (Applause)

Delores is also known as “Dutchy” but we call her “Saint Dutchy” at Berkshire headquarters because she gave birth some years ago to Joe Brandon, and Joe has been doing a fabulous job for us at General Re. He took over early in September.

It’s really going to be our number one asset. There’re been a lot happened since those days in September when Joe took over. I think you’re going to see some terrific results throughout our insurance business, but particularly at General Re.

I wrote Dutchy a letter and I said, you know, it’s terrific what you’ve done for us, but — you know, I was a little like the farmer that went into the henhouse, and I, you know, pulled out an ostrich egg, and said to the hens, you know, I don’t like to complain, but this is just a sample of what the competition’s doing. (Laughter)

Well, I berated her a little bit for not having twins, because if she just had a twin for Joe, we’d own the world.

But she tells me that — and she wrote me back and said — she really had done her best. I mean, she’d had seven children, five of whom are in the insurance business, and she has 19 grandchildren.

So, we have people out on the road trying to sign up these grandchildren now and — (Laughter)

If you get a chance, you know, tell her her productive years are not over. (Laughter)

WARREN BUFFETT: And finally, we have with us today the fellow who put together that terrific cartoon.

Anybody that can — even takes on the job of making me look like James Bond is a very brave person.

And, Andy Heyward has a company called DiC Entertainment, which is a leading producer of children’s programming. When you turn on the television on Saturday morning, you will be seeing his output.

And Andy puts this product together. He sends people to Omaha. He does it all.

It’s his script, it’s his production. He does it on his own time, on his own nickel, he just — it’s his contribution to the Berkshire meeting. And it, I mean, it’s absolutely fabulous.

And I have to tell you that this fall, Andy is going to have a series of 40 episodes that are called — I think it’s called “Liberty’s Kids.”

It will be on public broadcasting at 4:30, five days a week. And it’s really the story of America.

It’s told — Charlie will like this — Charlie doesn’t know about this — it will be told through the eyes of three young apprentices in Ben Franklin’s print shop.

And it will view the evolving of the American democracy and the Constitution, and all with Andy’s creative characters, but it will use the voices of various other people.

And I’m flattered. I get to be James Madison in this. And we have Sylvester Stallone, we have Billy Crystal, we have Whoopi Goldberg.

And Charlie will be crushed to find — I think its Walter Cronkite is going to be Ben Franklin.

I mean, I think Charlie held out for too much money or something. (Laughter)

But, it’s going to be a fabulous series. I mean, I am looking forward to this. It will run all this year, starting in the fall, and then it will run again in the following year. And it will be a great, great, piece for American children and American adults.

I plan on watching it myself. And it will just be the story of how this country came about, through the eyes of these three young apprentices of Ben Franklin.

So, Andy is here with his son Michael, and if Andy and Michael would stand up, I’d like to give them a hand myself. Andy, where are you? (Applause)

They’re here someplace. (Applause continues)

WARREN BUFFETT: We've got a lot of other special guests, but they’re up here in our managers’ section. You saw them up on the screen. They’re the people who make this place work.

We have a larger and better cast this year than we’ve had even in the past, and it will grow in the future.

This is a company of managers. And, you know, we confess to how little we do around headquarters, as you saw in the movie.

And we now have, I think — I’m not sure of the exact number, whether we have 130,000 now, or something like that — people working all over the world in all kinds of occupations.

And, I think they get a sense when they come here that they’re working for real people on this side, too.

I mean, they get to see people who are actual owners. We have some institution holders, but we have 350,000 individual owners now, and I think — I believe — it’s correct to say that our stock turns over — less turnover — in the shares of Berkshire than in any other company of major size in the country.

Which means, in effect, we have more what I would call real owners, people who want to be in partnership with the kind of managers we have. And Charlie and I are very proud of them.

WARREN BUFFETT: Now we’re going to get to the questions in just one second.

I thought I would give you a little update on, particularly, the insurance aspects of the first quarter, because insurance cost us a lot of money last year.

It’s our main business. It’s always going to be our main business. It’s a very, very big business, and it’s going to get bigger.

And, there were some special events of last year, and there were some mistakes of our own that made it a bad year for insurance last year.

Our float last year cost us almost 13 percent, and that’s a lot to pay for money.

It’s not our record. We had a period in the ‘80s when we ran into even more difficulties.

But I think there’s been — well, I know there’s been — there’s been a change in the market. There’s been a change, to a degree, in the culture at a very important unit.

And, I think that, barring some really mega-catastrophe, and we’ll talk about those later — possibility — that we are — I think we’re doing pretty well.

And if we could have the first chart that I — yeah — the first chart, which I can’t see myself here, but I think it will be the insurance underwriting results for the first quarter.

And you will see that two good things happened in the first quarter.

One is our float increased by $1.8 billion. That’s a lot of money to take in, net. I don’t think there’s any company, probably in the world, that had a gain in float that was even close to that.

And we actually achieved that with a small underwriting profit. So the float not only cost of nothing in the first quarter, but we had a gain of a billion-eight in it. And all units contributed to that. (Applause)

Our goal is to obtain more and more float at minimal or no cost. And there have been a number of years in the past when we’ve run an underwriting profit, which means that the use of that money is essentially free, or even better than free.

And we’ve had one very bad year, and a couple of so-so years before that.

But I think our cost of float over the next few years, unless we get into an extraordinary catastrophe, I think it should be pretty satisfactory.

Now, you’ll notice there’s a note down at the bottom that’s slightly technical, but it’s an important enough item in Berkshire, and in understanding our cost of float, that I thought I’d just devote a minute to it.

If you find this uninteresting, you can live a happy life without understanding what I’m about to explain next. You may even lead a happier life if you don’t understand it. (Laughter)

As I look at the people that understand it and don’t understand it, I’m not sure which group is happier. (Laughter)

When we write — we write a good bit — and have written a good bit, I should say — of retroactive insurance.

Now, in retroactive insurance, a company may come to us that’s merging with another company, and they want to put a cap on their liabilities, or define them better, from past incidents.

So they may come to us and say, we want you to pick up all the losses that are going to be paid from things that happened prior to, say, 1990.

And we think that we owe $1 billion — have yet to be paid in losses from that period — but we want to protect ourselves up to, say, $2 billion, or some number like that.

So they write us a check and we take over — this is called retroactive insurance — we take over their losses from the past for a specific period and for a specific amount.

And, when we do that, the accounting — it’s not accounting you run into every day — we’ve explained it in the past — but it creates a charge which will occur over time in the future.

And, as you can see, in the first quarter, the 20 million of underwriting profit we made was after a total of 112 million for the amortization of this charge that is set up.

So, if a company comes in and says, for example, we want you to protect us up to a billion-and-a-half for losses that occurred in the past, and we’ll give you a billion dollars for it, we will debit cash for a billion dollars and we’ll debit this deferred charge for half a billion and we’ll set up a liability for a billion-and-a-half.

And that 500 million we set up as a deferred charge, we amortize over a period of time as we expect to pay the claims.

Now, there would be a lot of room for judgement — there is a lot of room for judgement — in terms of how fast we amortize that.

We try to be conservative. We make an estimate of when we will pay those claims and how much we will pay, and we try to amortize it over a reasonable period.

I’ve got another slide that shows how those amortization charges will work over time.

And we’re going to put these slides on the internet, because we feel that our shareholders should understand the impact of these charges that will come against underwriting profits.

In the year 2002, we will have a 400 million-plus charge for this. It’s built into the figures now.

And if we do 20 billion of premium volume, that’s about a 2 percent charge.

So, to have our float be cost free, we have to make 400-plus million on underwriting elsewhere, in order to offset that.

And as you can see, we did that the first quarter and we’ll find out whether we do it for the full year.

It’s a — not many companies do this kind of business and it’s a big item with us, so I really want all the shareholders to understand it, and for that reason, we’ll put it on the internet.

I should emphasize that in all of these contracts, we cap our liability. So a lot of these contracts apply to liabilities that primarily — or not primarily — but in a significant way, and often primarily, arise from asbestos.

But when you read about asbestos claims accelerating and all of that, the numbers are capped in our case, in all of these contracts. So really don’t care whether we pay it on an asbestos claim or whether we pay it on an old auto liability claim, or whatever.

The question is whether we’ve been correct in estimating the speed at which we will pay. And in some cases, we may pay even less than our maximum amount.

So, anyway, that’s available for those of you who have previously were unhappy not understanding this and now are thrilled to know how it all works. (Laughter)

WARREN BUFFETT: Now the final item, which is a little easier to understand, is — we talked in the annual report about how we expected growth to resume at GEICO.

And I put up — again I can't see what’s up there — but I assume that we have the GEICO policies in force figure and the increase by — Charlie hasn’t seen these, as a factor of fact, so I’ll give him the slide.

And as you can see, growth, not at the rates of a couple of years ago, but quite a turnaround from last year. Growth has resumed at GEICO in a reasonable way.

We figure each policyholder of a preferred nature is worth $1000 to us, at least, and so if we had 40,000 policyholders in a month, we've created, in our view, $40 million of value.

And, of course, we have the earnings in the float, and so on, that goes with it.

You'll notice on the first slide, GEICO operated at a significant underwriting profit in the first quarter, so all of its float was free and its float has continued to grow.

We are — you saw one of our little squirrel ads there which I like — we are getting — we are not getting a whole lot more inquiries than a year ago, but we're closing a significantly higher percentage of those that call. So our growth has been — has been picking up because our closure rate has increased quite substantially, and our retention rate of old policyholders, also, is increasing month by month.

So we've got two trends that are quite favorable, in terms of adding business.

And the third one of adding more inquiries is something that we are working on, and we're delighted to spend a lot of money on it, if we can figure out the way to spend it intelligently.

But, the increase in the retention ratio, the increase in the closure ratio, is resulting in very decent growth at GEICO.

And it’s growth in all of our categories, in the preferred class, and the standard class, and the nonstandard class of business, whereas last year, the latter two fell.

Well, that's enough about the formal presentation.

WARREN BUFFETT: Now, we're going to go in the various zones.

I promised a young shareholder in zone one that he would get to ask the first question and we're ready for zone 1.

AUDIENCE MEMBER: Hello Mr. Buffett and Mr. Munger. My name is David Klein-Rodick from Lincolnshire, Illinois. Thank you for letting me ask the first question.

I wanted to say I am sorry for the loss of your friend Mrs. Graham last year.

My question is: you have said that your favorite time to own a stock is forever.

Yet, you sold McDonald’s and Disney after not owning them for long.

How do you do decide when to hold forever and when to sell?

And also, are you and Mr. Munger wearing Fruit of the Loom? (Laughter and applause)

WARREN BUFFETT: Charlie? (Laughter)

I think I better answer the question. I can answer unequivocally. I am wearing Fruit of the Loom.

I'm not sure whether Charlie wears underwear. Do you? (Laughter)

CHARLIE MUNGER: I haven't bought any new underwear in a long time and therefore I'm inappropriately attired. (Laughter)

WARREN BUFFETT: He's waiting for a discount, don’t let him kid you. (Laughter)

Well, the answer — it’s a very good question about selling. I mean, we — it's not our natural inclination to sell.

And on the other hand — and we have held the Washington Post stock since 1973. I've never sold a share of Berkshire, having bought the first shares in 1962.

And we’ve held Coke stock since 1988. We’ve held Gillette stock since 1989. Held American Express stock since 1991.

We had actually previously been in American Express in the ‘60s and Disney.

So, there are companies we are familiar with.

We generally sell by — we would sell if we needed money for something else — but that has not been the problem the last 10 or 15 years.

Forty years ago my sales were all because I found something that I liked even better. I hated to sell what I sold, but I also didn't want to borrow money, so I would reluctantly sell something that I thought was terribly cheap to buy something that was even cheaper.

Those were the times when I had more ideas than money. Now I've got more money than ideas, and that's a different equation.

So now we sell — really when we think that we’ve — when we’re reevaluating the economic characteristics of the business.

In other words, if you take the — don't want to name names — but take a stock we’ve sold, of some sort.

We probably had one view of the long-term competitive advantage of the company at the time we bought it, and we may have modified that.

That doesn't mean we think that the company is going into some disastrous period or anything remotely like that. We think McDonald's has a fine future. We think Disney has a fine future. And there are others.

But we probably don't think that their competitive advantage is as strong as we might have thought — as we thought it was — when we initially made the decision.

That may mean that we were wrong when we made the decision originally. It may mean that we're wrong now, and that their strengths are every bit as what they were before.

But, for one reason or another, we think that the strengths may have been eroded to some degree.

A classic case on that would be the newspaper industry, generally, for example.

I mean, in 1970, Charlie and I were looking at the newspaper business. We felt it was about as impregnable a franchise as could be found.

We still think it's quite a business, but we do not think the franchise in 2002 is the same as it was in 1970.

We do not think the franchise of a network television station in 2002 is the same as it was in 1965.

And those beliefs change quite gradually. And who knows whether they're precise — you know, whether they’re right, even.

But that is the reason, in general, that we sell now.

If we got into some terribly cheap market, we might sell some things that we thought were cheap to buy something even cheaper, after we’d bought lots and lots of equities. But that's not the occasion right now.

Charlie?

CHARLIE MUNGER: Nothing to add.

WARREN BUFFETT: He's been practicing for weeks. (Laughter)

WARREN BUFFETT: OK, let's go to zone 2.

AUDIENCE MEMBER: I'm John Bailey from Boston, Massachusetts and I hope I'm not asking you to repeat your insurance presentation, but I have a question about the growth of our float.

There's an increasingly popular piece of analysis out there where people project the growth of float for a large number of years into the future in order to determine the value of our business here.

But I wanted to ask more fundamentally, the existing float that we have runs off annually at a pretty considerable rate.

In order to maintain that, we have to replace it through our operations.

And then going the next step, to achieve the growth, we have more than replace it.

And so I wanted to ask you to address the characteristics of the — maybe the non-GEICO insurance businesses — that should give us the confidence to expect large amounts of replacement and growth float, at reasonable costs, going forward?

WARREN BUFFETT: Yeah, in a sense, float is somewhat similar to being in the oil business. I mean, you know, every day, some goes out as you pay claims, and the question is, did you find more oil than you produced that day? And it’s very relevant.

It’s a good question to, you know, what is the permanence of the float? What is the cost of the float? What’s the likelihood of it growing? Could it actually run off?

As you saw up on the slide, we have $37 billion-plus of float. I think we have more float in our property-casualty business. A little bit of that float is in General Re’s life and health business, but very small.

So, basically you're looking at property-casualty float when you look at that 37 billion.

I believe that's more than any company has in the United States and it's possible — I haven't checked Swiss Re and Munich — but it's even possible it's larger than anybody in the world.

Now, if you go to 30th and Harney Street, here in Omaha, you'll see National Indemnity building. It's the same building that was there when we bought the company in 1967 from Jack Ringwalt, when it had, maybe, 12 million of float.

And I had no idea that that 12 million, or whatever the number was, would turn into 37 billion. I mean, sometimes I can’t really quite figure out how it happened.

But in any event, it did, and it's — we don't want people focusing on growth in our insurance business. I mean, we want them focusing on intelligent growth when we can do it at a GEICO or whatever it may be.

But I think it’s suicide, from a business standpoint, to tell a bunch of insurance managers to go out and grow a lot.

So, you can say, well, with that lack of push from the home office, you know, how is that 37 1/2 billion going to grow? And I would say, just as I would have said to you for the last, you know, 30-odd years, I don't know.

But I think that — well, I can tell you this, that our float would have less natural runoff than the float from just about any company in the world.

I mean, we have a longer duration to our float because it arises from these retroactive contracts and from reinsurance, long-tail reinsurance, and that sort of thing.

So, our float has less natural erosion than any — just about any — that I know of in the world, but it erodes. It is a long-lived oil field, but it — we're pumping it every day.

You know, if I had to bet my life on whether the float would be higher or lower three years from now, or five years from now, I would certainly bet it would be higher.

And it’s turned out, over the decades, that it's grown at a very significant rate. But I don't want to push anybody to do it. It grew at $1,800,000,000 the first quarter.

Now, there are a few special transactions in that, but we seem to attract special transactions.

There’s nothing more important to Berkshire than to — to have that float, at least, be maintained, but I would say grow. And it will grow, I think. And to have it be obtained at low cost.

That float did us no good last year at all. That float was — lost us a lot of money in the year 2001, because it cost us, I think, 12.8 percent. And we didn’t have a way to make money with 12.8 percent money.

We will make a lot of money if we can obtain a float at no cost, as we did in the first quarter.

The answer to your question is that without knowing any specifics that — without being able to promise you any specifics — you know, I think the float is more likely to grow than to erode.

I said last year at this meeting that there — you know, that the float of the American property-casualty business was 300-and-some billion, and I thought we were sneaking up on 10 percent of it.

I was corrected later on. Ferguson pointed out to me that — he sent me the figures. The float of the American property-casualty business is well over 400 billion.

But even at that, you know, we are 8 or 9 percent, or some figure like that, of the float of the whole country.

And, obviously, we can’t grow at the same percentage rate starting from that kind of a base as we could when we started back in 1967.

But I still think we can grow it.

Charlie?

CHARLIE MUNGER: Yeah, I think the questioner realizes that growing float at a good clip, with very low costs, is extremely difficult.

It is. It’s almost impossible. But we intend to do it anyway. (Laughter)

WARREN BUFFETT: See, of the two variables, though, that the most important thing to do is to focus at getting it at a very low cost. If we get $37 billion at no cost, or very low cost, you know, then if we don’t do — if we don’t make money with that, shame on us.

I mean, the troops have delivered and then it’s up to Charlie and me to figure out ways to use that money.

So the important thing is the cost of the float and not the size of the float, although, obviously, we would like it to grow and we will do what we can to make sure that happens.

WARREN BUFFETT: Area 3.

AUDIENCE MEMBER: Good morning, gentlemen. My name is Hugh Stephenson. I’m a shareholder from Atlanta.

My question is on asbestos liability tort cases. It seems like this is growing to be a bigger and bigger problem, including more and more companies, including a number of companies in the Dow Jones 30 industrials.

What do you see for Berkshire as the risks and opportunities in the operating and insurance businesses?

And, if you two were in charge of writing or structuring a settlement for the whole problem, how would you do it?

WARREN BUFFETT: OK, I’m going to let Charlie tackle most of that, because he’s — we’ve both done a lot of thinking on it. I think Charlie’s thinking is — I know — it’s better, and it may even be more extensive.

Asbestos, as I mentioned in some of these retroactive contracts, is a big part of the liability, but it really doesn’t make any difference, unless — it’s much more dependent on the speed of payments than the amount of payment.

We are capped on all those types of contracts.

So, there’s a figure in the annual report about aggregate asbestos and environmental liability. And that number may look quite big compared to some other insurance companies — but most of that, there’s a limit on.

And, it’s a good thing, because asbestos continues to explode. It’s just — we talked about it last year at this meeting, and I said no matter how bad you thought it was, it was going to be worse. And it has been worse. And it will be worse.

And you make a very good point when you bring up the fact that many companies that are thought to be, or have been thought to have been, insulated from the asbestos litigation have now been dragged in one way or another. And that won’t stop, either.

Ironically, it’s not impossible that that asbestos litigation actually produces some opportunities for Berkshire, in terms of buying companies out of bankruptcy, free of their asbestos liabilities.

We did that — although it occurred much earlier in the — but we bought Johns Manville, which was the, in my memory, was the first major company, really big company, to go into bankruptcy and be forced there by asbestos liability. That happened back in the early ‘80s.

And that subsequently, they were cleansed of their liability by, in effect, giving a very high percentage of the company and its debt to the plaintiffs. And their lawyers, I might add.

And when we came along a year ago, I mean, that was all past history. But we probably wouldn’t own the Johns Manville company if it hadn’t been for some asbestos litigation that started 20 years ago or more.

We may see, actually, more companies that end up in Berkshire that have been forced into bankruptcy through asbestos.

But it is a — it’s really a cancer on the American corporate world. And it’s one that growing. And I think I’ll let Charlie talk about it.

CHARLIE MUNGER: Well, the asbestos liability situation in the country is morphed into a very disadvantageous situation where there’s an enormous amount of fraud.

And the wrong people are getting money, and there are vast profits for people who are arranging the fraud. And so it isn’t a good situation.

There’s also real liability to people who have serious injuries, and some of those people are being deprived because the meritless claims are taking so much of the money that there isn’t adequate money for the people who had the worst injuries.

The Supreme Court has practically invited Congress to please step in and create a solution, but, deterred by the plaintiffs contingency fee bar, Congress has refused to do anything.

This is not a good situation, and if you can do anything about it, why, I would encourage you to do so.

WARREN BUFFETT: What do you think it will look like in five years, Charlie?

CHARLIE MUNGER: I would be surprised if there were a constructive solution. I think we’ll have more of the mess we have now.

WARREN BUFFETT: It’s huge, too. I mean, you — there are companies that some of you may own stock in that had huge potential liabilities.

They didn’t think they had those liabilities, even, maybe, a few years ago. But, they’re finding ways to drag in almost anyone.

And, you know, it’s a concern when we buy businesses, because we are a deep pocket. And a tiny — a smaller — company may not have been worth people investing lots of hours on a speculative idea that they could create some kind of a connection with, you know, the ABC Company and hundreds of thousands of people that are claimed to be sick.

But, it gets more interesting if Berkshire — it could get more interesting — if Berkshire’s involved.

So, it’s a real problem for corporate America and they have not been able, in effect, to come up with a solution.

There was a solution, as I remember, and the Supreme Court didn’t allow it. Isn’t that right, Charlie?

CHARLIE MUNGER: That’s right.

WARREN BUFFETT: Yep.

We will be very careful, both in our insurance operations, but just as importantly, in our acquisitions and all of that, in terms of avoiding unnecessary exposure to asbestos liability.

I’m not terrified at all about our insurance operation, in terms of what’s there from the past.

I’m not saying that I know with any precision what the amounts will be, but I — that is not at the top of my list.

But, essentially you will have a plaintiffs bar that, going beyond asbestos, will try to turn any kind of human adversity into a claim against somebody that’s got a lot of money.

And that’s going on with mold. I mean, you may have seen Ed McMahon is suing his insurer for $20 million for the mold in his house. I just wish I could get some of that mold. I mean — (laughs) —

CHARLIE MUNGER: You probably have it.

WARREN BUFFETT: Yeah. (Laughter)

I hope you’re referring to the house. (Laughter)

WARREN BUFFETT: OK. Area 4.

AUDIENCE MEMBER: Good morning. My name is Tedd Friedman. I’m from Cincinnati, Ohio.

You said in the 1996 annual report that most investors will find that the best way to own common stocks is in an index fund that charges minimal fees.

Two questions. First: there are a lot of different index funds that hold different baskets of stocks. What criteria would you use, or recommend, to select an appropriate index fund?

Second: The price-to-earnings ratio of the S&P 500 is significantly higher than its historical average. What benchmark should an investor use in purchasing this index?

WARREN BUFFETT: Yeah, I would say that in terms of the index fund, I would just take a very broad index. I would take the S&P 500, as long as I wasn’t putting all my money in at one time.

If I were going to put money into an index fund in relatively equal amounts over a 20 or 30-year period, I would pick a fund — and I know Vanguard has very low costs. I’m sure there are a whole bunch of others that do. I just haven’t looked at the field.

But I would be very careful about the costs involved, because all they’re doing for you is buying that index. I think that the people who buy those index funds, on average, will get better results than the people that buy funds that have higher costs attached to them, because it’s just a matter of math.

If you have a very high percentage of funds being institutionally managed, and a great many institutions charge a lot of money for doing it and others charge a little, they’re going to get very similar growth results but different net results.

And I recommend to all of you reading — John Bogle’s written a couple of books in the last five years, and I can’t give you the titles but they’re very good books, and anybody investing in funds should read those books before investing, or if you’ve already invested, you still should read the books. And it’s all you need to know, really, about fund investing.

So I would pick a broad index, but I wouldn’t toss a chunk in at any one time. I would do it over a period of time, because the very nature of index funds is that you are saying, I think America’s business is going to do well over a — reasonably well — over a long period of time, but I don’t know enough to pick the winners and I don’t know enough to pick the winning times.

There’s nothing wrong with that. I don’t know enough to pick the winning times. Occasionally, I think I know enough to pick a winner, but not very often.

And I certainly can’t pick winners by going down through the whole list and saying, this is a winner and this isn’t and so on.

So, the important thing to do, if you have an overall feeling that business is a reasonable place to have your money over a long period of time, is to invest over a long period of time, and not make any bet, implicitly, by putting a big chunk in at a given time.

As to the criteria as to when you should or shouldn’t, I don’t think there are great criteria on that.

I don’t think price-earnings ratios, you know, determine things. I don’t think price-book ratios, price-sales ratios — I don’t think any — there’s no single metric I can give you, or that anybody else can give you, in my view, that will tell you this is a great time to buy stocks or not to buy stocks or anything of the sort.

It just isn’t that easy. That’s why you go to an index fund, and that’s why you buy over a period of time. It isn’t that easy.

You can’t get it by reading a magazine. You can’t get it by, you know, watching television. You can’t — you’d love to have something that said, you know, if P/Es are 12 or below or some number, you buy, and if they’re 25 or above, you sell.

It doesn’t work that way. It’s a more complex business than that. It couldn’t be that easy when you think about it.

So, if you are buying an index fund, you are protecting yourself against the fact that you don’t know the answers to those questions but that you think you can do well over time without knowing the answers to those questions, as long as you consciously recognize that fact.

And, you know, I would — if you’re a young person and you intend to save a portion of your income over time, I’d just say, just pick out a very broad index — I would probably use the S&P 500.

But I think if you start getting beyond that — starting to think you should be in small caps this time and large caps that time, or this foreign stock — and as soon as you do that, you know, you’re in a game you don’t know — you know, you’re not equipped to play, in all candor.

That would be my recommendation.

Charlie?

CHARLIE MUNGER: I think his second worry is that common stocks could become so high-priced that if you bought index funds, you wouldn’t expect to do very well.

I didn’t think I’d live long enough to think that was likely to happen, but now I think that may happen.

WARREN BUFFETT: But, probably what you’re saying there is they could get to a level and be at — they’d have to be at a sustained level like that for a long time.

CHARLIE MUNGER: They could be there and stay there for a long time.

WARREN BUFFETT: In which case, you might make 3 or 4 percent.

But would there be any way better than that around, under those circumstances, anyway? And pass the peanut brittle, please. (Laughs)

CHARLIE MUNGER: Well, in Japan, where something like this happened, the returns from owning a nice index over the last 13 years or so is negative.

Can something as horrible as that happen here? I mean, is it conceivable? I think the answer is yes.

WARREN BUFFETT: But the option in Japan, of course, is to have deposits in a bank, or own Japanese bonds, at somewhere between 0 and 1 or 1 1/2 percent.

So, if rates on everything get very low, which means stocks sell very high, you know, then it just means that you live in a different world than existed 20 or 30 years ago when, generally, capital got paid better.

CHARLIE MUNGER: I must say that we have very good packaging.

WARREN BUFFETT: Yeah. (Laughs)

Normally he does this in a less formal manner, but he’s on his good behavior today.

CHARLIE MUNGER: We're protecting the integrity of the peanut brittle.

WARREN BUFFETT: That is true. The package — the nature of anything with butter in it, you know, is that it starts going downhill from the moment you make it. And therefore, the packing has to be extraordinary in order to meet the quality standards that Charlie and I insist on. (Laughter)

WARREN BUFFETT: OK, we’ll go to zone 5.

AUDIENCE MEMBER: Mr. Buffett and Mr. Munger, my name is Thomas May (PH). I am 12 years old. I live in Kentfield, California. This is my fifth annual meeting.

I know you lost a lot of money as a result of 9/11. But I would like to know how 9/11 changed your life and your investment strategy?

WARREN BUFFETT: Well, I think it, in a sense, is changing — good question.

And, it made everybody, I think, in the country aware, I mean, we’ve gone through world wars and all of that, and essentially felt quite protected within these borders.

And I have been quite worried about — Charlie can attest to — you know, the possibility, particularly of some kind of nuclear device in this country, by — probably more likely by terrorists than by some, at least, declared act of war by another state.

And 9/11 made everybody realize that as humans have not progressed, particularly, in terms of how they behave with each other over the years, they have progressed enormously in their ability to inflict damage on those they hate for one reason or another.

And that has increased, you know, for a long time. In the world, if you didn’t like somebody, the most you could do was throw a rock at them.

And that went on for millennia, and then it moved into what you might characterize, ironically, as more advanced states. And in the last 50 years, it’s increased exponentially.

And so now people who are megalomaniacs, or psychotics, or religious fanatics, or whatever, and who hate others in some unreasonable way, now have means at their disposal to inflict a whole lot more damage, incredibly more damage, than they had not too many decades ago.

And 9/11 brought that home to everybody, something they probably understood subconsciously and didn’t think about very often, to something they thought about much more intensely and it’s become much more real to them.

It hasn’t really changed my view about — I mean, in the sense that I — you know, there are millions and millions and millions of people in the world that hate us. And most of them can’t do anything about it.

But, a few have always tried to do something about it, and now the instruments they can use, in the most extreme, in a sense, being the human bombs that have appeared in the Middle East, but there’s more ability to — incredibly more ability — for the deranged who want to inflict harm to do harm. And that’s the reality.

In terms of the business aspects of it, in your question, obviously the area at Berkshire that it effects most significantly, by miles, is insurance.

And prior to 9/11, even though we recognized that there could be huge monetary damages that flowed from the activities of what I would call deranged people, we hadn’t really written the contracts in such a way as to either get paid for taking that risk or to exclude the risk. In other words, we were throwing it in for nothing.

We had excluded risk for war. I mean, we knew that we’d seen what had happened in England in the 40s, and so we had taken account of something that some of us had seen with our own eyes, but we didn’t take account of something that we knew is possible, but we just hadn’t seen. And that’s, you know, that’s the human condition, to some degree.

Since September 11th, everybody in the insurance business recognizes that they had exposures that they weren’t charging for, and they either had to exclude those exposure or they had to charge for them.

We have written — first thing we had to do, of course, is we had lots of policies on the books that left us exposed to this, and most of those policies ran for a year, starting at different points. Those have run off to a great degree, but they’re not entirely run off.

The other thing we did was on new policies. We have sold a fair amount, quite a large amount, of terrorism insurance that excludes what we call NCB, nuclear, chemical, and biological, as well as fire following nuclear.

And, we can take a fair amount of exposure to that sort of terrorism, because it doesn’t — it won’t aggregate. It aggregated at the Twin Towers in a way that — World Trade Center — in a way that just about was as extreme as you could get for non-NCB-type activities.

I mean, that was a huge amount of damage done without nuclear, chemical, or biological.

But we can have tens of billions of dollars with NCB excluded throughout a greater New York area, or something, but we can’t have hundreds of billions of exposure that would be exposed, say, to, nuclear activities, because there an act or two, or three, coordinated, could cause damage that would destroy the insurance industry.

And if we had coverage on that, it would destroy us as well. So, we write very little — we do write a little, because we can take —we can lose a billion or two billion dollars, and if we got paid appropriately for taking the risk, you know, that’s a business we’re in.

But we can’t lose 50 or 100 billion dollars. And, so we take a little bit — we take a few risks that involve nuclear, chemical, or biological, but, generally speaking, the terrorism insurance that we’re writing, and we’ve written a fair amount of it, excludes those particular risks.

You can say, you know, take biological. How could that be something significant from an insurance standpoint?

Well, many people don’t realize it, but the World Trade Center loss was, by a huge margin, the largest workers’ compensation loss in history.

We think of it as property damage, but, in the end, close to 3000 people had died who were working at the time they died, and therefore, covered by workers’ compensation.

If the same thing had happened at Yankee Stadium while they were all watching a baseball game, or some other place, they wouldn’t have been covered by workers’ compensation. So it was happenstance, to some degree.

But that was — became the largest workers’ compensation loss in history by a huge margin.

Now, if you were trying to cause huge damage in this country, and you could figure out something in the way of a biological agent — and there are people working on this — that could be injected into the ventilation systems, or whatever, of large plants, large office buildings, you could create workers’ compensation losses that, you know, would just totally boggle your mind.

And anybody that was working on such a thing, you have to expect they would — if they thought they had perfected it — would try to do something close to simultaneously in areas where there would be thousands and thousands of people working. And it could make the World Trade Center loss look like nothing.

So, we have to be, basically, vigilant, in how much risk we let aggregate in something of that sort.

People have always been vigilant about how many houses they’ll insure along a shoreline, or, in terms of physical risk, you know, they don’t want too many homes or factories on the San Andreas Fault, or something of the sort, because they recognize that as having aggregation possibilities.

But now you have to think about things that man may plan in the way of catastrophes that will have aggregation possibilities, and that is something that’s pretty much been introduced into the insurance world’s thinking since September 11.

And I can tell you, you know, we think a lot about it. But — I mean, the social consequences are far worse than insurance, but we have to think about how we’d pay our claims, because if we ever do anything really foolish and endanger — take an aggregation — that would cause us to lose the net worth of Berkshire, we would not only not be able to pay the claims of the people in that disaster, but there are other people that suffered injuries 15 years ago, paraplegics and all that, that we’re making payments to for the rest of their lifetime. And we wouldn’t be able to make those payments. And we’re not going to run our business that way.

Charlie?

CHARLIE MUNGER: Yeah. To the extent that September 11th has caused us to be less weak, foolish, and sloppy, as we plainly were in facing some plain reality, it’s a plus.

We regret, of course, what happened, but we should not regret at all that we now face reality with more intelligence.

This inconvenience that we all have, this tightening of immigration procedures, etc., should have been done years ago.

WARREN BUFFETT: The most important thing in investments is not having a high IQ, thank God.

I mean, the important thing is realism and discipline. And you don’t need to be extraordinarily bright to do well in investments, if you are realistic and disciplined.

And the same thing applies in insurance underwriting. It is not some arcane science that, you know, the ability to which to do successfully is given only to a few, or which requires the ability to do — mathematics have very little to do with it.

There’s an understanding of probabilities and all that, a kind of gut understanding, that’s important. But it does not require the ability to manipulate figures — does not — you know, you can do it without calculus, you can do it — you can really do it with a good understanding of arithmetic and an inherent sense of probabilities.

As Charlie says, to the extent that — I think we’ve always, from the investment standpoint, you know, if we’ve had any distinguishing characteristics, it would be that, in terms of realism and discipline.

And generally that means finding what you don’t know.

In insurance underwriting, it’s the same thing. You have to have — you have to be realistic about what you can understand and what you can’t understand, and therefore, what you can insure and what you can’t insure.

And you have to be disciplined about turning down all kinds of offerings where you’re not getting paid appropriately.

And September 11th drove home those lessons and probably redefined getting paid appropriately in certain cases.

WARREN BUFFETT: Area 6?

AUDIENCE MEMBER: Hello. My name is Everett Puri (PH). I’m from Atlanta.

I wanted to ask you to comment on the relative P/E multiples of bank stocks versus the S&P.

They seem to be at 30, 35 to 50-year year relative lows to the S&P, and I was wondering if that’s the result of the market — a change in the market’s perception of the forward growth rates of banks or if the market has perceived that there’s a change in risk there.

WARREN BUFFETT: You’re asking about the performance of what group compared to the S&P?

AUDIENCE MEMBER: Banks.

WARREN BUFFETT: Banks? Well, and what was your assertion about the performance, historically?

AUDIENCE MEMBER: Well —the relative multiple of bank stocks versus the S&P.

Back in the ‘40s — ‘40s, ‘50s, ‘60s, they commonly traded at, say, one times the S&P multiple and now they’re maybe half that level.

WARREN BUFFETT: Yeah. Harry Keith (PH) used to have a lot of figures on this.

I don’t really think about them. I mean, the appropriate multiple for a business, relative to the S&P, will depend on what you expect that business to achieve in terms of returns on equity, and incremental returns on incremental equity, versus that S&P.

I mean, if you’ve got two types of businesses, and we’ll say the S&P earns X on equity, and can deploy an additional amount of capital at Y, and then you compare that with any other business, and that’s how you determine which one is cheaper.

I would not characterize all banks as the same. I mean, we have in this room John Forlines, who runs the Bank of Granite — Granite, North Carolina — and they’ve earned 2 percent on assets without taking any real risks for decades. It’s a tremendous record.

And then you have other banks that have been run by people that took them right into the ground.

I mean, whether it was First Pennsylvania, going back 30 years ago, I think it was John Bunting, and they — they’re not a homogeneous group.

We own a couple of — stock — in a couple of banks. We own stock in M&T, that has an exhibit downstairs today. We own stock in Wells Fargo. And we think those institutions are somewhat different than other businesses.

So, I don’t think there’s — it goes back to that earlier question.

People always want a formula. You know, they — I mean, they go to the Intelligent Investor and they think, you know, somewhere they’re going to give me a little formula and then I can plug this in and I know I’ll make lots of money. And it really doesn’t work that way.

What you’re trying to do is look at all the cash a business will produce between now and judgment day, and discount it back at a rate that’s appropriate, and then buy it a lot cheaper than that.

And, whether the money comes from a bank, whether it comes from an internet company, or whether it comes from a brick company, the money all spends the same.

Now the question is, what are the economic characteristics of the internet company or the bank or the brick company that tell you how much cash they’re going to generate over long periods in the future.

And I would come to a very different answers, you know, on M&T Bank versus some other bank.

So, I wouldn’t want to have a single yardstick, or a, you know, relative P/E that I went by.

I think that banks have sold — a good many banks have sold — at very reasonable prices.

We bought all of a bank in 1969. We bought a bank in Rockford, Illinois.

Charlie and I went and looked — we must have looked at a half a dozen banks at that — you know, in a two or three-year period.

CHARLIE MUNGER: Absolutely.

WARREN BUFFETT: Yeah. We trudged around and we found some very oddball banks that we liked.

And they were characterized by very little risk on the asset side and very cheap money on the deposit side. And even Charlie and I can understand that. And low prices, incidentally, too.

And then they passed the Bank Holding Company Act in 1969, and they killed off our chances to do anything further in buying all of banks.

So, we look at banks. We will own bank stocks from time to time in the future. We’ll probably buy stocks in other banks.

We’ve also seen all kinds of banks ruined. I think it was, what was the fellow? M.A. Schapiro, who came up with the statement, he said, “There are more banks than bankers.”

And if you think about that a bit, you’ll see what I mean. (Laughter)

There have been — you know, there have been a lot of people that have run banks in a very injudicious manner, but that’s made for opportunities for other people.

A lot of banks have disappeared over time. I mean, up in Buffalo, where Bob Wilmers runs M&T, there were some other very prestigious institutions that went right down the tubes. And a lot of that happened in the early ‘90s or late ‘80s.

I wouldn’t look for a single metric like relative P/Es to determine what — how — to invest money.

You really want to look for things you understand, and where you think you can see out for a good many years, in a general way, as to the cash that can be generated from the business.

And then, if you can buy it at a cheap enough price compared to that cash, it doesn’t make any difference what the name attached to the cash is.

Charlie?

CHARLIE MUNGER: Yeah, I think the questioner is, maybe, even asking the wrong people that question.

I would argue that Warren and I have failed to properly diagnose banking. I think we underestimated the general good results that would happen because we were so afraid of what non-bankers might do when they were in charge of banks.

WARREN BUFFETT: There are a number of banks, that over the last five or six years, on tangible net worth, the number net of goodwill, but on tangible net worth have earned over 20 percent on equity.

You would think that would be difficult for an industry to do dealing in a commodity like money, and, of course, the banks will argue it’s not a commodity — but it’s got a lot of commodity-like characteristics —and you would think those kind of returns in a world of 6 percent long-term interest rates and much lower, you would think that would be very hard — well, you would have though it wouldn’t have occurred, you’d think it would be hard to sustain.

We been wrong in the sense that banks have earned a lot more money on tangible equity than Charlie and I would have thought possible.

Now, I think, to some extent, they’ve done because they stretched out equity much further than was the case 20 or 30 years ago.

I mean, they operate with more dollars working per dollar of equity than people thought was prudent 30 or 40 years ago.

But, however they’ve done it, they’ve earned — a number of banks have earned — very high returns on equity in recent years.

And, if you earn high enough returns on equity and you can keep employing more of that equity at the same rate — that’s also difficult to do — you know, the world compounds very fast.

You know, banking as a whole has earned at rates that are well beyond, on tangible equity, you know, well beyond, I think, what much more glamorous businesses have earned in recent years.

Charlie, you have any further thoughts on that?

CHARLIE MUNGER: No, I say again, we didn’t diagnose it as it actually turned out and, even worse than that, we haven’t changed. (Laughter)

WARREN BUFFETT: And even worse than that, we won’t. (Laughter)

WARREN BUFFETT: Area 7.

AUDIENCE MEMBER: Good morning, Mr. Buffett and Mr. Munger. My name is Andrew Sole, and I’m a shareholder from New York City.

I have two questions. The first one, I’d like to direct to Mr. Munger.

Pertaining to cash flow analysis, given the practices of numerous corporations of deliberately fabricating cash flow numbers, which occurred in some of the telcos, where they characterized like-kind exchanges as product sales.

How do you ferret out this type of fraud? What do you recommend a shareholder, an individual investor, to do, short of obtaining a degree in forensic accounting to uncover this type of fraud?

And the second question is, on a lighter note, what books would either of you gentlemen recommend to shareholders that you read this year that you liked?

CHARLIE MUNGER: Yeah. I think you’re asking for a lot if you want some simple way of not being taken in by the frauds of the world.

If you stop to think about it, enormously talented people deliberately go into fraud, drift gradually into it because the culture carries them there, and the frauds get very sophisticated and they’re very slickly done.

I think it’s part of the business of getting wisdom in life that you avoid getting taken by the frauds.

And so I think you’re asking a very good question, but I don’t think there is any short answer.

I think there are whole fields that you can just quit playing because it looks like there’s too much fraud in it.

And I think we do a lot of that, don’t we, Warren?

WARREN BUFFETT: Yeah. How many times have we been defrauded in the last 20 years?

CHARLIE MUNGER: Well, damn little that we can — it’s amazing how little.

WARREN BUFFETT: Yep.

CHARLIE MUNGER: And I’ve always said that the guy who takes us is going to have a modest little office and a modest demeanor and —

WARREN BUFFETT: He’ll carry around Ben Franklin’s autobiography, I can —

CHARLIE MUNGER: The kind of people who defraud us are not going to be the kind of people who are defrauding everybody else.

WARREN BUFFETT: Yeah. I mean, it’s a very good question. It’s tough to answer.

But I will tell you that we haven’t, and we won’t get defrauded often. Now, that may mean we pass up a whole lot of other opportunities, too.

But, for example, you raised the question about cash flow. I would say the number of times we’re going to buy into a company, whether it’s through stocks or through the entire company, where people are talking about EBITDA, is going to be about zero.

I mean, we start out with — if somebody’s talking about EBITDA, you know — if we take all the people in the world that talk about EBITDA and all the people in the world who haven’t talked about EBITDA, there are more frauds in the first group, percentage-wise, by a substantial margin. Very substantial. I mean, it is, you know, it’s just a start.

Now, that isn’t — you know, that — it’s very interesting to me. If you look at some enormously successful companies, Walmart, General Electric, Microsoft, I don’t think that term has ever appeared in their annual reports.

I mean, they just — so when people start talking about that sort of thing, either they’re trying to con you in some way, or they’ve conned themselves, to a great degree. I mean —

CHARLIE MUNGER: Or both.

WARREN BUFFETT: Yeah. Well, that often happens. I mean, if you set out to con somebody, after a while you con yourself, which is why some of the people in the internet stocks, you know, stayed with them.

It’s — if somebody is — if they think you’re focusing on EBITDA, they may arrange things so that that number looks bigger than it really is.

It’s bigger than it really is, anyway. I mean, the implication of that number is it has great meaning.

You take telecoms, they’re spending every dime that comes in, I mean, in many cases.

There isn’t — it isn’t cash flow. I mean, the cash is flowing out. But it — you know, you can look at the statement and there’s billions of dollars, supposedly, in depreciation and so on. But there — you know, interest is an expense.

Actually, taxes are going to be an expense. Anybody that tells us that making a lot of money before taxes, in terms of EBITDA, is meaningful — you know, you get depreciation by laying out money ahead of time. It’s the worst kind of expense.

We look for float, where we get the money and then pay out later on. But depreciation occurs because you buy an asset first and then you get the deduction later on. It’s the worst kind of expense there is.

And you start paying taxes when you actually make money, and when the depreciation runs out at some point.

So these — it just amazes me how widespread the usage of EBITDA has become, and I would say there have been people who have tried to dress up financial statements in a way to appeal to people who are impressed by such a number.

Charlie and I have found, actually, that — at least to us — many of the crooks look like crooks.

Now, we have spotted — we haven’t shorted them — but we have spotted a lot of frauds over the years in public companies. And years before, you know, that the roof fell in.

And they usually are people that tell you things that are too good to be true, for one thing.

I mean, they, you know, they tell you very mediocre businesses are wonderful businesses for one reason or another. Or they — they just have a smell about them, you know, in effect.

Wouldn’t you say that’s true, Charlie?

CHARLIE MUNGER: Well, sometimes it’s amazingly obvious. Maxwell, of England, his nickname was the “bouncing Czech.”

And three weeks before he went under, Salomon —

WARREN BUFFETT: (Inaudible)

CHARLIE MUNGER: — Salomon was aggressively seeking more business from him, with both Warren and I on the board. It shows how much influence outside directors often have.

WARREN BUFFETT: Yeah. Wall Street is —

CHARLIE MUNGER: Imagine extending credit to a guy whose nickname is the “bouncing Czech.” You’d think it — if you wrote it as satire, people would say it was too extreme to be funny. (Laughter)

WARREN BUFFETT: We have read — I mean, Charlie and I have — it’s a hobby keeping track of the Maxwells of the world, and the —

They get — there’s a syndrome. I mean, they give off a lot of the same messages.

I mean, Maxwell was a classic case, but there — time after time — Wall Street has no filter against them. Wall Street loves them, as long as, you know, as long as they’re pushing out securities and the commissions are there.

Charlie and I could not have stopped Salomon from making a deal with Maxwell, you know, right to the last 30 seconds before he sunk, you know, under the ocean.

CHARLIE MUNGER: We didn’t stop First Normandy with Lou Simpson and Warren Buffett and Charlie Munger on the board.

WARREN BUFFETT: Yeah. First Normandy was a case of some guy that manufactured a record out in California that he claimed was from owning a bunch of securities, including Berkshire Hathaway.

And, he was going to go public and Salomon was courting him. And this — the record was, you know, it was total baloney.

And I think they actually went public for a day or so and then the SEC pulled it back.

CHARLIE MUNGER: Absolutely. They had the offering and then they canceled it before the money changed hands.

But it was a very embarrassing episode. And we remonstrated against this obvious insanity, they told us the underwriting committee had approved it.

WARREN BUFFETT: I don’t think they changed underwriting committees, either. (Laughs)

WARREN BUFFETT: OK. Zone 8.

WARREN BUFFETT: We're a cheery group up here, aren’t we, on the human condition?

AUDIENCE MEMBER: Good evening from Germany. My name is Norman Reinzhoff (PH). I’m a shareholder for about 10 years. And I want to thank you gentlemen for your long-term performance.

I brought you two of my favorite German chocolates. One for you, Mr. Buffett. One for you, Mr. Munger. And I will give them to you tomorrow at the steak house.

WARREN BUFFETT: How much do they sell for a pound? I’m just curious. (Laughter)

AUDIENCE MEMBER: Well, by the way, this is not the chocolate company you wrote to two years ago.

WARREN BUFFETT: Oh.

AUDIENCE MEMBER: They were sold about a week ago for a very low price.

WARREN BUFFETT: Is that —

AUDIENCE MEMBER: This can still be fixed. (Laughter)

My question is concerning that what you were just describing as smelling.

And, I mean, you told us in former shareholder meetings that if management loves money, do not invest.

If they love what they do, preferably if they come tap dancing to the office every day, and all other things are right, then invest.

That resonated to me very good with the biblical truth that not money itself, but love for money, is the root of all evil.

As a principal that once made once made Prussia the largest of all kingdoms, namely the ethos of doing a job for its own sake.

You tell us in this year’s report that you buy a company after talking to the owners for no more than 90 minutes.

I’m wondering what kind of — is it the wisdom of experience, just like you described it, or do you do more background work before talking to the owners for 90 minutes?

What’s the process like? Do you do background checks or do you talk to competitors?

Do the other people in headquarters do that work for you? How does this whole thing work?

WARREN BUFFETT: Well, it’s a very good question. And all of the things you suggest might well make sense. I mean, talking to competitors, talking to ex-employees, talking to current employees, talking to customers, talking to suppliers, all of those things Phil Fisher laid out in a book over 40 years ago, and we have done a fair amount of that over the years.

But, Charlie would have behaved exactly the same way I did on the company you’re referring to.

I got a call from Craig Ponzio in December, on a Monday. It was about a company that made custom picture frames.

I’d never heard of the company before. I’d never heard of Craig before.

I didn’t talk to him on the phone much more than 15 minutes. He’s a very — he’d be here today but his wife became seriously ill, at least we hope it’s not serious, but at least there was a problem last night — but Craig talked to me, maybe 20 minutes. And, you can tell when — I mean, it’s just all the difference in the world.

And he laid out what the custom frame — how the — custom frame picture business works, and it’s not complicated.

I hadn’t thought about it for 10 seconds in my whole life up till then, you know. I’d had some pictures framed — you know, I get around (laughs)

But it’s not hard — I mean, if you think about it for 30 seconds, you — the economics of the industry will sort of make themselves manifest to you.

There are 18,000 or so framers in the country. It’s a small business. So you’re dealing with thousands of people.

Now, what’s important to those thousands of people that you’re dealing to? They’re doing 250 thousand, or 300, or 400 thousand dollars of business a year, and they have customers who come in periodically — like I come in once every three months, or every six months, and say, here, I’d like a frame, and they may ask me about what kind of frame I want or I may leave it up to them.

It’s a service operation to a very great degree. And Craig built something starting with, in 1980 or so, with 3 million of sales, he built an organization that became enormously responsive to these 18,000 or so framers.

They call on those people five or six times a year. They get 85 percent of the frames to those people the next day when they order them. That’s what counts in that kind of a business.

You know, you’re not supplying the Big Three with auto parts. You’re not — there’s all kinds of things that give it a distinctive economic character.

So Craig told me about that, like I say, in not more than 20 minutes. And he told me the price and he told me the capital that was employed and he gave me some — a few figures.

I knew in talking to him that he had a deal that made sense, you know, and I said, when can you come in? That was on a Monday. He said, I’ll be there Wednesday morning. And he came with Steve McKenzie, who is here today, and who I encourage you to meet, and I think they got there at nine and they left at 10:30, and we’d shaken hands.

I was hoping to see Craig at the — today — or tomorrow — but I won’t because of this illness.

But, I haven’t seen Craig since, you know. I mean, we made — he got this money, he knew he was making a deal, he had a reason why he wanted — he wanted to sell it to somebody that would be sure to close, that would be a good owner, where the people who worked there wouldn’t be worried because he was leaving.

He was leaving with a lot of money, and, you know, people — he wanted to be sure — a lot of people leave with a lot of money and they leave the employees behind and they don’t care what happens. But this guy cared. And I could tell that, and that’s a big plus with me.

So, you know, I have not been to their headquarters yet. I plan to be at their headquarters. Steve, I apologize.

But I understand what the business is about. And you can — most good businesses, you can understand what they’re about in a very few minutes, unless they’re a kind of business that you can never understand what they’re about.

I mean, there are other businesses, if you spent years on them you still wouldn’t understand what the hell is going on.

I don’t know which one of — which American auto company is going to the best 10 years from now. And if I spent all year talking to dealers for Ford and Chrysler and General Motors, and I talked to suppliers, and I talked to people who are driving their cars, I still wouldn’t know anything about what it’s going to look like five or 10 years from now.

But I know that you can’t crack our custom picture frame business. I mean, you cannot figure out a way to call on those 18,000 people that are in that business and figure out a way to divert their business to you when you can’t offer a frame as good as ours and you can’t offer service remotely like ours. So it’s a good business.

And Craig was 100 percent up — I mean, he told me exactly what he wanted to receive for the business. He wanted cash. You know, that fits us.

And there’s nothing complicated about it. I mean, you can drag it out for a long time. But what would be the sense of it? I mean, if you’re going to make a deal, you’re going to make a deal.

Charlie?

CHARLIE MUNGER: Yeah. If you stop to think about it, the ordinary result when a big publicly-held corporation buys another corporation is that, maybe two-thirds of the time, it’s a terrible deal for the buying corporation and yet the people have taken an enormous time doing it.

And we’ve bought all these businesses taking practically no time in doing it, and on average they’ve worked out wonderfully.

Why is that? That’s a good question. The answer is we wait for the no-brainers. We’re not trying to do the difficult things.

WARREN BUFFETT: We’re for those.

CHARLIE MUNGER: Yeah. And we have the patience to wait. And then we’re so peculiar that there actually are a good number of businesses in America where they prefer selling to us than to other people. That’s very helpful.

WARREN BUFFETT: I just saw a review of a major company. Made 10 acquisitions in a recent five-year period.

Every one of those 10 acquisitions was preceded by due diligence and all the baloney they go through, and they probably had an investment banker’s book and everything.

Not one of the 10 in 2001 lived up — or was even close — to the expectations of the presentation that was made at the time of purchase.

In aggregate, the 10 earned one-quarter of what they were projected to earn in 2001. In other words, the projections were for four times the actual earnings.

And these were companies with strategic — this is a company with a strategic, you know, acquisition department with loads of people to go over the due diligence with investment bankers, quote, “helping them,” end quote, all along the way.

And, you know, and 10 out of 10 failed miserably. And, you know, you have to ask yourself, how can you produce that? Because the world didn’t go to hell during that period, either. I mean, that was not a time when we went into a great depression or anything of the sort.

It’s — they were getting — they were buying what was getting sold to them, and it was fulfilling some things that the management — myths — that the management had about itself. And managements have many myths about themselves.

And it isn’t that complicated if you just wait for the fat pitch. And the fat pitch doesn’t have to be somebody else doing something dumb or anything like that, because people don’t do that.

People come to us, come for a good reason. I mean, they usually want a transaction that a) they want one they’re sure to close. They want —if a deal is made — and they want one that will leave the people happy, that are at the business.

When it was announced at Johns Manville, I believe, that Berkshire was the buyer, I understand there was a standing ovation. And I’ve seen it at, you know, whether it’s Jordan’s or Star Furniture.

People are concerned. If you’ve been working at a company for 20 years and you know that the owning family is getting older and has some problems to take care of, believe me, they talk in the hallways about that.

What’s going to happen when, you know, the family sells the place? And people worry about that.

And to have an answer for them, so that they all sleep the night that it’s announced that the business has changed hands, means some —a lot — to some owners. And it doesn’t mean anything to other owners.

I don’t think we’ve ever bought a business from a financial operator. Can you think of any, Charlie?

CHARLIE MUNGER: I can’t think of one.

The — you know, somebody once defined hell, in a legal system, as a place with endless due process and no justice. And we’re getting close.

And similarly, in the corporate world, if you have endless due diligence and no horse sense, you’ve just described a corporate hell, at least for the people who own the business.

WARREN BUFFETT: Go back to zone 1.

Oh, I’m sorry. Excuse me one second. We have — we have — Mark, do we have a number of people in the music hall that —

Pardon me?

VOICE: Yes.

WARREN BUFFETT: Do we have somebody at zone nine?

VOICE: Yes.

WARREN BUFFETT: OK.

AUDIENCE MEMBER: Mr. Buffett, my name is Luke Nosek from Palo Alto in California.

The first thing I’d like is just to thank you for saving my shirt from the internet stocks for the last few years.

And, actually, it’s not quite true. I lost my shirt but you did save my underpants. I bought the stock in late 2000.

And, it’s actually not just been about the stock. It’s about — been about — learning from you and your investment philosophy and your character.

It’s been very inspiring at the beginning of my professional life to have a mentor like that.

And I would love to — (Applause)

I think it’s been very inspiring for all of us for, I guess, it’s been almost 50 years of your investment professional life that’s been continuing to go over the top.

I’d love that — for that — to continue for a long time. I’d love to see the next 50 years.

And, I don’t know if that’s possible, given current medical technology, but I have some friends in biotech who have been involved in companies that do something called cryonic suspension.

And I’m curious if you’ve heard of it. It’s the process of — or looked into it — the process of freezing people as they’re dying, and —

WARREN BUFFETT: Just don’t do it too early with me. (Laughter)

AUDIENCE MEMBER: It’s, actually, legally, after pass away.

But even if the risks are — even if the chances of it working are very small and the discount rate is huge over a long period of time, I wonder if you’d looked into it?

What — if you would consider or think about that possibility?

And again, thank you for your service and all the lessons for the last 50 years (inaudible)?

WARREN BUFFETT: Well, I appreciate the suggestion and there probably isn’t much downside to it. (Laughter)

CHARLIE MUNGER: It takes a lot of electricity to keep you frozen for all eternity. (Laughter)

WARREN BUFFETT: That’s all right. We get our electricity wholesale at MidAmerican. (Laughter)

We’re for anything that extends our productive years.

I must say, at 71, I can’t recall ever having any more fun than I’m having now. And I think Charlie seems to be in pretty good spirits too, so it —

We are lucky to be in the business we’re in. I mean, just imagine, you know, if we’d been in — been halfway athletic, or anything like that, where you’re, you know, you — essentially you’re limited by age.

But, there’s really no — there are no problems in this business. I mean, as long as I can kind of lift the phone up (laughs) and hear Craig on the other end, or if I can’t hear him, I get him to tell to Charlie and he can relay it on to me.

It’s a very easy business to conduct throughout your life. And we’re fortunate that way.

WARREN BUFFETT: Zone 10, do we have anybody?

AUDIENCE MEMBER: Good morning. My name is Pamela Harrington and I live here in Omaha, Nebraska.

And my question concerns your investment in Fruit of the Loom.

Could you tell us about how that investment fits in with your philosophy about turnaround situations and your preference for businesses that have barriers to entrance? Thank you.

WARREN BUFFETT: Yeah. Well, Fruit of the Loom got in trouble for two reasons.

One is they borrowed too much money. They borrowed about a billion, 200-million, and actually it went something beyond that because they were engaged in some other transactions that were off balance sheet and so on.

So, it was a company that, in a financial sense, was out of control. Simultaneously with that, they had a lot of operating problems, too.

But we were not going to inherit the capital structure and we were not going to inherit the management that had caused the operating problems.

But, much to our pleasure, we were going to inherit a management that had done an incredible job in running the business for a long time prior to the sins of the recent period.

And, we made a condition — I don’t think there’d probably ever been a condition made to a bankruptcy court proposal — where we said our offer is not contingent on financing, it’s not contingent on, you know, if war breaks out, our offer is still good and everything else.

But John — but we did make it contingent on John Holland being available to run the business, because John had done a sensational job of running the business before the difficulties of the excess leverage and operating insanities. And he was willing to come back, which was very important to us.

And Fruit of the Loom has, I don’t know, between 40 and 45 percent of the men’s and boy’s market. It’s a product that has a deserved quality image.

It’s accepted in a big way by very important retailers who were disturbed by things that took place prior to, and early in, the bankruptcy, but who loved the idea of having a product like Fruit of the Loom in their stores.

And it’s a very low-cost producer of a very basic product.

So, it fits us very well. And now the management can simply worry about building the brand and running plants as efficiently as possible.

And there’s been some rearrangement of plants, as has happened throughout to many things connected with textiles.

But it’s an absolutely first-class business. And, you know, we’d like to get a little more share in the women’s market. We’d like to get a little more share in the men’s and boy’s market, too.

But it's made to order for us. But it’s only made to order with the present management.

If we had to take on the management that was there for a few years, you know, we wouldn’t have bought it for a dollar. It would have been a disaster. And it was a disaster for a while.

But fortunately, it’s a little like GEICO in the mid ‘70s. I mean, GEICO was a marvelous company that got mismanaged in a big way for a while.

But its fundamental advantages were there throughout the period, and what you had to do was get rid of the mismanagement and get back to the basics.

Charlie?

CHARLIE MUNGER: Yeah, I don’t have anything on that subject, but I neglected to answer the question about what books would we recommend.

The two books that I recommend this year were both sent to me by Berkshire shareholders who thought I might like them, and boy were they right.

The first is called “Ice Age,” which is a description of the past history of glaciation in the last few hundred-thousand years and how they figured out what had happened and why it had happened.

And I think it’s the best book of scientific explanation I have ever read. It’s been published in England and it’s going to be published in the United States this fall. And the airport has like 20 copies — PD Waterhouse — which they did by scrounging all of Canada.

And so, I recommend that book to you, but a lot of you are going to have to wait for the fall, I think.

The other book was “How the Scots Have Helped Create the Modern World.” That’s a subject that’s always interested me, how a tiny, poor, little population of Celtic people had such a huge favorable impact on the world, starting from poverty.

And, of course, it’s related to the Irish, who were a similar ethnic strain with a different religion.

And, it was marvelous book. And I forget the author’s name, but I recommend both of those books to all of you.

WARREN BUFFETT: Yeah. I’ll recommend a book which may sound a little self-serving, but it nevertheless — I think — I think this group, many of you would enjoy reading about the Berkshire managers.

And Bob Miles has brought out a book and it tells about the people who are handling your capital. And, I don’t think you could have a — well, I know you couldn’t have a better group.

And so therefore, if you feel like reading about them, I would — Bob has done a good job of interviewing — and I would encourage you to read about them.

And I think you’ll like your investment better after you read about the managers than if you just read what Charlie and I write.

WARREN BUFFETT: Let's go back to zone 1.

We're going to break at noon, incidentally, and we'll probably break for 30 minutes or thereabouts and then we'll come back. Go ahead.

AUDIENCE MEMBER: Hello, Mr. Buffett and Mr. Munger. My name is Jesse Spong (PH) and I am 12 years old, from California.

This is my second consecutive year in attendance. My parents brought me here to learn from you.

My question is not about money. It's about friendship.

How do you remain friends and business partners for so long? And what advice do you have for young people like me in selecting true friends and future business partners? Thank you. (Applause)

WARREN BUFFETT: Well, when Charlie and I met in 1959 we were introduced by the Davis family, and they predicted that within 30 minutes we would either not be able to stand each other or we would get along terrifically.

And that was a fairly insightful analysis, actually, by the Davises, because you had two personalities that both had some tendencies toward dominance in certain situations.

But we hit it off. We have disagreed, but we have never had an argument that I can remember at all in 43 years.

And yet we both have strong opinions and they aren't the same strong opinions at times.

But the truth is we've had an enormous amount of fun together, we continue to have an enormous amount of fun, and nothing will change that, basically.

It may have worked better because he's in California and I'm in Omaha, I don't know. (Laughs)

I'll let Charlie comment on it.

CHARLIE MUNGER: Well, that's a wonderful question you've asked, because Warren and I both know some very successful businessmen who have not one true friend on earth. And rightly so. (Laughter)

WARREN BUFFETT: That’s true.

CHARLIE MUNGER: And that is no way to live a life. And if by asking that question, you're asking how do I get the right friends, you are really onto the right question.

And when you get with the right friends, if you've worked hard at becoming the right sort of fellow, I think you'll recognize what you have and then all you have to do is hang on.

WARREN BUFFETT: The real question — what is — the question is what do you like in other people? I mean, what do you want from a friend?

And if you'll think about it, there are certain qualities that you admire in other people, that you find likeable, and that cause you to want to be around certain people.

And then look at those qualities and say to yourself, "Which of these is it physically or mentally impossible for me to have?" And the answer will be none, you know.

I mean, you — it's only reasonable that if certain things that attract you to other people that, if you possess those, they will attract other people to you.

And secondarily, if you find certain things repulsive in other people, whether they brag or they're dishonest or whatever it may be, if that turns you off, it's going to turn other people off if you possess those qualities. And those are choices.

You know, very few of those things, you know, are in your DNA. They are choices.

And they are also habits. I mean, if you have habits that attract people early on, you'll have them later on.

And if you have habits that repel people, you're not going to cure it when you're 60 or 70.

So it’s not a complicated equation. And, as I remember, Ben Franklin did something like that one time. Didn't he list the qualities he admired, and then just set out to acquire them?

CHARLIE MUNGER: Absolutely. He went at it the way you’ve gone after acquiring money. (Laughter)

WARREN BUFFETT: They're not mutually exclusive.

CHARLIE MUNGER: No.

WARREN BUFFETT: Area 2.

AUDIENCE MEMBER: Hello, Mr. Buffett and Mr. Munger. My name is Kevin Hewitt (PH) and I'm a shareholder from Chicago, Illinois. This question is for you, Mr. Buffett, and Mr. Munger.

Mr. Buffett, I’ve followed your career since I first read about you in the first edition of the Forbes 400 that came out in '82.

Reading your profile also led me to Ben Graham’s book, The Intelligent Investor.

Since that time, I've followed the careers of — I’ve also followed the careers of other successful investors, such as Walter Schloss, Bill Ruane, Richard Rainwater, Robert Bass, and Edward Lampert.

In following your career, and the careers of these other highly successful investors, it's my observation and my firm belief that despite their obvious high level of intelligence and some of them having gone to some of the best schools in the country, none of these people, including yourself, were born great investors.

Every one of these, including yourself, learned to be a great investor. Graham learned from his experience. You, Bill Ruane, Walter Schloss, learned from Graham.

Richard Rainwater learned from you, Bill Fisher, and Charlie Allen, and from reading Graham.

Robert Bass and Ed Lampert learned from Richard Rainwater and, most likely, from reading Graham and Fisher as well.

These observations lead me to the conclusion that despite intellectual brilliance, although that probably helps, I’ve come to the conclusion that great investors are made, not born.

Do you and Mr. Munger agree with this conclusion? If so, why? If not, why not?

And if you do agree, what things would you recommend that someone do if they wanted to become a great investor?

Also, what mental attributes do you think a person should have if they want to try to become a great investor? Thank you very much.

WARREN BUFFETT: Yeah, I’d largely agree with what you said.

I would say that there — I don't know to what extent — an ability to detach yourself from the crowd, for example — I don't know to what extent that's innate or to what extent that's learned — but that's a quality you need.

I would agree totally with you that a great IQ is not needed. I mean, you do not have to be terrifically smart to do well as an investor, at all.

I would say you're 100 percent right that I learned from Graham first in a very, very big way, and I learned something additionally from Bill Fisher, and I learned a lot from Charlie.

And the proof is in my record, actually. From 11 to 19, I was reading Garfield Drew, and Edwards and Magee, and all kinds of — I mean, I read every book — Gerald M. Loeb — I mean, I read every book there was on investments, and I didn't do well at all.

And I had no real investment philosophy. I had a lot of things I tried. I was having a lot of fun. I wasn't making any money.

And I read Ben's book in 1949 when I was at University of Nebraska, and that actually just changed my whole view of investing. And it really did, basically, told me to think about a stock as a part of a business.

Now, that seems so obvious. You can say, you know, that why should you regard that as the Rosetta Stone? But it is a Rosetta Stone, in a sense.

Once you crank into your mental apparatus that you're not looking at things that wiggle up and down on charts, or that people send you little missives on, you know, saying buy this because it's going up next week, or it's going to split, or the dividend's going to get increased, or whatever, but instead you're buying a business.

You've now set a foundation for going on and thinking rationally about investing. And there's no reason why you need a high IQ to do that. There's no reason why you have to be born in some way.

I do think there's certain matters of temperament that may be innate, they may be learned, they may be intensified by experience as you go on, partially innate, but then reinforced in various ways by your experience as you go through life, but that's enormously important.

I mean, you have to be realistic. You have to just define your circle of competence accurately. You have to know what you don't know and not get enticed by it.

You can’t be — you’ve got to have an interest in money, I think, or you won't be good in investing. But I think if you're very greedy, it'll be a disaster, because that will overcome rationality.

But I think the same books I read had really molded what I — how I — thought about businesses and investing. I think that they're just as valid now.

I mean, I haven't seen anything in the last 25 years, and I read — I glance through — most of the books. I've seen nothing to improve on Graham and Fisher in terms of the basic approach of going about investing, which is to think about stocks as businesses, and then think about what makes a good business.

And really, that's all there is to investing, and having a margin of safety, which Ben talks about, and so on.

It’s not a complicated process, but it definitely requires a discipline.

It requires insulating yourself from popular opinion. You just simply cannot — you can’t pay any attention to it. It doesn’t mean anything.

So you can’t — the idea of listening to lots of people tell you things, it's just a waste of time, you know. You'd be better off just sitting and thinking a little bit.

I mean, there were no analyst reports on custom frame makers, you know. It just doesn’t — and they wouldn't have been any good anyway.

You just have to think, but you have to think about them in terms of their business characteristics and what they can earn on capital employed, and that sort of thing.

I would just read the, you know, I would read the Graham and the Phil Fisher books. And then read lots of annual reports, think about businesses, and try and think about which businesses you understand and which you don't understand.

And you don't have to understand them all. Just forget about the ones that you don't understand.

Charlie?

CHARLIE MUNGER: Yeah, I have a deeper level of generality.

If you have a passionate interest in knowing why things are happening, you always are trying to figure out the world in terms of why is this happening or why is this not happening, that cast of mind, kept over long periods, gradually improves your ability to cope with reality.

And if you don't have that cast of mind, I think you're destined, probably, for failure, even if you've got a pretty high IQ.

WARREN BUFFETT: I would say we've seen relatively little correlation between investment results and IQ.

I mean, not that there are a whole bunch of people out there with 80 IQs that are knocking, you know, the cover off the ball, but there are all kinds of people with high IQs that get no place.

And, yet, it’s probably, in a sense, it's more interesting to look at why people with high IQs don't succeed, and then sort of cast out those factors, see if you can cast them out in yourself, and leave a residual that will work.

Because it's like Charlie always says, "All I want to know is where I'm going to die, so I'll never go there." (Laughter)

If you study the people who die financially, you know, with high IQs and say why do they die, you know, you'll see certain overwhelming characteristics that are present in most of the cases.

And you've just got to make sure that either you don't possess them, or if you do possess them, that you can get rid of them or control them in some manner.

WARREN BUFFETT: Area 3?

AUDIENCE MEMBER: Yes. Steve Pattice (PH), shareholder from Los Angeles. Good morning, Warren and Charlie.

I'd like to address the domestic Coke business.

It seems to me that Coke has been pulling back from what former great CEO Roberto Goizueta often said, and I paraphrase, we can't control what soft drinks people buy at retail. But in public venues, including food service, we can control that.

We've all heard about the marquee lawsuits that Coca-Cola has had, such as the NFL, United Airlines, and emerging restaurant brands like Baja Fresh Mexican Grill.

But they're also losing contracts with major — or minor — league baseball, college, and high school vendors.

Furthermore, it’s my understanding that our competitor PepsiCo has been the fastest-growing domestic beverage company for three consecutive years.

My question is has Coke’s vision changed, and is my perception that the domestic fountain division has lost their way correct?

WARREN BUFFETT: No, I would not say that’s correct, but I understand the reason for the question. Because there is the question, always, of the marquee-type accounts.

I mean, the truth is, either of the two major colas that are going to be sold and associated with, say, the Olympics or Disney World, or whatever it is, is going to lose a lot of money, if only directly thought of in terms of those contracts.

But there is that association over years. I mean, Coke wants to be where people are happy, and they want that in people's minds.

And that tends to be, you know, sporting events, it's the Disneylands, Disney Worlds, of the world.

But, in the end, can you have a determination to be at every one of them at any price? And the answer, obviously, is no.

It was sort of interesting, about five years ago, or thereabouts, Coke took Venezuela, essentially, away from Pepsi.

Pepsi — Venezuela was one of the few countries in the world in which Pepsi was the leader, and that was because the Cisneros family had developed the business down there very early.

So, Pepsi had 70 percent or 80 percent of the business. And in sort of a midnight raid, Coke bought the Cisneros operation, converted it all to Coke overnight, flew 747s in because they didn’t want to have — they wanted it to be a surprise, and they just reversed the whole situation in Venezuela.

And, it actually — whether that is going to turn out to be smart or not is another question, because they paid a lot of money to do it.

But in any event, Pepsi was very upset.

And so, the University of Nebraska pouring rights came up, very shortly thereafter. And the universities, as you know, bid out these things to give sort of an exclusive to a given university.

And Pepsi came in and bid about twice as much for the Nebraska pouring — the University of Nebraska — pouring rights, as was the sort of the standard, in terms of per-student at universities throughout the country, at Penn State or something.

And I like to think that they were trying to stick it in the eye of Coke by doing that in Nebraska. And I feel that the University of Nebraska really should give me credit for about 5 million a year of contribution to the university, because I don't think Pepsi would have done it if it hadn't been Nebraska.

Now, the question is, people at Coke called me, and they said, you know, "Do you want us to go up against this?" And I said, you know, no.

I mean, it's nice to have everybody at University of Nebraska drinking Coke, but if we've got everybody at Penn State drinking Coke, I mean, it’s probably worth as much, as potential Coke customers.

So, there is this bit where one organization or the other, particularly if they've lost one in the immediate past, may overbid a little for the next one.

And you know, for United Airlines, the question is how far do you let United, or whomever it is, drive you, in terms of making that specific deal.

I would say that in something like the Olympics, you know, I think Eastman Kodak made a huge mistake when they let Fuji take away the Los Angeles Olympics 20 years ago or so, because it allowed Fuji to get put on a mental parity, to a degree, with Kodak, whereas Kodak had always owned that.

And now Fuji was there with Coca-Cola and IBM and a few premier companies. And it was a mistake.

So, in the end you end up overpaying, in any kind of an objective quantitative sense, for most of these marquee properties. But you can’t — it'd be foolish to think that you had to have them all.

Coca-Cola, actually Pepsi-Cola — colas have generally declined, somewhat, as a percentage of per capita consumption in the United States. And Pepsi-Cola has lost considerably more than Coke.

What has kept Pepsi doing well, basically, is Mountain Dew. Mountain Dew has been a very successful product for Pepsi, and that has gained share in carbonated soft drinks.

Carbonated soft drinks — the average person in this room drinks 64 ounces of liquid a year. Carbonated soft drinks are just under 30 percent of that. And beer and milk are each about 11 or 12 percent. They're both down from 10 years ago. Carbonated soft drinks are up substantially.

Bottled water is up somewhat, but the only two categories that are really up are carbonated soft drinks, from ten years ago, and bottled water.

Coffee is down significantly. You think Starbucks has done a lot, but coffee just keeps going down and down and down.

If you look at Coke, of the almost 30 percent of the liquids consumed in the United States, they have about 43 percent of the 30, in their arenas.

So you're talking 13 percent of all liquids, you know, tap water, everything else that the American water — the American people — drink, is a Coca-Cola product.

And it’s off a couple tenths of 1 percent from the high, but it’s higher than five years ago, it's higher than 10 years ago. And, actually, in the first quarter, it did quite well, too.

So, I think there's been no — I mean, I’m sure there’s been no loss of marketing vigor.

Doug Daft is a marketer at heart. He's a, you know, he comes from the same — he's put together the same way as — along the same lines — as Don Keough. There'll never be another Don Keough.

But Doug is the same type of guy. He's in tune with the product.

And I would — if I had to bet, I would bet the market share of Coke, in terms of both carbonated soft drinks and in terms — actually in terms of water.

I mean, the Dasani — the gains in Dasani last year were like 95 percent, in the first quarter they were about 60 percent. Those were huge gains. And Pepsi got an earlier start with Aquafina. But Coke has almost closed that gap.

Coke is a very, very powerful marketing organization. So 18, I think, point-seven billion cases, there's nothing like it in the world.

And I do not think they've lost their focus or drive in any way whatsoever.

Charlie?

CHARLIE MUNGER: I've got nothing to add.

WARREN BUFFETT: You might try Vanilla Coke, too. It'll be out next month.

WARREN BUFFETT: Area 4.

AUDIENCE MEMBER: Good morning, Mr. Buffett, Mr. Munger. My name is Jerry McLaughlin. I'm from San Mateo, California.

First, I just want to thank you for all the effort you put into the annual reports, the letters, and these conversations.

I've learned a lot, and they're terrific, which is why I'm here from half a country away. (Applause)

You know, you've said that great companies are those that have an economic moat, and I understand that phrase to mean a sustainable competitive advantage.

Do businesses begin their lives with sustainable competitive advantages, or must that be developed over a very long time?

And then, what are the fundamental bases upon which you've seen companies successfully develop sustainable competitive advantages?

Of those, which do you think is the most enduring and which is the least?

WARREN BUFFETT: Well, sometimes they can develop it very quickly.

I mean, I would say that Microsoft, in terms of the operating system, you know, that was a relatively quick development. But that was an industry that was exploding, and things were changing very fast.

On the other hand, if you go back to See's Candy, which started in 1921, you know, there was no way you could build a sustainable competitive advantage, at least that would be recognizable, in times measured shorter than decades.

I mean, you opened up one shop at a time, and nobody'd heard of you originally, and then a few people did.

And boxed chocolates were something that, you know, people may have bought once or twice a year for a holiday occasion or whatever.

So, you weren't going to embed yourself in the minds of Californians in one or two or five years just because you were turning out, you know, outstanding box of chocolates.

So it depends on the way the industry itself is developing.

Walmart has done a fabulous job in a — an incredible job — in quite a short period of time. But even they, you know, they took it in the small towns, and they progressed along, and refined their techniques as they went.

But I would say that there could be things in new industries.

I would say with NetJets, we have a sustainable competitive advantage. And that's an industry that was only originated in 1986 when Rich Santulli got the idea, and it was in its infancy — I mean total infancy — for a good many years after that.

But what he has built, and is building and fortifying, is that sustainable competitive advantage.

But it depends very much on the industry you're in.

And I mean, Coca-Cola, 1886, Jacobs Pharmacy, Atlanta, Georgia, you know, John Pemberton came up with a product. And did he have a sustainable competitive advantage that day? If he did, he blew it because he sold the place for 2,000 bucks to Asa Candler.

He did — and it took decades, thousands of competitors over that time, and — you know, but they were painting one barn at a time and designing one Saturday Evening Post ad at a time, and all of that.

And — and pebbles — you know, around the world in World War II, General Eisenhower went to Mr. Woodruff and he said, "I want a Coke within the arm's length of every American serviceman." He said, "I want something to remind them of home."

And so he built a lot of bottling plants for Coke around the world. And that was a huge impetus.

But that was, what, 60 years or so after the product was invented. So it takes — it takes a long time in certain kinds of products, but I could see certain areas of the world where a huge competitive advantage is built in a very short period of time.

I would say that probably, in terms of animated feature-length films, for example, Walt Disney did that.

And after “Snow White” and a few more, it took him a while until he could cash in on it, but he — it became Disney and nobody else in that field for quite a while, and fairly quickly.

Charlie?

CHARLIE MUNGER: Yeah, there are a lot of different models that create a sustainable competitive advantage. And there are also some models of where you can lose it very fast.

Just ask Arthur Andersen. That was a very good name in America not very long ago.

And I think it would be harder to lose the good name of Wrigley's gum than the good name of Arthur Andersen.

I think there's some perfectly remarkable competitive advantages that people have gotten over time.

And the great trouble with the investment process is that they're so damned obvious that the stocks sell at very high prices.

WARREN BUFFETT: Snickers has been the number one candy bar for probably 30 or 40 years now.

CHARLIE MUNGER: Yeah, and —

WARREN BUFFETT: Well —

CHARLIE MUNGER: — in Russia, it turns out that everybody likes Snickers.

WARREN BUFFETT: What — how do you really knock it off?

You know, I mean, we make candy, we would love to displace Snickers, but it's hard to think of ways to knock them from the number one spot.

I mean, my guess is that they'll be number one in, you know, 10 years from now in candy bars, and the list doesn't change much in that field because — if you think about the nature of how you make that choice as to what candy bar —

If you were chewing Spearmint chewing gum five years ago, and you buy a pack of some chewing gum today, it's likely to be Spearmint.

I mean, there's just things that you experiment a lot with, and there're things that you don't fool around with once you're happy.

And, you know, you can understand that if you observe your own habits and people's habits around you.

But there’s other — usually if something can gain competitive advantage very quickly, you have to worry about them losing it quickly, too.

I mean, when an industry is in flux, there are a lot of people that think they're the survivors, or the ones that are going to prosper, where it turns out otherwise.

WARREN BUFFETT: Area 5.

AUDIENCE MEMBER: Mr. Buffett, my name is Pete Danner (PH) from Boulder, Colorado. And I would also like to thank you two for what you bring to the game.

I heard your response to the Coke — to the question regarding Coca-Cola.

In the annual report a few years back, you described Coca-Cola and Gillette as the two “invincibles.”

With Pepsi as a strong competitor today, do you still continue to view Coca-Cola as the “invincible?”

Additionally, with respect to American Express Company, with last year's financial results at American Express, how do you now view American Express?

WARREN BUFFETT: Yeah, I think the term I used was “inevitables,” actually, but it's very close to the same thing.

And I would — and I think when I made that statement, I said Coca-Cola in soft drinks or Gillette in blades and razors. I mean, I did not extend them to the entire corporate portfolio, particularly in the case of Gillette, but to the blade and razor business.

Gillette now has 71 percent, by value, of the blade and razor business in the world. Just think of that. I mean, 71 percent.

Here's a product that everybody knows what it does, they know how to — you know, they know where it's sold, they know that it's a high-margin business. I mean, it isn't like the world — the capitalist world — is unaware of the money that could be made if they could knock off Gillette.

But they can't knock off Gillette, and it's 71 percent. And that's a little higher percentage than when I wrote about it.

Actually, Coca-Cola's worldwide market share is a little higher now than it was when I wrote that five years ago.

And I would say that five or 10 years from now I would be amazed if Gillette or Coca-Cola has lost market share in their respective fields.

Coca-Cola sells half, roughly, of the soft drinks in the world, and soft drink consumption per capita goes up, basically, every year, and the per capitas go up — I mean the capitas — go up every year, also.

So you get these gains, maybe they're 3 percent or 5 percent in units, or 4 percent, 5 percent in the first quarter, but it was poorer than that. I think it was 3 percent last year.

But when you have half the world, and the world's population is growing at a little under 2 percent and you're getting 3 percent or 4 percent from something as pervasive as soft drinks, you know, you are doing all right.

And it was crazy, in my view, for people to think that earnings can grow 15 or 18 percent a year in a business where units — we had half the world's business, and units are going to grow fine — but they're not going to grow anything like 15 or 12 percent or 10 percent.

The Coca-Cola business has done fine. People went crazy, in terms of valuing some of these businesses a few years back, and I think we had some cautionary language in there, generally, about the valuations at which the businesses sold.

But the businesses — at 71 percent in blades and razors, that is a — there's some countries where it's 90. In the U.S., it's also about 70 percent.

Those are huge market shares of something people use every day. In this country, you know, it's a little over eight ounces per day, more like — well ,actually more like 9 1/2 ounces per day — for every man, woman, and child in the United States, out of the 64 ounces they drink.

Well, you're not going to have galloping percentage increases from that arena. But the company's made, basically, good progress.

People got carried away from the stock — with the stock — and I would argue that they may have gotten encouraged a little bit too much by, not only Wall Street, but even by company pronouncements, in terms of attainable — possibly attainable — gains.

There aren’t large companies —you know, there may be one someplace, somehow, very large now that will grow at 15 or 18 percent a year — but it just isn't in the cards in the world.

And we don't want anybody to think Berkshire can do that either, because we can't do it from a very large base. The world doesn't allow that.

But it does allow making reasonable progress, and certainly Coke and Gillette, in those areas where I said they were inevitable, have done very well.

They haven’t — Gillette has not done as well with acquisitions, which is clear.

I mean, the Duracell — the Gillette acquisition of Duracell — resulted in giving 20-odd percent of the business for another business, and that business has not done nearly as well as either the management or the investment bankers thought it was going to do at the time the deal was made.

Charlie?

CHARLIE MUNGER: Well, I would say, regarding that last instance, that that's the normal result.

When you try and — you've got a wonderful business and you issue shares in it to buy another business, I'd say at least two times out of three, it's a terrible idea.

WARREN BUFFETT: Well, GEICO is a great example. GEICO is a wonderful business. Absolutely wonderful, gets more wonderful by the day, has the world's best manager, Tony Nicely, running it.

GEICO, in the last 20 years, went into three — at least three — other insurance businesses I can think of.

They went into Resolute Insurance, which was a reinsurance operation started in the mid-80s. It was a disaster.

They went into two others, Southern something or other, and another one that started with an M.

I don't know why in the hell they would go into them. I mean, they had a great, great insurance business, and there aren't that many great insurance businesses. And neither one of those amounted to anything. I think, you know, they sold them off at some point.

But why would you have an absolutely wonderful business and start one and buy two others that are obviously mediocre, where you bring nothing to the party?

But managements — it’s very human to want to do that. It's no great sin that the GEICO management did it, because we see it happen time after time after time.

I can tell you this: Charlie and I have no urges like that. I mean, we want to buy easy things. We do not have to prove our manhood by doing something terribly difficult.

And I think a lot of managements feel that necessity. They've got a wonderful business —

The cigarette companies did that. Cigarette companies had these great businesses, and, you know — it irritated them that they — they liked to think they’re business geniuses, so they would go out and buy other things and those other businesses, generally, did not do that well.

I'm not saying they should've been in the cigarette business in the first place, but they were not business geniuses because they made a lot of money selling an addictive, you know, product.

That did not make them business geniuses, and so they wanted to prove it other ways, and they bought businesses and fell on their face, in many cases.

Charlie, do you have any more to add on cigarette companies?

CHARLIE MUNGER: No, but I think a lot of people rise to the top in publicly-held corporations, who come up in sales or, you know, engineering, or drug development, or what have you.

It's natural to assume once you're sitting in the top chair that now you know pretty much everything.

Or at least, how to get wisdom out of this wonderful staff and all these outside advisors that are now available to you.

And so I think it's very natural that perfectly terrible acquisition decisions get made, I'd say, more often than not.

WARREN BUFFETT: Area 6.

We have a break in about five minutes. In fact, we'll do this question and then we'll break.

AUDIENCE MEMBER: OK. My name's Paul Tomasik from Illinois.

I'd like to talk about your thinking, if you don't mind.

In the “Fortune” magazine article that you sent to all the shareholders, you referenced a practice by Darwin that when he found something that was contrary to his established conclusions, he quickly wrote it down because the mind would've pushed it out.

And if you read “The Origin of Species,” Darwin's very careful to avoid fooling himself. He very carefully asks and answers the hard questions.

It's a feedback mechanism, and you've picked up on one of his feedback mechanisms to avoid fooling yourself.

So the two questions are this:

If you look — model — how you think, Charlie thinks, how physicists think, how mathematicians think, you see the same pattern.

You want to use logic. You're dedicated to logic. But logic's not enough. You have to avoid fooling yourself, so you build feedback mechanisms.

So the first question is, do you see it that way? That you’re thinking just like mathematicians, physicists, and some of the other exceptional businessmen, by being logical and being careful to have feedback mechanisms?

And the second question is about other feedback mechanisms.

Your partnership — sitting next to you is a great feedback mechanism. Hard to fool yourself when you partner with Charlie Munger.

WARREN BUFFETT: Right.

AUDIENCE MEMBER: This meeting's a feedback —

WARREN BUFFETT: Hard to fool him, too. (Laughter)

AUDIENCE MEMBER: But that's not an accident.

The meeting is one level of feedback mechanism, the way you attack the annual report letter is a feedback mechanism.

So you could comment, both of you, on other feedback mechanisms you developed? Thank you.

WARREN BUFFETT: Well, you've come up with two very good ones. I mean, there's no question that Charlie will not accept anything I say because I say it, whereas a lot of other people will.

You know, I mean, it’s just the way the world works.

And it’s terrific to have a partner who will say, you know, you're not thinking straight.

CHARLIE MUNGER: It doesn't happen very often.

WARREN BUFFETT: There's no question, the human mind — what the human being is best at doing is interpreting all new information so that their prior conclusions remain intact. I mean, that is a talent everyone seems to have mastered.

And how do we guard ourselves against it? Well, we don’t achieve it perfectly.

I mean, Charlie and I have made big mistakes because, in effect, we have been unwilling to look afresh at something.

You know, that happens.

But we do have — I think the annual report is a good feedback mechanism. I think that reporting on yourself, and giving the report honestly, whether you do it through an annual report or do it through some other mechanism, is very useful.

But there — I would say a partner, who is not subservient, and who himself is extremely logical, you know, is probably the best mechanism you can have.

I would say that on the contrary, to get back to looking things you have to be sure you don't fall into, I would say the typical corporate organization is designed so that the CEO opinions and biases and previous beliefs are reinforced in every possible way.

I mean, having staff surround you that know what you want to do, you are not going to get a lot of — you’re not going to get a lot of contrary thinking.

I mean, most staffs, if they know you want to buy a company, you're going to get a recommendation.

Whatever your hurdle rate, if it’s 15 percent internal rate of return, which very few deals ever work out at, you know, or 12 or — they're going to come back, and they’re going to come back with whatever they feel that you want.

And if you arrange your organization so that you basically have a bunch of, you know, sycophants who are cloaked in other, you know, titles, you're not going to get — you are going to leave your prior conclusions intact, and you're going to get whatever you go in with your biases wanting.

And the board is not going to be much of a check on that. I've seen very, very few boards that can stand up to the CEO on something that's important to the CEO and just say, you know, “You're not going to get it."

You've hit on a terribly important point. All of us in this room want to read new information and have it confirm our cherished beliefs. I mean, it is just built into the human system.

And that can be very expensive in the investment and business world.

And, like I say, I think we've got a pretty good system. And I think that most of the systems aren't very good, that exist in corporate America, to avoid falling into the trap you're talking about.

Charlie?

CHARLIE MUNGER: Yeah, I think it also helps to be willing to reverse course even when it's quite painful.

As we sit here, I think Berkshire is the only big corporation in America that is running off a derivative book.

And we originally made the decision to allow the General Re derivative book to continue, and it's a very unpleasant thing to do to reverse that decision, yet we're perfectly willing to do it.

Nobody else is doing it, and yet it's perfectly obvious, at least to me, that to say that derivative accounting in America is a sewer is an insult to sewage. (Laughter)

WARREN BUFFETT: I would second that. I might not have chosen those exact words, and we may not even use those words in describing why we got out of it, but —

Yeah. And in the first quarter of this year, we'll show quite a bit of income — and anything we say here, we ought to put on the internet, Marc — but I think we'll show, what, 100 and, I don't know, 60 million or something like that of financial — maybe it's 140, I'll take a look here.

Well, you’ll have 160-odd million of income in that funny little line we have from financials income.

But that will be after an $88 million loss, in terms of getting — the first steps — of getting out of the General Re — what used to be called General Re Financial Products — derivative book.

You know, those losses were there. I mean, some of that is a shutdown loss, 30-odd, 30 million or thereabouts is severance pay and that sort of thing.

But the truth is that derivative accounting is absolutely terrible in this country, and there are a lot of companies that will not want to face up to what would be involved if they actually got out.

Now you're seeing derivative accounting unwound at Enron, in a very major way. And believe me, it's not being unwound at a profit, except to the extent that the bankruptcy court lets them disaffirm certain contracts.

I mean, it is — there was no place where there was as much potential for phonying numbers at a place like Enron than the derivative kind of data.

They were marking-to-model, they were doing all these things.

You give a whole bunch of traders the ability to create income by putting little numbers down on a piece of paper that nobody can really check, and it, you know, it can get out of control. It will get out of control.

And so we decided, finally, to bite the bullet on it, and we'd get out of it.

And it would — incidentally, we would not have reported $88 million of loss if we'd stayed in it. Might have reported a tiny profit or something, but, in the end, you know, the loss was there.

And there will be — it could well be — some more to come in that, because once you get into derivatives — I think our longest contract may run 40 years or something like that.

The guy who put the 40-year contract on the book probably got paid, you know, that week for putting it on, virtually. And, you know, we've got a bunch of assumptions as to how it's all going to work out over 40 years. You couldn't devise a worse system.

And, in the end, you know, we didn't want to be in the business when we got in it, and we are now in the process of getting out.

But you don't get out of fast — out fast — in something like this.

I mean, it's, you know, it’s a little like hell. It's easy to get into, and it's hard — very hard — to get out of. (Laughs)