WARREN BUFFETT: Thank you, and good morning.

That's Charlie. I'm Warren. (Laughter)

You can tell us apart because he can hear and I can see. That's why we — (laughter) — work together so well. We each have our specialty.

I'd like to welcome you to — we've got a lot of out-of-towners here, and I'd like to welcome you to Omaha. It's a terrific — (Applause)

Thank you.

It's a terrific city. And Charlie's lived in California now for about 70 years, but he's still got a lot of Omaha in him.

Both of us were born within two miles of this building that you're in. And Charlie — as he mentioned [in the pre-meeting movie] in his description of his amorous triumphs in high school — Charlie graduated from Central High, which is about one mile from here. It's a public school.

And my dad, my first wife, my three children and two of my grandchildren have all graduated from the same school.

In fact, my grandchildren say they've had the same teachers that my dad — (Laughter)

The — but it's a great city. I hope you get to see a lot of it while you're here.

And in just a minute we will start a question period — hopefully a question and answer period that will last till about noon, and then we'll take a break for an hour or so. We'll reconvene at one. And then we'll go — continue with the question and answer period till 3:30.

And then we'll break for 15 minutes or so. And then we'll convene the annual meeting of Berkshire, which I — we have three propositions that people wish to speak on, so that could last perhaps as long as an hour.

Before we start, I'd like to make a couple of introductions, the first being Carrie Sova, who's been with us about seven years. And can we have a light on Carrie? I think she — Carrie, are you there? (Applause)

Carrie. Stand up, Carrie, come on. (Laughter and applause)

Carrie puts on this whole program. She came to us about seven years ago and a few years ago I said, "Why don't you just put on the annual meeting for me?" And she handles it all. And she has two young children.

And she has dozens and dozens and dozens of exhibitors that she works with and, as you can imagine, with all of what we put on and all of the numbers of you that come, the hotels and the airlines and the rental cars and everything, she does it as if, you know, she could do that and be juggling three balls at the same time.

She's amazing, and I want to thank her for putting on this program for us. And — (Applause)

I also would like to welcome and have you welcome our directors.

They will be voted on later, so I'll do this alphabetically. They're here in the front row. And if we could just have the spotlight drop on them as they're introduced.

And alphabetically, is Howard Buffett, Steve Burke, Sue Decker, Bill Gates, Sandy Gottesman, Charlotte Guyman, we have Charlie Munger next to me, Tom Murphy, Ron Olson, Walter Scott, and Meryl Witmer. Yeah. (Applause)

One more introduction I'm going to make, but I'll save that for just a minute.

WARREN BUFFETT: And our earnings report was put out yesterday.

The — as we regularly explain, the realized investment gains or losses in any period really mean nothing. I mean, they —

We could take a lot of gains if we wanted to. We could take a lot of losses if we wanted to. But we don't really think about the timing of what we do at all, except in relation to the intrinsic value of what we're buying or selling. We are not —

We do not make earnings forecasts. And we have — on March 31st, we have over $90 billion of net unrealized gains. So if we wanted to report almost any number you can think of and count capital gains as part of the earnings, we could do it.

So in the first quarter — and I would say that we have a very, very, very slight preference this year, if everything else were equal — well, it's true in any year, but it's a little more so this year — we would rather take losses than gains, because of the tax effect if two securities were equally valued.

And there's probably just one touch more of emphasis on that this year, because we are taxed on gains at 35 percent, which means we also get the benefit — the tax benefit — at 35 percent of any losses we take.

And I would say that there's some chance of that rate being lower, meaning that losses would have less tax value to us after this year than they would have this — after this year than this year.

That is not a big deal, but it would be a very slight preference. And it may get to be more of a factor in deferring any gains, and perhaps accelerating any losses, as the year gets closer to December 31st, assuming — and I'm making no predictions about it — but assuming that there were to be a tax act that had the effect of reducing the earnings.

So in the first quarter, insurance underwriting was the swing factor. And the — there's a lot more about this in our 10-Q, which you can look up on the internet.

And you really, if you're seriously interested in evaluating our earnings or our businesses, you should go to the 10-Q, because the summary report, as we point out every quarter, does not really get to a number of the main points of valuation.

I would just mention two factors in connection with the insurance situation, which I love.

In the first four months — not the first three months — but the first four months, GEICO's had a net gain of 700,000 policy holders, and that's the highest number I can remember.

There may have been a figure larger than that somewhere in the past. I did not go back and look at them all. But last year I believe that figure was like 300,000.

And this has been a wonderful period for us at GEICO, because several of our major competitors have decided — and they publicly stated this — in fact one of them just reiterated it the other day — although they've now changed their policy — but they intentionally cut back on new business because new business carries with it a significant loss in the first year. There's just costs of acquiring new business.

Plus the loss ratio, strangely enough, on first-year business tends to run almost 10 points higher than on renewal business. And so not only do you have acquisition costs, but you actually have a higher loss ratio.

So when you write a lot of new business, you're going to lose money on that portion of the business that year.

And we wrote a lot of new business, and at least two of our competitors announced that they were lightening up for a while on new business, because they did not want to pay the penalty of the first-year loss.

And, of course, that's made to order for us, so we just put our foot to the floor and tried to write as much business — good business — as we can. And there are costs to that.

A second factor — well, it was not a factor in the P&L — but an important event in the first quarter is that we increased our float.

And on the slide, I believe it shows that year-over-year, 16 billion. Fourteen billion of that came in the first quarter of this year, so we had a $14 billion increase in float.

And for some years I've been telling you it's going to be hard to increase the float at all, and I still will tell you the same thing.

But it's nice to have $14 billion or more, which is one reason, if you look at our 10-Q, you will see that our cash and cash equivalents, including Treasury bills, now has come to well over 90 billion.

So I think I feel very good about the first quarter, even though our operating earnings were down a little bit.

One quarter means nothing. I mean, over time, what really counts is whether we're building the value of the businesses that we own.

And I'm always interested in the current figures, but I'm always dreaming about the future figures.

WARREN BUFFETT: There's one more person I would like to introduce to you today, and I'm quite sure he's here. I haven't seen him, but I understood he was coming. There's a — I believe that he's made it today. And that is Jack Bogle, who I talked about in the annual report.

Jack Bogle has probably done more for the American investor than any man in the country. (Applause)

And Jack, would you stand up? There he is. (Applause)

Jack Bogle, many years ago, he wasn't the only one that was talking about an index fund, but he — it wouldn't have happened without him.

I mean, Paul Samuelson talked about it. Ben Graham even talked about it.

But the truth is, it was not in the interest of invest — of the investment industry of Wall Street. It was not in their interest, actually, to have the development of an index fund — the index fund — because it brought down fees dramatically.

And, as we've talked about some in the reports, and other people have commented, index funds, overall, have delivered for shareholders a result that has been better than Wall Street professionals as a whole.

And part of the reason for that is that they've brought down the costs very significantly.

So when Jack started, very few people — certainly Wall Street did not applaud him, and he was the subject of some derision and a lot of attacks.

And now we're talking trillions when we get into index funds, and we're talking a few basis points when we talk about investment fees, in the case of index funds, but still hundreds of basis points when we talk about fees elsewhere.

And I estimate that Jack, at a minimum, has saved — left in the pockets of investors, without hurting them overall in terms of performance at all — gross performance — he's put tens and tens and tens of billions into their pockets. And those numbers are going to be hundreds and hundreds of billions over time.

So, it's Jack's 88th birthday on Monday, so I just say happy birthday, Jack, and thank you on behalf of American investors. (Applause)

And Jack, I've got great news for you.

You're going to be 88 on Monday, and in only two years you'll be eligible for an executive position at Berkshire. (Laughter)

Hang in there, buddy. (Laughter)

WARREN BUFFETT: OK. We've got a panel of expert journalists on this side, and expert analysts on that side, and expert shareholders in the middle. And we're going to rotate, starting with the analysts. And some who are here I have a — here we go. And we will — we'll do this through the afternoon.

After we — if we get through 54 questions, which would be six for each journalist, six for each analyst, and 18 more for the audience, then we will go strictly to the audience.

I don't think I've got any information as to what the situation is on overflow rooms. But we'll go to at least one of them.

But let's start off with Carol Loomis of Fortune Magazine, the longest serving employee in the history of Time Inc., I believe, with 60 years. And Carol, go to it. (Applause)

CAROL LOOMIS: Thank you. Thanks from all of us journalists up here.

I know that there are many, many people out there who have sent us questions that aren't going to get answered. And I just want to say that it's very hard to get a question answered.

The one thing I could suggest is that you follow Warren's thought in the annual report, that he wants everybody to go away from this meeting more educated about Berkshire than they were when they came.

And one way you can do that is keep your questions quite directly Berkshire-related or relating to the annual letter. Even then it will be hard to get your question answered.

The three of us only have 18 questions in total, but I encourage you to think in the Berkshire-related direction when you're submitting a question next year.

CAROL LOOMIS: Now, my first question. It's about Wells Fargo, which is Berkshire's largest equity holding — 28 billion at the end of the year. And this question comes from a shareholder who did not wish to be identified.

"In the wake of the sales practices scandal that last year engulfed Wells Fargo, the company's independent directors commissioned an investigation and hired a large law firm to assist in carrying it out.

"The findings of the investigation, which were harsh, have been released in what is called the Wells Fargo Sales Practices Reports." You can find it on the internet.

"It concludes that a major part of the company's problem was that, and I quote, 'Wells Fargo's decentralized corporate structure gave too much autonomy to the community banks' senior leadership,' end of quote.

"Mr. Buffett, how do you satisfy yourself that Berkshire isn't subject to the same risk, with its highly decentralized structure and the very substantial autonomy given to senior leadership of the operating companies?"

WARREN BUFFETT: Yeah, it's true that we at Berkshire probably operate on as — we certainly operate on a more decentralized plan than any company of remotely our size.

And we count very heavily on principles of behavior rather than loads of rules.

It's one reason at every annual meeting you see that Salomon description. And it's why I write very few communiqués to our managers, but I send them one once every two years and it basically says that we've got all the money we need. We'd like to have more, but we're — it's not a necessity.

But we don't have one ounce of reputation more than we need, and that our reputation at Berkshire is in their hands.

And Charlie and I believe that if you establish the right sort of culture, and that culture, to some extent, self-selects who you obtain as directors and as managers, that you will get better results that way in terms of behavior than if you have a thousand-page guidebook.

You're going to have problems regardless. We have 367,000, I believe, employees. Now, if you have a town with 367,000 households, which is about what the Omaha metropolitan area is, people are doing something wrong as we talk here today. There's no question about it.

And the real question is whether the managers at — [audio drops out] — are in a better — are worrying and thinking about finding and correcting any bad behavior, and whether, if they fail in that, whether the message gets to Omaha, and whether we do something about it.

At Wells Fargo, you know, there were three very significant mistakes, but there was one that dwarfs all of the others.

You're going to have incentive systems at any business — almost any business. There's nothing wrong with incentive systems, but you've got to be very careful what you incentivize. And you can't incentivize bad behavior. And if so, you better have a system for recognizing it.

Clearly, at Wells Fargo, there was an incentive system built around the idea of cross-selling and number of services per customer. And the company, in every quarterly investor presentation, highlighted how many services per customer. So, it was the focus of the organization — a major focus.

And undoubtedly, people got paid and graded and promoted based on that number — at least partly based on that number.

Well, it turned out that that was incentivizing the wrong kind of behavior.

We've made similar mistakes. I mean any company's going to make some mistakes in designing a system.

But it's a mistake. And you're going to find out about it at some point. And I'll get to how we find out about it.

But the biggest mistake was that — and I don't know — obviously don't know all the facts as to how the information got passed up the line at Wells Fargo.

But at some point, if there's a major problem, the CEO will get wind of it. And that is — at that moment, that's the key to everything, because the CEO has to act.

That Salomon situation that you saw happened because of — on April, I think, 28th, the CEO of Salomon, the president of Salomon, the general counsel of Salomon, sat in a room and they had described to them, by a fellow named John Meriwether, some bad practice, terrible practice, that was being conducted by a fellow named Paul Mozer, who worked for them.

And Paul Mozer was flimflamming the United States Treasury, which is a very dumb thing to do. And he was doing it partly out of spite, because he didn't like the Treasury and they didn't like him. So he put in phony bids for U.S. Treasurys and all of that.

So on April 28th, roughly, the CEO and all these people knew that they had something that had gone very wrong, and they had to report it to the Federal Reserve Board in New York — the Federal Reserve Bank of New York.

And the CEO, John Gutfreund, said he would do it, and then he didn't do it. And he undoubtedly put it off just because it was an unpleasant thing to do.

And then on May 15th, another Treasury auction was held, and Paul Mozer put in a bunch of phony bids again.

And at this point, it's all over, because the top management had known ahead of time, and now a guy that was a pyromaniac had gone out and lit another fire. And he lit it after they'd been warned that he was a pyromaniac, essentially.

And it all went downhill from there. It had to stop when the CEO learns about it.

And then they made a third mistake, actually, but again, it pales in comparison to the second mistake.

They made a third mistake when they totally underestimated the impact of what they had done once it became uncovered, because they — there was a penalty of 185 million. And in the banking business, people get fined billions and billions of dollars for mortgage practices and all kinds of things.

The total fines against the big banks, I don't know whether the total's 30 or 40 or a billion or whatever the number may be.

So, they measured the seriousness of the problem by the dimensions of the fine. And they thought $185 million fine signaled a less offensive practice than something involved 2 billion, and they were totally wrong on that.

But the main problem was they didn't act when they learned about it. It was bad enough having a bad system, but they didn't act.

At Berkshire, we have — the main source of information for me about anything that's being done wrong at a subsidiary is the hotline. Now, we got 4,000 or so hotline reports — or that come — we get communications on the hotline — perhaps 4,000 times a year.

And most of them are frivolous. You know, the guy next to me has bad breath or something like that. I mean it's — (laughter) — but there are a few serious ones, and the head of our internal audit, Becki Amick, looks at all those. People — a lot of them come in anonymous, probably most of them.

And some of them, she refers back to the companies, probably most of them. And — but anything that looks serious, you know, I will hear about, and that has led to action — well, put it, more than once.

And we've spent real money investigating some of those. We put special investigators, sometimes, on them. And, like I say, it has uncovered certain practices that we would not at all condone at the parent company.

I think it's a good system. I don't think it's perfect. I don't know what — I'm sure they've got an internal audit at Wells Fargo, and I'm sure they've got a hotline.

And I don't know the facts, but I would just have to bet that a lot of communications came in on that, and I don't know what their system was for getting them to the right person. And I don't know who did what at any given time.

But that was — it was a huge, huge, huge error if they were getting — and I'm sure they were — getting some communications and they ignored them, or they just sent them back down to somebody down below.

Charlie? You've followed it. What are your thoughts on it?

CHARLIE MUNGER: Well, put me down as skeptical when some law firm thinks they know how to fix something like this.

If you're in a business where you have a whole a lot of people under incentives very likely to cause a lot of misbehavior, of course you need a big compliance department.

Every big wirehouse stock brokerage firm has a huge compliance department. And if we had one, we would have a big compliance department too, wouldn't we, Warren?

WARREN BUFFETT: Absolutely.

CHARLIE MUNGER: Absolutely, but doesn't mean that everybody should try and solve their problems with more and more compliance.

I think we've had less trouble over the years by being more careful in whom we pick to have power and having a culture of trust. I think we have less trouble, not more.

WARREN BUFFETT: But we will have trouble from time to time.

CHARLIE MUNGER: Yes, of course. We'll be blindsided someday.

WARREN BUFFETT: Charlie says an ounce of prevention — he said when Ben Franklin, who he worships, said, "An ounce of prevention is worth a pound of cure," he understated it. An ounce of prevention is worth more than a pound of cure.

And I would say a pound of cure, promptly applied, is worth a ton of cure that's delayed. It — problems don't go away.

John Gutfreund said that problem, originally, was — he called it a traffic ticket. He told the troops there at Salomon it was a traffic ticket. You know, and it almost brought down a business.

Some other CEO, that they described the problem that he'd encountered as a foot fault. You know, and it resulted in incredible damage to the institution.

And so you've got to act promptly. And frankly, I don't know any better system than hotlines and anonymous letters to me. I get anonymous letters. And I've gotten three or four of them probably in the last six or seven years that have resulted in major changes.

And very, very occasionally they're signed. Almost always they're anonymous, but it wouldn't make any difference, because there were — will be no retribution against anybody, obviously, if they call our attention to something that's going wrong.

But I will tell you, as we sit here, somebody is doing — quite a few people — are probably doing something wrong at Berkshire, and usually, it's very limited. I mean maybe stealing small amounts of money or something like that.

But when it gets to some sales practice like was taking place at Wells Fargo, you can see the kind of damage it would do.

WARREN BUFFETT: We will now shift over to the analysts and Jonny Brandt.

JONATHAN BRANDT: Hi, Warren. Hi, Charlie. Thanks for having me.

You've addressed the risk of driverless cars to GEICO's business. But it strikes me that driverless trucks could narrow the cost advantage of railroads, even if the number of crew members in a locomotive eventually declines from two to zero.

Is autonomous technology more of an opportunity or more of a threat for the Burlington Northern?

WARREN BUFFETT: Oh, I would say that driverless trucks are a lot more of a threat than an opportunity — (laughs) — to the Burlington Northern.

And I would say that if driverless cars became pervasive, it would only be because they were safer. And that would mean that the overall economic cost of auto-related losses had gone down, and that would drive down the premium income of GEICO.

So, I would say both of those — and autonomous vehicles — widespread — would hurt us if they went — if they spread to trucks, and they would hurt our auto insurance business.

I think my personal view is that they will certainly come. I think they may be a long way off, but that will depend. It'll probably, frankly, depend on experience in the first early months of the introduction in other than test situations.

And if they make the world safer, it's going to be a very good thing, but it won't be a good thing for auto insurers.

And similarly, if they learn how to move trucks more safely, there's a — tends to be driver shortages in the truck business now — it obviously improves their position vis-à-vis the railroads.

Charlie?

CHARLIE MUNGER: Well, I think that's perfectly clear. (Laughter)

WARREN BUFFETT: Finally, approval. All these years. (Laughter)

WARREN BUFFETT: OK. Station 1. The shareholder.

AUDIENCE MEMBER: Hi, Warren and Charlie. My name is Bryan Martin and I'm from Springfield, Illinois.

In the HBO documentary, "Becoming Warren Buffett," you had a great analogy comparing investing to hitting a baseball and knowing your sweet spot.

Ted Williams knew his sweet spot was a pitch right down the middle. When both of you look at potential investments, what attributes make a company a pitch in your sweet spot that you'll take a swing at and invest in?

WARREN BUFFETT: Well, I'm not sure I can define it in exactly the terms you would like, but the — we sort of know it when we see it.

And it would tend to be a business that, for one reason or another, we can look out five, or 10, or 20 years and decide that the competitive advantage that it had at the present would last over that period.

And it would have a trusted manager that would not only fit into the Berkshire culture, but that was eager to join the Berkshire culture. And then it would be a matter of price.

But the main — you know, when we buy a business, essentially, we're laying out a lot of money now based on what we think that business will deliver over time. And the higher the certainty with which we make that prediction, the better off — the better we feel about it.

You can go back to the first — it wasn't the first outstanding business we bought, but it was kind of a watershed event — which was a relatively small company, See's Candy.

And the question when we looked at See's Candy in 1972 was, would people still want to be both eating and giving away that candy in preference to other candies?

And it wouldn't be a question of people buying candy for the low bid. And we had a manager we liked very much. And we bought a business that was — paid $25 million for it, net of cash, and it was earning about 4 million pretax then. And we must be getting close to $2 billion or something like that, pretax, that was taken out of it.

But it was only because we felt that people would not be buying, necessarily, a lower-price candy.

I mean it does not work very well if you go to your wife or your girlfriend on Valentine's Day — I hope they're the same person — (laughter) — and say, you know, "Here's a box of candy, honey. I took the low bid." You know, it doesn't — it loses a little as you go through that speech.

And we made a judgment about See's Candy that it would be special and — probably not in the year 2017 — but we certainly thought it would be special in 1982 and 1992. And fortunately, we were right on it. And we're looking for more See's Candies, only a lot bigger.

Charlie?

CHARLIE MUNGER: Yeah, well, but it's also true that we were young and ignorant then. And —

WARREN BUFFETT: Now we're old and ignorant. Yeah. (Laughter)

CHARLIE MUNGER: And yes, that's true, too.

And the truth of the matter is that it would have been very wise to buy See's Candy at a slightly higher price. You know if they'd asked it, we wouldn't have done it, so we've gotten a lot of credit for being smarter than we were.

WARREN BUFFETT: Yeah, and to be more accurate, if it had been 5 million more, I wouldn't have bought it. Charlie would have been willing to buy it, so, yeah.

Fortunately, that we didn't get to the point where we had to make that decision that way. But he would've pushed forward when I probably would've faded.

It's a good thing that a guy came around — actually the seller was the — well, he's the grandson of Mrs. See, wasn't he, Charlie? He was Larry See's son. Am I correct? Or Larry See's brother.

But he was not interested in the business. And he was interested in — more interested in girls and grapes, actually. And he almost changed his mind. Well, he did change his mind about selling.

And I wasn't there, but Rick Guerin told me that Charlie went in and gave a — an hour talk on the merits of girls and grapes over having a candy company. (Laughter)

This is true, folks. And the fellow sold to us, so that — (laughter) — I pull Charlie out in emergencies like that. He's — (Laughter)

CHARLIE MUNGER: We were very lucky that, early, the habit of buying horrible businesses because they were really cheap. It gave us a lot of experience trying to fix unfixable businesses as they headed downward toward doom.

And that early experience was so horrible, fixing the unfixable, that we were very good at avoiding it, thereafter. So, I would argue that our early stupidity helped us.

WARREN BUFFETT: Yeah, yeah. We learned we could not make a silk purse out of a sow's ear.

CHARLIE MUNGER: No, we learned —

WARREN BUFFETT: So, we went out looking for silk after that.

CHARLIE MUNGER: But you have to try it for a long time and fail and have rub — have your nose rubbed in it to really understand it.

WARREN BUFFETT: OK, Becky? Becky Quick.

BECKY QUICK: This question comes from a shareholder named Mark Blakley in Tulsa, Oklahoma, who says, "There has been more news than usual in some of Berkshire's core stock holdings.

"Wells Fargo in the incentive and new account scandal, American Express losing the Costco relationship and playing catch-up in the premium card space, United Airlines and customer service issues, Coca-Cola and slowing soda consumption.

"How much time is spent reviewing Berkshire's stock holdings? And is it safe to assume, if Berkshire continues to hold these stocks, that the thesis remains intact?"

WARREN BUFFETT: Well, we spend a lot of time think — those are very large holdings. If you add up American Express, Coca-Cola, and Wells Fargo, I mean, you're getting up, you know, well into the high tens of billions of dollars. And those are businesses we like very much. There're different characteristics.

In the case of — you mentioned United Airlines, we actually are the largest holder of all four of the — we're the largest holder of the four largest airlines. And that is much more of an industry thought.

But all businesses have problems. And some of them have some very big plusses.

I personally — you mentioned American Express. If you read American Express's first quarter report and talk about their Platinum Card, the Platinum Card is doing very well.

The gains around the world. You know, I think there were 17 percent or something like that in billings in the U.K. and 15 percent is original currency — or the local currency — Japan, Mexico, and very good in the United States.

There's competition in all these businesses. If we thought — we did not buy American Express or Wells Fargo or United Airlines, Coca-Cola, with the idea that they would never have problems or never have competition.

What we did buy — why we did buy them — is we thought they had very, very strong hands. And we liked the financial policies in the cases of many of them. We liked their position.

We've bought a lot of businesses. And we do look to see where we think they have durable competitive advantage.

And we recognize that if you've got a very good business, you're going to have plenty of competitors that are going to try and take it away from you. And then you make a judgment as to the ability of your particular company and product and management to ward off competitors.

They won't go away, but the — we think — I'm not going to get into specific names on it — but those companies generally are very well-positioned.

I've likened essentially — if you've got a wonderful business, even if it was a small one like See's Candy, you basically have an economic castle. And in capitalism, people are going to try and take away that castle from you.

So, you want a moat around it, protecting it in various ways that can protect it. And then you want a knight in the castle that's pretty darn good at warding off marauders. But there are going to be marauders. And they'll never go away.

And if you look at — I think Coca-Cola was 1886. American Express was 18 — I don't know — '51 or '52 — starting out with an express business.

Wells Fargo was — I don't know what year they were started. Incidentally, I — American Express was started by [Henry] Wells and [William] Fargo as well.

So these companies had lots of challenges. And they'll have more challenges. And the companies we own have had challenges.

Our insurance business has had challenges. But, you know, we started with National Indemnity's $8 million purchase in 1968. And fortunately, we've had people like Tony Nicely at GEICO. And we've had Ajit Jain, who's added tens of billions of value.

And we've got some smaller companies that you probably don't even know about, but really have done a terrific job for us.

So there'll always be competition in insurance, but there'll always be things to do that a really intelligent management with a decent distribution system, various things going for him, can do to ward off the marauders.

So I — there was a specific question, "How much time is spent reviewing the holdings?" I would say that I do it every day. I'm sure Charlie does it every day.

Charlie?

CHARLIE MUNGER: Well, I don't think I had anything to add to that, either. (Laughter)

WARREN BUFFETT: We'll cut his salary if he doesn't participate here. (Laughter)

WARREN BUFFETT: OK, Jay Gelb.

JAY GELB: This question is on Berkshire's retroactive reinsurance deal with AIG, which was the largest ever of its kind.

Based on AIG's track record of reserve deficiencies and the opportunity for Berkshire to invest the float, what is your level of confidence that this contract covering up to $20 billion of AIG's reserves in return for $10 billion of premiums will ultimately be profitable for Berkshire?

WARREN BUFFETT: Well, at the time we do every deal, I think it's smart. And then sometimes — (laughs) — I find out otherwise as we go along.

The deal, that Jay knows, but might be unfamiliar to many people, is that AIG transferred to us the liability for 80 percent of 25 billion — excess — of 25 billion.

In other words, they had to pay the first 25 billion. And then on the next 25 billion, we had to pay 80 percent of what they paid up to a limit of 20 billion, 80 percent of 25. And we got paid $10.2 billion for that.

And we had — and this applies to their losses in many classes of business written — or earned — before December 31st, 2015.

So Ajit Jain, who has made a lot more money for Berkshire than I — for you — than I have, but he evaluates that sort of transaction.

We talk about it a fair amount ourselves. I just find it interesting. I particularly find the 10.2 billion that they're going to give us interesting.

And the — we come to the conclusion that we think we'll do well by getting 10.2 billion today with a maximum payout of 20 billion over some — I mean, between now and judgment day — on this large piece of business.

AIG had very good reasons for doing this, because their reserves had been under criticism. And this essentially — probably — and should have, I think — put to bed the question of whether they were underreserved on that business. And we get the 10.2 billion.

And the question is how fast we pay out the money and how much money we pay out. And Ajit does 99 percent of the thinking on that. And I do one percent. And we project out what we think will happen.

And we know whatever our projection is, that it will be wrong, but we try to be conservative.

And we've done a fair amount of these deals. This is the largest. The second largest was a creature that was formed out of Lloyd's of London some years ago.

And we've been wrong on one transaction that involved something over a billion of premium. I mean clearly wrong.

And there are a couple of others that may or may not work out depending on what you assume we have earned on the funds. But they're OK.

But they probably didn't come out as well as we thought they would, though. But overall, we've done OK on this.

It's less OK when we're sitting around with 90-plus billion of cash. So the incremental 10.2 billion we took in in the first quarter is earning us peanuts at the moment. And peanuts is not what fits into the formula for making this an attractive deal.

So we have — we do have to assume we'll find uses of the money, but the money will be with us quite a while. And I think our calculations are on the conservative side. They are not the identical calculations that AIG makes. I mean, we come up with our own estimate of payouts and all of that.

And I think it — actually, I think it was quite a good transaction from AIG's standpoint. Because they did take 20 billion of potential losses off for 10.2 billion.

And I think they satisfied the investing community that they were quite unlikely to have adverse development in the period prior to 2015 that was not accounted for by this transaction.

Charlie?

CHARLIE MUNGER: Well, I think it's intrinsically a dangerous kind of activity. And — but that's one of its attractions. I don't think there are any two people in the world that are better at this kind of transaction than Ajit and Warren.

And nobody else has had the experience we've had. Just get me in a lot more of those businesses and I'll accept a little extra worry.

WARREN BUFFETT: There's one thing I should mention, too, that we actually were the only insurance operation in the world that would write that sort of a contract and that — where it would be satisfactory to the other party.

I mean, when somebody hands you $10.2 billion and says, "I'm counting on you to pay 20 billion back, even if it's 50 years from now, on the last dollar," there are very few people that they'd want to hand 10.2 billion to. And there —

So it's a — there's limited people on the other side. I mean, there's not that many people remotely that have that kind of size deal. But —

CHARLIE MUNGER: "Very few" is a good expression. He means "one." (Laughter)

WARREN BUFFETT: Yeah.

WARREN BUFFETT: OK. We'll go to station 2.

AUDIENCE MEMBER: Hello, Mr. Buffett, Mr. Munger. My name's Grant Gibson (PH). I'm from Denver, Colorado, and this is my fifth consecutive year here. So thank you for having us.

WARREN BUFFETT: Thanks for coming.

AUDIENCE MEMBER: Appreciate it. With all due respect, Mr. Buffett, this question is for Mr. Munger. (Laughter)

In your career of thousands of negotiations and business dealings, could you describe for the crowd which one sticks out in your mind as your favorite or is otherwise noteworthy?

CHARLIE MUNGER: Well, I don't think I've got a favorite. But the one that probably did us the most good as a learning experience was See's Candy.

It's just the power of the brand, the unending flow of ever-increasing money with no work. (Laughter)

AUDIENCE MEMBER: Sounds nice. (Laughter)

CHARLIE MUNGER: It was. And I'm not sure we would have bought the Coca-Cola if we hadn't bought the See's.

I think that a life properly lived is just learn, learn, learn all the time. And I think Berkshire's gained enormously from these investment decisions by learning through a long, long period.

Every time you appoint a new person that's never had big capital allocation experience, it's like rolling the dice. And I think we're way better off having done it so long. And —

But the decisions blend, and the one feature that comes through is the continuous learning. If we had not kept learning, you wouldn't even be here.

You'd be alive probably, but not here. (Laughter)

WARREN BUFFETT: There's nothing like the pain of being in a lousy business — (laughs) — to make you appreciate a good one.

CHARLIE MUNGER: Well, there's nothing like getting into a really good one that's a very pleasant experience and it's a learning experience.

I have a friend who says, "The first rule of fishing is to fish where the fish are. And the second rule of fishing is to never forget the first rule." (Laughter)

And we've gotten good at fishing where the fish are.

WARREN BUFFETT: Yeah, that's only metaphorically.

CHARLIE MUNGER: There're too many other —

WARREN BUFFETT: I went to fish with Charlie one time. He didn't get —

CHARLIE MUNGER: There are too many other boats in the damn water. (Laughter)

But the fish are still there.

WARREN BUFFETT: Yeah, we bought a department store in Baltimore in 1966. And there's really nothing like being in an experience of trying to decide whether you're going to put a new store in a area that hasn't really developed yet enough to support it, but your competitor may move there first.

And then you have the decision of whether to jump in. And if you jump in, that kind of spoils it. Now you've got two stores where even one store isn't quite justified.

How to play those games — those business games — is — you learn a lot by trying. And what you really learn is which ones to avoid.

I mean, it — you just stay out of a bunch of terrible businesses, you're off to a very great start, as far as — because we've tried them all.

CHARLIE MUNGER: But you can really learn, because the experience is a lot like eating cuttle (PH) burgers. And it really gets your attention. (Laughter)

WARREN BUFFETT: Well, we won't expand on that. (Laughter)

WARREN BUFFETT: Andrew Ross Sorkin.

ANDREW ROSS SORKIN: Good morning, Warren.

This question comes from a long-time shareholder who I should tell you accosted me last night in the lobby of the Hilton Hotel with this question.

"Warren, for years, you stayed away from technology companies, saying they were too hard to predict and didn't have moats. Then you seemed to change your view about technology when you invested in IBM, and again when you recently invested in Apple.

"But then on Friday you said IBM had not met your expectations and sold a third of our stake.

"Do you view IBM and Apple differently? And what have you learned about investing in technology companies?"

WARREN BUFFETT: Well, I do view them differently. But, you know, obviously, when I bought the IBM — started buying it six years ago — I thought it would do better in the six years that have elapsed than it has.

And Apple — I regard them as being in quite different businesses. I think Apple is much more of a consumer products business, in terms of the — in terms of sort of analyzing moats around it, and consumer behavior, and all that sort of thing.

It's obviously a product with all kinds of tech built into it. But in terms of laying out what their prospective customers will do in the future, as opposed to, say, IBM's customers, it's a different sort of analysis.

That doesn't mean it's correct. And we'll find out over time. But they are two different types of decisions.

And I was wrong on the first one, and we'll find out whether I'm right or wrong on the second. But I do not regard them as apples and apples, and I don't quite regard them as apples and oranges, but they're — it's somewhat in between on that.

Charlie?

CHARLIE MUNGER: Well, we avoided the tech stocks, because we felt we had no advantage there and other people did. And I think that's a good idea not to play where the other people are better.

But, you know, if you ask me, in retrospect, what was our worst mistake in the tech field, I think we were smart enough to figure out Google. Those ads worked so much better in the early days than anything else.

So I would say that we failed you there. And we were smart enough to do it and didn't do it. We do that all the time, too.

WARREN BUFFETT: Yeah. We were their customer very early on with GEICO, for example. And we saw — I don't — these figures are way out of date, but I — as I remember, you know, we were paying them 10 or 11 dollars a click or something like that.

And any time you're paying somebody 10 or 11 bucks every time somebody just punches a little thing where you've got no cost at all, you know, that's a good business, unless somebody's going to take it away from you.

And so we were close up, seeing the impact of that.

And incidentally, if any of you don't have anything to do in your hotel rooms tonight, just keep punching Progressive or something. And — (Laughter)

Don't really do that. (Laughter)

The thought just happened to cross my mind. The — (Laughter)

But, you know, that is — and you've never seen a business — almost never seen a business — like it, where —

And I think for LASIK surgery and things like that, I think the figures were, you know, 60 or 70 bucks a click with no incremental — no cost.

So — and I knew the guys. I mean, they actually designed their prospectus. They came to see me. And they — a little bit after the original one, when they went public, a little bit after Berkshire even. And so I had plenty of ways to ask questions or anything of the sort, educate myself. But I blew it — (laughs) — and —

CHARLIE MUNGER: We blew Walmart, too. When it was a total cinch, we were smart enough to figure that out and we didn't.

WARREN BUFFETT: Yeah, figuring out — execution is what counts. So — (Laughs)

Anyway, we'll — and I could be making two mistakes on IBM. I mean, the — you know, they're — they —

It's harder to predict, in my view, the winners in various items, or how much price competition will enter in to something like cloud services and all of that.

I will — I made a statement the other day, which it's really remarkable, and I was — I asked Charlie whether he could think of a situation like it — where one person has built an extraordinary economic machine in two really pretty different industries, you know, almost simultaneously, as has happened —

CHARLIE MUNGER: From a standing start at zero.

WARREN BUFFETT: From a standing start at zero, with other — with competitors with lots of capital and everything else.

To do it in retailing and to do it with the cloud, like Jeff Bezos has done, I mean, I —

People like the Mellons invested in a lot of different industries and all of that. But he has been, in effect, the CEO, simultaneously, of two businesses starting from scratch that if — you know, Andy Grove used to use — at Intel — used to say, you know, "Think about if you had a silver bullet and you could shoot it at — and get rid of one of your competitors, who would it be?"

Well, I think that both in the cloud and in retail, there are a lot of people that would aim that silver bullet at Jeff.

And he's done — it's a different sort of game — but he's, you know, at The Washington Post, he's played that hand as well as anybody I think possibly could.

So it's a remarkable business achievement, where he's been involved, actually, in the execution, not just bankrolling it, of two businesses that are probably as feared by their competitors, almost, as any you can find.

It's — Charlie, you got further thoughts?

CHARLIE MUNGER: Well, we're sort of like the Mellons, old-fashioned people who done all right. And Jeff Bezos is a different species. (Laughter)

WARREN BUFFETT: And we missed it entirely, incidentally. We never owned a share of Amazon. (Laughs)

WARREN BUFFETT: OK, Gregg Warren.

GREGG WARREN: Warren, my question relates to some recent stock purchases as well.

Unlike the railroads, which benefit from colossal barriers to entry due to their established, practically impossible to replicate, networks of rail and rights of way, the airline industry seems to have few, if any advantages.

Even with the consolidation we've seen during the past 15 years, the barriers to entry are few and the exit barriers are high.

The industry also suffers from low switching cost and intense pricing competition, and is heavily exposed to fuel costs, with rising fuel prices being difficult to pass on, and declining fuel prices leading to more price competition.

Compare this with rail customers who have few choices and thus wield limiting buying power, and where fuel charges allow the industry to mitigate fuel price fluctuations.

While you've noted several times since the airline stock purchases were announced that the two industries are quite different and that comparisons should not be made to Berkshire's move into railroads a decade ago, could you walk us through what convinced you that the airlines were different enough this time around for Berkshire to invest close to $10 billion in the four major airlines?

Because it would seem to me that UPS, which you have a small stake in, and FedEx, both of which have wider economic moats built on more identifiable and durable competitive advantages, would be a better option for long-term investors.

WARREN BUFFETT: Yeah, the decision in respect to airlines had no connection with our being involved in the railroad business.

I mean, you can classify them, you know, maybe in — as transportation businesses or something. But it had no connection, had no more connection than the fact we own GEICO or, you know, any other business.

You couldn't pick a tougher industry, you know, ever since Orville [Wright] went up and I said, you know, that if anybody'd really been thinking about investors, they should have had Wilbur [Wright] shoot him down and save everybody a lot of money for a hundred years.

You can go to the internet and type in "airlines" and "bankrupt," and you'll see that something like a hundred airlines — in that general range, you know, gone bankrupt in the last few decades.

And actually, Charlie and I were directors for some time of USAir. And people write about how we had a terrible experience in USAir. It was the — one of the dumbest things I'd ever done. And there's a lot of —

CHARLIE MUNGER: You made a fair amount of money out of it, too.

WARREN BUFFETT: Yeah, and we made a lot of money out of it. (Laughs)

CHARLIE MUNGER: It was undeserved.

WARREN BUFFETT: But we made a lot of money out of it, because there was one little brief period when people got all enthused about USAir. And after we left as directors and after we sold our position, USAir managed to go bankrupt twice in the subsequent period.

I mean, you've named all of the — not all of them — but you've named a number of factors that just make for terrible economics.

And I will tell you that if capacity — you know, it's a fiercely competitive industry. The question is whether it's a suicidally competitive industry, which it used to be.

I mean, when you get virtually every one of the major carriers, and dozens and dozens and dozens of minor carriers going bankrupt, you know, it ought to come upon you, finally, that maybe you're in the wrong industry.

It has been operating for some time now at 80 percent or better of capacity — being available seat miles — and you can see what deliveries are going to be and that sort of thing.

So if you make — I think it's fair to say that they will operate at higher degrees of capacity over the next five or 10 years than the historical rates, which caused all of them to go broke.

Now the question is whether, even when they're doing it in the 80s, they will do suicidal things in terms of pricing, remains to be seen.

They actually, at present, are earning quite high returns on invested capital. I think higher than either FedEx or UPS, if you actually check that out.

But that doesn't mean — tomorrow morning, you know, if you're running one of those airlines and the other guy cuts his prices, you cut your prices, and as you say, there's more flexibility when fuel goes down to bring down prices than there is to raise prices when prices go up.

So the industry, you know — it is no cinch that the industry will have some more pricing sensibility in the next 10 years than they had in the last hundred years. But the conditions have improved for that.

They've got more labor stability than they had before, because they're basically all going to — they've been through bankruptcy.

And they're all going to sort of have an industry pattern bargaining, it looks to me like. They're going to have a shortage of pilots to some degree. But it's not like buying See's Candy.

Charlie?

CHARLIE MUNGER: No, but the investment world has gotten tougher with more competition, more affluence, and more absolute obsession with finance throughout the whole country. And we picked up a lot of low-hanging fruit in the old days, where it was very, very easy. And we had huge margins of safety.

Now we operate with a less advantageous general climate. And maybe we have small statistical advantages, where in the old days it was like shooting fish in a barrel.

But that's all right. It's OK if it gets a little harder after you get filthy rich. (Laughter)

WARREN BUFFETT: Yeah. Charlie's more philosophical than I am on that point. (Laughter)

CHARLIE MUNGER: Well, I can't bring back the low-hanging fruit, Warren. You're just going to have to keep reaching for the higher branches.

WARREN BUFFETT: Gregg, the — I don't — I think the odds are very high that there are more revenue passenger miles five years from now or 10 years from now.

If the airlines — if the airline companies are only worth, five or 10 years from now, what they're worth now, in terms of equity, we'll get a pretty reasonable rate of return, because they're going to buy in a lot of stock at fairly low multiples.

So if the company's worth the same amount at the end of the year and there's fewer shares of stock outstanding, over time we make decent money. And all four of the major airlines are buying in stock at a —

CHARLIE MUNGER: You've got to remember that the railroads were a terrible business for decades and decades and decades and then they got good.

WARREN BUFFETT: Yeah, it — we like — I like the position. Obviously, by buying all four, it means that it's very hard to distinguish who will do the — at least in my mind — it's hard to distinguish who will do the best.

I do think the odds are quite high that, if you take revenue passenger miles flown five or 10 years from now, it will be a higher number. And that will be —

There'll be low-cost people who come in. And, you know, the Spirits of the world and JetBlues, whatever it may be. But the — my guess is that all four of the companies we have will have higher revenues. The question is what their operating ratio is.

They will have fewer shares outstanding by a significant margin. So even if they're worth just what they're worth today, we could make a fair amount of money. But it is no cinch, by a long shot.

WARREN BUFFETT: OK, station 3.

AUDIENCE MEMBER: Good morning, everybody. My name is Savilla Aliance (PH). I'm from Germany. And I'm member of board of Ethecon Foundation Ethics and Economy.

I'm very happy that I can put my question here. And maybe you are not as happy as I am to listen to it.

WARREN BUFFETT: (Laughs) Well, we'll try to stay happy. Thank you for coming. (Laughter)

AUDIENCE MEMBER: Thank you. Mr. Buffett, a few years ago, I saw a movie in which you proclaimed that the print on the dollar bill — "In God We Trust" — does not really express your philosophy. In your opinion, only cash counts. And your credo is, "in the dollar I trust." You obviously thought —

WARREN BUFFETT: I don't think I've ever said that actually. But —

AUDIENCE MEMBER: Well, I can show you the movie. (Laughs) That will prove.

WARREN BUFFETT: Oh, well, I — send me a clip. I —

AUDIENCE MEMBER: Well, maybe it was just joking. But always behind a joke there is also a truth. So — well, you laughed heartily at that moment.

You, as one of the most richest men in — of all times on this Earth, are you not a good-humored, friendly, elderly gentleman?

Whatever motivated those who designed the dollar notes, they certainly wanted to say that there is something higher than the value of this printed paper.

Regrettably, you have shown many times in your life that you see this differently. You have accumulated billions of dollars — (applause) — showed extraordinary cleverness and skill, and you knew — you knew better to pick up than many others who, like you, used the rules which are inherent to capitalism for their own intentions.

But have you ever given a thought to what troubles and sacrifices, slavery and destruction of Mother Earth, and even diseases and deaths stick to the dollar bills which you gather so eagerly? (Booing)

Let's take Coca-Cola. (Booing)

Ethecon Foundation Ethics and Economy from Germany has awarded the Black Planet Award to the members of the board of directors as well as to the large shareholders, Warren Buffett and Allen — and Herbert Allen —because you are co-responsible for all of what makes these group make so much money, isn't it?

Among other things, Coca-Cola deprives people —

WARREN BUFFETT: Well, I —

AUDIENCE MEMBER: — of their drinking water —

WARREN BUFFETT: — at some point, yeah, I —

AUDIENCE MEMBER: — in drought-prone areas of the world.

WARREN BUFFETT: Well, are you asking a question?

AUDIENCE MEMBER: And many (inaudible) contaminate the groundwater in these areas.

WARREN BUFFETT: I don't want to interrupt you, but are you — (applause) — making a speech or asking a question?

AUDIENCE MEMBER: Well, I put my question right now.

WARREN BUFFETT: OK, good.

AUDIENCE MEMBER: Will you give up your Coca-Cola shares if the destruction of the environment, the monopolization of the right to healthy drinking water, and the shameless exploitation of the workers continue?

CHARLIE MUNGER: Well, that's more of a speech than a question.

WARREN BUFFETT: Yeah. (Applause)

I don't think that quote you had earlier — I have — I've said once or twice that it should say "In the Federal Reserve We Trust" because they print the money. And if they print too much of it, it could decline in value.

But I've never — to my knowledge, I've never said anything like you originally said.

And I would say this. I think I've been eating things I like to eat all my life. And Coca-Cola — this Coca-Cola's 12 ounces, I drink about five a day. (Laughter) It has about 1.2 ounces of sugar in it.

And if you look at what people — different people — get their sugar and calories from, they get them from all kinds of things. I happen to believe that I like to get 1.2 ounces with this. And it's enjoyable.

Since 1886, people have found it pleasant. And I would say that if you pick every meal in terms of what somebody in some recent publication has told you is the very best for you, I offer you that. I say, "Go to it."

But if you told me that I would live one year longer. And I don't even think that — that I would live one year longer if I'd eaten nothing but broccoli and asparagus and everything my Aunt Alice wanted me to eat all my life or I could eat everything I enjoyed eating, including chocolate sundaes, and Coca-Cola, and steak, and hash browns, you know, I would rather eat what — in a way I enjoy for my whole life than — and — than, you know eat some other way and live another year. (Applause)

And I do think that choice should be mine, you know? If somebody decides sugar is harmful, you know, there — maybe you'd encourage the government to ban sugar. But sugar in Coca-Cola is not different than eating sugar, you know, put on my Grape-Nuts in the morning or whatever else I'm having.

So I think Coca-Cola's been a very, very positive factor in America for — and the world — for a long, long time. And you can look at a list of achievements of the company. (Applause)

And I really don't want anybody telling me I can't drink it.

Charlie?

CHARLIE MUNGER: Well, I've solved my Coca-Cola problem by drinking Diet Coke. And I swill the stuff like other people swill I don't know what. And I've been doing it for just as long as you've been taking all those Coca-Colas that — I've had breakfast with Warren when he has Coca-Colas and nuts. (Laughter)

WARREN BUFFETT: And pretty damn good too. (Laughter)

CHARLIE MUNGER: If you keep doing that, Warren, you may not make a hundred.

WARREN BUFFETT: Well — (laughter) — I think there's something in longevity to feeling happy about your life, too. It's not —

CHARLIE MUNGER: Absolutely. (Applause)

WARREN BUFFETT: OK, Carol?

CAROL LOOMIS: This question is from Franz Tramberger (PH) of Austria. And it concerns intrinsic value, which is neither — Warren may rather — he may amend this, my definition here, but — which is neither a company's accounting value nor its stock market value, but is rather its estimated real value.

So the question is, "At what rate has Berkshire compounded intrinsic value over the last 10 years? And at what rate, including your explanation for it please, do you think intrinsic value can be compounded over the next 10 years?"

WARREN BUFFETT: Yeah. Intrinsic value, you know, can only be calculated — or gains — you know, in retrospect.

But the intrinsic value pure definition would be the cash to be generated between now and Judgment Day, discounted at an interest rate that seems appropriate at the time. And that's varied enormously over a 30 or 40-year period.

If you pick out 10 years, and you're back to May of 2007, you know, we had some unpleasant things coming up. But we've — I would say that we've probably compounded it at about 10 percent.

And I think that's going to be tough to achieve, in fact almost impossible to achieve, if we continued in this interest rate environment.

That's the number one — if you asked me to give the answer to the question, if I could only pick one statistic to ask you about the future before I gave the answer, I would not ask you about GDP growth. I would not ask you about who was going to be president.

I would — a million things — I would ask you what the interest rate is going to be over the next 20 years on average, the 10-year or whatever you wanted to do.

And if you assume our present interest rate structure is likely to be the average over 10 or 20 years, then I would say it'd be very difficult to get to 10 percent.

On the other hand, if I were to pick with a whole range of probabilities on interest rates, I would say that that rate might be — it might be somewhat aspirational. And it might well — it might be doable.

And if you would say, "Well, we can't continue these interest rates for a long time," I would ask you to look at Japan, you know, where 25 years ago, we couldn't see how their interest rates could be sustained. And we're still looking at the same thing.

So I do not think it's easy to predict the course of interest rates at all. And unfortunately, predicting that is embedded in giving a good answer to you.

I would say the chances of getting a terrible result in Berkshire are probably as low as about anything you can find. Chance of getting a sensational result are also about as low as anything you can find. So if I — I would — I —

My best guess would be in the 10 percent range, but that assumes somewhat higher interest rates — not dramatically higher — but somewhat higher interest rates in the next 10 or 20 years than we've experienced in the last seven years.

Charlie?

CHARLIE MUNGER: Well, there's no question about the fact that the future, with our present size is, in terms of percentages of rates of return, is going to be less glorious than our past. And we keep saying that. And now we're proving it. (Laughter)

WARREN BUFFETT: Do you want to end on that note, Charlie? Or would you care to — (Laughter)

CHARLIE MUNGER: Well, I do think Warren's right about one thing. I think we have a collection of businesses that on average has better investment values than, say, the S&P average. So I don't think you shareholders have a terrible problem.

WARREN BUFFETT: And I would say we probably — well, I'm certain — we have — we do have more of a shareholder orientation than the S&P 500 as a whole. I mean, for — you know, the —

This company has a culture where decisions are made for — as an owner, as a private owner would make them. And frankly, that's a luxury we have that many companies don't have. I mean, they're under pressures today, sometimes, to do things.

One of the questions I ask the CEO of every public company that I meet is, "What would you be doing differently if you owned it all yourself?" And the answer, you know, is usually this, that, and a couple of other things.

If you would ask us, the answer is, you know, we're doing exactly what we would do if we owned them all — all the stock ourselves. And I think that's a small plus over time.

Anything further, Charlie? (Applause)

CHARLIE MUNGER: I think we have one other advantage. A lot of other people are trying to be brilliant. And we're just trying to stay rational. And — (laughter and applause) — it's a big advantage. Trying to be brilliant is dangerous, particularly when you're gambling.

WARREN BUFFETT: OK, Jonathan?

JONATHAN BRANDT: If corporate tax rates are reduced meaningfully, Berkshire will enjoy a one-time boost to book value because of its sizable deferred tax liability, and its go-forward earnings should be higher, too, at least in theory.

How much of the reduced tax rate will be passed along to Berkshire's customers through, for instance, lower electricity rates or lower railroad shipping rates? And how much will go to Berkshire shareholders?

WARREN BUFFETT: Yeah, the question is, in the case of our utility businesses, all benefit of lower tax rates goes to customers. And it should be, because we are allowed a return on equity — in general — I mean, I'm simplifying a little bit. But the —

We're allowed a return on equity that's computed on an after-tax basis. And the utility commissions would, if taxes were raised, would presumably give us higher rates to compensate for that.

And if taxes are lowered, they would say, "You're not entitled to make more money just because tax rates — on equity — because tax rates have been lowered." So forget about the utility portion of the deferred taxes.

The deferred taxes that are applicable to our unrealized gains in securities, we would get all the benefit of. Because I mentioned we had 90 billion-plus of unrealized gains. And if the rates were changed on those in either direction, our owners, dollar for dollar, will participate in that.

And then you get into the other businesses. You mentioned the railroad, but it can be all of our other businesses.

To some extent, if tax rates are lowered, to different degrees in different industries, depending on the number of players, the competitive conditions, some of it may — some if it almost certainly gets competed away. And some of it would likely not be competed away.

And that's — you know, economists can argue about that a lot. But I've seen it in action in a lot of cases.

You got a big decline in rates, for example, in the U.K. And we've had them over my lifetime. We had 52 percent corporate rates. You know, we've had a lot of different numbers.

So I have seen how behavior — economic behavior — works. And I would say that it's certain that some of any lower rate would be competed away. And it's virtually certain that some would enure to the benefit of the shareholders. And it's very industry and company specific in how that plays out.

Charlie?

Well, we — dollar for dollar, I mean, there's 90 or 95 billion, if the rate were to drop 10 percent, that 9 1/2 billion is — by 10 percentage points — that 9 1/2 billion's real.

On the other hand, if it goes up as it did — went up from 28 to 35 percent, they can take it away from us, too.

CHARLIE MUNGER: Well, I think it's true that we're peculiar in one way. If things go to hell in a handbasket and then get better later, we're likely to do better than most others.

And we don't wish for that. And we don't want our company to have to suffer through it. And we fear what might happen if the country went through the ringer like that.

But if that real adversity comes, we're likely to do better in the end. We're good at navigating through that kind of stuff.

WARREN BUFFETT: Yeah, and occasionally, there will be —

CHARLIE MUNGER: A lot — in fact, we're quite good at it. (Laughter)

WARREN BUFFETT: There will be occasional hiccups in the American economy. Doesn't have much to do with who's president or anything like that. Those people may get blamed or given credit for different things.

But it's just — it is the nature of market systems to occasionally go haywire in one direction or another. And it's been ever thus, you know, and it'll be ever thus.

It's not — it does not have a — there's not a — it's not a — on a regular sine wave-type picture or anything of the sort. But it's certain to happen from time to time.

And we will probably have a fair amount of money and credit at that time. And we certainly —

We're not affected. When the rest of the world is fearful, we know America's going to come out fine. And we will not have a trouble — any trouble — psychologically, acting at all.

And then the question is how much do we have in the way of resources? We'll also never put the company in any kind of risk just because we see a lot of opportunities. We'll grab all the ones we can that we can handle. And not lose a day of sleep.

(Someone shouts in the audience)

I didn't quite get that. But —

WARREN BUFFETT: In any event, we will now go to station 4. And if the person yelling — are we up there in station — are you on station 4?

AUDIENCE MEMBER: Yes, Dr. Bruce Hertz from Glenview, Illinois. I wanted to thank you for allowing me to attend. I feel both honored and blessed.

My question for Mr. Buffett is, you've always advised us to purchase equities that appreciate in value. Yet a few years ago you sold your used Cadillac at a tremendous profit. (Laughter)

How can you justify selling a depreciating asset for a significant profit? Thank you.

WARREN BUFFETT: Yeah, well — (laughter) — actually I gave it to Girls Inc. And they sold it. And it was kind of an interesting — (Applause)

A very nice guy bought it for a hundred and some thousand dollars. And I did not — and Girls Inc. got the money. And he got in the — he came later, actually, with his family.

And he drove it away without any plates. He was driving back to New York. And he got picked up by the police — (laughter) — in Illinois. And he said, "Well" — he started giving this explanation about how he'd given this money to Girls Inc. and was driving the car back. And he had this nice looking family with him.

And the cops were quite skeptical. But fortunately, I'd signed the dashboard for him as part of the deal when he — and so they looked at that. And then they just said, "Well, did he give you any stock tips?" And they let him go. (Laughter)

I can't recall ever selling a used car at a profit. But we — I don't think I've sold any personal possession. Well, I've got a house for sale.

CHARLIE MUNGER: You don't have any personal possessions. (Laughter)

WARREN BUFFETT: Yeah. No, I — anything you see with a figure attached like that —

CHARLIE MUNGER: You're a fatter version of Mahatmas Gandhi — (laughter) — Mahatma Gandhi.

WARREN BUFFETT: The guy was a very nice guy that bought it. And, you know, his check cleared. So we were fine. (Laughter)

WARREN BUFFETT: Becky?

BECKY QUICK: I'd like to ask a question that can serve as a follow-up to the question that Carol had asked. And Charlie, in that response, said that he thinks that Berkshire's businesses on the whole will do better than the S&P 500.

Clark Cameron (PH) from Birmingham, Alabama, who owns 281 shares of Berkshire B, writes in and asks, "Why have you advised your wife to invest in index funds after your death rather than Berkshire Hathaway? I believe Munger has counseled his offspring to quote, 'Not be so dumb as to sell.'"

WARREN BUFFETT: Yeah. (Laughter)

She won't be selling any Berkshire to buy the index funds. All of my Berkshire, every single share, will go to philanthropy.

So the — I don't even regard myself as owning Berkshire, you know, basically — (applause) — it's committed.

And so far, about 40 percent has already been distributed.

So the question is, somebody who is not an investment professional will be, I hope, reasonably elderly by the time that the estate gets settled.

And what is the best investment, meaning one that there would be less worry of any kind connected with and less people coming around and saying, "Why don't you sell this and do something else?" and all those things. She's going to have more money than she needs.

And the big thing, then, you want is money not to be a problem. And there will be no way that if she holds the S&P — or virtually no way, absent something happening with weapons of mass destruction — but virtually no way that she won't — she'll have all the money that she possibly can use.

She'll have a little liquid money so that if stocks are down tremendously at some point, there's — they close the stock exchange for a while, anything like that — she'll still feel that she's got plenty of money.

And the object is not to maximize. It doesn't make any difference whether the amount she gets doubles or triples or anything of the sort. The important thing is that she never worries about money the rest of her life.

And I had an Aunt Katie here in Omaha, who Charlie knew well, and worked for her husband, as did I. And she worked very hard all her life. And had lived in a house she'd paid, I think, I don't know, $8,000 for at 45th and Hickory all her life.

And because she was in Berkshire, she ended up — she lived to 97 — she ended up with, you know, a few hundred million. (Laughter)

And she would write me a letter every four or five months. And she said, "Dear Warren, you know, I hate to bother you. But am I going to run out of money?"

And — (laughter) — I would write her back. And I'd say, "Dear Katie, it's a good question because, if you live 986 years, you're going to run out of money." And — (laughter) — then about four or five months later, she'd write me the same letter again.

And I have seen there's no way in the world, if you've got plenty of money, that it should become a minus in your life. And there will be people, if you've got a lot of money, that come around with various suggestions for you, sometimes well-meaning, sometimes not so well-meaning.

So if you've got something as certain to deliver — you know, it was all in Berkshire, they'd say, "Well, if Warren was alive today, you know, he would be telling you to do this." I just don't want anybody to go through that.

And the S&P will be a — I think actually what I'm suggesting is what — a very high percentage of people should do something like that. And I don't think they will have as — I think there's a chance they won't have as much peace of mind if they own one stock.

And they've got neighbors and friends and relatives that are trying to do some — like I say, sometimes well-intentioned, sometimes otherwise, to do something else. And so I think it's a policy that'll get a good result and is likely to stick.

Charlie?

CHARLIE MUNGER: Well, as Becky said, the Mungers are different. I want them to hold the Berkshire.

WARREN BUFFETT: Well, I want to hold the Berkshire, too. (Laughter)

CHARLIE MUNGER: No, but I mean I don't like the — I recognize the logic of the fact that that S&P algorithm is very hard to beat. You know, diversified portfolio of big companies. It's all but impossible for most people. But, you know, it's — I'm just more comfortable with the Berkshire.

WARREN BUFFETT: Well, it's the family business.

CHARLIE MUNGER: Yeah.

WARREN BUFFETT: Yeah. But it — I've just — I've seen too many people as they get older, particularly, being susceptible and just having to listen to the arguments of people coming along.

CHARLIE MUNGER: Well, if you're going to protect your heirs from the stupidity of others, you may have some good system. But I'm not much interested in that subject.

WARREN BUFFETT: OK. (Laughter)

WARREN BUFFETT: OK. Jay?

JAY GELB: Berkshire reportedly partnered with 3G and Kraft Heinz's attempt to acquire Unilever for $143 billion.

How much was Berkshire willing to invest in this deal? And does this mean Berkshire's next large acquisition is likely to be in partnership with 3G?

WARREN BUFFETT: Yeah, well, Kraft, I — you'd have to distinguish between two situations. Kraft Heinz was a widely-owned company in which we and 3G act as a control group and have a little over 50 percent of the stock.

But as originally contemplated — no certainty that this exactly is what would have happened — we would have invested an additional 15 billion and 3G would have invested an additional 15 billion if a friendly agreement could have been reached.

So if the deal had been made, if the independent directors of Kraft Heinz had approved the transaction, the likely — well, then the likelihood is that we would have invested 15 billion. But it would've required the approval of the independent directors as well.

Now Kraft Heinz, in going forward with making that offer, wanted to be sure that there would be enough equity capital, in addition to the debt that would be incurred, to make the deal. And so, informally, we had basically committed the 15 billion.

It only was approved on the basis that it be a friendly deal with Unilever. And initially, we thought they would be at least possibly interested in such a deal.

And when we found out otherwise, we withdrew the offer. So it would have been 15 billion of additional money, in all probability.

WARREN BUFFETT: OK, station 5?

AUDIENCE MEMBER: Dear Honorable Mr. Buffett and Mr. Munger, I'm Tian Du Hua (PH) from China. My company (Inaudible) Holdings is spreading value investing philosophy in Asia.

My business partner Ken Chi (PH), Cho Quy Ying (PH), and I are committed to awake 100 million Chinese people to return to rational way of investing.

The hardest thing in this world is to change people's values or belief system. And we should like to awake investors to change from speculate in the market to investing in the market. It's not changing the speculator's values or belief system.

May I ask you, Mr. Buffett, can you kindly advise us what we should do to spread your value investing philosophy? Or is there any word of encouragement? Thank you.

WARREN BUFFETT: Yeah, the — when — in any system — Keynes wrote about this in 1936 — I think it was, in "The General Theory," or '35. I think it's Chapter 12. It's — great chapter on investing.

And he talked about investment and speculation and the propensity of people to speculate and the dangers of it.

And worded eloquently, there's always the possibility of, I mean, there's always some speculation, obviously, and there's always some value investors and all that sort of thing in the market. But there's —

When speculation gets rampant, and when you're getting what I guess Charlie would call "social proof" — that it's worked recently — people can get very excited about speculating in markets. And we will have it from time to time in this market.

There's nothing more agonizing than to see your neighbor who you think has an IQ about 30 points below you getting richer than you are by buying stocks. And whether it's internet stocks or whatever. And it — and people succumb to it. And they'll succumb in this economy just as elsewhere.

There's also a point which gets to your question. I would say that early on in the development of markets — there is probably a — there's some tendency for them, I think, to be more speculative than markets that have been around for a couple hundred years because the — it has a — invest —

Markets have a casino characteristic that has a lot of appeal to people, particularly when they see, like I say, people getting rich around them. And those that haven't been through cycles before are probably a little more prone to speculate than people who have experienced the outcome of wild speculation.

So I — you know, basically in this country, Ben Graham was, in the book I read in 1949, was preaching investment. And that book continues to sell very well.

But if the market gets hot, new issues are doing well and people on leverage are doing well, a lot of people will be attracted to, not only speculation, but what I would call gambling. And I'm afraid that that will be true in the United States.

And I think that China, being a newer market, essentially, in which there's widespread participation, is likely to have some pretty extreme experiences in that respect. We will have some in this country, too.

Charlie?

CHARLIE MUNGER: Well, I certainly agree with that. (Laughter)

The Chinese will have more trouble. They're very bright people. They have a lot of action and, sure they're going to be more speculative.

And it's a dumb idea. And to the extent you're working on it, why, you're on the side of the angels. But lots of luck. (Laughter)

WARREN BUFFETT: Well, it will offer the investor more opportunities actually — (laughs) — if they can keep their wits about them — if you have wild speculation. I mean, we —

Charlie just mentioned earlier, you know, that if we get into periods that are very tough, Berkshire certainly will do reasonably well because it won't — we won't be — we won't get fearful. And fear spreads like you cannot believe until you've seen a few examples of it.

At the start of September 2008, you had 35 million people with their money in money market funds with $3 1/2 trillion in them. And none of them were afraid that that dollar wasn't going to be a dollar when they went to cash in their money market fund.

And three weeks later, they were all terrified, and 175 billion flowed out in three days. And so the way the public can react is really extreme in markets. And that actually offers opportunities for investors.

You'll never — people like action and they like to gamble. And if they think there's easy money to be made, a lot of them, you'll get a rush to it. And for a while it will be self-fulfilling and create new converts until the day of reckoning comes. They'll —

Just keep preaching investing, and if the market swings around a lot, you'll keep adding a few people here and there to a group that recognizes that markets are there to be taken advantage of, rather than to instruct you as to what is going on. OK. Andrew?

Anything more on that, Charlie?

CHARLIE MUNGER: We've done a lot of preaching, Warren, without much effect.

WARREN BUFFETT: Right. And that's probably good, from our standpoint.

WARREN BUFFETT: OK. Andrew?

ANDREW ROSS SORKIN: Thank you, Warren. This question comes from Ryan Prince (PH).

"President Donald Trump and his advisors have talked about proposing a substantial investment tax credit to provide incentives for long-term corporate fixed capital investment.

"In BNSF, Berkshire owns a sprawling infrastructure portfolio requiring regular routine maintenance investment of substantial scale.

"What impact would an investment tax credit have on BNSF's capital investment decision-making, from a return on investment capital perspective, as well as in terms of timing?

"And just as importantly, given the current economy and employment picture, would such a tax credit amount to a subsidization of otherwise mandatory maintenance capital investment or a proper incentive to stimulate investment?"

WARREN BUFFETT: Yeah, well, it would all depend on how it was worded — you know, because — we've had investment tax credits in this country, and we've had bonus depreciation. It's another form of it. We — and we do get extra first-year depreciation. That does not enter into our calculation very much.

You know, in fact — certainly at the Berkshire level, I've never instructed anybody to do anything different because of investment tax credits or accelerated depreciation. There may be some calculations done down at the operating company level.

It's certainly true in something like wind projects and solar projects. They are dependent on the tax law, currently. There may come a time when they aren't, but they wouldn't have been done without some subsidization through the tax law.

But I would say, if you change the depreciation schedules and, you know, double depreciation — triple depreciation, for — that — we're going to do what we need to do at the railroad to make it safer and more efficient if we just had ordinary depreciation.

And I doubt if there'd be any dramatic differences. Obviously, if you were going to, say, buy a bunch of planes and the law was going to change on December 31st, and the math made it better to wait till January 1st or do it this December 31st, you make that kind of calculation.

But I can't recall, in all the years, that I've ever sent out anything to our managers saying, "Let's do this because the tax law is being changed or might be changed," or something of the sort.

As I mentioned earlier, it changes just a little bit if you think there's going to be a change in capital gains rates at a given time. Obviously if it's going to — the rate's going to be lowered, you would take losses ahead of time and defer gains, maybe, a little.

And that's why it's useful, actually, if the tax committees in the Senate and the House are working on something, it might be useful if the chairmans would say that, "If we do make any changes, we're likely to use this effective date," or something of the sort. And I think they've done that a few times in the past.

We are not, the big tax-driven item — is — in wind and solar. And that is a specific policy, because the government has decided they want to move people — or society has decided — they want to move people toward those forms of electric generation. And the market system wouldn't do it.

And there may come a time when the market system will do it all by itself.

We won't make big changes. And it's so speculative anyway, in terms of even what the law would be.

But beyond that, if it becomes less speculative as the law and it really looks like something is going through, it doesn't change us big time at all.

Charlie?

CHARLIE MUNGER: Nothing to add. We're not going to change anything at the Berkshire — at the railroad — for some little tax jiggle.

WARREN BUFFETT: Yeah, if we need a bridge repaired, we're going to repair the bridge, you know. And if need — we need a lot of track maintenance all the time and that sort of thing. And it just, I don't think [BNSF's] Matt [Rose] and I have ever had a talk about it since we've owned the railroad, but —

WARREN BUFFETT: Gregg?

GREGG WARREN: Warren, my question also relates to Burlington Northern.

Despite the current administration's belief that they can bring the coal industry back, market forces continue to lead to the industry's demise.

While 90 percent of U.S. coal consumption is driven by electricity generation, natural gas has been both cheaper and cleaner burning, and renewable electricity generation has remade parts of the market as wind and solar have gained scale and become cheaper alternatives.

This has created problems for Burlington Northern, with coal shipments accounting for just 18 percent of volume and revenue for the railroad last year, down from an average of 24 percent for both measures the previous 10 years.

While some of this was due to large buildup of coal supplies the past couple of winters, which finally seem to be working their way out, what are your expectations for the contribution coal can make to BNSF longer term?

And I know that the railroad currently handles some export shipments going through Canada's Pacific Coast ports, but will there be enough growth there to offset domestic demand? Or will BNSF need to rely more heavily on segments like intermodal to offset lost coal volumes?

WARREN BUFFETT: Yeah, the answer is coal's — coal is going to go down over time. I don't think there's much question about that.

The specifics of any given year relate very importantly to the price of natural gas. I mean, right now there are — there —

Demand is somewhat up — fair amount up — from last year because natural gas is at 3.15 or 3.20, and the utilities can produce electricity, in many cases, quite a bit cheaper with coal than with natural gas. Whereas, with a $2, it would all be — it would be natural gas.

But over time, coal is — in my mind — is essentially certain to decline as a percentage of the revenue of the railroad.

The speed at which it does, you know, it — you don't build — create generation plants overnight. And so it —

You can't predict the rate. And if natural gas is cheap enough, it's going to be a — you'll see a big conversion back to natural gas.

So coal is a — coal is going to go down, as a percentage of revenues, significantly.

You know, certainly over 10 years it'll be quite significant, and who knows exactly, year by year. We are looking for other sources of growth than coal. If you're tied to coal, you got problems.

Charlie?

CHARLIE MUNGER: Well — you go out over the extremely long term, I think that all hydrocarbons will be used, including all the coal.

So I think that, in the end, these hydrocarbons are a huge resource for humanity, and I don't think we've got any good substitute.

And I've never minded saving them for the next generation. I don't like using them up very fast. So, I'm often on a road on my own on this one.

And people think that all this hydrocarbons are going to be stranded and the whole world's going to change. I think we're going to use every drop of the hydrocarbon sooner or later. We'll use them as chemical feed stocks. It's —

I regard all these things as very hard to predict. And I'm not at all sure that — I would eventually expect natural gas to be pretty short in supply.

WARREN BUFFETT: A change in storage would make a big difference.

We will produce, within a few years, as much electricity in Iowa — or virtually as much — electricity in Iowa from wind as our customers use. But the wind only blows about 35 percent of the time or something like that. And sometimes it blows too hard.

But the storage, you know, having it 24 hours a day, seven days a week, is a real problem, even if we've got the capability of producing, like I say, a self-sufficient amount, essentially, in Iowa before very long.

Coal — our shipments of coal are up fairly substantially this year on the BNSF. But they were very low last year, and as you said, stockpiles grew and have come down somewhat. They're still on the high side.

But in my mind — Charlie's got a longer-term outlook on this — in my mind, we're going to be shipping a whole lot less coal 10 or 20 years from now than we are now.

On the other hand, I think there's some decent prospects in other long hauls.

I mean, it's a pretty cheap way to move bulk commodities long distance. Rail is. And I think it's a good business, but the coal aspect of it's going to diminish.

WARREN BUFFETT: OK. Station 6.

AUDIENCE MEMBER: Good morning. It's Marcus Burns from Sydney, Australia.

My question, Mr. Buffett, is, you used to buy capital-light, cash-generative businesses, but now buy lower-growth, capital-consumptive businesses.

I realize Berkshire generates a lot of cash flow, but would shareholders have been better off if you had continued to invest in capital-light companies?

WARREN BUFFETT: Well, we'd love to find them. I mean, there's no question that buying a high-return-on-assets, very light-capital-intensive business that's going to grow beats the hell out of buying something that requires a lot of capital to grow.

And this varies from day to day, but I believe — and I don't think it's sufficiently appreciated. I believe that probably the five largest American companies by market cap — and some days we're in that group and some days we aren't — let's assume we're not in that group on a given day — they have a market value of over $2 1/2 trillion, and that 2 1/2 trillion is a big number.

I don't know whether the aggregate market cap of the U.S. market is, but that's probably getting up close to 10 percent of the whole market cap of the United States. And if you take those five companies, essentially, you could run them with no equity capital at all. None.

That is a very different world than when Andrew Carnegie was building a steel mill and then using the earnings to build another steel mill and getting very rich in the process, or Rockefeller was building refineries and buying tank cars and everything.

Generally speaking, over — for a very long time in our capitalism, growing and earning large amounts of money required considerable reinvestment of capital and large amounts of equity capital, the railroads being a good example.

That world has really changed, and I don't think people quite appreciate the difference.

You literally don't need any money to run the five companies that are worth collectively more than $2 1/2 trillion, and who have outpaced any number of those names that were familiar, if you looked at the Fortune 500 list 30 or 40 years ago, you know, whether it was Exxon or General Motors or you name it.

So we would love — I mean, there's no question that a business that doesn't take any capital and grows and has, you know, almost infinite returns on required equity capital, is the ideal business.

And we own a couple of businesses — a few businesses — that earn extraordinary returns on capital, but they don't grow.

We still love them, but if they had — if they were in fields that would grow, believe me, we wouldn't — you know, they would be number one on our list.

We aren't seeing those that we can buy and that we understand well.

But you are absolutely right that that's a far, far, far better way of laying out money than what we're able to do when buying capital-intensive businesses.

Charlie?

CHARLIE MUNGER: Yeah. The chemical companies of America, at one time, were wonderful investments.

Dow and DuPont sold at 20-some times earnings, and they kept building more and more complicated plants and hiring more Ph.D. chemists, and it looked like they owned the world.

Now, most chemical products are sort of commoditized and it's a tough business being a big chemical producer. And in comes all these other people like Apple and Google and they're just on top of the world.

I think the questioner's basically right that the world has changed a lot, and that the people who have made the right decisions in getting into these new businesses that are so different from the old ones have done very well.

WARREN BUFFETT: Yeah, Andrew Mellon would be absolutely baffled by looking at the high-cap companies now. I mean, the idea that you could create hundreds of billions of value essentially without assets — without tangible assets —

CHARLIE MUNGER: Fast.

WARREN BUFFETT: Fast, yeah. But that is the world. I mean, there is —

When Google can sell you something that — where GEICO was paying 11 bucks or something every time somebody clicked something — that is a lot different than spending years finding the right site and developing, you know, iron mines to supply the steel plants and, you know, railroads to haul the iron to where the steel is produced and distribution points, and all that sort of thing.

Our world was built — you know, when we first looked at it, our U.S. — our capitalist system, basically, was built on tangible assets, and reinvestment, and all that sort of thing, and a lot of innovation and invention to go with it.

But this is so much better, if you happen to be good at it, to essentially be able to build hundreds of billions of market value without really needing any capital.

That is a different world than existed in the past. And I think, listen, I think it's a world that is likely to continue. I mean, the trend is, I don't think the trend in that direction is over by a long shot.

CHARLIE MUNGER: A lot of the people who are chasing that sort of thing very hard now in the venture capital field are losing a lot of money. It's a wonderful field, but not everybody's going to win big in it. A few are going to win big in it.

WARREN BUFFETT: OK. Carol?

CAROL LOOMIS: This question is from a shareholder in California, in the Silicon Valley area, who didn't want his name mentioned because he said he wasn't looking for publicity, but whose picture makes him appear to be a millennial.

"Every Berkshire shareholder knows about the stock market value of Berkshire, but my question is about the value of Berkshire to the world.

"For instance, the value of Apple to the world has been iPhones. The value of GEICO is cost-effective auto insurance. The value of 3G," and I will tell you that there are some shareholders who would be arguing about it here, but "the value of 3G is improved operations."

"But about Berkshire, I just don't know. In managing Berkshire's subsidiaries, as Mr. Munger once famously said, you practice 'delegation just short of abdication.' So, hands-on management can't be the answer.

"That means the majority of Berkshire's subsidiaries would do just as well if they were to stay independent companies. So that's my question. What is the value of Berkshire to the world?"

WARREN BUFFETT: Yeah, well, the — I would say the question about — I'm with him to the point where he says that our — which he accurately describes as "delegation to the point of abdication."

But I would argue that that abdication, actually, in many cases, will enable those businesses to be run better than they would if they were part of the S&P 500 and the target, perhaps, of activists or somebody that wants to get some kind of a jiggle in the short term.

So I think that our abdication actually has some very positive value on the companies. But that, you know, you'd have to look at it company by company.

We've got probably 50 managers in attendance here. And naturally, they're not going to say anything, probably, on television or anything where they knock a certain thing.

But get them off in a private corner and just ask them whether they think their business can be run better with a "management by abdication" from Berkshire, but with also all the capital strengths of Berkshire, that when any project that makes sense can be funded in a moment without worrying whether the banks are still lending, like in 2008, you know, or whether Wall Street will applaud it or something of that sort.

So I think our very — our hands-off style, actually, I think can add significant value in many companies, but we do have managers here you could ask about that.

We certainly don't add to value by calling them up and saying that we've developed a better system, you know, for turning out additives at Lubrizol, or running GEICO better than Tony Nicely can run it or anything of the sort.

But we do take a — we have a very objective view about capital allocation.

We can free managers up. I would say that we might very well free up at least 20 percent of the time of a CEO in the normal public — who would have — otherwise have a public company — just in terms of meeting with analysts, and the calls, and dealing with banks, and all kinds of things that, essentially, we relieve them of so that they can spend all of their time figuring out the best way to run their business.

So I think we bring something to the party, even if it — even if we're just sitting there with our feet up on the desk.

Charlie?

CHARLIE MUNGER: Yeah. We're trying to be a good example for the world. I don't think we'd be having these big shareholders meetings if there weren't a little bit of teaching ethos in Berkshire.

And I've watched it closely for a long time. I'd argue that that's what we're trying to do, is set a proper example. Stay sane. Be honest. Yeah. (Applause)

So I'm proud of Berkshire, and I don't worry too much if we sell Coca-Cola. (Laughter)

WARREN BUFFETT: We — I would say, you know, GEICO is an extraordinarily well-run company and it would be extraordinarily well-run if it were public.

But it has gone from 2-and-a-fraction percent of the auto insurance market to 12 percent.

And part of the reason, a small part — the real key is GEICO and Tony Nicely — but part of the reason is that when other — at least two of our competitors — and big competitors — said that they would not meet their profit objectives if they didn't lighten up their interest in new business, eight or 10 months ago, I think our business decision to step on the gas is a better business decision.

But I think that GEICO, as a public company, would have more trouble making that decision than they do when they're part of GEICO [Berkshire].

Because we are thinking about nothing but where GEICO's going to be in five or 10 years, and if that requires having new— we want new business cost to penalize our earnings in the short-term.

And other people have different pressures. I'm not arguing about how the —how they behave, because they have a different constituency than GEICO has with Berkshire and what Berkshire has with its shareholders, in turn.

And I think in that case, our system's superior. But it's not because we work harder. Charlie and I don't do hardly anything. (Laughter)

WARREN BUFFETT: Jonathan?

JONATHAN BRANDT: Could you please talk about your periodic payment annuity business? The weighted average interest rate on these contracts is 4.1 percent, which doesn't sound particularly attractive given the current interest rate environment.

Is the duration of these liabilities long enough to make that an attractive cost of funds? Or were these contracts executed primarily when rates were higher?

WARREN BUFFETT: Well, those contracts — these are what are called structured settlements, primarily.

And when somebody young has a terrible auto accident or whatever it may be — perhaps urged by the court, urged by family members who really do have the interest of the injured party at heart, or — they may convert what could be a large sum settlement, probably against the insurance company — you know, maybe a million dollars, maybe $2 million — into periodic payments for the rest of the life of the injured party.

And we issue those for other insurance companies.

In fact, sometimes the court directs that Berkshire — or hints strongly — that Berkshire should be the one to issue those, because you're talking about somebody's life 30 or 40 or 50 years from now.

And the court, or the lawyer, or the family, they want to be very, very sure that whoever makes that promise is going to be around to keep it. And Berkshire has a preferred position in that.

We look — to get to your question, Jonny — we look for taking the longer maturity situations. We always have.

And we have to make assumptions about mortality, and we have to make — and then we have to decide at what interest rate we'll do it.

The 4.1 is a mix of a lot of contracts over a lot of years, obviously. We write maybe 30 million of these, 20 to 30 million a week, looking for the long maturities.

And so, if you take an average of 15 years, or something of the sort, that's how we come up with that sort of a figure. We adjust them to interest rates at all times.

And when doing that, we're making an assumption that we're going to earn more money that — than is inherent in the cost of these structured settlements. It's a business we've — I think we've got six or seven billion up now. And we'll keep doing them.

And incidentally, probably a significant percentage of the six or seven billion, we're not yet paying anything on. Somebody else may have the earlier payments. And they're certainly weighted far out. So it's a business that we'll be in 10 or 20 years from now.

We've got some natural advantage, because people trust us more than any other company to make those payments. And the test is whether we earn, over time, a return above that which we're paying to the injured party.

And that's a bet we're willing to make. But if interest rates continued at present levels for a long time — we would, assuming we kept the money in fixed-income instruments — we would — we'd have some loss in that.

We've got an allowance in there for the expenses, incidentally, because we do make monthly payments to these people, eventually.

And we have to keep track of whether they're still alive or not. Because you cannot count on the relatives of somebody that's deceased when a check is coming in every month to notify you promptly that the person has become deceased. But it's — it'll —

That number will go up over time. If interest rates stay where they are, that 4.1 will come down a little bit as we add new business.

WARREN BUFFETT: OK. Station 7.

AUDIENCE MEMBER: Thank you, Mr. Buffett and Mr. Munger, for all you've done and the opportunity to learn even more from your approach to investing and life.

My name's Harry Hong, and I'm a respirologist from Vancouver, British Columbia.

The question involves, back in 2001, you made an initial investment in USG, shortly before the company declared bankruptcy due to the mounting asbestos liability.

You held those shares through the bankruptcy process, even though standard wisdom says that the equity in Chapter 11 is usually worthless. Can you explain why USG's equity was a safe investment?

WARREN BUFFETT: Well, I don't really remember all the details then.

CHARLIE MUNGER: It was very cheap. (Laughter) Very cheap. (Laughter)

WARREN BUFFETT: Yeah, but I would say this. USG, we own — I'm not sure what percent, but it's very significant percentage. I don't know what —

CHARLIE MUNGER: Twenty percent, or something.

WARREN BUFFETT: Probably 30 percent or something like that. But USG, overall, has just been disappointing because the gypsum business has been disappointing.

And I think — I may be wrong — I think they went bankrupt twice, first from asbestos going back and then, subsequently, because they just had too much debt. So it has not been a brilliant investment.

Now if gypsum prices were at levels that they were in some years in the past, it would have worked out a lot better.

CHARLIE MUNGER: But it hasn't been terrible.

WARREN BUFFETT: No, it hasn't been terrible, but it — gypsum took — has taken a real dive several times, and there has been too much gypsum capacity.

And then when it comes back, the managements have been — not necessarily at USG, but including USG perhaps — they've gotten more optimistic about future demand than they should have. And it —

And they like — going back historically a way — they like to build new plants. And it's a business where the supply has been significantly — potential supply — has been significantly greater than demand in a lot of years. I mean, it —

You've seen housing starts in — since 2008 and 2009 — not come back anywhere near as much as people anticipated. So gypsum prices have moved up but not dramatically.

So just put that one down as not one of our great ideas. Not one of my great ideas. Charlie wasn't involved in that. It's no disaster, though.

CHARLIE MUNGER: No it isn't. It's —

WARREN BUFFETT: Becky?

BECKY QUICK (off microphone): This question — this question —

WARREN BUFFETT: Oh.

BECKY QUICK: Hello? Oh, there we go.

WARREN BUFFETT: OK.

BECKY QUICK: This question comes from Axel Meyersiek in Germany who writes, "If Ajit Jain were to retire, God forbid, be promoted, what would be the impact on the insurance operations, both with regards to underwriting profit as well as the development of float?"

WARREN BUFFETT: Well, nobody will — could possibly replace Ajit. I mean, it just — you can't come close.

But we have a terrific operation in insurance. We really do, outside of Ajit, and it's terrific-squared with Ajit.

There are things only he can do. But there are a lot of things that are institutionalized, a lot of things in our insurance business, where we've got extraordinarily able management, too.

So Ajit, for example, bought a company that nobody here has heard of, probably, called Guard Insurance a few years ago, based in worker's comp, primarily. It's based in — improbably — in Wilkes-Barre, Pennsylvania.

And it's expanding like crazy in Wilkes-Barre. And it — it's been a gem. And Ajit oversees it, but we've got a terrific person running it.

And we bought Medical Protective some years ago. Tim Kenesey runs that. Ajit oversees it, but Tim Kenesey can run a terrific insurance company, with or without Ajit. But he's smart enough to realize that, if you got somebody like Ajit that's willing to oversee it to a degree, that's great.

But Tim is a great insurance manager all by himself, and Medical Protective has been a wonderful business for us. Most people don't know we own it. The company goes back into the 19th century, actually.

We've got a lot of good operations. If you look at that section of the annual report called "Other" — insurance company, I mean that is — in aggregate, that is a wonderful insurance company. There's very few like it. GEICO is a terrific company.

So, Ajit has made more money for Berkshire than I have, probably. But we've still got what I would consider the world's best property-casualty insurance operation, even without him. And with him, you know, it — nobody, I don't think anybody comes close.

Charlie?

CHARLIE MUNGER: Well, a few years ago, California made a little change in its workmen's compensation law, and Ajit saw instantly that it would cause the underwriting results to change drastically.

And he went from a tiny percent of the market, (inaudible) 10 percent of the market, which is big, and he just grasped a couple billion dollars, at least, out of the air, like it was snapping his fingers. And when it got tough, he pulled back.

We don't have a lot of people like Ajit. It's hard to just snap your fingers and grab a couple billion dollars out of the air. (Laughter)

WARREN BUFFETT: Well, we've — actually, the California Workers' Comp (inaudible), Guard has moved into that. I — we have got a lot of terrific insurance managers. I mean, I don't know of a better collection any place. And Ajit has found some of those.

I've gotten lucky a few times. I mean, Tom Nerney at U.S. Liability, that goes back, what, 15, 16 years. He has a terrific operation. It's not huge, but it is so well-managed.

And people don't even know we own these things. But if you look at that last line — and now we've added Peter Eastwood with Berkshire Hathaway Specialty. And these are really good businesses, I got to tell you. (Laughs)

When you can produce underwriting prowess, and on top of that just hand more float — we don't have many businesses like that. Those are great businesses.

We've got a hundred — you know, whatever it is — a hundred billion-plus of money that we get to earn on, while at the same time, overall, you know, on balance, we're likely to make some additional money for holding it.

And if you can get somebody to hand you $104 billion and pay you to hold it while you get to invest and get the proceeds, it's a good business.

Now, most people don't do well at it. And, you know, the problem is that what I just described tempts lots of people to get into it.

And recently, people have gotten into it, really, just for the investment management. It's a way to earn money offshore. And we don't do that, but it can be done for small companies with investment managers.

So there's a lot of competition in it. But we have some fundamental advantages, plus we have — in certain areas — plus we have absolutely terrific managers to maximize those advantages. And we're going to make the most of it.

WARREN BUFFETT: I've just been handed something Kraft Heinz came out with. They just came out with it commercially a couple days — a few days ago, maybe a few weeks ago. At the directors' meeting they had this. I had three of these.

I'm sure that there's a member or two of the audience that may not approve of it, but they — (laughter) — I got to tell you folks, it's good.

It's a cheesecake arrangement with topping and Philadelphia Cream Cheese (Inaudible), so you create your own cheesecake.

And I thought that I can eat it while Charlie's talking. And — (laughter) — you'll be able to get it at the halftime. It's selling very well.

And I think, just so you don't feel too guilty, I think it's 170 calories for this cherry one. Like I say, I had three of these here. I don't mind having five- or 600 calories for dessert, you know. (Laughter)

I'll let somebody else eat the broccoli and I'll have the dessert. (Laughter)

So we'll be eating this, but you, too, at halftime — I think they brought 8- or 9,000 of these. I'll be disappointed if we don't run out. Actually, I'll be disappointed in you, not them. (Laughter)

WARREN BUFFETT: OK. Jay?

JAY GELB: This question is on the topic of succession planning.

Warren, there seem to be fewer mentions, by name, of top-performing Berkshire managers in this year's annual letter. Does this mean you're changing your message regarding the succession plan for Berkshire's next CEO?

WARREN BUFFETT: Well, the answer to that's no. And I didn't realize there were fewer mentions by name.

I write that thing out and send it to Carol [Loomis], and she tells me, "Go back to work." (Laughs)

I don't actually think that much about how many personally get named.

I would say this. And this is absolutely true. We have never had more good managers — now, it's because we've got more good companies — but we have never had more good managers than we have now, so I — but it has nothing to do with succession.

Charlie?

CHARLIE MUNGER: Well, I certainly agree with that. We don't seem to have a whole lot of 20-year-olds. (Laughter)

WARREN BUFFETT: Certainly not at the front table. (Laughter)

No, we've got an extraordinary group of good managers, which is why we can manage by abdication.

It wouldn't work if we had a whole bunch of people who were — had come with the idea of getting my job. I mean, if we had 50 people out there, all of who wanted to be running Berkshire Hathaway, it would not work very well. And —

But they have the jobs they want in life. Tony Nicely loves running GEICO. You know, it — then you go down the line. They have jobs they love.

And that's a lot better, in my view, than having a whole bunch of them out there that are kind of doing their job there kind of hoping the guys competing with them will fail so that, when I'm not around, that they'll get the nod.

It's a much different system than exists at most American corporations.

Charlie, got anything?

WARREN BUFFETT: Well, we'll go to Station 8.

AUDIENCE MEMBER: Hi, Warren and Charlie. My name's Vicky Wei. I'm an M.B.A. student from the Wharton School of Business.

This is my first time to be in the first — in the annual meeting. I'm really excited about it. Thanks for having us here. My —

WARREN BUFFETT: Thanks for coming.

AUDIENCE MEMBER: My question is, where do you want to go fishing for the next three to five years? Which sectors are you most bullish on, and which sectors are you most bearish on? Thank you.

WARREN BUFFETT: Yeah. Charlie and I do not really discuss sectors much. Nor do we let the macro environment or thoughts about it enter into our decisions.

We're really opportunistic. And we — we, obviously, are looking at all kinds of businesses all the time. I mean, it's a hobby with us, almost — probably more with me than Charlie.

But we're hoping we get a call, and we've got a bunch of filters.

And I would say this is true of both of us. We probably know in the first five minutes or less whether something is likely to — or has a reasonable chance of happening.

And it's just going to go through there, and it's going to — first question is, "Can we really ever know enough about this to come to a decision?" You know, and that knocks out a whole bunch of things.

And there's a few. And then if it makes it through there, there's a pretty good — reasonable chance we're going to — we may do something. But it's not sector specific. It —

We do love the companies, obviously, with the moats around the product long — where consumer behavior can be, perhaps, predicted further out. But I would say it's getting harder to — for us, anyway — to anticipate consumer behavior than we might've thought 20 or 30 years ago. I think that it's just a tougher game now.

But we'll measure it and we'll look at it in terms of returns on present capital, returns on prospective capital. We may have — we can —

A lot of people give you some signals as to what kind of people they are, even in talking in the first five minutes, and whether you're likely to actually have a satisfactory arrangement with them over time. So a lot of things go on fast, but it —

We know the kind of sectors we kind of like to — or the type of business we'd kind of like to end up in. But we don't really say, "We're going to go after companies in this field, or that field, or another field."

Charlie, you want to?

CHARLIE MUNGER: Yeah. Some of our subsidiaries do little bolt-on acquisitions that make sense, and that's going on all the time. And, of course we like it when —

But I would say the general field of buying whole companies, it's gotten very competitive. There's a huge industry of doing these leveraged buyouts. That's what I still call them.

The people who do them think that's a — kind of a bad marker, so they say they do private equity. You know, it's like (inaudible) a janitor call himself the chief of engineering or something. (Laughter) And —

But at any rate, the people who do the leveraged buyouts, they can finance practically anything in about a week or so through shadow banking. And they can pay very high prices and get very good terms and so on.

So, it's very, very hard to buy businesses. And we've done well, because there's a certain small group of people that don't want to sell to private equity. And they love the business so much that they don't want it just dressed up for resale.

WARREN BUFFETT: We had a guy some years ago, came to see me, and he was 61 at the time. And he said, "Look, I've got a fine business. I got all the money I can possibly need." But he said, "There's only one thing that worries me when I drive to work."

Actually, there's more than one guy's told me that that's used the same term.

He said, "There's only one thing that bothers me when I go to work. You know, if something happens to me today, my wife's left.

"You know, I've seen these cases where executives in the company try to buy them out cheap or they sell to a competitor and all the people —"

He says, "I don't want to leave her with the business. I want to decide where it goes, but I want to keep running it, and I love it."

And he said, "I thought about selling it to a competitor, but if I sell it to a competitor, you know, their CFO's going to become the CFO of the new company, and there, you know, on down the line.

"And all these people who helped me build the business, you know, they're — a lot of them are going to get dumped. And I'll walk away with a ton of money, and some of them will lose their job." He said, "I don't want to do that."

And he says, "I can sell it to a leveraged buyout firm, who would prefer to call themselves private equity, but they're going to leverage it to the hilt and they're going to resell it. And they're going to dress it up some, but in the end, it's not going to be in the same place. I don't know where it's going to go."

He said, "I don't want to do that." So he said, "It isn't because you're so special." He says, "There just isn't anyone else." (Laughter)

And if you're ever proposing to a potential spouse, don't use that line, you know. (Laughter)

But that's what he told me. I took it well, and we made a deal.

So, logically, unless somebody had that attitude, we should lose in this market. I mean, you can borrow so much money so cheap. And we're looking at the money as pretty much all equity capital.

And we are not competitive with somebody that's going to have a very significant portion of the purchase price carried in debt, maybe averaging, you know, 4 percent or something.

CHARLIE MUNGER: And he won't take the losses if it goes down. He gets part of the profit if it goes up.

WARREN BUFFETT: Yeah, his calculus is just so different than ours. And he's got the money to make the deal.

So, if all you care about is getting the highest price for your business, you know, we are not a good call.

And we will get some calls in any event. And we can offer something that — wouldn't call it unique, but it's unusual.

The person that sold us that business and a couple of others that have — actually it's almost, word for word, the same thing they say. They are all happy with the sale they made, very happy.

And, you know, they are — they have lots and lots and lots of money, and they're doing what they love doing, which is still running the business. And they know that they made a decision that will leave their family and the people who work with them all their lives in the best possible position.

And that's — in their equation, they have done what's best. But that is not the equation of many people, and it certainly isn't the equation of somebody who buys and borrows every dime they can with the idea of reselling it after they, you know, maybe dress up the accounting and do some other things.

And — but there — when the disparity gets so wide between what a heavily debt-financed purchase will bring as against an equity-type purchase, it gets to be tougher. There's just no question about it. And it'll stay that way.

CHARLIE MUNGER: But it's been tough for a long time, and we've bought some good businesses.

WARREN BUFFETT: Yeah. Yeah.

WARREN BUFFETT: OK. Andrew?

ANDREW ROSS SORKIN: Warren. This comes from a shareholder who I think is here, who asked to remain anonymous.

Writes: "Three years ago, you were asked at the meeting about how you thought we should compensate your successor. You said it was a good question, and you would address it in the next annual letter. We've been patiently waiting. (Laughter)

"Can you tell us now, at least philosophically, how you've been thinking about the way the company should compensate your successor, so we don't have to worry when the pay consultants arrive on the scene?"

WARREN BUFFETT: Yeah. Well, that — unfortunately, at my age I don't have to worry about things I say — said three years ago, but this guy, obviously much younger, remembers. (Laughter)

I'm not — well, I'll accept his word that I said that. But the — there's a couple possibilities, actually.

I don't want to get into details on them, but you may have — and I, actually, would hope that we would have somebody, A) who's already very rich — which they should be if they've been working a long time and have got that kind of ability — that's very rich, and really is not motivated by whether they have 10 times as much money that they and the families can need or a hundred times as much.

And they might even wish to perhaps set an example by engaging for something far lower than actually what you could say their true market value is. And that could or could not happen, but I think it'd be terrific if it did. But I can't blame anybody for wanting their market value.

And then — if they didn't elect to go in that direction, I would say that you — would probably pay them a very modest amount and then have an option which increased in value by — or increased in striking price — annually.

Nobody does this, hardly. The Washington — Graham Holdings has done it, The Washington Post Company did a little bit — but would increase because it's assuming that there were substantial retained earnings every year.

Because why should somebody retain a bunch of earnings and then claim they've actually improved the value, simply because they withheld the money from shareholders?

So it's very easy to design that, and in private companies people do design it in that way. They just don't want to do it in public companies, because they get more money the other way.

But they might have a very substantial one that could be exercised, but where the shareholder's — the shares had to be held for a couple years after retirement, so that they really got the result over time that the majority of the stockholders would be able to get, and not be able to pick their spots, as to when they exercised and sold a lot of stock.

It's — it would — it's not hard to design. And it really depends who you're dealing with, in terms of actually how much they care about money and having money beyond what they can possibly use.

And most people do have an interest in that, and I don't blame them.

But I don't know. What do you think, Charlie?

CHARLIE MUNGER: Well, I — one thing I think is that I have avoided, all my life, the compensation consultants. To me it's a — I hardly can find the words to express my contempt. (Laughter)

WARREN BUFFETT: I will say this. If the board hires a compensation consultant after I go, I will come back. (Laughter)

CHARLIE MUNGER: Mad. Mad.

So I think there's a lot of mumbo jumbo in this field, and I don't see it going away.

WARREN BUFFETT: Oh, it isn't going to go away. No, it's going to get worse. It — I mean, the — if you look at, I mean, the way compensation gets handled, I mean, it — you know, everybody looks at everybody else's proxy statement and says, "We can't possibly hire a guy that hasn't been — "

CHARLIE MUNGER: It's ridiculous.

WARREN BUFFETT: —so on. And the human relations department, you know, who work for the CEO, come in and suggest a consultant.

What consultant is ever going to get another assignment if he says, "You should pay your CEO below the — down in the fourth quartile because you're getting a fourth quartile result?" It —

I mean, it just, you know — it isn't that the people are evil or anything. It's just the nature of the situation just — it produces a result that is not consistent with how representatives of the owners should behave.

CHARLIE MUNGER: It's even worse than that. Capitalism is the golden goose that we all live on. And if people generally get so they have contempt for it because they don't like the pay arrangements in the system, your capitalism may not last as well. And that's like killing the golden goose.

So I think the existing system has a lot wrong with it.

WARREN BUFFETT: I think there is something coming in pretty soon — I may be wrong about this — where companies are going to have to put in their proxy statement the CEO's pay to the average pay, or something like that. That isn't going to change anything. I mean —

CHARLIE MUNGER: It won't change a thing.

WARREN BUFFETT: It won't change a thing. And, you know, it'll cost us virtually —

CHARLIE MUNGER: By the way, it won't get any headlines, either. It'll be tucked away.

WARREN BUFFETT: It'll cost us a lot of money, with 367,000 people employed around the world. And, I mean, we'll hope to get something that makes it somewhat simpler so we can use estimates or something of the sort.

But to get the median income or mean income or whatever, however the rules may read, you know, and —

CHARLIE MUNGER: That's what consultants are for, Warren. (Laughter)

WARREN BUFFETT: It — it's, you know, it is human nature that produces this. And, you know, the most —I write in this letter to the managers every two years, I said, "The only excuse I won't take on something is that everybody else is doing it."

But of course, "everybody else is doing it," is exactly the rationale for why people did not want to count the costs of stock options as a cost — I mean, it was ridiculous.

All these CEOs went to Washington and they got the Senate, I think, to vote 88 to 9 to say that stock options aren't a cost. And then a few years later, you know, it became so obvious that they finally put it in so it was a cost. You know, it reminded me of Galileo or something, I mean, all these guys.

CHARLIE MUNGER: Worse. It was way worse. The pope behaved better to Galileo in the —and he was —

WARREN BUFFETT: Well, anyway, it's — it — I would hope, you know, like I say, somebody — well — and it doesn't even have to be, I'm not talking about the current successor or anybody else.

I mean, successors down the line are probably going to have gotten very wealthy by the time they're running Berkshire. And the incremental value of wealth gets very close to zero at some point. And there is a chance to use it as a different sort of model.

But I don't have any problem, if it's — a system is devised that recognizes retained earnings. Nobody wanted — I've never heard anybody talk about it, you know, in the 20 boards I've been on.

You know, if you and I were partners in a business, you know, and we kept retaining earnings in the business and I kept having the value to buy a portion of you out at a constant price, you'd say, "This is idiocy."

But of course that's the way all option systems are designed, and it's better to be — for the CEO and for the consultants. And of course, usually if there's — there's some correlation between what CEOs are paid and what boards are paid.

If CEOs were getting paid at the rate that they got paid 50 years ago, adapted to present dollars, director pay would be lower. So it's — you know, it's got all these built-in things that, to some extent, sort of kindle the —

CHARLIE MUNGER: No Berkshire director is in it for the money.

WARREN BUFFETT: Well, they are if they own a lot of stock. And they bought it in the market just like the —

CHARLIE MUNGER: Yeah, it's —

WARREN BUFFETT: — shareholder did.

CHARLIE MUNGER: It's a very old-fashioned system.

WARREN BUFFETT: I looked at one company the other day, and seven of the directors had never bought a share of stock with their own money. Now they'd been given stock, but not one of them — I mean, I shouldn't say not one — seven of the directors had never actually bought a share of stock.

And there they are, you know, making decisions on who should be CEO and how they should be paid and all that sort of thing. But, you know, they never felt like shelling out a dollar themselves. Now they'd been given a lot of stock.

And it's, you know, we're dealing with human nature here, folks. (Laughs) And that — what you want is to have a system that works well in spite of how human nature's going to drive it.

And we've done awfully well in this country in that respect. I mean, American business has — overall has done very well for the Americans generally. But not every aspect of it is exactly what you want to teach your kids.

WARREN BUFFETT: OK. Gregg?

GREGG WARREN: Warren.

WARREN BUFFETT: Yeah.

GREGG WARREN: Between 2010 and 2015, intermodal rail traffic enjoyed double-digit rates of revenue growth as shorter-haul freight converted from truck to rail.

During the past year or so, though, cheaper diesel prices and more readily available truckload capacity have made trucking more competitive, leading to a decline in intermodal rail traffic.

While carload growth is expected to be solid longer term, helping to offset weakness in other segments like coal, what impact do you expect the widening of the Panama Canal, which was completed last year, to have on the West Coast port shipments that BNSF has traditionally carried through to exchange points for the Eastern U.S. railroads, as shippers elect to have goods unloaded at ports in the Gulf of Mexico or up the Eastern seaboard?

And while loss of volumes is never a good thing, could there be a small trade-off here as the bottleneck in Chicago, where most East-West cargo is handed off, eases a bit over time, if some of the current traffic gets rerouted?

WARREN BUFFETT: Well, you know — I — Chicago has got lots of problems, and it's going to continue for a while. I mean, that requires a good solution.

When you think of how the railroads developed, I mean, they — Chicago was the center and, you know, they laid the rails — and there were a whole bunch of different railroads — you know, a hundred years ago. And the city grows up around them and everything. So Chicago is a — can be a huge problem.

But getting to intermodal, I think intermodal will do very well. But you are correct that car loadings actually hit a peak in 2006, so here we are 11 years later.

And the investment of the five big Class I railroads — four of the biggest — if you look at their investment beyond depreciation, it's tens and tens of billions of dollars, and we're carrying less freight before, in aggregate, than we were in 2006. And coal will continue to decrease.

It's a good business, and it has big advantages over truck in many respects. Truck gets much more of a free ride in terms of the fact that their right of way, which is the highway system, is subsidized to a much greater degree beyond the gas tax — you know, we — than the railroad industry.

But it has not been a growth business, in physical volume, to any great degree. I think it's unlikely to be. I think it's likely to be a good business. I think we've got a great territory.

I like the West better than the East, and as you mention, you know, there will be some intermodal traffic that gets diverted to Eastern ports perhaps or so on.

Overall, I —we've got a terrific system in that respect. And we will do well.

It would be more fun if we had something where you could expect aggregate car loadings to increase two or three or four percent a year, but I don't think that's going to happen.

I do think our fundamental position is terrific, however. I think we'll earn decent returns on capital. But that's — I think that's the limit of it.

Charlie?

CHARLIE MUNGER: Nothing to add.

WARREN BUFFETT: OK. Station 9.

AUDIENCE MEMBER: I'm from — Shankar Anant from Gurnee, Illinois. Thank you for doing everything you do for us. I have a question.

The two of you have largely avoided capital allocation mistakes by bouncing ideas off of one another.

Will this continue long into Berkshire's future? And I'd like to — I'm interested in both at headquarters and at subsidiaries.

CHARLIE MUNGER: It can't continue very long.

WARREN BUFFETT: I — (Laughter)

Don't get defeatist, Charlie. (Laughter)

Any successor that's put in at Berkshire, capital allocation abilities, and proven capital allocation abilities, are certain to be uppermost in board's minds or in, in the current case — in terms of my recommendation, Charlie's recommendation, for what happens after we're not around.

Capital allocation is incredibly important at Berkshire. Right now we have 280 or -90 billion, whatever it may be, of shareholders' equity. If you take the next decade alone, you know, nobody can make accurate predictions on this.

But in the next 10 years, if you just take — and depreciation right now is another seven billion a year, something on that order.

The next manager in the decade is going to have to allocate, maybe, 400 billion or something like that, maybe more. And it's more than already has been put in.

So 10 years from now, Berkshire will be an aggregation of businesses where more money has been put in in that decade than everything that took place ahead of time. So you need a very sensible capital allocator in the job of being CEO of Berkshire. And we will have one.

It would be a terrible mistake to have someone in this job where, really, capital allocation might be — might even be their main talent. It probably should be very close to their main talent.

And of course, we have an advantage at Berkshire, in that we do know how important that is and there is that focus on it.

And in a great many companies, people get to the top through ability, and sales sometimes, if they come from the legal side, something like that — all different sides — and they then have the capital allocation, sort of, in their hands.

Now, they may not establish strategic thinking divisions. And they may listen to investment bankers and everything, but they better be able to do it themselves.

And if they've come from a different background or haven't done it, it's a little bit, as I put in one of my letters, I think — it's like getting to Carnegie Hall playing the violin, and then you walk out on the stage and they hand you a piano.

I mean, it is something that — Berkshire would not do well if somebody was put in who had a lot of skills in other areas but really did not have an ability to capital allocation.

I've talked about it as being something I call a "money mind." I mean, people can have 120 IQs or 140 IQs or whatever it may be, very similar scoring abilities in terms of intelligence tests. And some of them have minds that are good at one kind of thing and some of them another.

I've known very bright people that do not have money minds, and they can make very unintelligent decisions. They can do all kinds of other things that most mortals can't do. But it just doesn't, it isn't the way their wiring works.

And I've known other people that really would not do that brilliantly. They do fine, but on an SAT test or something like that. But they've never made a dumb money decision in their life. And Charlie, I'm sure, has seen the same thing.

So we do want somebody — and hopefully they've got a lot of talents — but we certainly do not want somebody that — if they lack a money mind.

Charlie?

CHARLIE MUNGER: Well, there's also the option of buying in stock, which — so, it isn't like it's some hopeless problem. One way or another, something intelligent will be done.

WARREN BUFFETT: And a money mind will recognize when it makes sense to buy in stock and doesn't. You know, and —

In fact, it's a pretty good test for some people, in terms of managements, how they think about something like buying in stock, because it's not a very complicated equation if you sort of think straight about that sort of a subject.

But some people think that way and some don't, and they're probably miles better at something else. But they say some very silly things when you get to something that seems so clear as whether, say, buying in stock makes sense.

Anything further, Charlie?

CHARLIE MUNGER: No.

WARREN BUFFETT: OK, Carol?

CAROL LOOMIS: This question comes from Steve Haverstroll (PH) of Connecticut.

"Warren, you have made it very clear in your annual letter that you think the hedge fund compensation scheme of '2 and 20' generally does not work well for the fund's investors.

"And in the past, you have questioned whether investors should pay, quote, 'financial helpers,' unquote, as much as they can. But financial helpers can create tremendous value for those they help.

"Take Charlie Munger, for instance. In nearly every annual letter and on the movie this morning, you describe how valuable Charlie's advice and counsel has been to you and, in turn, to the incredible rise in Berkshire's value over time.

"Given that, would you be willing to pay the industry standard, quote 'financial helper' fee of one percent on assets to Charlie? Or would you perhaps even consider '2 and 20' for him? What is your judgment about this matter?"

WARREN BUFFETT: Yeah. (Laughter)

Well, I've said in the annual report that I've known maybe a dozen people in my life — and I said there are undoubtedly hundreds or maybe thousands out there.

But I've said that I've known, personally, a dozen where I would have predicted or did predict — in a fair number of those 12 cases — I did predict that the person involved would do better than average in investing over a long period of time.

And obviously, Charlie is one of those people. So would I pay him? Sure. But would I take financial advisors as a group and pay them one percent with the idea that they would deliver results to me that were better than the S&P 500 by one percent, and thereby leave me breaking even against what I could have done on my own? You know, there's very few.

So it's just not a good question to ask whether, you know, I'd pay Charlie one percent. That's like asking, you know, whether I'd have paid Babe Ruth, you know, 100,000 or whatever it was to come over from the Red Sox to the Yankees. I mean, sure I would have, but there weren't very many people I would have paid 100,000 to in 1919, or whatever it was, to come over to the Yankees.

And so, the — it's a fascinating situation, because the problem isn't that the advisors are going to do so terrible. It's just that you have an option available that doesn't cost you anything that is going to do better than they are, in aggregate.

And it — it's an interesting question. I mean, if you hire an obstetrician, assuming you need one, they're going to do a better job of delivering the baby than, you know, if the spouse comes in to do it, or if they just pick somebody up off the street.

And if you go to a dentist, if you hire a plumber, in all of the professions, there is value added by the professionals as a group, compared to doing it yourself or just randomly picking laymen.

In the investment world, it isn't true. I mean, they, the active group, the people that are professionals, in aggregate, are not, cannot do better than the aggregate of the people who just sit tight.

And if you say, "Well, in the active group there's some person that's terrific," I will agree with you. But the passive people can't all pick that person. And they wouldn't — they don't know how to identify them. So I —

CHARLIE MUNGER: It's even worse than that. The (inaudible) — the expert who's really good, when he gets more and more money in, he suffers just terrible performance problems.

WARREN BUFFETT: Yeah. Yeah.

CHARLIE MUNGER: And so you'll find the person who has a long career at "2 and 20," and if you analyze it, net, all the people who've lost money because some of the early people have had a good record but more money coming in later and they lose it.

So, the investing world is just, it's a morass of wrong incentives, crazy reporting, and I'd say a fair amount of delusion.

WARREN BUFFETT: Yeah, if you asked me whether I — those 12 people I picked would do better than the S&P working with a hundred billion dollars, I would answer that probably none of them would. I mean, they — that would not be their prospective performance.

They're not, but when I was talking of them, I — you know, or referencing them — and when they actually worked in practice, they dealt, generally, with pretty moderate sums. And as the sums grew, their relative advantage diminished.

It — I mean, it's so obvious from history. The example I used in the report — I mean, the guy who made the bet with me, and incidentally all kinds of people didn't make the bet with me because they knew better than to make the bet with me.

You know, there were hundreds, at least a couple hundred underlying hedge funds. These guys were incented to do well. The fund of fund manager was incented to pick the best ones he could pick. The guy who made the bet with me was incented to pick the best fund of funds.

You know, and tons of money, and just in with those five funds, a lot of money went to pay managers for what was subnormal performance over a long period of time. And it can't be anything but that.

And it's an interesting — you know, it's an interesting profession when you have tens of thousands, or hundreds of thousands of people, who are compensated based on selling something that, in aggregate, can't be true: superior performance. So —

But it'll continue, and the best salespeople will tend to attract the most money. And because it's such a big game, people will make huge sums of money, you know, far beyond what they're going to make in medicine or you name it. I mean, you know, repairing the country's infrastructure, I think.

I mean, the big money — huge money — is in selling people the idea that you can do something magical for them.

And if you have — if you even have a billion-dollar fund, you know, and get two percent of it — for terrible performance, you make — that's $20 million.

In any other field, you know, it would just blow your mind. But people get so used to it, you know, in the Wall — in the field of investment that it just sort of passes along. And $10 billion, I mean, $200 million fees?

We've got two guys in the office, you know, that are managing $11 billion. Well, no they're not. I'm sorry. Yeah, they're managing 20 billion, you know, between the two of them, 21 billion maybe.

And, you know, we pay them a million dollars a year, plus the amount by which they beat the S&P. They have to actually do something to get contingent compensation, which is much more reasonable than the 20 percent.

But how many hedge fund managers in the last 40 years have said, "I only want to get paid if I do something for you?" You know, "Unless I actually deliver something beyond what you can get yourself, you know, I don't want to get paid." It just doesn't happen.

And, you know, it get back — it's get back — it gets back to that line that I've used, but when I asked a guy, you know, "How can you, in good conscience, charge '2 and 20?'" And he said, "Because I can't get 3 and 30." You know — (Laughter)

Any more, Charlie? Or have we used up our —

CHARLIE MUNGER: I think you've beaten up on them enough.

WARREN BUFFETT: Yeah, well. (Laughter)

WARREN BUFFETT: Jonathan.

JONATHAN BRANDT: Precision Castparts represents the second largest acquisition Berkshire has ever made. There wasn't much qualitative or quantitative information about it in the 2016 annual.

Would you be willing to update us here with how it is doing currently, what excites you about its prospects, and what worries you most about it?

I'm also curious if there were any meaningful purchase price adjustments beyond intangible amortization that negatively impacted Precision's earnings in 2016, as was the case with Van Tuyl in 2015?

And finally, are there any opportunities in sight for bolt-on acquisitions?

WARREN BUFFETT: Yeah, we've actually made acquisitions, and we will make more that fit there, because we've got an extraordinary manager. And we've got a terrific position in the aircraft field.

So there will be sensible — there will be the chance for sensible acquisitions. And we've already made two, anyway. And we will make more over time. The — it's —

The amortization of intangibles is the only big purchase price adjustment. That's something over $400 million a year, nondeductible. In my mind, that's 400-and-some million of earnings.

I do not regard the economic goodwill of Precision Castparts being diminished at that rate annually. That is a — and, you know, I've explained that in some degree. The —

As a very long-term business, you can worry about 3-D printing. I don't think you have to worry about aircrafts being manufactured. But aircraft deliveries can be substantially altered in relation to any given backlog in most cases.

So the deliveries can be fairly volatile, but I don't think the long-term demand is anything I worry about.

And the question is, whether anybody can do it better or cheaper, or like I say, whether 3-D printing at least takes away part of the field in some respects.

But overall, I would tell you I feel very good about Precision Castparts. It is a very long-term business. I mean, we have contracts that run for a very long time, and like I say, the initiation of a new plane may be delayed or something of the sort.

But if you take a look at the engine that's in the other adjoining room here and in our exhibition hall, you would, if you were putting that engine together for the 20 or 25-year life or whatever it may have, carrying hundreds of people, you would care very much about your supplier.

And you'd care not only in the quality, you know — which would be, absolutely you'd care — of the work being done. But you also, if you were an engine manufacturer or an aircraft manufacturer further down the line, you would care very much about the reliability of delivery on something.

Because you do not want a plane that — or an engine — that's 99 percent complete while somebody's dealing with a problem of faulty parts or anything else that would delay delivery.

So, the reliability is incredibly important. And I don't think anybody has a reputation better than Mark Donegan for — and the company — for delivery.

So I love the fact we bought Precision Castparts.

Charlie?

CHARLIE MUNGER: Yeah, well, what's interesting about them, too, is that it's a very good business purchased at a fair price under — but this is no screaming bargain like the old days.

WARREN BUFFETT: No.

CHARLIE MUNGER: For quality businesses, you pay up now a lot more than we used to.

WARREN BUFFETT: Yeah, that's absolutely true, and we — you don't get a bargain price.

The 400-plus million incidentally, you know, goes on for quite a while, too.

And we'll explain it in the report just like — just as we'll explain that the depreciation charge at a railroad would not be adequate. I mean, it's the way accounting works.

WARREN BUFFETT: And starting — I don't even want to tell you about this one — but starting the first of next year, accounting is going to become sort of a nightmare in terms of Berkshire and other companies because they're going to have us mark our equities to market just like we were a Wall Street trading firm or something.

And those changes in the value of Coca-Cola, or American Express, or everything, are going to run through the income account every quarter. In fact, they run through it every day in this theory, so that it really will get confusing.

Now, it's our job to explain things so that you aren't confused when we report GAAP earnings, but GAAP earnings, as reported, will become even more meaningless, if looking only at the bottom line, than they are now, and —

CHARLIE MUNGER: That was not necessarily a good idea.

WARREN BUFFETT: No, I think it's a terrible idea, but we'll deal with it. And we'll — and, I mean, it's my job to explain to what extent GAAP accounting is useful to you in evaluating Berkshire, and the times when it actually distorts things.

Accounting isn't supposed to — it's not supposed to describe value.

On the other hand, it's a terribly useful tool, if understood, in order to estimate value if you're analyzing businesses. And so, you know, certainly, you can't blame the auditing profession for doing what they think is their job, which is not to present value. Although, by using these market values —

CHARLIE MUNGER: But you can blame the audit —

WARREN BUFFETT: What's that?

CHARLIE MUNGER: You can blame the audit profession for that one.

WARREN BUFFETT: OK, well.

CHARLIE MUNGER: That was really stupid. (Laughter)

WARREN BUFFETT: Well, I agree with that actually. (Laughter)

But we will do our best to give you — we're always going to give you the audited figures.

And then we're going to explain their shortcomings in either direction and how they — how what you should use and what you probably should ignore in looking at those numbers and using them to come to a judgment as to the value of your holdings.

And I'll explain it to you the same way I would explain it to my sisters or anybody else that — you know, we want you to understand what you own. And we try to cover the details that are really important in that respect.

I mean, there's a million things you can talk about that are just of minor importance when you're talking about a $400 billion market value.

But they're the things that, if Charlie and I were talking about the company, that they'd be the figures or the interpretations or anything that we would regard as important in sort of coming to an estimate of the value of the business. But it's going to be —

You can't knock the media. I mean, they've only got a few paragraphs to describe the earnings at Berkshire every quarter. But if they simply look at bottom line numbers, what can be silly this year will become absolutely ludicrous next year because of the new rule that comes into effect for 2018.

WARREN BUFFETT: OK. Station 10.

AUDIENCE MEMBER: Hello Warren. This is a question from China.

VOICE: (Inaudible)

WARREN BUFFETT: Pardon me?

AUDIENCE MEMBER: I am Jeff Chan (PH), a pension fund manager from China, Shanghai. My question is quite simple.

What is the probability of duplicating your great investment track record in China's stock market the next decades or two in terms of a (inaudible)? That's all.

And I thank my friends from (FOREIGN LANGUAGE) Fund Management House for guiding me in writing this question. Thank you.

WARREN BUFFETT: Charlie, you're the expert on China. (Laughter)

CHARLIE MUNGER: It's like determining the order of precedency between a louse and a flea. Yeah.

I do think that the Chinese stock market is cheaper than the American market. And I do think China has a bright future. And I also think that there'll be growing pains, of course. And —

But —

WARREN BUFFETT: Well —

CHARLIE MUNGER: We have this opportunistic way of going through life. We don't have any particular rules about which market we're in or anything like that.

WARREN BUFFETT: Well, Charlie's delivered a headline anyway, now: "Munger Predicts China Market Will Outperform U.S." (Laughter)