Berkshire Hathaway Inc. (BRK.A)

ASM 2002 Part 2

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May 4, 2002

You've heard us talk here about the importance of our managers. However, occasionally, Charlie and I get involved in management ourselves and we would normally be too modest to claim any great accomplishments, but we have had one rather incredible performance, which since Charlie participated in it well as I do, I think if we put up the slide on the company that Charlie and I have managed personally, you'll see that this entity, you can't Charlie, here it is right here. It's one where we took over 30 odd years ago. And as you can see, 46,000 excuse me, are you sure? Oh, okay. I guess we better put up the next slide. They got that first, they got it reversed. We were doing $120,000,000 when we took over and we're now doing $46,000 a year. But we may get a bounce one of these years. That was a company that also had a lot of float and we were attracted to. And the interesting thing is this was blue chip stamps, although blue chip was a copy of a sword of Sperry and Hutchinson, which really was the main inventor of trading stamps on a large scale in the country and they go back to the 19th century. But if you think about it, S and H stamps, green stamps or blue chip stamps had many similarities to frequent flyer miles. The only difference being that you got them a lot of like grocery stores and all of that and then you had to look and put them in a book and what whereas now it's all done electronically. But the basic underlying business was very similar to frequent flyer miles which had this incredible hold on the American public. But somehow, we were not able to make the transfer. We haven't yet made the transformation, let's put it that way, from the Lickett stamp to something that the public will accept. But we've still got $47,000 of revenue annually from the entire state of California. So we're building a base. Charlie and I continue to spend most of our time working on this one. Let's go to Area 7. I think we stopped in Area 6 last time and we'll go from there. Yes. My name is Mort November. I'm from Cleveland, Ohio. I'm here with my wife, Iris, who in 1986 founded the Statue of Liberty Collectors Club. I wanted to tell you personally what Berkshire Hathaway has meant for me. By owning it, we have become philanthropists in Cleveland. And the way it happened is we sold all our other stock. It was never any fun owning it. And I could never understand that my stock went down and the CEO's bonuses went up. So got rid of that and we took all of that money and we're doing things for children in Cleveland. On May 16th, we're sending a group. Thank you. On May 16th, for the 10th year in a row, we're sending a group of children from Cleveland Municipal Schools who win the trip by doing good work in their class and good work in the community to Dearborn, Michigan Henry Ford Museum Greenfield Village. It's a lot of fun for them and it's really a lot of fun for us. We invested in a building in the Cuyahoga National Park for campers, And hopefully, we'll be able to help put up an addition to a library in East Cleveland, Ohio, which really needs all the help it can get. So my wish for you, gentlemen, is that you have many, many more years of good health and that we have the opportunity to see you on this stage or any stage for as many years as you want. I salute you both. Thank you. Thank you. It's terrific what a number a large number of Berkshire shareholders, particularly the ones perhaps, well maybe not particularly but in the Omaha area because they go way back to the partnership and a number of them are in their mid-70s or thereabouts. But there have been a lot of things that have come out of the stock. In fact, there's been a suggestion that somebody may do a book on some of the things that have flowed from various Berkshire shareholders. I'm sure many of you know about the case of Don and Mid Othmer. Don went to Central High here in Omaha. Mid Othmer's mother, Maddie Top was a wonderful woman who was the customer when I started selling securities when I was 20 or 21 and she ran a dress shop and they left about $750,000,000 to a group of mainly 4 or 5 charities, one of which was the University of Nebraska. But there have been all kinds of things in there. There may actually be something done on that at some point, but I'm glad to hear what you're doing in Cleveland. Let's hear from Area 8, please. Hi. My name is Jennifer Perlman from Toronto, Canada. Mr. Buffett, in 1998, you were asked to comment on the pharmaceutical industry. And at that time, your answer was that you considered it a mistake not to have taken a basket approach to the industry. I was wondering if you could revisit the issue now that valuations have contracted so dramatically. And also considering that healthcare spending is outpacing inflation, and that there are significant motes in the industry, I was wondering if you could share with us your thoughts on the healthcare industry at large. Charlie may be better equipped on that than I am but certainly it's been as an industry a very, very good business over time. I mean if you the aggregate capital in it and what it's earned over time, it's been a very, very good business and we did make a mistake. Your memory is 100% accurate and what we said earlier meetings because we should have taken a package approach. We actually did buy a tiny, tiny bit, but that's worse than buying none almost. I mean, it's just aggravating. Back there in 'ninety three, they're certainly the kind of businesses that as an industry we can understand, we would not have great insights on specific companies. So if we did something, it would we would be more inclined to do it on an industry wide basis. It's hard to evaluate the individual companies. As you know, Bristol Myers has recently had a big stumble and even Merck has fallen back and so it's hard to pick the winners but that's no reason not to have a basket approach to the industry and at some valuation level it would be something we would think very hard about and it's something where we could put quite a bit of money if it happened, which is another plus to us. Charlie? Well, having failed to get it right the last time, we'll probably fail to get it right the next time. I don't know what he had for lunch. Okay, we'll go to number 1. Well, wait a second. Is there anybody at number 9? Probably not now. Yes, there is. Okay. Good enough. 9. Phil McCall from Greenwich, Connecticut. Could you discuss if and how you take into account the individual balance sheets of the Coca Cola bottlers to The Coca Cola Company and if you view various regulatory control issues as a potential problem for Coca Cola? Yes. Well, certain Coca Cola bottlers became quite leveraged. The ones that were in general acquiring companies. Coca Cola Enterprise certainly became very leveraged over started out fairly leveraged and it became more leveraged in recent times. And they have a business that's a solid steady business, but it's not one with abnormal profitability. So it can take leverage in the sense that it won't be subject to huge dips, but it also is a business where it's very tough to increase margins significantly. So if most of the money goes to debt service, that is something that you have to take into account when you value the equity. It's a fairly capital intensive business, the bottling business. On average, you'll probably spend between 5% 6% of revenues on capital expenditures just to stay in the same place. And in a business that before depreciation makes an interest in taxes makes maybe $0.15 on the dollar, having $0.05 or $0.06 on the dollar go to capital expenditures is a pretty healthy percentage of that. That's true at the Pepsi Cola Bottling Company too. It's just the nature of the bottling business. It's a reason why I like basically the syrup business better than the bottling business. It's less capital intensive. And then the bottling business is a perfectly decent business. It isn't a wonderful business because it's very competitive out there. I mean, on any given weekend, the big supermarket in town or the Walmart or whatever is going to be featuring 1 or the other of the colas and they're going to it's going to be based on price and you're going to read ads saying, you know, 12 or something or other or 6 or something or other. And it has become something where a lot of people will switch from one to another based on price on that weekend and that makes it tough business for bottlers. But it's a decent business. But it doesn't in terms of the Coca Cola Company itself, its bottlers are going to do perfectly okay over time and they've got to earn enough money to be able to sustain that kind of capital expenditure and earn a cost of capital. And if they get in trouble, it's because they if they pay too much for another bottle, it gets tough to make the math work. Is there a second question about Coca Cola then too? Well, I was curious if you concern yourself when you see FASB type issues come out about control. No. Yes. No, I understand. And buying all the balance sheets type of thing. Yes. That really doesn't make any difference to us. I mean, in the end, the Coca Cola Company, there's no question about it in my mind, Coca Cola Company needs a successful bottling group in order to prosper as a syrup manufacturer. But the profitability of bottling will allow that and the capital requirements at the big coke as it's called are relatively minor. So most of the money they make can either be used as dividends or share repurchases, but nobody's going to run out of money at Coca Cola nor are their bottlers basically going to run out of money. So it is not a big balance sheet issue at all. And whether the figures are consolidated or otherwise, the economics are basically the same. I mean, you have a it is not there's not going to be a capital crunch of any kind. It would show different ratios if you consolidate and if you didn't, but it really wouldn't change the economics any. Charlie? Yes. I don't think it changes anything on a basic level. But ideally, in the world, you wouldn't have capitalization structures that are designed partly for appearances sake. Thank you. We pay a lot of attention to what we regard as the reality of the balance sheets and economic conditions and cash situation, all of that of a business. And sometimes we think accounting reflects reality and sometimes we don't. It's a good starting point for us always. But I mean, there are companies in the United there's at least one company at least last year that was using a 12% investment return assumption on its pension plan and there are other companies that use, I think, even below 6%, certainly 6. And in the end, should we look at the figures the same of 1 company, particularly the pension fund is a big element that uses 12% and 6%. No, we look at what it says they're using. But in our minds, we don't think the company that's using a 12% assumption is likely to do any better with their pension fund. That's the one that's using 6%. In fact, we might even think the one that's using 6% is likely to do better because we might think they're more realistic about the world. So we start with the figures of the companies we look at, but we've got our own model in mind as to what they will look like. It's true of our the businesses we own 100 percent of. Some of them have some debt in them, some of them don't. Partly that situation is inherited. In the end, we've got the same metrics that apply to them whether they happen to have some debt on their own particular balance sheet or not because in the end, we're not going to be willing to have very much debt at all at Berkshire. And where it's placed doesn't really make any difference because we're going to pay everything we owe no matter where it is. And it's almost an accident whether Company A or Company B has a little debt attached to it. Area 10, is there anybody there? Yes, sir. My name is Adam Shud. I'm from Columbus, Ohio. I attend the Ohio State University. My question is your comments on the new standards for the accounting of goodwill. Yes. The question about the new standards for goodwill. Actually, if you read, I think, the annual report that maybe the 2000 annual report and maybe even earlier, but we prescribed we said what we thought would be the preferable system for how goodwill was handled namely that it would not be amortized and that combinations of companies be accounted for as purchases. And it pretty well is what ended up coming out of the accounting profession. So the goodwill rules now are in accord with what we believe they should be. And for a long time, they weren't. You might argue that it was against our interest to have what we think proper accounting is put in because some people were averse to buying businesses because of a goodwill charge they would incur, whereas it didn't make no difference to us whatsoever. We just looked at the underlying economics. So we may have a little more competition even on buying businesses simply because now competitive buyers are not faced with a goodwill charge, which may have bothered them but didn't bother us. I regard the present goodwill rules as making sense. Charlie? Well, I agree. Okay. Thank you. Area 1. My name is Martin Wiegand from Bethesda, Maryland. Thank you for hosting this wonderful and informative shareholder meeting. Thank you also for running a Berkshire in a manner that is an example to corporate America and the world. You make us proud to be shareholders. My question, you touched on just before the lunch break. Did the compensation plans at Berkshire and its competitors have anything to do with the mispriced insurance policies they issued? And if so, has Berkshire's competitors changed their compensation plans to correctly price those policies? It's certainly my I asked you this last year, I think, but are you my Martin's son or grandson? Son. Son. Okay. Good enough. Martin's father and I went to high school together. As a matter of fact, your Aunt Barbara and I went to high school together also and she went out on one date with me and that was the end. It was not because I didn't ask her out again, but I picked her up in her hearse. I think that kind of put the I think compensation plans lead to a lot of silly things, but I would say that at at Berkshire's Insurance Companies, I don't think I don't think our problems resulted from compensation plans at all. I think we had an and we're talking about General Reh here basically because that's where we had the problem. I think General Reh had an enormously successful operation and which went on for a long time and I think that there was some drift away perhaps because competitors were drifting away in a big way too from certain disciplines and we paid a price for that. But I don't think the comp plans entered in any significant way, if at all, into the fact that we did drift away for a while. I think you want to have rational comp plans. I think we've got a rational comp plan at General Reeb, and it's quite similar to what we had before. And I just I don't think that was the problem. I it's very difficult. It's difficult in the investment world. When other people are doing things that look like they're working very well and they get sillier and sillier, it could be difficult for many people to not succumb and do the same things and that happens in investments but it also happens in insurance and it was, you know, it's a competitive world and your people are out there every day and they're competing against Swiss Re and Munich Re and Employers Re and all of these people and you've worked hard to get clients and the client says I want to stay with you. But the competitor says if I go with him I don't have to do this or that or I can get a little cheaper whatever. It's you know that it's tough to walk away and it may even be a mistake to walk away in certain cases. So I just think that there was a what you might call a cultural drift. I don't think it was a shift, but it was a drift and I think it was produced in part by the environment in which the company was operating and it took a joke to get it back and I think that it is back. I think it's probably stronger than ever in terms of what we have now but I would not attribute it much to the compensation system but I have seen a great many compensation systems that are abominations and lead to all kinds of behavior that I would regard not as in the interest of shareholders. But I don't think we've had much of that at Berkshire. Charlie? Yeah. I think if you talk generally about stock option plans in America, you see a lot of terrible behavior caused and no doubt they do a lot of good at other places. But whether they do more good than harm overall, I wouldn't know. I think in particular, you have a corporation where a man has risen to be CEO. He now has 100 of 1,000,000 of dollars in the stock of the company. He's been loyal to the company and the company has been loyal to him for decades. And he has his directors, Vodim, a great stock option annually to preserve his loyalty to the company and his enthusiasm to the business when he's already old, I think it's demented. How about when they grant out, they leave the company? And I also think it's immoral. I think that there comes a time when when And I don't think you would improve the behavior of the surgeons at the Mayo Clinic or the partners of Crevasse, Wayne and Moore if you gave the top people stock options in their 60s. I mean, by that time, you ought to have settled loyalties And, you ought to be thinking more about the right example for the company than whether you take another $100,000,000 for yourself. Yeah. Well, we had a case. We've inherited some option plans because companies we merged with had them and some cases they got settled for cash at the time, some cases they continued on depending on situation. But more money has been made from options at Berkshire by accident and this is not it just happened that way, but more money was made by people that had options on General Re stock during a period when General Re contributed to a decrease in value of Berkshire. So we had all of the other managers essentially in great many cases turning in fine results and we had a bad result at General Re and yet more money by a significant margin was made under options at General Re than has been made probably by all other entities combined. But it was an accident, but that's the point. It leads it can lead to extremely capricious compensation results that have no bearing on the performance of the people. In some cases get great benefits and in other cases people did great jobs and their efforts were negated by results elsewhere. So it would be very capricious at Berkshire. You can argue that at Berkshire, for those that succeed me and Charlie that anybody that is in the very top position at Berkshire has got the job of allocating resources for the whole place. There could be a logically constructed auction plan for that person and it would make some sense because they are responsible for what takes place overall. But a logically constructed plan would have a cost of capital build into it for every year. We don't pay out any dividends. So why should we get money from you free? We could put it in a savings account and it would grow in value without us doing anything and a fixed price option over 10 years would accrue dramatic value to whoever was running the place if they had a large option for putting the money in a savings account or in government bonds. So there has to be a cost of capital factor in to make options equitable. In my view, there can be cases where they make sense. They should not be granted it below the intrinsic value of the company. I mean, the market CEO says, my stock is ridiculously low when a merger when somebody comes around and wants to buy the company, but then grants himself an option at a price that just gotten through saying is ridiculously low that bothers me. So if somebody says, I wouldn't we don't want to sell this company for less than $30 this year because it's going to be worth a lot more later on. My notion is that the option should be at $30 even if the stock is $15 Otherwise, you have an actually a premium built in for having a low stock price in relation to value. And I've never gotten too excited about that. Charlie, do you have any further thoughts on options? Well, we've been, we're so different from the rest of Corporate America on this subject that we can sound like a couple of Johnny One notes, but I don't think we ever quite tire of the subject. A lot is horribly wrong in corporate compensation in America. And the system of using stock options on the theory they really don't cost anything has contributed to a lot of gross excess. And that excess is not good for the country. You know, Aristotle said that systems work better when people look at the different outcomes and basically appraise them as fair. And when large percentages of people look at corporate compensation practices and think of them as unfair, it's not good for the country. It will be It will be hard to change though because basically the corporate CEOs have their hands on the switch. I mean they control the process. You can have comp committees and all of that, but it's a practical matter. I've been on 19 public boards, Charlie has been on a lot of them and in the end the CEOs tend to get pretty much what they want and what they want tends to go up every year because they see other people getting more every year and there's a ratcheting effect and the consultants fan the flames and it's very difficult to get change and right now you've got corporate CEOs descending upon Washington to doing everything from trying to persuade to threaten your elected representatives to not have options expensed. And it's I think it's kind of shameful actually because this group who is getting fed very well under the system does not want to have those what clearly is a compensation expense recorded because they know they won't get as much. I mean, it's that simple and it's not based on anything much more complicated. Area 2. Good afternoon. David Winters, Mountain Lakes, New Jersey. Mr. Buffet and Mr. Munger, thank you for hosting Woodstock for Capitalists. I know it's a lot of fun for everybody and I think a lot of fun for you too. Assuming growth of low cost float and the sins of the past do not impede progress, does the sheer size of the float create constraints that change the allocation of future investments to more high quality fixed income obligations rather than equity coupons or workouts that can grow over time. It seems otherwise, Virtuar is incredibly well positioned if valuations ever decline. Well, I think the answer is we probably are pretty well positioned if valuations decline. And it's a good question. If you have $37,000,000,000 afloat, are you going to be more constrained to conventional investments than if you were working with a $500,000,000 or $1,000,000,000 as we were not so long ago. As long as you have a huge capital position, which we have and will continue to have and as long as you have a lot of outside earning power, which we have and will continue to have. I don't think we're constrained very much. I mean that we'll always want to have a significant level of liquidity relative to any kind of payment pattern that we see for a good length of time. But we will probably be operating with so much capital and with so much earning power independent of the insurance business and with so much liquidity that we really will be able to make decisions as to where as to how the asset should be deployed in terms of simply where we see the best returns and virtually no risk. And sometimes we see virtually no risk in equities when they're extremely cheap. We don't see that situation now, but we could see it again. And I don't think we'll be much I don't think we'll be very constrained when the time comes. Charlie? Yes. Our constraint doesn't come from structure. It comes from a lack of enthusiasm for stocks generally. The bonds are held as a default option. Area 3. Dear Mr. Buffet and Mr. Munger, my name is Adrian Chew and I'm a shareholder from Hong Kong. Thank you for your leadership and inspiration as always. It's wonderful always listening to you. If I may, I would like to ask of you both gentlemen a question in 2 parts. Perhaps I can ask the second part after you've answered the first part. The first part of the question relates to the Fortune article dated 10th December you included now shareholder materials. In this article, you mentioned that one couldn't explain the remarkable divergence in markets by differences in the growth of GNP. However, one could explain the divergence by interest rates. The first question I have is this. I wonder, sir, if you were to look at the price of gold during the two periods of times you mentioned, that is to say, 19,480, 60 4 and 60 4, 81, if the explanation could be even more clear. Thus, the logical reason would be why the Dow in $48,000,000 was $177,000,000 was because and half the level of $1929,000,000 at 3.81 index points is because of the 71% devaluation of the American dollar from $0.25 an ounce to $0.35 an ounce, which would put the fair value of the Dow at $1.66 after factoring in the record 50% per capita gain of the 1940s that you had mentioned? Yes. I grew up in a household and my sisters are here, where gold was talked about frequently. So I've been exposed to a lot of thinking on that over the years. I don't really think gold has really the price of gold, I should say, has anything really to do with the valuation of businesses. It may reflect certain things that are going on in prices attached to those businesses at a given time. But I would not regard, I mean, the price of gold does not enter into my thinking in any way, shape or form in terms of how I value a business today, a year ago, 10 years ago or tomorrow. When we look at Larson Jules, the custom picture frame operation, I'm not thinking against I'm not thinking of that and relating in any way to what gold has done. So it's just not a factor with us any more than other commodities would be. I mean, whether it's wheat, whether it's cocoa beans or whatever, it has a certain hold on some people and they but it's we don't look at it as an interesting investment and we don't look at it as a yardstick for valuing other investments. Charlie? Yeah. Warren is right when he says that interest rates are very important in determining the value of stocks generally. I think he's also right when he says gold is very unimportant. The second part of the question? Thank you, sir. The second part of my question is this, given your assumptions on gold, if you were to factor a significant decline in the value of the dollar against GOL, let's say 40% or more, and given the correlation of 19.29, 40 8, 60 4, 81 positively to decline of the dollar and the negative correlation in the other two areas that you had studied, would you care to adjust the 7% total annual return you were quoted as expecting for common equity in the coming decade? And in conjunction with that, would you care to comment on your expected rate of return on all other major asset classes, perhaps like bonds, real estates? And which would you believe offers the best value for investors? Thank you very much. Except under unusual circumstances, my expected rate my expectancy on something like bonds is what bonds are producing at a given time. I don't think I'm smarter than the bond market. Now you can say when those rates swing all over, does that mean I swing all over? The answer is pretty close to yes. I mean that I don't know what the right rate for bonds is. I think that if there's I'm very leery of economic correlations. I mean, I spent years fooling around with that sort of thing. And I mean, I correlated stock prices with everything in the world. And the problem was when I found a correlation. I mean, it's you've seen these things on whether the AFC or the NFL wins the Super Bowl and all that sort of thing. You can find something that correlates with something else. But in the end, a business or any economic asset is going to be worth what it produces in the way of cash over its lifetime. And if you own us, if you own an oilfield, if you own a farm, if you own an apartment house, with the oilfield, it's the life of the oilfield and what you can get out of it, maybe you get secondary recovery, maybe get tertiary recovery, whatever it may be, it's worth the discounted value of the oil that's going to come out and then you have to make an estimate as to volume and as to price. With a farm, you make an estimate as to crop yield and costs and crop prices. And the apartment house, you make an estimate as the rentals and operating expenses and how long it'll last and when people will build other new apartment houses the potential renters in the future will find preferable and so on. But all investment is, is laying out some money now to get more money back in the future. Now there's 2 ways of looking at getting the money back. 1 is from what the asset itself will produce. That's investment. One is from what somebody else will pay you for it later on irrespective of what the asset produces and I call that speculation. So if you are looking to the asset itself, you don't care about the quote because the asset is going to produce the money for you. And that's how that's what society as a whole is going to get from investing in that asset. Then there's the other way of looking at it is what somebody will pay you tomorrow for it even if it's valueless and that's speculation and of course society gets nothing out of that eventually but one group profits to at the expense of another. And of course, you had that operate in a huge way in the bubble of a few years ago, you had all kinds of things that were going to produce nothing, but where you had great amounts of wealth transfer in the short term as investments, you know, they were a disaster. As means of wealth transfer, they were a disaster. As means of wealth transfer, they were terrific for certain people and they were for the other people that were on the other side of the wealth transfer, they were disasters. We looked solely, we don't care whether something's quoted because we're not, we don't buy it with the idea of selling it to somebody. We look at what the business itself will produce. We bought See's Candy in 1972. The success of that has been because of the cash it's produced subsequently. It's not based on the fact I call up somebody at a brokerage house every day and say what's my See's Candy stock with and that that is our approach to anything on interest rates I'm no good. I bought some REITs a couple of years ago because I thought they were undervalued. Why do I think they were undervalued? Because I thought they could produce 11% or 12% in terms of the assets that those companies had and I thought an 11% or 12% return was attractive. Now the REITs are selling at higher prices and they're not as attractive as they were then. But you just look at every asset class, every business, every farm, every REIT, whatever it may be and say what is this thing likely to produce over time and that's what it's worth. It may sell at vastly different prices from time to time but that just means one person is profiting against another and that's not our game. Charlie? What makes common stock prices so hard to predict is that a general liquid market for common stocks creates from time to time, either in sectors of the market or in the whole market, a Ponzi scheme. In other words, you have an automatic process where people get sucked in and other people come in because it worked last month or last year and it can build to perfectly ridiculous levels and the levels can last for considerable periods. Trying to predict that kind of thing, sort of a Ponzi scheme, which is, if you will, accidentally thrown into the valuation of common stocks by just the forces of life. By definition, that's going to be very, very hard to predict. That's what makes it so dangerous to short stocks even when they're grossly overvalued. It's hard to know just how overvalued they can become in addition to the overvaluation that exists. And I don't think you're going to predict the Ponzi scheme effect in markets by looking at the price of gold or any other correlation. Charlie and I, I mean, you're pulling a figure out of the air. We have probably agreed on at least 100 companies, maybe more that we felt were frauds, bubble type things. And if we'd acted on shorting those over the years, we might be broke now. But we were right. I'm probably just about 100 out of 100. It's very hard to predict how far what Charlie calls the Ponzi scheme will go. It's not exactly a scheme in the sense that it isn't concocted in most cases by 1, but it's a sort of a natural phenomenon that seems to nursed along by promoters and investment bankers and venture capitalists and so on. But it's they all sit in a room and work it out. It just it plays on human nature in certain ways and it creates its own momentum and eventually it pops, you know, and nobody knows when it's going to pop And that's why you can't short. At least we don't find it makes good sense to short those things, but they are right. It is recognizable. You know when you're dealing with those kind of crazy things but you don't know when how high they'll go or when it'll end or anything else and people who think they do, you know, sometimes plan and other people know how to take advantage of it. I mean, there's no question about that. You don't you do not have to have a 200 IQ to see a period like that and figure out how to have a big wealth transfer from somebody else to you. And that was done on a huge scale in recent years. It's not the most admirable aspect of capitalism. Area 4. Yes. Good afternoon, Mr. Buffet and Mr. Munger. My name is Ho Nam and I'm from San Francisco, California. I I have a question related to an issue you touched on a few moments ago. On the debate over whether or not stock options should be expensed and reflected on the income statement of companies. With the current system, shareholders are incurring the burden of stock options since exercised options dilute earnings per share. As a shareholder of companies that issue stock options, I think I'm okay with that, especially in entrepreneurial companies that may not have enough cash to attract talent from larger competitors or in cases where you have younger employees or lower level employees who do not have the cash to purchase stock without the use of options. I have a 2 part question. If companies are required to expense stock options and it hits impacts the P and L, does it would that lead to double counting the impact of stock options? And the second part is, if the use of stock options are largely eliminated, might that impact the competitiveness of entrepreneurial companies which help drive innovation and growth and create more of a dividing line between shareholders and employees? Yes. The first question is that there really isn't the double counting necessarily. For example, just take a company with 1,000,000 shares of stock outstanding, selling at $100 a share. And let's say that options are granted for 9,000,000 shares, we'll make it extreme at $100 a share. At that moment, you've given 90% of the upside to the management, taking a very extreme example. That's been a huge cost to the shareholders. Now interestingly enough, if the stock was selling at $100 a share, the fully diluted earnings are exactly the same as the basic earnings in that year because the dilution is not counted at all unless the stock is selling above and then only by the difference in the market value, what it costs to repurchase the option shares. So there is not double counting and you could issue very fact that you issued that 1,000,000 the options on 9,000,000 more shares at 100 would undoubtedly cause the price to actually fall well below 100 and there would be no dilution shown in terms of the way GAAP reports diluted earnings. The second question is to whether if you expense the options, it would discourage the option use. Well, the argument that is made when there are people issue options is doing more for the company than giving people cash compensation, maybe more convenient than cash compensation too for young and upcoming companies. But the fact that you are doing something in terms of paying people in a way that you say is even more effective than paying them in cash to say that therefore you shouldn't have to record the payment. I've never really followed. I don't have any objection to options under some conditions. I've never taken a blanket position that options are sinful or anything of the sort. I just say they are an expense. And to be truthful with people about your what you're earning, you should record the expense and if a company can't afford to be truthful, I have trouble with that and we will take as we've said that you can pay your insurance premium to me and options. There'd be lots of companies. I'd be happy to take options in and give them credit. I take options above the market. Give me a 10 year option 50% above the market in many companies and we will take that appropriate number of shares in terms and take that in lieu of cash. But that means we would simply like the value of what we're getting better than the equivalent amount of cash and we think the company that gives it to us has incurred an expense. We say something of value. They've given some value up and that's income to us and expense to them. And I think all of the opposition at bottom to the expensing of options comes from people who know they're not going to get as many options if they're expensed and they would like cash not to be expensed, but they can't get away with that. I mean, if you had an accounting rule that said the CEO salary should not be counted as in cash. Believe me the CEOs would be in there fighting to have that rule maintained. I mean it because no one would they would feel that they were going to get more cash if it wasn't expensed and options are the same way. It's another argument I get a kick out of, I just reading it the other day where they say, well, options are too tough to value. Well, I've answered that in various forms, but I noticed that what is it, Dell Computer, it always has a great number of put options out and it's going to cost them a lot of money on the put options they have out. And for a company to say we can't figure out the value of options and therefore we can't expense them and then at the same time being dealing in 1,000,000,000 of dollars worth of options, they are saying we are out buying or selling options in the 1,000,000,000 of dollars, but we don't know how to value these things. That strikes me as a little bit specious, a little disconnected, cognitive dissonance as they say. Charlie? Yes. I'm not at all against stock options and venture capital, for instance. But the argument that prominent venture capitalists have made that not expensing stock options is appropriate because if you expense them, it would be counting the stock options double. That's an insane argument. The stock option is both an expense and a delusion and both factors should be taken into account in proper accounting. John Doerr, the venture capitalist, as he argues to the contrary, is taking a public position that were it offered to me as part of my employment. I would rather make my living playing a piano in a whorehouse. Number 5. Good afternoon. My name is Bob Baden from Rochester, New York. Mr. Munger, this morning, while discussing index funds, used the example of Japan as a real example of poor performance of a major index over a long period. Indeed, the S and P 500 Index declined over 60% in real terms from the early 60s through the mid-70s. Could you discuss the mental models you use to consider the impact of inflation or deflation on your investment decisions and the likelihood of either occurring over the next decade? Well, that's partly easy and partly tough. If interest rates are going to go way up, you can obviously have a lot of deflation of stock prices and a lot of that happened in the American period you're talking about. What's interesting about Japan is that I don't think anybody thought that a major modern Keynesian democracy pervaded by a good culture in terms of engineering, product quality, product innovation and so forth could have a period where you would have negative returns over 13 years without major depression either. I think that and that it would occur while interest rates were going down not up. I think that was so novel that the models of the past totally failed to predict it. But I think these anomalies are always very interesting. And I think it's crazy for Americans to assume that what's happening in Argentina, what has happened in Japan are totally inconceivable forever in America. They are not totally inconceivable. You had a huge bubble in equity prices in Japan and now you've had interest rates go to virtually nothing. You've had the passage of time. The country hasn't disappeared. People are going to work every day and you've had this the Nikkei, you know, now at a third of what it's sold for not that many years ago. It's an interesting phenomenon. And huge fiscal stimulus in the whole period from the government. Post bubble periods, I think, depending on how big the bubble is, but and how many were participating in but post bubble periods I think can produce fallout that not everyone will be terribly good at predicting. 6. Hi. I'm Steve Rosenberg. I'm 22 from Ann Arbor, Michigan. It's a privilege to be here. First, I'd just like to thank you both for serving as a hero and positive role model for me and many others. Much more than your success itself, I respect your unparalleled integrity. I have three quick questions for you. The first is how a youngster like myself would develop and define their circle of competence. The second involves the role of creative accounting and the stories of tremendous growth and success over many years. GE, Tyco and IBM immediately come to mind for me. But I was hoping you could also discuss that issue in relation to Coke. Some people have said that their decision to lay off much of the capital in the system onto the bottlers who earn low returns on capital is a form of creative accounting. On the flip side, others counter that Coke's valuation at first glance and say a price to book metric is actually less richly valued than it seems because they earn basically all the economic rents in the entire system. My final question is if you could comment on the AW Jones model, the long short equity model. I understand that it doesn't make sense for capital the size of Berkshire's to take that type of a strategy. But it just seems to me that playing the short side in combination also seems incredibly compelling, even giving the inherent structural and mathematical disadvantages of shorting. And I was wondering if you could talk a little bit more about why you would have lost money on your basket of 100 frauds? Yeah. It's an interesting question and we'll start we'll go in reverse order. Many people think of A. W. Jones who was a fortune writer at one time and who developed the best known hedge fund, whenever it was in the early '60s or thereabouts, maybe the late '50s even. And for the rest for some of the audience, the idea originally with A. W. Jones is that they would go long and short more or less equal amounts and have a market neutral fund. So that didn't make any difference which way the market went. They didn't really stick with that over time and I'm not even sure whether AW Jones said that they would. But they sometimes they'd be 140% long and 80% short, so they'd have a 60% net long or whatever it might be. They had they were not market neutral throughout the period, but they did operate on the theory of being long stocks that seemed underpriced and short stocks that were overpriced. Even the Federal Reserve, in a report they made on the long term capital management situation a few years ago, credited A. W. Jones with being sort of the father of this theory of hedge funds. As Mickey Newman, if he's still here knows, I think it was in 1924 that Ben Graham set up the Benjamin Graham Fund, which was designed exactly along those lines and which even used paired securities. In other words, he would look at General Motors and Chrysler and decide which he thought was undervalued relative to the other and go long one and short the other. So the idea and he was paid a percentage of the profits and it had all of the attributes of today's hedge funds except that was started in 1924. And I don't know that Ben was the first on that, but I know that he was 30 years ahead of the one that the Federal Reserve credited with being the first and that many people still talk about as being the 1st A. W. Jones. Ben did not find that particularly successful. And he even wrote about it. Some in his in terms of the problems he encountered with that approach. And my memory is that a quite high percentage of the paired investments worked out well. He was right. The undervalued one went up and the overvalued or the spread between the 2 narrowed. But the one time out of 4 or whatever it was that he was wrong lost a lot more money than than the average of the 3 that he was right on. And, all I can say is that I've shorted stocks in my life and had one particularly harrowing experience in 1954. And I have I can hardly think of a situation where I was wrong if viewed from 10 years later, but I can think of some ones where I was certainly wrong from the view of 10 weeks later, which happened to be the relevant period and during which my net worth was evaporating and my liquid assets were getting less liquid and so on. So it's all I can tell you is very difficult and the interesting thing about it of course is A. W. Jones was a darling of the late 1960s and Carol Loomis is here and she wrote an article called The Jones Nobody Keeps Up With and it's a very interesting article but nobody was writing articles about AW Jones in 1979. I mean something went wrong and there were spin offs from his operation. Carl Jones spun off from his operation. Dick Radcliffe spun off from his operation. They were down the list. And out of many, many, many that left, they a very high percentage of them bit the dust, including suicides, cab driver, subsequent employment, the whole thing. And these people were there was a book written in the late '60s, had a lot of pictures and I don't remember the name of it but it showed all these portraits of all these people that were highly successful in the hedge fund business but they didn't bring out a second edition. So it's just tough. I logically, it should work well, but the math of only you can't short a lot of something. You can buy till the cows come home if you got the money, buy the whole company if he would, but you can't short the whole company. The name Robert Wilson, there's some interesting stories about he's a very, very smart guy and he took a trip to Asia one time being short. I think it was Resorts International or maybe it was Mary Carter Paint it was still called in those days and he lost a lot of money before he got back to this country. He's a very smart guy. He made a lot of money shorting stocks, but it just takes one to kill you. And you need more and more money as the stock goes up. You don't need more and more money when a stock goes down as you paid for it originally and didn't buy it on margin. You just sit and find out whether you're a right or not, but you can't necessarily sit and find out whether you're right on being short of stock. I think I'll let Charlie comment on that before I go to the other two questions. Well, he asked about creative accounting and he named certain companies. I wouldn't agree that that all those companies were plainly sinful, although I'm sure there are very significant sins in the group as a whole. Creative accounting is an absolute curse to a civilization. You can argue that one of the great inventions of man was double entry bookkeeping where we could keep our economic affairs under better control. And it was a North Italian development spread by a monk and anything that sort of undoes the monks work by turning this great system into kind of a tool for fraud and folly, I think, does enormous damage to the country. Now, I think that democracy is ordinarily set up, so it takes a big scandal to cause much reform. And there may be some favorable fallout from Enron because that was certainly the most disgusting example of a business culture gone wrong that any of us has seen in a long, long, long time. And what was particularly interesting was it took in eventually a lot of nice people that you wouldn't have expected to sink into the whirlpool. And I think we'll always get Enron type behavior, but it may be moderated some in the next few years. Question of accounting and the economic profits to be gathered in the bottling system versus the production of the syrup at Coke. I've just gotten through reading the annual reports of Coca Cola, FEMSA and Panamco which are 2 big Latin American bottlers. And I mean, they make pretty decent money, quite significant money. And there is more money in owning the trademark. It isn't the plants that make the syrup or anything. The trademark is where a huge amount of value is. The trademark is where a huge amount of value is in See's Candy. Those are big, big assets and I would say that you can make good money as a bottler, a bottler. A lot of bottlers have become rich over the years. If I had a choice between owning the trademark and owning a bottling business, I'd rather own the trademark. But that doesn't mean the bottling business is a bad business at all and it's writing on the back of a trademark. I mean that is why a bottling system is valuable is because it has the right to sell a trademark product which hundreds of millions of people every day are going to go in and ask for by name and the right to distribute that product is worth good money. And it really I don't see any accounting questions in that sort of thing. In other words, if the Coca Cola Company did not own a share in any of its bottlers And for many years, it either owned 100 percent of a bottle or large part or very few of those or none of it. But if they owned no interest in their borrowers, I think the economics would be very, very similar to what they are now. I mean, the borrowers would still be able to borrow a lot of money because they would have contracts with the Coca Cola Company and that were important and that would allow them to make decent money distributing the product but they don't make the kind of money that you make if you own the trademark, just the way it works. What was the first question again? It was how a youngster like myself would define and develop a circle of competence. Oh, yeah. That's a good question. I would say this, if you have doubts about something being in your circle of competence, it isn't. I mean, in other words, I would look down the list of businesses and I will bet you that you can I mean, you can understand a Coke bottler? You can understand the Coca Cola Company, you can understand McDonald's, you can understand in a general way General Motors, you may not be able to value it. But there are all kinds of business. You can certainly understand Walmart. That doesn't mean whether you decide whether the price should be, but you understand Walmart. You can understand Costco. And if you get to something that your friend is buying or that everybody says a lot of money is going to be made and you're not sure whether you understand it or not, you don't. And it's better to be well within the circle than to be trying to tiptoe along the line and you'll find plenty of things within the circle. I mean it's not terrible to have a small circle of competence. I'd say my circle of competence is pretty small but it's big enough. I can find a few things and when somebody calls me with a Larson Jewell, that is within my circle of competence. I hadn't even thought about it before but I know it's within it. I mean, I can evaluate a business like that And if I get called, I got called the other day on a very large finance company. I understand what they do, but I don't understand everything that's going on within it and I don't understand that whether I can continually fund it on a basis independent from using Virtu's credit and so on. So even though I could understand every individual transaction they did, I don't regard the whole enterprise or the operation of it necessarily as being within my circle of competence. Charlie? Yes. I think that if you have competence, you almost automatically have a feeling of where the edge of the competence is because after all, it wouldn't be much of a competence if you didn't know its boundary. And so I think you've asked a question that almost answers itself. And my guess is you do know what you're perfectly competent to do in all kinds of areas. And you do have all kinds of other areas where you know you'd be over your depth. I mean, you're not trying to play chess against Bobby Fischer or do stunts on the high trapeze if you had no training for it. My guess is you know pretty well where the boundaries of your competence lies. And I think you also probably know pretty well where you want to stretch the boundary and you've got to stretch the boundary by working at it, including practice. One of the drawbacks to Berkshire, of course, is that Charlie and I, our circles largely overlap. So you don't get 2 big complete circles at all, but that's just the way it is. It's probably why we get along so well too. Number 7. Good afternoon, gentlemen. Wayne Peters is my name and I'm from Sydney, Australia. I'd have never guessed. No. I'll speak a little slower so my accent doesn't throw you. Good. My question goes further to the resolution on population control raised this morning. Firstly, can I say I've added against it And I guess that's just the beauty of the democratic society? Our concern, however, was the gentleman's implication that the world's population has decreased or is decreasing. Having read the book Charlie recommended last year by Garrett Hardin called Living Within Limits, I've got a reasonable feel and understand the population grew by about 1.7% last year, which is approximately 67,000,000 people. In my terms, I'd relate that to approximately 4 times the population of Australia. Clearly, an alarming rate over the long term, if you're talking 500 or 1000 years. Reading between the lines, my guess is that the issue of population growth is likely to be a key focus of the Buffett Foundation. My question to you this afternoon is, how do you currently see this critical issue being tackled? Yeah. Well, population projections are just that, they're projections. And they've been notoriously inaccurate over the years. And then gentleman made the motion referred to a recent New York Times story. And there are some there are projections that based on fertility rates and what happens to them in different countries under different economic conditions and all that. I mean, you can come up with all kinds of projections. I don't know the answer on it. Nobody does at any given time. And the carrying capacity of the earth has turned out to be a lot greater than people have thought in the past. But there is some amount that does relate to the carrying capacity. It may have been expandable but it's not infinitely expandable. And I would suggest that the errors of being on the low side in terms of population rather to estimated carrying capacity, the danger from those areas is far, far less than the dangers from overshooting in terms of population compared to carrying capacity. And since we don't know what carrying capacity is or will be 100 years from now, I think that generally that mankind has an interest in making sure it doesn't overshoot in terms of population. There's no great penalties attached to undershooting at all that I see. And it's very you know, it's the old analogy. If you were going to go on a spaceship for 100 years and and you knew in the back of the spaceship there were provisions, there were a lot of provisions, but you didn't know exactly how much. In terms of filling the front of the spaceship with a given number of people you would probably on the low side. I mean you would if you thought maybe it could handle 300 in terms of the provisions. I don't think you'd put 300 people in there. I think you'd put about 150 or 200 and you'd figure that you just didn't know for sure the spaceship would get back in 100 years, you wouldn't know how much was in the back and you would be careful in terms of not overshooting the carrying capacity of whatever the vehicle you were in. And we are in a vehicle called Earth. We don't know it's carrying capacity. We we learned that it's a lot larger than might have been thought by Malthus or somebody a few 100 years ago. But that doesn't mean it's infinite at all. And I don't the one thing I will assure you is that the projections that were running the New York Times a few weeks ago are not going to be the ones that are going to be run 50 years from now or 30 years from now. And it's not the sort of thing that is cured after the fact. I mean, you're not going to go around trying to intentionally reduce the population. It's much better to prevent population growth and then try and correct afterwards. And Garrett Hardin has got some interesting stuff on that. Charlie? Yeah. I will say that the whole controversy has been interesting in the way both sides don't understand the other side's model. By and large, on the population alarm side, the ecology side, they've always underestimated the capacity of modern civilization to increase carrying capacity. And the more they underestimate by the least, the less they seem to learn. That is not to the credit. And the other side has equal folly. I think it's I think you're just talking about the human condition. It's a complicated, controversial subject. People feel strongly about it and they learn slowly. And I just think that's the way it's going to be as far ahead as you can see. Chances of a world inhabited by 15,000,000,000 people having behavior on average better than if the world were inhabited by 5,000,000,000 people is low, but that is we'll never find a way to test that, but that's my instinct on it. Number 8? My name is Bert Flossbacher. I'm from Cologne in Germany. And first of all, I would like you gentlemen for all the monitoring you have done and the pristine investment philosophy, which is more and more followed in Germany as well. My question refers to the importance of realism. If the dim prospects of the on the stock market Mr. Manga made earlier become true and given that the size of Berkshire Hathaway diminish the impact of small investments, what do you think would be the realistic return on the flow over the next 10 years or 20 years? Well, I wish I knew. The only thing I can tell you is it'll be less than it's been in the last 20 years. But I think it'll be satisfactory compared to most alternatives. But I don't know whether the alternatives are going to produce 4% a year or 8% a year. I don't think they're going to produce 15% a year. And I would think that if we obtain very low cost float, which I think we should and I think we will, And we keep getting chances to buy businesses on reasonable terms, not sensational terms. And we get occasional market, which we even had a few occasions of things we've done in the bond market, last few years. We haven't made huge amounts of money, but we've made pretty good amount of money and we'll see some things to do on equities. I think overall, we can have a return that we won't be ashamed of, but we won't come close to a return that you might think looking back we could achieve. But we don't think the returns on equities are going to be terrible over the next 20 years. We just think that people whose expectations were built by 1982 to 1999 are going to be very disappointed. But there's nothing wrong with earning 6% or 7% on your money. I mean, it's in a world of relatively low inflation. You know how much more is capital entitled to than that? I mean it has to come out of somebody and to keep doing it on increasing amounts of money. If you earn much higher returns than that, you would have a whole shift in the national income stream over time. So I think we'll get chances to do things that will leave us satisfied. But the question is whether they leave you satisfied. Charlie? Well, I certainly can't improve on that, but it won't stop me from trying to say something. I think one of the smartest things that a person can do under present conditions is just dampen the expectations way down from the investment achievements of the past, including of course with reference to Berkshire stuff. I think that's maturity in good sense. All that said, I like our model and I like what we have in place and I like what's been coming in recently. And I think we've had a lot of fun in the past and some achievement and my guess is we'll continue to do that. And I'm just up here most of the time to indicate to the rest of you that maybe you've got 10 more tolerable years coming out of Warren And I'm doing the best I can at that. Number 9, please. Good afternoon. I'd like to get back to the basics and talk about the insurance side, which is the core of Berkshire. In 98 when we bought January, they had a Lloyd's syndicate DP man now known as Faraday. In addition, in 2000, we bought the Marlboro Agency. I'd like to get your perspective on what you see happening at Lloyd's and their future as well as our commitment to the Lloyd's market? Yes. Well, we do have what is now known as the Faraday Syndicate and actually our takedown of their capacity, which I think was maybe, I don't know, in the area of 30% a few years back is now well into the mid-90s percent. So we in effect have a much larger commitment through Faraday to the London market and I would think we would do pretty well with that commitment. But in the end it really doesn't make any difference whether you're in London or whether you're in Washington as GEICO is or whether you're in I mean actually for a while, Ajit lived here in Omaha or whether you know it really depends because it's a worldwide market. You're going to see things assuming that you have a reputation for paying claims and for having the capital to do things and being willing to act. You're going to see things every place in the world. It's really like investing. I mean, you can invest whether you're in London or Omaha or New York. That means it's where you're located. What counts is the ability to and the discipline to look at 1,000 of different things and select from them a group to do. You can do anything in the world in insurance. I mean we could write tens of 1,000,000,000 of premiums in a month if we just open the floodgates. But it's out there. There's lots of business out there. There's lots of investment opportunity or investment choices out there. And the question is, what you say yes to and what you say no to. And that should be determined by what you are able to evaluate and in the case of insurance even if they're attractive preventing an aggregation risk that could cause you major embarrassment sometime. But we don't have any we don't specifically think the London market is better than the U. S. Being domiciled in the U. S. Or vice versa. And as you know, we have an operation domiciled in Germany and that isn't the key to it. The key is having people making decisions daily where they accept risks they understand and that are properly priced and avoiding undue aggregation and the occasional problem in terms of dealing with people that are less than honest. But the first two items are important ones day in day out and that can be done at Lloyd's, it can be done at Omaha. I mean, national indemnity did not have any great geographical advantage and sitting at 30th and Harney but it's done very well just in its primary business ever since Jack Ringwald founded it in 1941 or whatever year it was. I mean it and Jack Ringwald, some of you here may have known him. Jack Ringwald, very good friend of mine, but Jack Ringwald was not an insurance genius And he never, you know, my guess is he, he never looked at an actuarial book in his life or even thought about it, but he just was an intelligent fellow who had enough sense to do is to stick with what he understood in virtually all cases and to make sure that he got paid appropriately for the risk he was taken And he beat the pants off. People have been around for 100 years in Hartford who had vast agency organizations and huge amounts capital and actuaries and all kinds, you know, all kinds of data and everything, but they didn't have it. They didn't have the discipline he had. And that's what it's all about. So I don't really relate it to geography. I would like to be exposed to as much business in the world as possible and have that exposure be the, manifested, through people that have the disciplines I talked about. And if we can see everything that takes place in the world and people want to come to us for one reason or another often because of our capital position or our willingness to take on volatility. If those people come to us wherever they come to us and the people that they represent us use the guidelines we've talked about, we'll do very well and, you know, the more places they have to intersect with us as far as I'm concerned as long as that intersection takes place with people who have that discipline. Charlie? Yeah. The insurance business is a lot like the investment business at Berkshire. If you combine a vast exposure with a vast decline rate, you have an opportunity to make quite a few good decisions. And I think we're making them now. You can check on me next year on that. Number 10. I'm Lowell Christman from Phoenix, Arizona. I'm retired and teaching in seniors in high school. I wish they could be here to hear you today. I'm teaching these people an investment course part time. And the 1st class I went to, they asked me to teach them how to prepare for retirement. I would like to know what the 2 or 3 things are that you would suggest that I include in this course. Well, I hope it's warm to know about retirement. Yeah. We haven't even thought about it. Now let me give you one suggestion for that group. I use this sometimes when I talk to a high school, a bunch of high school seniors down in Nebraska Westwind a few weeks ago. But tell the youngsters in the class, they're probably around 16 or 17. And if they're like I was when I was 16, I was only thinking of 2 things and Martin's Aunt Barbara wasn't going out with me. So I was down to cars. I tried horses but that didn't work. And let's assume and I use this with let's assume a genie appeared to you when you were turned 16 and the genie said, you get any car you want tomorrow morning tied up in a big pink ribbon, anything you name and it can be a Rolls Royce, it can be a Jaguar, it can be a Lexus, you you name it, and that car will be there and you don't owe me a penny. And having heard the genie stories before, you say to the genie, what's the catch? And of course, the genie says, well, there's just one. That car, which you're going to get tomorrow morning, car of your dreams, is the only car you're ever going to get. So you can pick 1 but that's it. And you still name whatever the car of your dreams is and the next morning you receive that car. Now what do you do knowing that's the only car you're going to have for the rest of your life? Well, you read the owner's manual about 10 times before you put the key in the ignition. You keep it garaged. You change the oil twice as often as they tell you to do. You keep the tires inflated properly. If you get a little nick, you fix it that day so it doesn't rust on you. In other words, you make sure that this car of your dreams at age 16 is going to still be the car of your dreams at age 50 or 60 because you treat it as the only one you'll ever get in your lifetime. And then I would suggest to your students in Phoenix that they are going to get exactly one mind and one body and that's the mind and body they're going to have at age 405060. And it isn't so much a question of preparing for retirement precisely at those ages, it's a question of preparing for life at those ages and that they should treat the importance of taking care and maximizing that mind and taking care of that body in a way that when they get to be 50 or 60 or 70, they've got a real asset instead of something that's rusted and been ignored over the years. And it will be too late to think about that when they're 60 or 70. You can't repair the car back into the shape it was. You can maintain it and in the case of a mine you can enhance it in a very big way over time. But the most important asset your students have is themselves. I will take a person graduating from college and assuming they're in normal shape and everything, I will be glad to pay them U. S. Dollar market. Well, I'm willing to pay them 10% for 50,000 for 10%. That means they're worth 500,000 if they haven't got a dime in their pocket as long as they've got a good mind and a good body. Now that asset is far, far more important than any other asset they've got unless they've been very lucky in terms of inheritance or something. But overwhelmingly, their main asset is themselves and they ought to treat their main asset as they would any other asset that was divorced from themselves. And if they do that and they start thinking about it now and they develop the habits that maintain and enhance the asset, they will have a very good car mind and body when they get to be 60 and if they don't, they'll have a wreck. Charlie? Number 1. Good afternoon, Mr. Buffet, Mr. Munger. I'm George Brumley from Durham, North Carolina. It's been reasonably argued that the most critical factor in evaluating the business is establishing the sustainability of a competitive advantage. Let's assume that we have knowledge in hand about a few truly unique companies that possess sufficient strengths to outdo their competition and that we can therefore estimate future cash flows with relative certainty. I admit that getting this far is far from easy. Moreover, it seems that the wildcard of an unchecked tort system has great potential to turn even such sound analysis on its head. Predicted cash flows and reasonably estimated terminal values can be effectively driven to 0 for business owners via transfer to both litigants and litigators. My question is how should intelligent investors attempt to factor such uncertainty into their valuations of potential investment opportunities? Charlie is the lawyer, so I'll tell him how I'll have him tell you how to protect yourself from I have a quick follow-up. I think it is entirely fair as an investor to just quitclaim certain areas of business as having too many problems. I almost feel that way about workman's compensation insurance in California. In other words, the system morphs into something that is so unfair and so crazy, I'm willing to pretty much at least leave it behind. And I think there are all kinds of areas like that. Another fellow and I once controlled a company that invented a better policeman's helmet and we told them not to make it. We told them to sell it to somebody else who was judgment proof or we wanted the policeman to have the helmet, but we didn't want to make it. I think there are whole areas of activity where for the already rich, the tort system makes participation foolish. And I think you can sort of figure out where those are and avoid them. I don't think the tort system is going to be fixed quickly. Yeah, George, actually George Gillespie is I think here today and he and I were directors of Pinkerton 20 years ago and in fact, we owned a very significant percentage of Pinkerton's although it was controlled by the family of foundation. But one of the interesting problems then was a question of whether we would want to supply guards, for example, at airports. And if you think about it, Berkshire itself, we'll forget about PINKER, would be absolutely crazy to go into the business of supplying guards to airports. We might be more responsible in terms of selecting the guards. But if we were to have a guard say at that Portland Airport, from which a plane took off or from what the original boarding was of people that took off from Logan or we would have the guards at Logan or wherever. We might have been held liable for 1,000,000,000 and 1,000,000,000 of dollars. You know that people would have gone after us because we would have had deep pockets and we would have had an employee of ours and people would have said that if it hadn't been for your employee, these people wouldn't have all died and everything else wouldn't have happened. And for us to be in a business like Charlie in the helmet business, I mean for us to be in a business like that would be madness when some other guy operating out of his basement can have guards and if, you know, if they blow up the whole airport, it doesn't make any difference because he's judgment proof. So it actually is a system that may discourage perhaps more responsible people from ever even dreaming of being in that kind of business. And unfortunately, I would say that the range of businesses since 1981, we were thinking about that sort of thing at Pinkerton's. The range of businesses to whom such reasoning might apply has probably enlarged to a significant degree. There's just a lot of things that a rich corporation shouldn't do because they will pay a price if they are wrong or even if somebody maybe suspects they were wrong that would be incredibly disproportionate to what somebody in different economic circumstances would bear. It's absolutely a selection by the torch system of people that are going to provide certain services and products. And I don't know any answer for that except to avoid it. Now you had another question, George? Yes. Just briefly, if you could give us an update on the economics of the FENOVA deal? Well, the FENOVA deal is about like well, it is like when we wrote the annual report and actually FENOVA's annual report deals with this too. I think most of you know the terms of it. We guaranteed what was originally going to be a $6,000,000,000 loan that enabled creditors to be paid a large percentage of their claim in the Finova bankruptcy. And we only took down $5,600,000,000 of the $6,000,000,000 because there have been payments made faster at FENOVA. FENOVA was a failed finance company, very big one. And we're in partnership with Leucadia in this operation and they have management responsibility and they're doing a fine job. That loan of 5,600,000,000 on which in effect we make roughly a 2% override on 90% of the loans. So if it had been $6,000,000,000 we would have had a carry of $108,000,000 a year, although it was going to come down. Now the loan is down to 3 point $2,000,000,000 I believe there was a bulk sale of some franchise receivables for about $500,000,000 to GE credit here not so long ago. So the exposure is down to $3,200,000,000 but of course the 2% override is down to 2% on $3,200,000,000 We feel well after September 11, many of the assets of Fonovo were aircraft and they were not the latest of aircraft and they were not to the greatest of lessees in many cases. So there was a big hit to the aircraft portfolio and there were other receivables relating to resort properties and that sort of thing, which were also hit by anything that impacted travel and that sort of thing. So the portfolio was worth less, appreciably less on September 12 than it was on September 10. And that will not, in my view, our 3,200,000,000 as far as I'm concerned, we've guaranteed it, but I think that is very close to 100 percent okay. And then there's a group of bonds underneath it which are the residual bonds you might say of the ones that existed in the bankruptcy because 70% got paid off and 30% didn't. And we own that means of that residual, we own 13% or so. Those bonds are going to be worth a lot less than we thought they were going to be worth summer of last year. We bought our position at 0 point 67 the dollar and we've already we got $0.70 on the dollar plus these bonds, plus we get the override on the Arcadia loan. So we got all our money back and then some on the bonds we bought and we get the override in the Burcadia. We will in all likelihood almost certainly, I would say, although who knows, I mean, I didn't know about September 11, but we will almost we're very, very likely to make a significant amount of money on the whole transaction, but not as much money as we thought we were going to make last summer. We feel very pleased with the way Lucati is handling things, but there is not as much value in that portfolio today because of the events of September 11th. Charlie? Yeah. It's an interesting example of Ben Graham's margin of safety principle. A whole lot has gone wrong that we didn't predict. And yet we're coming out fine. Yeah, we should make some 100 of 1,000,000 in aggregate over time on it, but a lot went wrong. But we, as Charlie said, we had a margin of safety when we bought into we felt we had a margin of safety and it turns out we needed it. Number 2. I'm Bob Klein from Los Angeles. I wonder if you could give us a glimpse into your investment process, where you approach looking at particular industry. And I wonder if you could use real estate as an example. I know real estate hasn't been a big huge part of Berkshire's portfolio over the years. And I wonder if that's because you view real estate as a commodity business or if maybe the cash flows from real estate tend to be more predictable than perhaps from some other industries and thus it tends to be less likely to be mispriced and therefore less likely to find terrific bargains in real estate. So go ahead. So just wondering if we could if we were watching a discussion between you and Charlie hashing out the merits of real estate, how it would go? Well, it would go like all our other conversations. He would say no for about 15 minutes. And I would gauge by the degree to which he the motion he put into his nose whether he really liked the deal or not. But We both had a fair amount of experience in real estate and Charlie made his early money in real estate. The second point is the more important point. Real estate is not a commodity, but I think it tends to be more accurately priced, pretty developed real estate, more accurately priced most of the time. During the RTC period when you had huge amounts of transactions and you had an owner that didn't want to be an owner in a very big way and they didn't know what the hell they owned and all of that sort of thing. I mean you had a lot of mispricing then and I know a few people in this room that made a lot of money off of that. But under most conditions, it's hard to find real estate that's really mispriced. I mean, when I look at the transactions that REITs engage in currently and you get a lot of information on that sort of thing, They're very similar but it's a competitive world and they all know about what a Class A office building in Chicago or wherever it may be is going to produce. So at least they may all be wrong as it turns out because of some unusual events. But it's hard to argue with the current conventional wisdom most of the time in the real estate world. But occasionally there have been some there could be big opportunities in the field. But if they exist, it will certainly be because there's probably there'd be a lot of chaos in real estate financing for one reason or another. We've done some real estate financing and you have to have the money shut off to quite a degree probably to get any big mispricing across the board. Charlie? Yes. We don't have any competitive advantage over experienced real estate investors in the field and we wouldn't have if we were operating with our own money as a partnership. And if you operate as a corporation such as ours, which is taxable under Chapter C of the Internal Revenue Code, you get a whole layer of corporate taxes between the real estate income and the use of the income by the people who own the real estate. So by its nature, real estate tends to be a very lousy investment for people who are taxed under subchapter C of the code relating to corporations. So the combination of having it generally allows the activity for people with our tax structure and having no special competence in the field means that we spend almost no time thinking about anything in real estate and then such real estate as we've actually done like holding surplus real estate and trying to sell it off, I'd say we have a poor record at. C Corps really doesn't make any sense. I mean, I know there are C Corps around that are in real estate, but there are other structures that are more attractive. There really aren't other structures. I mean, Lloyd's is an attempt at it to some degree, but there aren't other structures that work well for big insurance companies or I mean, you can't have a Walmart very well that does not exist in a C Corp. So they are not subject to S Corp or partnership competition that determines the returns on capital in the discount store field. But if you're competing with S equivalent of S Corps, REITs or partnerships or individuals, you've just got an economic disadvantage as a C Corp which is for those of you who don't love reading the internal revenue code, it's just a standard vanilla corporation that you think of all of the Dow Jones companies, all of the S and P companies and so on. And as Charlie says, it's unlikely that the disadvantage of our structure combined with the competitive nature of people with better structures buying those kinds of assets will ever lead to anything really interesting. Although I would say that we missed the boat to some extent during the RTC days. I mean it was a sufficiently inefficient market at that time and there was a lack of financing that we could have made a lot of money if we had been geared up for it at that time. We actually had a few transactions that were pretty interesting but nothing that was significant in relation to our total capital. We thought significantly about buying the Irvine Corporation when it became available. So, but that's the only big one I can remember that we seriously thought about. Yeah, that was in 1977 or so. Yeah, Mobile Oil was interested in, you know, Don Brennan ended up putting together a group port. But you know, that kind of thing could conceivably happen, but it's unlikely. Number 3. Hello. My name is Joseph Lapre. I'm a shareholder from Minneapolis, Minnesota and I'd like to thank you for opportunity to ask a question. Mr. Buffet, you mentioned earlier today that you'd be willing to sell insurance in exchange for stock options. If possible, could you please describe the methodology for the valuation of stock options, particularly in cases where there is no market pricing data available for the option being valued? Yeah, I wouldn't I could figure out what I would pay for an option on a private business. I could figure out what I could pay for an option on a public business might be a little easier. I could figure out what I'd pay for an option on an apartment house or a farm. I had a friend, I mean, when I was 20 years old, we developed a big plan. We were gonna go out and option out up for option farms, you know, outside of what were then the city limits of Omaha and we figured that if we offered a farmer a modest amount which would be annual income to him the option is farm at double the price it was bringing then that it would you know he would be happy to sell for double the price that year and maybe we could do something and if I'd have worked out okay. Every option has value. I've got a house worth X. If you offer me a few dollars to give you an option of 2x for 10 years, I'm not going to take it because all kinds of possibilities in terms of inflation, all options have value and people that get options usually understand that better than people that give options. I'm not talking about stock options now, but in other arenas. So we would be happy. I mean, what I could let's say, we'll just pull one out of the air. Let's take an untraded company like Mars Inc. Or would I be happy to have an option, 10 year option on a piece of Mars Inc. At some given price? Sure, I would. And there's an amount I would take for that. I would take in lieu of getting cash if I was writing a big insurance policy with Mars Inc. They're not going to do this with me but that and I would be happy you know and instead of if you buy homeowners insurance from me if you want to give me an option on your house for 10 years I'll take that in lieu of the premium I'll make my own calculations to value. It won't be Black Scholes, although that might be the best arrangement under many circumstances, this in my own case. We bought and sold options. A matter of fact, on June 3, Berkshire Hathaway will receive $60,000,000 if the S and P 500 closes at 11.50 something or below. And 2 years ago, when the S and P was 14 something, We agreed for on that June 3 option or whatever it was, dollars 400,000,000 nominal value where in effect the counterparty would get the profit above 2,000 and something 42% up from the current cash price. And we got the profit between 5% 20% on the downside on a put. People who were calculating the values of options at that time under traditional methods felt that that was a cashless transaction that the value of the call that we gave was equal to the value of the put that we received. I decided differently. So we don't accept blindly option values as determined by the calculations of people who win Nobel Prizes. Instead, we actually put in an aspect of judgment into some. There would be businesses that would come out with identical Black Shoals values on options for 10 years and we would pay a different amount for 1 than the other maybe a significantly different amount. But we would pay something for just about any option And it is the nature of prices in this world to change and economic conditions to change and an option is a chance to participate in a change without giving up anything other than that original premium you pay. Many people just don't seem to grasp that. But believe me, the people who are getting options on stock do grasp that and the people who are giving them, which are the shareholders represented by a group like this who don't have any real voice in giving it but they sometimes don't fully realize what's being given away. Imagine going up few miles away from here and having 2 farms for sale and you say to the guy how much do you want from it will say $1,000 an acre but the one guy says but every year, I want you to option I want you to give me 2% of the place back at $1,000 So at the end of 10 years, 20% of the upside belongs to me, but you've got all the downside. I mean, which farm are you going to buy? And the one without the options or the one with the options? It's not very complicated. And we will we are dead serious when we say we will take options in lieu of cash. Incidentally, the company that gives us those options in lieu of cash for an insurance premium has to record the expense in terms of the fair value of the option they've given us. The only item for which they don't have to record that as expense is compensation. But if they give it to us for their light bill or they give it to us for their insurance premium or they give it to us for their rent, they have to call it a cost. But only when it comes to the CEO's compensation and other people like it. Do they not have to record it as a cost? And that's because they've been able to get Congress to bow to their will into their campaign contributions. Charlie? Yeah. The Black Scholes crowd really did get a Nobel Prize for embedding this formula to value options, not executive stock options, but just options generally. And if you don't know anything about the company, except the past price history of stock transactions and if it's and the dividend being paid And if the option is over a very short term, it's a very good way of approximating the value of the option. But if it's a long term option and you think you know something, it's an insane way to value the option. And Wall Street is full of people with IQs of 150 that are using Black Scholes to value options that shouldn't be tortured into the model. And all of corporate of America is using Black Scholes to price stock options in the footnotes of the accounting statements. And they do that because it comes up with the lowest cost number. Well, they not only do that, but they assume the term is less than the actual term of the for to determine the number in the 1st place. So it's a Mad Hatter's Tea Party. And the only thing that's consisting consistent in it is that the whole thing is disgusting. Number 4, please. I'm John Golub from Kansas City. I'm mostly retired but also teach a course on financial markets at the University of Missouri in Kansas City. I always tell my students that I learned much more about investing at Berkshire Hathaway meetings than I ever did from my professors at the Wharton School. I have a general question about investment banks. Given your connection with Solomon, I'm always surprised that sort of the attitude you represent to this industry. Somehow I get the idea that you view them as just their main social value is charging very high fees for unnecessary churning. I'm wondering if you have any perspective on the general influence of investment banks and U. S. Finance that is just rising or falling. I hate to be a Pollyanna, but I might hope that Enron like debacles would reduce maybe the influence of investment banks that people wouldn't necessarily trust, some of the advice they're giving. I think Enron is bound to have some favorable fallout in various areas. I mean, to the extent that it causes people to look more carefully at how various entities behave and that sort of thing. I think Enron was a plus for the American economy and the truth is our capital system, despite all kinds of excesses and errors and everything else, one way or another, we've come up in this country with 50 odd percent of the world's market value for 4.5 percent of the world's population. So I'm not negative on how the American capital system has developed. I do get negative about how certain people behave within that system, but they would behave badly in any system. So it's the human condition. But that is Charlie and I still think we should criticize things that we think are improper. But we don't criticize the whole system in any way shape or form. It's been a tremendous economic machine in this country. But I would say that a market system and I don't have anything better than in fact I think a market system is responsible in a material way for the prosperity of this country. So I have no substitute in mind for the market system. I do think it produces extraordinarily inequitable results in terms of some overall view of humanity and that that should be largely corrected by a tax system. I don't think it should be any comparable word system or anything like that. I just the idea of the government trying to sign all that distracts me as wild. But the market system lets a fellow like me you know make so much money because I know how to allocate capital you know compared to a great teacher or nurses cancer, whatever. I mean it just showers rewards on somebody that has this particular skill at this particular time. And that's great for me but it's in a really prosperous society that there should be some corrective aspects to that because it really strikes me as inappropriate that the spread of prosperity in a hugely prosperous economy should be decided totally by the quirks of skills that come into play and get rewarded so hugely from the market system. So I believe that that's why I believe in a progressive tax system and so on. I would say in terms of investment banking particularly, I mean, I was standing one time with an investment banker, he was looking out the window and he said, just look, she says, as far as you can see, nobody's producing anything. And I said, yes, that seems to be a mandate they take pretty seriously too. There is a huge amount of money in a system with $14,000,000,000,000 or whatever it may be of market values and where people are spending other people's money and corporations and where the more you spend for something sometimes you get gets equated with values and fairness opinions and all of that sort of thing. It's quite disproportionate to what I really think the ultimate contribution to the country is of various people, but I don't have a better system to substitute for it. I don't want to I don't want anybody to think come away thinking that I think we ought to tinker with that very much. I think that the I think your tax system should be the way that you distribute the prosperity in in a somewhat better way. When we ask people to go to war and all that sort of thing, We don't take the person that's made the most money and say, well, they benefited the most from society, so we'll send them and put them in the front lines or anything like that. I mean, there's various aspects of being a citizen in this country that I think should make sure the people that don't get the great tickets for that make them prosper in a market size, they still should do pretty darn well as far as I'm concerned. And really people like me should, it doesn't make any sense to compensate me the way this world has and it wouldn't have happened if I'd been born in Bangladesh or wouldn't happen if I'd been born 200 years ago. You know somebody, another one of those genie stories. Imagine, you know, when I was 24 hours before I was born and there had been some guy with exactly my DNA right next to me who was also going to be born in 24 hours And a genie had come to the 2 of us and said, we're now going to have a bidding contest. And the one that bids the most of their future income gets to be born in the United States and the one that loses in this is born in Bangladesh. And what percent of your future income will you give to be born in the United States? I'd have gone pretty high in the bidding. I mean that would have been an interesting test of how important I thought my own abilities were compared to the soil in which I was going to be planted. So I feel I'm lucky and I am lucky, I mean, obviously. But I think we ought to figure out ways to take care of the people that are less lucky and I think that investment bankers should consider themselves in the lucky part of society. And you know there's nothing wrong with what they do raising capital for American business is a fine thing and all that. I just think that they are paid in relation to the talent and that sort of thing they bring to the game. I think they're paid obscenely high, but I think that's true of me too. Charlie? Yes. But I would argue that the general culture of investment banking has deteriorated over the last 30 or 40 years. And remember, we issued a little bond issue, Warren, way back $6,000,000 Diversified Retailing and these very high grade investment bankers from Omaha and Lincoln. And they cared terribly whether their customers, whom they knew, were going to get their money back. And they fussed over every clause in the indenture and they talked about whether we were really okay. And so that was a very admirable process that we were put through. We were screened. We were screened and intelligently screened. I may not have been too intelligent to let us through, but it was an intelligent process. And I'd say the culture on Wall Street lately has drifted more and more to anything that can be sold at a profit will be sold at a profit? Yeah. Can you sell it? That's the question. Can you sell it is the moral test. That is not an adequate test for investment banking. There used to be 2 classes of investment bankers too, really. I mean, there were the ones that did the screening and all of that. And then there was a really low class element that essentially merchandise securities no matter what they were. And there were clear lines but the lines have disappeared. Yeah. So it hasn't been good to have this deterioration of standards in high finance. And will it ever swing back? You would certainly hope so. You can see why we were so popular at Salomon. But in fairness, we had very effective investment banking service from Solomon. That is true. That is true. And we when we sold the B stock for example, now we set the rules and they wouldn't have done it that way necessarily but they did a very good job of doing it the way we asked them to do it. And so we said we don't want people hyped into the stock. We want a very low commission and we're going to issue as much as the market takes so that nobody gets excited about the aftermarket behavior and buys because they think it's a hot issue. I mean we set a bunch of rules we thought were rational and Salama did a terrific job of following through on that doing exactly what we asked them to and it was successful by our standards. So no, I would say they did a terrific job in that. And they thoroughly enjoyed doing it. People are working on the job. Well, they never done that like it before. That's true. Yeah. We've changed our whole opinion here in a matter of seconds. Well, but there's a lesson in that. Certain kinds of clients get higher quality service than other kinds of clients. In fact, there are many clients who should never be accepted at all at investment banking houses. Yes, they are. Are you thinking of the fellow at Normandy? Yes. I mean, can you imagine that guy getting in the door? I mean, it blows your mind. And he went to jail subsequently. They should have. He was married to his high school teacher who was at least 2 decades older than he was. Charlie has more opinions on this kind of thing than I do, but go ahead. There were enough peculiarities in the situation. I wouldn't have thought it so peculiar except that he was a man and she was a woman. Okay. Number 5. Good afternoon. Mike and Dean from Chelmsford, Massachusetts. I noticed in the annual report that you took a charge off for Dexter and put under the management of H. H. Brown. And I was thinking back, I believe in 1985, you wrote about the process you went through in closing the textile business. And I was wondering if you could elaborate how this situation is different. I believe you indicated in the textile business that despite excellent management, it wasn't possible to earn an economic return on the assets. Yes. Did you say that we took a charge off on H. H. Brown? No, I meant to say we took a charge off on Dexter. Oh, Dexter. Yeah, absolutely. Yeah, we lost a very significant amount of money on Dexter. Thanks to a dumb decision that I made and maybe several dumb decisions there. And I mean that is a business that went offshore in a huge way. There are close to 1,200,000,000 pairs of shoes made in or used in this country. I never can figure out how they get to that number. I mean I use a pair of every 5 years but 4 for every man, woman and child, I don't know. But that's the number. And I don't know whether it's 5% now, but it's something in that area are made in this country. 100 of 1000 of jobs have gone offshore with that. The textile business as you know has gotten almost destroyed in this country. And when you have somebody like Burlington go into bankruptcy, a wonderful company, spent lots of money on keeping their plants up to date and all of that sort of thing. But in the end, if you're paying 10 times as much per hour for labor as somebody else, it's awfully hard to be that good. And that's going on in furniture manufacturing now too. We have a number of furniture retailers and Bill Child or Herb Blumkin will go over to the Orient fairly frequently now. We buy a lot of furniture comes from there and that trend is moving in that direction in a very significant way. And your question is was your question why Fruit of the Loom would be different? No. I was just wondering if there's any hope for, Dexter or if it's going down the same path. Oh, no. Well, Dexter is now part of H. H. Brown and it's selling product which overwhelmingly is produced abroad. And H. H. Brown sells a very significant amount of product that's produced outside the United States, although they still produce a lot of product in the United States. But now the Dexter, we will have a significant shoe business. Shoe business, we had some contracts on the books from Dexter that were unprofitable and they will run for another quarter. But we made a fair amount of money in the shoe business in the Q1. Justin made money. I think our shoe business will be okay. It won't be a bonanza over time. But I think our shoe business, we've got very good management in there. We've got good management at at H. H. Brown. We've got good management at Justin. And I would expect that we would have a substantial and a, a reasonably profitable shoe business in the future, but we will not be able to do it with 100% or 90% or 80% domestic produced shoes. And in that respect, I was very wrong in paying what I did and paying it in the manner I did, which was stock in the case of Dexter, for a domestic shoe manufacturer. Charlie? Yes. That shows, which is important to show, that no matter how hard you work at having systems for avoiding error and practices of trying to stay within your circle of competency, etcetera, etcetera, you still make mistakes. And I think I can confidently promise that it won't be our last mistake. Yeah. Here's our blue chip stamps. But you know, you might think about this a bit too. We had a lot of workers up in Dexter, Maine and we've had a lot of workers at some of the HH Brown plants and we take a little hit financially and we make it up by some trading strategy and government bonds or something like that that requires no effort and not really too much brainpower. And when you think of the consequences to the people that have spent a lifetime learning one trade and who live in those areas. And through no fault of their own, none. I mean, they've done a good job. They've done a great job working their productive but in the end their cost was 10 times or more and they weren't getting paid that well but they're 10 times what it could get done for elsewhere in the world. So we haven't really paid the price for that change in economic conditions. I mean, it's the people who work there, the people who work at Burlington or wherever where the jobs disappear and that's no argument for huge tariffs or anything of the sort. But retraining doesn't do much good if you worked in our textile mill as many people did years ago and you're 60 years old and you only we're the lucky ones basically in these situations and it is tough when you know one trade, if you live in a small town, not lots of other employment opportunities, I think. So we have a charge off and they have a huge change in their lives basically. Number 6. Jack Hurst, Philadelphia. I have 3 questions or 3 points. The first is I want to thank you for the pleasure it is to shop at Borsheim's or Nebraska Furniture Mart or even Benjamin Moore, you have terrific people working there. And I've never been as satisfied with products as is what I thought at those firms. Thank you for that and I thank you on behalf of the management. They are terrific people that work at those companies. I agree with that. You've dropped quite a bit from the annual report. There must be some God given decree that would be limited to 72 pages but I wondered if you could put that in an internet message such as that wonderful table about GEICO, its renewal policies and new policies And the 4 pages at the end of the report about the business categories where you separate the insurance from the finance from the manufacturing and also that discussion that you had of look through earnings. I think that's invaluable for looking at the company. Okay. Well, I appreciate the suggestions. I have a third point. Go ahead. But we do go through a I mean, I don't know whether 72 pages is the magic number or when I get to about 11,000 words. But occasionally, we do make an editorial decision. The look through earnings, for example, didn't seem that important and they're fairly easy to roughly calculate for anybody that's interested. But they are something that if I wrote for 15,000 words, I would have included. So I appreciate the suggestion on it and I don't think anybody's accused me of writing too short a report yet, but I'll take it certainly on the pie. It's possible on the Internet to put up anything and we'll put up any material we've given you here before the opening on Monday morning so that nobody has a jump on any information. We try to make it, I really want to cover the things that would be important to me if I were hearing about them on the other end and we try to keep it to some number of pages but I'm glad you want more. Okay. The third point is the 1st March, the Wall Street Journal analyzed or compared the auditing fees by the fees related to audit services and other audit services for the 30 stocks in the Dow Jones Industrial Average. And there seems to be an inverse relation between the amount of non audit fees with respect to market capitalization, inverse correlation with that factor to the 5 year compound growth of earnings or the 5 year total return for the companies. And for the top for the companies with the lowest ratio of non audit fees to market capitalization, The increase in earnings was 10% annually. The total return was 18% annually. For the other for the other for the other for the total, it was 5.2% return annually on increase in earnings and 11% increase in total return. Is it because these non audit fees are non productive that it has this result or is it a chance of just this spurious fluctuation or is there something to the relation? I don't know the answer to that. And I hadn't seen what you are referring to, but it doesn't totally surprise me because we like places that care about expenses. And I've never I think Jack Welch had something in his book about no company ever getting going broke from cutting expenses too rapidly. And when you see managements that are pretty lavish in what they toss around, I think on balance that group doesn't do as well for shareholders the other, but I have no statistical way of proving that. And I don't know a way that I don't know how you would set up a sample that would really be valid in terms of one kind versus the other kind. But what you say doesn't shock me. We try to watch all expenses around Berkshire. And I think that at our subsidiaries, we generally speaking, we have managers that are very, very good about that. And I think that our audit costs relative to the size of the enterprise and all of that, I think are fairly low, although they're not as low as they were a few years back. But it's something that we care about. I can assure you that. I don't know how to I wouldn't want to buy stocks though or sell stocks based on any kind of statistical measure like that, even though it looks good on what they call a back test. Charlie? Well, one of the reasons our audit costs are so low is we have this passion for keeping everything simple. We don't want to be difficult to audit and and we prefer activities that are simple. If you take the See's Candy Company, the whole company goes to cash at the end of December every year as if it were a farm where the crop came in and was sold in December. I mean, an idiot could audit the See's Candy Company without getting into trouble. And And there's a lot in Berkshire that's like the See's Candy Company. It would be really hard to screw up. We don't like complicated accounting. I mean, we really do like things that produce cash and Enron is a good example. Enron is grotesque in what happened. But there's no question in my mind that auditors have been unduly compliant to client wishes over the last few decades and more so as they went along even to the point where they started suggesting what I would consider quite doubt, quite dubious accounting to people in mergers and so on, so as to make their figures look better later on and I've seen it firsthand. So I just I think that although the auditors are supposed to work for the shareholders that they got too much so they were working for management, but I think that Enron may push them back significantly even in the other direction. So I think Enron will have a distinct beneficial effect on auditing and it was needed. So it's going to have a distinct beneficial effect on 1 fewer auditors. Yeah. Although, you know, it's an interesting question and Charlie and I may differ on this. I mean, I don't think that I don't know how many people Anderson employed but it was a huge number and I certainly, it's clear that the weaknesses and culpability at Anderson goes far beyond anything remotely we saw at Solomon, but it would have been a shame for Solomon with 8,000 people to have actually the bad acts of 1 guy and the lapse in terms of reporting and all of that which was a big mistake but by a few other people cause 8,000 people to get dislocated in their lives and lose their jobs. I don't know, how do you feel, Charlie, about the bottom 40,000 people at Anderson who really didn't have a damn thing to do with shredding or the Houston office or anything of the sort. I mean, their lives are really getting changed in many cases. I regard it as very unfair and totally undeserved in all those cases. Yet even so, I think that the capitalism without failure, somebody once said it's like religion without sin or Religion without hell. Religion without hell. I think when it gets this bad and the lack of adequate control mechanism throughout the system. I mean Anderson plainly didn't have a good total system of control and I think that it may be that capitalism should just accept this kind of unfairness in all these individual cases and let the firms go down. Well, let's say you and I did something really terrible, Charlie, at Berkshire. How do you feel about the other 130,000 people then? I mean, should they You'd feel terrible about them and there's no question about it. And but I'll tell you something, they wouldn't go down. The way we're organized, they wouldn't go down. There's nothing you can do that is going to destroy the value of the subsidiaries and the careers within the subsidiaries. You can blow your own reputation. You can blow the reputation at the holding company level, but you can't destroy their livelihood. That is a good way to be organized. We could mess up their lives though. I mean, if they lost their funding or I mean, I agree with you about their viability. Anderson was particularly vulnerable being a professional partnership. But maybe you should be extraordinarily careful if you're a professional partnership with what clients you take on and how far you go for them. The law firms that I admire most have fairly strict cultures of risk control. I think it's crazy in the kind of world we inhabit to operate in any other way. Okay. Number 7. My name is Rian Martens from Cape Town, South Africa and I became a big fan and avid reader of your ideas about 10 years ago. In 1999, I did an MBA and was nicknamed Warren Buffett because I quoted you in all the cast room discussions. All I wanted to learn was how to value a stock and think about stock prices, but sadly I was rather disappointed to find out that our MBA did not really teach that. Mr. Buffard and Mr. Munger, my question is this. If you had to predict who would be the superior investors from a group of young bright people who share your investment philosophy and possess the realism and discipline you referred to earlier? Which characteristics or work habits would you like to know about the individuals in the group? And what weighting would you place on each factor to ensure the greatest probability of your prediction being correct? Well, that's too easy a question for me. So I'll let Charlie answer that. I think the fair answer to that one is I'm not capable of answering it. No, but I do I think this, I think that's exactly right. I mean, if you ask me, what should how should you pick a wife? You know, 18% to humor, 12% to looks, you know, 17% you know, the parents. I can't give you the formula, but I think you'll make the right decision. And I think if Charlie and I were around a dozen very bright MBAs with good records and all of that and we spent some time with them, I think we'd have a reasonable chance of picking somebody from that group that might not necessarily be number 1, but they would be in the upper quartile in terms of how they actually turned out. And I but I can't tell you how to I can't write out a software program or anything that will enable you to do And I had that problem exactly at Solomon on that Saturday morning, whatever it was August 17th and I had to pick a guy to run the place and there were a dozen or so people that all thought that they were the ones or a number of them thought they were the ones to run it. And they all had high IQs and they all had lots of experience in investment banking and everything. And in the end, I had to pick 1. And I did pick the right one, I will say that. And could I be 100% sure at that time was the right one? Well, probably not, but I felt pretty sure I had the right one. And I can't tell you. I've had people say to me, well, what did you ask them and how did you evaluate it? And I only had about 3 hours to do it. And I don't know, I mean I can't write you out a set of questions that you should ask somebody. Some of it may be body language and different things of that sort. There are a lot of variables in it. But I think in the end, you would have picked the same person I picked if you'd been in that spot, you'd had to pick somebody in the 3 hours and it but quantifying it for you, I just I can't do it. Charlie, you got new Well, when multiple factors are causing success, you get these anomalies. You could have 2 people who are going to be equally successful and one is terribly good at A and terrible at Z and the other is terribly good at Z and is very good at Z and terrible at A. They're equal. Which factor is most important? The answer, it doesn't matter in that case. When you got multiple factors, great strength in one will compensate some for weakness in another. And the factors can be quite different. I think the investment world is full of people who are succeeding based on quite different sorts of talent. We'll try to do better next year. Number 8. Good afternoon. My name is Catherine Dorr from Minneapolis, Minnesota. This is my first time here. Thank you for hosting this meeting today. With the political and financial and corporate developments since September 11, I am thankful every day that persons of your integrity and the managers that you have are still managing my inheritance money. And I believe that the character and integrity is the most important criteria. I can sleep well at night. I have two questions. The first one is for Mr. Munger. When will there be a permanent store location, not a cart, of See's Candies at the Mall of America in Bloomington, Minnesota? This is the largest indoor shopping mall, I believe, in the country and hosts 1,000 of domestic and foreign visitors each year. A hint, you can sell seized candies to other nationalities when they visit us. Also, is it possible for Costco stores to sell C's candies? Since Mr. Munger has a shareholder interest in Costco, I would be interested in his answer. We could sell related products in our system. And I'll wait for his answer to ask the second question to Mr. Buffet. The short answer to your questions is that under our decentralized system, decisions of that kind go rightly to the person in charge of CS who's here, Chuck Huggins. He may not be here through this afternoon session. He may have some limited interest. But Chuck can answer those questions. He knows a lot about candy oil. We have a Helzberg we do have a Helzberg's at Mall of America though incidentally with the We have a Helzberg's operation at Mall of America which does fine. And I would add, we have not done as well moving away from the West as Charlie and I might have well, certainly as well as we hoped for when we originally bought Sea's. I mean we've done way, way better in terms of the overall result but it has been interesting to us. Now bear in mind, no one really makes any money with box chocolates through retail through their own retail outlets in the United States except for seeds. I mean, there's only 1 pound per capita of boxed chocolates roughly sold in the United States. I'm told I gave the wrong figure on, I said 64 ounces per year on people drinking. You really don't look like you only drink 64 ounces of liquid a year as it was a day. But on this one, it is 1 pound per capita per year on boxed chocolate. So it is not a big business. It's not a business. Well, the truth is 100 and 100 of firms including some that were a lot larger than C's have failed and there really is no one making any money elsewhere. Russell Stover makes very good money selling through a distribution channel that is different, But nobody's found a way to do it in stores. We found a way to do it in the West. We have not found a way to do it elsewhere. And it's very irritating to me and to Chuck as far as that's concerned that we can't figure out a way because it's so successful when it works as it does in the West. But the answer is you can look at Archibald Candy, you know, the bonds are selling for 50. They own Fannie Farmer and Fannie Mae and Laura Secord up in Canada. It is a very tough business in this country because Americans just don't buy much box chocolate. They're always happy to get it as a gift. Everybody in this room would love to get a gift of it and they may buy it when they're here, but you don't normally walk down the street or walk in a mall and buy it for yourself. It's usually a gift or it's usually at holiday time. And so we don't do as well as you might think we would when we get to very successful malls that are located in other parts of the country. We have opened holiday shops, kiosks really at 50 stores at Christmas time around the country away from our natural territory and we make some money out of that. But we wouldn't make money if we were there year round and we've been thinking about I'll guarantee you for 30 years because it's a terrific business where it works. And it's a very good question to ask because you would think, I mean, Mall of America is an obvious example. Simon would be tough to deal with the landlord, but we could figure out a way to do that. But you would think we could make money at a Mall of America and we do fine with Helzberg's there. But I'm not positive a candy store would work, but we may try one just because you asked the question. Well, I'll talk to Chuck about it. How about Costco? My second question. So Costco makes its own decisions and so does C's and I wouldn't think of getting into that one. Well, I'll get into it. We don't want people discounting our candy. It's very simple. Any more than Rolex wants somebody discounting their watches. And we will not we're not going to go through any distribution channel at Sea's. We're already getting a bargain at our retail prices. We're not going to go through any other distribution channel any distribution channel at Seas that's going to discount and Costco has no interest and I don't blame them. I mean they are based on giving people special prices and that's fine and God bless them and we'll buy things from Costco but we're not going to sell a product where the price is part of the integrity of the product. We're not going to sell it through a distribution system that we're discounting is basic to their whole approach. Costco is a wonderful operation and Caesar is a wonderful operation and never the twain shall meet. Very logical. My second question is to Mr. Bockett. Since I am a new shareholder and because this is my first attendance here, I am not sure if this question has been asked before or not. And if it is addressed in your publications, I may have overlooked it. So please bear with me. This is on the relationship between the A and the B shares. On Page 1 of the booklet, it states, Each share of Class A stock is entitled to 1 vote per share, and each share of Class B stock is entitled to onetwo hundredth of 1 vote per share. Calculating the voting weight per share would therefore be 200 Class B shares equaling 1 vote equally weighted of 1 Class A share. However, the Class B share price is onethirty traditionally of a Class A share. Given that the B share owners are purchasing into the same corporation and assets as the A share owners and the cash is just as green no matter which share you buy, therefore, it would be logical that the voting weight and price relationship of the shares be proportional all around, either onethirtyth or onetwo hundredth of pricing and voting weight, respectively. The question there for is why are the B shares not given voting weight of onethirtyth instead of onetwo hundred? Or conversely, why the B shares are not priced at onetwo hundredth of an A share? This may or may not be popular depending on which share you own. And I would appreciate your insight on that. Yes. Thanks. It's a good question. You may not be aware of the history of the issuance, but we issued the B shares. There were no I mean, they're just a common share. So we renamed the old shares A shares but we issued the B shares whatever it was about 7 or 8 years ago, Charlie, something like that. And we did that in response to some people, particularly fellow in Philadelphia, who we felt was going to induce people who really didn't understand Berkshire at all into a terribly expensive way of owning tiny pieces of Berkshire probably sold on the basis of an historical record that we did not think was representative of what could be incurred in the future. In other words, we were disturbed by somebody who saw a chance to make a lot of money off of people who were really uninformed using our stock as the vehicle and we were going to reap the unhappiness of those people subsequently they're going to run into tax problems and various administrative cost problems and so on. So to ward that off and only to ward that off, I mean, we issued the B stock which effectively put that fellow out of business because it was a better vehicle for doing what he was going to try and get people to do at great profit for himself. And when we issued it, it had not existed before and we made we put 2 differences in it from the A stock. A, we want to create a lower value per share, so we did it on a onethirty basis. At the time, it was around $1100 or thereabouts because the A was selling for in the low $30,000 but we put on the prospectus which is a very unusual prospectus in other respects. We put on that we were going to differentiate the stock in only 2 ways, but we were going to differentiate it in those 2 ways. And one was the voting power because we didn't want to issue the stock and we didn't want to change the voting situation much. And the second way was in terms of the designated charitable contributions which we the A was going to continue to enjoy and the B would not participate in. And the reason the B wasn't going to participate in it is because the amounts would have gotten to a point that would have been an administrative nightmare. I mean this year we designated $18 on the A shares. We've got a lot of 1 share B holders which would be $0.60 and it just does not make any sense. And we saw that. So we just said if you buy the B shares, you're buying into an instrument which economically is equal to 1 30th of an A. In voting, it is not equal to 1 30th of an A because we don't want to change the voting that much and it does not it has a slight economic difference in terms of the fact it doesn't get to participate in the charitable contributions program which is a very small item relative to the whole capitalization, but it's still it's something. But we do not you'll notice our A and B compared to other companies that have different voting arrangements. I was just looking at one the other day where the premium for the voting stock is 10% or 12% or something like that relative to economic interest. That's because people assume that if, you know, if the company's ever sold or anything like that, the guy that owns the a will get treated better than the B and Charlie and I have been in a situation where we got somewhat taken because of a situation because of a relationship like that. We will treat the B exactly as the A except for those two things which at the time of issuance, we set out as being differences. And those two items, everybody saw coming into the picture and they're going to stay, they will stay as part of the picture. Actually, in terms of when the meeting will be held 2 years from now, you know, we aren't even going to vote by votes in a sense. I mean I'm going to get a sense of what people want to do but I regard in that respect, I think that it ought to be the most convenient for the most people, not for them most number of shares. A will not vote any different than B or anything because you're all individual people and I want whatever works best for the most. But in terms of those two other items, they were set out that way and they'll stay that way. If we'd set out a different we would not change the relationship once the of the 2 stocks once they were issued, we would not benefit 1 relative to the other. But those are the terms of the 2. Charlie? Yeah. We had the issue of the B stock to frustrate the ambitions of this jerk promoter. And yet we didn't want to split the A stock down all of it down to tiny little fractions, which would have frustrated him but forced us to have a stock split we didn't want. So we created a vehicle which was had these two slight disadvantages and that kept most of our capitalization in its traditional A stock and also frustrated the promoter. It's an historical quirk. It's an accident of life. And the B is sold at a remarkably consistent relationship to the A. The discount got as low as or as high, I should say, as I think it was over 4% for a small period of time, but it's generally speaking, the B is sold at parity to slightly, very slightly below parity and indeed A shares get converted to B and that would not happen unless the B were at parity. So it's I think it's worked out pretty well. I mean we didn't we backed into it, but I don't think anybody's been disadvantaged by it. Number 9. I'm reading the question of Mark Russigno from New York. I've idolized you since I first heard of you 10 years ago. My only regret so far is that both of my children are girls, so I couldn't name them Warren. How about Warren Nello? That might work. Is there any merit to the argument that leasing of silver is suppressing the price of the metal and thereby not allowing it to reflect the fundamentals? Well, you hear that all the time. I don't think so. And in the end, the question of where it will sell will be affected by how much there is around and how much there isn't. And people get upset with shorts and they get upset with forward sales by producers and they get upset with leasing and all of that sort of thing. But in the end, if silver gets tight, it will go up in price. And if it isn't tight, it really doesn't make much difference whether it's leased or not. It's like companies that get upset about the short position of their stock. I've even had a few people write me because there'd be some I don't care whether there's 1,000 shares short of Berkshire or 300,000 shares short. It really doesn't make any difference because someday the people that are short have to buy and it's part of markets. So the leasing of silver takes place because somebody's got some silver around, would rather get a small amount of income by leasing it to somebody that needs to use it for one reason or another. But it's because the solar was sitting around in the 1st place that it's available for lease and it really doesn't make much difference, I don't think, in terms of pricing over time. Charlie? I have nothing to say. Okay. We got time for one more question from number 10 and that will complete the cycle also. So shoot. My name is Jerry Miller, Highland Park, Illinois shareholder. I don't want to end this meeting on a down and although I'm going to do it. Before I say that, I would like to make a positive statement. 1 of many, but I'll hold it to 1. I've been retired, I've gone to quite a few shareholders meetings and I only wish there were some way I could force most of the CEOs to attend. They may not understand what's going on, but I would just like them to see how a shareholders meeting should be handled. And now for the down a little bit. I'm downstairs. I can hear some good results. The, if you're going to sit behind the desk says the $37,000,000,000 bucks stop here, you're going to have to handle all questions. The one that I was really surprised, I didn't hear that not today from anybody, including you, the 2 of you. Although they've taken the e word away from us and the AA word away from us, I don't want them to take the Berkshire Hathaway k word away from us. Do you understand that? If you do just wave a finger and not not, I'll explain it. You're over 2 at the head table, so better explain it. This morning, I had to chide some of the fellows down the stairs at the Kirby a couple of weeks ago. There was a stain or a tarnish appeared on the Berkshire Hathaway name and a little crack appeared in the charisma. Did you happen to see the program? Yeah, I saw the program and it was interesting because it was focusing on the sales practices or alleged sales practices of some people that don't work for us but work for distributors just like salesman work for Ford dealers or something of the sort. And in particularly, it was talking about them selling to older people. And interestingly enough, over 10 years ago, we put in a policy which to my knowledge is the only one like it in the country and that anybody, anybody over 65 who buys a Kirby vacuum and is unhappy for any reason, anytime up to a year, 11 months 29 days later, can tell us so and they get their money back without question. And I don't know of another consumer durable soul like that in the country. And one of the interesting things was that the fellow they interviewed who talked about his mother having bought one and being terribly unhappy about it had actually used the product for 8 or 9 months and gotten a full refund and that fact was not mentioned on the program nor was the fact even though we had this policy. And I really regard that as rather extraordinary journalism. I trust you're not dusting off your Solomon notes then to read to the Kirby people. No, I can understand your reaction to the program because it was pointed out to ABC News several times prior to the program that this policy existed, the 300 and some people in the previous year. And if they gave us a trade in on the audit and they decided to call her off 11 months later, we gave them their money back plus a machine equal to the or better than the machine they gave us and not a word was said about that in the program. So I do not regard it as a great moment in ABC Journalism. Anyway, thanks for all. Okay. Well, thank you. Thank you. We'll see you all next year. Thank you.

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