1998 Berkshire Hathaway Annual Meeting (Full Version)

[Applause] Morning! [Applause] Good morning, I'm Warren Buffett, chairman of Berkshire, and this is my partner. This hyperactivity fellow over here is Charlie Munger. We'll do this as we've done in the past, following the Saddam Hussein School of Management. We're going to go through the business meeting in a hurry, and then we're going to do questions. We'll do those until 3:30, with a break at noon. One will take off for 30 minutes or so while you can grab lunch. For those of you in overflow rooms now, you can join the main for the afternoon break because we'll have plenty of room then. We'll go until 3:30. We'll try to get all the questions we can. We've got 11 zones, 10 of them in this room, and we'll just make our way around them. I've got a little map here which I'll get oriented on here in a second.

Let's see, and I think we'll get through the business meeting now. Incidentally, I don't see that movie before it's shown, but that was one of our directors singing in that final session there. We keep costs down at Berkshire. Okay, the meeting will now come to order. I'm Warren Buffett, chairman of the board of directors of the company, and I welcome you to this 1998 annual meeting of shareholders. I will first introduce the Berkshire Hathaway directors that are present in addition to myself.

We have, and I can't see very well with the lights here, but if you'll stand as I name you: Susan T. Buffett, the vocalist; Howard G. Buffett, the non-vocalist; Malcolm G. Chase; Charlie, you've met; Ron Olson; and Walter Scott. Also with us today are partners in the firm of Deloitte and Touche, our auditors. They are available to respond to appropriate questions you might have concerning their firm's audit of the accounts of Berkshire. Mr. Forrest Cutter, secretary of Berkshire, will make a written record of the proceedings. Ms. Becky Hammock has been appointed inspector of elections at this meeting. She will certify to the count of votes cast in the election for directors. The named proxy holders for this meeting are Walter Scott Jr. and Mark D. Hamburg. Proxy cards have been returned through last Friday, representing 1 million 39,276 Class A Berkshire shares and 1 million 80,509 Class B Berkshire shares. The number of shares represents a quorum.

We will conduct the business of the meeting and then adjourn the formal meeting. After that, we will entertain questions that you might have. The first order of business will be a reading of the minutes of the last meeting of shareholders. I recognize Mr. Walter Scott Jr. who will place a motion before the meeting.

I moved that the reading of the minutes of the last stockholders meeting be dispensed with. Do I hear a second? A lot of seconds! The motion has been moved and seconded. Are there any comments or questions? We will vote on this motion by voice vote. All those in favor say aye. Opposed? Motion carried.

Does the secretary have a report of the number of Berkshire shares outstanding, entitled to vote and represented at the meeting? Yes, I do. As indicated in the proxy statement that accompanied the notice of this meeting that was sent by first-class mail to all shareholders of record on March 6, 1998, the record date for this meeting, there were 1 million 199,680 shares of Class A Berkshire Hathaway common stock outstanding, with each share entitled to one vote on motions considered at this meeting, and 1 million 245,081 shares of Class B Berkshire Hathaway common stock outstanding, with each share entitled to one two-hundredth of one vote on motions considered at the meeting. Of that number, 1 million 39,276 Class A shares and 1 million 80,509 Class B shares are represented at this meeting by proxies returned through last Friday.

Thank you, Forrest. For shareholders present who wish to withdraw a proxy previously sent in and vote in person on the election of directors, he or she may do so. Also, if any shareholder that is present has not turned in a proxy, please identify yourself to meeting officials in the aisles who will furnish a ballot to you. Those persons desiring ballots please identify themselves so that we may distribute them.

The one item of business at this meeting is to elect directors. I now recognize Mr. Walter Scott Jr. to place a motion before the meeting with respect to the election of directors. I move that Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chase, Charles T. Munger, Ronald L. Olson, and Walter Scott Jr. be elected as directors. Is there a second? Ben? Woman second? The motion is for Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chase, Charles T. Munger, Ronald L. Olson, and Walter Scott Jr. be elected as directors. Are there any other nominations?

Is there any discussion? Nominations are ready to be acted upon. If there are any shareholders voting in person, they should now mark their ballots on the election of directors and allow the ballots to be delivered to the inspector of elections with the proxy holders. Please also submit to the inspector of elections a ballot on the election of directors voting the proxies in accordance with the instructions they have received.

As Amick, when you are ready, you may give your report. My report is ready. The ballots of the proxy holders in response to proxies that were received through last Friday cast not less than 1 million 39,298 votes for each nominee. That number far exceeds a majority of the number of the total votes related to all Class A and Class B shares outstanding. The certification required by Delaware law of the precise count of the votes, including the additional votes to be cast by the proxy holders in response to proxies delivered at this meeting, as well as those cast in person at this meeting, if any, will be given to the secretary to be placed with the minutes of this meeting.

Thank you, Ms. Amick. Warren E. Buffett, Susan T. Buffett, Howard G. Buffett, Malcolm G. Chase, Charles T. Munger, Ronald L. Olson, and Walter Scott Jr. have been elected as directors. After the adjournment of the business meeting, I will respond to questions that you may have that relate to the businesses of Berkshire but do not call for any action at this meeting. Does anyone have any further business to come before this meeting before we adjourn? If not, I recognize Mr. Walter Scott Jr. to place a motion before the meeting. I move this meeting be adjourned. Second? Motion to adjourn has been made and seconded. We will vote by voice. Is there any discussion? If not, all in favor say aye. Opposed? The meeting is adjourned. [Applause]

Charlie and I may not get paid much, but we work fast on an hourly basis. Now we're going to do this by zones, and I think you can see who is manning each. Yeah, I see we've got a number out there already. Please ask just one question. The only thing that I can think of that we won't discuss is what we're buying or selling or maybe buying or selling, but we'll be glad to talk about anything that's on your mind.

So let's go right to zone one and start in. Thanks for the beautiful, beautiful weekend in Omaha. I'm Mike Azale from New York City, with a question for Warren and Charlie about what makes a company's price-to-earnings ratio move up relative to other companies in its industry. How can we, as investors, find companies and even industries that will grow their relative price-to-earnings ratios as well as their earnings? Thank you for the wonderful weekend and for sharing your brilliance with the shareholders. Thank you.

The, um, it's very simple that price-earnings ratios, relative price-earnings ratios move up because people expect either the industry or the company's prospects to be better relative to all other securities than they have been in their preceding view, and that can turn out to be justified or otherwise. Absolute price-earnings ratios move up in respect to the earning power of the prospective earning power of that being viewed by the investing public of future returns on equity and also in response to changes in interest rates.

In the recent well, really ever since 1982, but in extension, recent years you've had decreasing interest rates pushing up stocks in aggregate and you've had an increase in corporate profits. The return on equity of American businesses improved dramatically recently and that also and people are starting to believe it, so that has pushed up absolute price-earnings ratios. And then within that universe of all stocks, when people get more enthusiastic about a specific business or a specific industry, they will push up the relative P/E ratios for that stock or industry.

Charlie? Yes, I think he also has how do you forecast these improvements in price-earnings ratios? That's your part of the question around here. I would say that if our predictions have been a little better than other people's it's because we tried to make fewer of them. We also try not to do anything difficult which ties in with that.

We really do feel that it's – you get paid just as well – you know, this is not like Olympic diving. In Olympic diving, you know, they have a degree of difficulty factor, and if you can do some very difficult dive, the payoff is greater if you do it well than if you do some very simple dive. That's not true in investments. You get paid just as well for the most simple dive as long as you execute it all right. And there's no reason to try those three and a halves when you get – long as you execute it all right, and there's no reason to try those three and a halves when you get paid just so.

We looked for one-foot bars to step over rather than seven-foot or eight-foot bars to try and set some Olympic record by jumping over, and it's very nice because you get paid just as well for the one-foot bars.

Okay, zone two. Good morning. My name is Joe Lacy. I'm from Austin, Texas. In this era when the financial departments of the institutions of higher learning are referring to you as an anomaly and they preach the efficient markets hypothesis, saying that you can't outperform the market, where does one go to find a mentor like you found in Ben Graham? Someone you can ask questions to regarding value investing. My understanding is that the University of Florida has instituted a couple of courses that Mason Hawkins gave them a significant amount of money to finance, and I believe they're teaching something other than efficient markets there.

There's a very good course at Columbia. I know that it gets a lot of visiting years teaching that come in. I go in there and teach occasionally, but a number of practitioners. I think the efficient market theory is less holy writ now than it was 15 or 20 years ago in universities.

But it was well then it was 15 or 20 years ago in universities. It's well than it was 15 or 20 years ago in universities. But it's 20 years ago. I'd recommend looking into those two schools. It's really quite useful.

If you had a merchant shipping business, if all of your competitors believe the world is flat, you know that it is a huge edge because they will not take on any cargo to go to places that are beyond where they think they will fall off. And so we should be encouraging the teaching of efficient market theories in universities, and it amazes me.

But what it – it amazes me. But what it – you know, it – I am almost economical about ideas that they make the ones they learn in graduate school last a lifetime. And what happens is that you spend years getting your Ph.D. in finance and you learn theories with a lot of mathematics that the average layman can't do, and you become sort of a high priest.

And you get an enormous amount of yourself an ego and even professional security invested in those ideas, and it gets very hard to back off after a given point, and I think that to some extent has contaminated the teaching of investing in the universities. Charlie?

Well, I would argue that the contamination was massive, but it's waning. It is waning. It's waning. The good ideas eventually triumph.

And the word “anomaly” I've always found interesting on that because it – you know, after a while, I mean, Columbus was an anomaly. What it means is something that the academicians could not explain. And rather than re-examine their theories, they simply just discarded any evidence of that sort as anomalous, and I think when you find information that contradicts previously cherished beliefs that you've got a special obligation to look at it and look at it quickly.

I think Charlie told me that one of the things Darwin did was that whenever he found out anything that contradicted some previous belief, he knew that he had to write it down almost immediately because he felt that the human mind was conditioned so conditioned to reject contradictory evidence that unless he got it down in black and white very quickly, his mind would simply push it out of existence. Charlie knows more about Darwin than I do; maybe he can explain that.

Well, I don't know about Darwin, but I did find it amusing one of these extreme efficient market theorists explained Warren for many, many years as an anomaly of luck and he got to six sigmas, six standard deviations of luck, and then people started laughing at him because six sigmas of luck is a lot. So he changed his theory not because six sigmas – because six sigmas of luck is a lot, so he changed his theory.

Now, see, I'd rather have the six sigmas of luck. Actually, the one thing he couldn't bear to leave was his six sigmas.

Let's try zone three. My name is Warren Hayes. I'm from Chicago, Illinois. I understand from various publications like Outstanding Investor Digest that many of the best value investors are buying high-quality multinational Japanese companies that are trading below net-net working capital value. Do you agree that these values exist in Japan, and would you consider the purchase of some of them?

I will give a tout on it. I read the Outstanding Investor Digest, OID, and it's a very good publication, and I have read some of those some of the commentary about Japanese securities. We've looked at securities in all major markets, and we certainly looked at them in Japan, particularly in recent years when the Nikkei has so underperformed the S&P here.

We're quite a bit less enthused about those stocks as being any kind of obvious bargains than the people that you read about in OID. The returns on equity in most areas of Japanese business are very low, and it's extremely difficult to get rich by being the owner of a business that earns a low return on equity.

You know, we always look at what a business does in terms of what it earns on capital. We want to be in good businesses. What we really want to be in is in businesses that are going to be good businesses and better businesses 10 years from now, and we want to buy them at a reasonable price.

But many years ago, we gave up what I labeled the cigar-butt approach to investing, which is where you try and find a really kind of pathetic company, but it's all so cheap that you think there's one good free puff left in it.

We used to pick up a lot of soggy cigar butts. You know, I mean, I had a portfolio full of them, and there were free puffs in there. But we don't find many cigar butts around that we would be attracted to.

But those are the companies that have low returns on equity, and if you have a business that's earning five or six percent on equity and you hold it for a long time, you are not going to do well in investing, even if you buy it cheap to start with. Time is the enemy of the poor business, and it's the friend of the great business.

I mean, if you have a business that's earning 20 or 25 on equity and it does that for a long time, time is your friend. But time is your enemy if you have your money in a low-return business, and you may be lucky enough to pick the exact moment when it gets taken over by someone else.

But we like to think when we buy a stock, we're going to own it for a very long time, and therefore, we have to stay away from businesses that have low returns on equity. Charlie?

Yeah, it's not that much fun to buy a business where you really hope this sucker liquidates before it goes broke. [Applause]

We've been in a few of those too, right? Yeah, Charlie and I – at least I have. I've owned stock in anthracite, and I don't know what anthracite is, street railway companies, windmill manufacturers. What other gems do we have? Tax dolls – yeah, it's actually going to have turtles.

Yeah, don't even think. Yeah, Berkshire was a mistake, believe it or not. I mean, it – we went into Berkshire because it was cheap statistically, just as a general investment back in the early '60s.

It was a company that in the previous 10 years had earned less than nothing. I mean, it had a significant net loss over the previous 10 years. It was selling well below working capital, so it was a cigar-butt.

And we could have done the things we've done subsequently from a neutral base rather than a negative base, and actually it would have worked out better. But it's been a lot of fun.

Number four. Hello, my name is Martin Weigand from Bethesda, Maryland. Again, I want to thank you for your letters and principles. They're a great help for small business people running their business. My question is, last year you said you had filters in your mind to help you quickly analyze businesses.

How do your filters take into account the very fast changes of technology and the way that businesses communicate with their customers, take orders, things like that?

Well, we do have filters, and some of those sometimes are very irritating to people who check in with us about businesses, because we really can say in 10 seconds or so note a 90 percent plus of all the things that come in simply because we have these filters.

We have some filters in regard to people too. But the question of technology is very simple: that doesn't make it through our filter.

I mean, so if something comes in where there's a technological component that's of significance or where we think the future technology could hurt the business as it presently exists, we look at – you know, we look at that as something to worry about.

It won't make it through the filter. We want things that we can understand, which filters out a lot of things, and we want them to be good businesses, and we want the people to be the people.

We're very comfortable with that. That means ability and integrity. And we can do that very fast. We've heard a lot of stories in our lives, and it's amazing how they – you can become quite efficient in probably getting 95 percent of the ideas through in a very short period of time that should get through.

Charlie? Yeah, we have to have an idea that is a good idea, and b, a good idea that we can understand. It's just that simple.

And so those filters are filters against consequences from our own lack of talent. Filters haven't changed much over the years either.

Okay, area five. Hi, I'm Alan Maxwell. I live on the wonderful tropical island of Omaha. That's right, up there with a sarban, that's Nebraska spelled backward. Everyone in this room has got to be wondering the same question: who, in your opinion, both of you, is the next Warren Buffett? Charlie, who's the next Charlie Munger?

Let's try that first. That's a more difficult question. There's not much demand. [Applause] I don't think there's only one way to succeed in life, and our successors in due time may be different in many ways, and they may do better.

Incidentally, we have a number of people in the company, some of whom are in this room today and the ones you saw on that screen, who are leagues ahead of Charlie and me in various kinds of abilities.

I mean, a lot of different talents. We've got a fellow in this room tonight today who's the best bridge player probably in the world, and Charlie and I could work night and day, and if he spent 10 minutes a week working on it, he'd play better bridge than we would, and all kinds of intellectual endeavors that for some reason or another one person's a little bit better wired for than someone else.

And we have people running our businesses that if Charlie and I were put in charge of those businesses, we couldn't do remotely as well as they do. So there's a lot of different talents.

The two that we're responsible for is keeping able people who are already rich motivated to keep working at things where they don't need to do it for financial reasons.

I mean, it's that simple, and that's a problem any of you could think about, and you'd probably be quite good at it if you gave it a little thought, because you'd figure out what would cause you to work if you were already rich and didn't need the job.

Why would you jump out of bed and be excited about going to work that day? And then we try to apply that to the people who work with us. Secondly, we have to allocate capital, and these days we have to allocate a lot more capital than we had to allocate a decade ago.

That job is very tough at present. Sometimes it's very easy and it will be easy at times in the future, and it will be difficult at times in the future, but there are other people that can allocate capital, and we have them in the company, Charlie.

I mean, no, okay. Number six, good morning. My name is Chad Corey. I'm from Gaithersburg, Maryland. I just want to thank you for sharing your wisdom, and my question is, what criteria do you use to sell stock?

I kind of understand how you buy it, but I'm not sure how you sell. Yeah, well, the best thing to do is buy a stock that you don't ever want to sell. I mean, that's true when we buy an entire business.

I mean, we bought all of Geico, we bought all of See's Candy or the Buffalo News. We're not buying those to resell. I mean, what we're trying to do is buy a business that we will be happy with if we own it the rest of our lives, and we expect to.

The same principle applies to marketable securities. You get extra options with marketable securities. You can add to holdings, obviously, easier.

We can never own more than 100 percent of a business, but if we own two percent of a business and we like it at a given price, we can add and have four or five percent.

So that's an advantage. Sometimes if we need money to move to another sector, like we did last year, we will trim from some holdings, but that doesn't mean we're negative on those businesses at all.

I mean, we think they're wonderful businesses or we wouldn't own them, and we would sell if we needed money for other things.

The Geico stock that I bought in 1951, I sold in 1952. It was, you know, went on to be worth 100 or more times before the 1976 problems, 100 or more times what I paid.

But I didn't have the money to do something else, so you sell if you need money for something else.

You may sell if you believe that valuations between different kinds of markets are somewhat out of whack. You know, we've done a little trimming last year in that map, but that could well be a mistake.

I mean, the real thing to do with a great business is just hang on for dear life. Charlie?

Yes, but the sales that do happen, the ideal way is when you found something you like immensely better. Isn't that obvious? That's the ideal way to sell.

And incidentally, the ideal purchase is to find is to have something that you already like be selling at a price where you feel like buying more of it.

I mean, we probably should have done more of that in the past in some situation, but that's the beauty of marketable securities. You really do, if you're in a wonderful business, you do get a chance periodically maybe to double up in it or something of that sort.

If the market, the stock market would sell a lot cheaper than it is now, we would probably be buying more of the businesses that we're all we that we already own. They would certainly be the first ones that we would think about. They're the businesses we like the best.

Charlie? Nothing more. Okay, zone seven. Good morning, Mr. Buffett, Mr. Munger. My name is Ron Wright from Iowa City, Iowa. New companies have always been an interest to me. Is it reasonable to assume an Omaha-based company with only five billion dollars in the bank might succeed in telecommunications?

Well, I think that a new company with five billion in the bank is probably better off than most new companies. But like Jennifer Gates, there's a newborn – the – I think you're probably referring to a company that was created out of one of our local operations that's run by Walter Scott, one of our directors from the keyword Company Level 3.

I can tell you he's got very able management, and I'll take your word for it. It's also got five – but you'll have to make your own judgment on this stock. I know Charlie won't comment on that one.

Zone eight. Zone eight? Yes. Good morning, this is Mo Spence from Omaha, Nebraska. In the past, you've often said that the insurance operation is the most important business in Berkshire's portfolio. Is that true, and what are numbers two and three?

I'd also like to ask, is it true that Charlie chose the colors for the cover of this year's annual report? Did Charlie choose them?

I chose them! They were a tribute to the Nebraska football team and Tom Osborne, who you saw. Tom, incidentally, has a very low-key style. And Bobby Bowden a few years ago was in Lincoln, and he said that on their first date that Nancy had to slap Tom three times.

Somebody said, was he that fresh? And she said no, I was just checking to be sure he was alive. Tom had a fairly conservative offense for a time in the past, although it hasn't been so conservative the last few years.

But somebody said at that time the most reckless thing he did was to eat some cottage cheese a day after the expiration on the carton. But then, but I chose the colors.

Now, what was the question? What was the question, Charlie? You know a memorable question but give it to us again. Are we back there in zone eight? Oh, the numbers! Yeah, sure.

The question was about the insurance business, which we have said will be by far the most important business at Berkshire. We see that many, many years ago, and it's proven to be the case. Obviously, it got a big leg up when we purchased all of Geico Insurance.

As far as the eye can see, it will be by far the most significant business at Berkshire. And the question about two and three, in terms of earnings, Flight Safety is the second largest source of earnings.

But we don't really think of them that way. I mean, we do know our main business as insurance, but we really have a lot of fun out of all of our businesses. I mean, I have a great time out of Borsheims yesterday or at a Dairy Queen, so it will be, to some extent, the second or third or fourth largest.

That'll be determined by opportunity. We've bid on certain businesses, negotiated on them, that could have been very large businesses if they become part of Berkshire, and that'll happen again in the future.

So we have no predetermined course of action whatsoever at Berkshire. We have no strategic planning department. We don't have any strategic plan; we react to what we think are opportunities.

And if it's a business we can understand, particularly if it's big, we would love to make it number two. Charlie? I also want to say proudly that we have no mission statement.

It's hard to think of anything that we do have, as a matter of fact, and we've never had a consultant. And we try to keep things pretty simple.

We still have 12 people at headquarters. We have about 40,000 people that now work for Berkshire, and we hope to grow a lot, but we don't hope to grow at headquarters.

Number nine. Yes, my name is Patty Buffett, and I'm from Albuquerque, New Mexico. I like your name. Thanks!

In your opinion, what effect will the year 2000 compliant issue have on the U.S. stock market and the global economy? Well, I get different reports on 2000, but the main report I hear, I think, you know, we wouldn't want to rely on me on this, but you could rely on our managers, and I think we're in good shape.

It's costing us some money, but not huge amounts of money to be prepared for 2000. With companies in which I'm a director, you know, I hear some reasonably good-sized numbers.

Those numbers are in their annual reports and described as to the cost of compliance. But what I'm told by people that know a lot more than I do is that they think probably that the weakest link, maybe, in terms of where they stand versus the commercial sector in terms of reaching where they need to be by 2000 is perhaps in some areas of both national and state and local governments and foreign governments where they're really behind the curve now.

That is not an independent judgment of mine, but somebody said you want to be very careful about making a phone call at five seconds before midnight at the millennium because you make a charge for 100 years! [Laughter]

So it'll be interesting. I don't think it's going to affect Berkshire in any material way, and I certainly have a feeling that the world will get past it very easily, but it is turning – it is expensive for some companies, and it's going to be very expensive for governments.

Charlie? Yeah, I find it interesting that it is such a problem. You know, it was predictable that the year 2000 would come! Yeah, we decided that back in 1985.

Actually, we didn't welcome it. Understand? That's not Berkshire's style, though.

It is fascinating, isn't it, when you think about it, that a whole bunch of people with 160 IQs could build up such a problem, but here we are, and that's why we stick with simple things.

Number ten. My name is Kristen Schramm. I'm from Springfield, Illinois, and I'm a proud shareholder of Berkshire Hathaway. We're glad to have you here.

I've heard a little about your thoughts on trying to control campaign spending. Could you tell us more about your thoughts and efforts on this topic? Thank you.

I think it was campaign spending, okay? I'm saying spending. Yeah, I have joined something with Jerry Colbert. This is personal; this has nothing to do with Berkshire, but Jerry Colbert spearheaded, and it's taken a position under probably 30 or so, mostly business people taking a position against soft money and also taking a position on very fast disclosure campaign finance money, because I personally think that the arms race in terms of campaign spending by businesses, you know, has just begun.

I mean, it doubled in the last election, but political influence – and I don't mean that by buying a vote but I mean just in terms of having a big ear in Washington or in other state capitals.

Political influence has been an underpriced product in the past. I mean, the government is enormously important in this country to most companies.

It was amazing how cheap – cheaply it could be – attention could be purchased. But those prices are going up, and there will be an escalation, and I don't think it's easy if you're the manager of a business, and you own one-tenth of one percent of it, and you're in a business that's heavily affected by government.

I don't think it's very easy to tell your board of directors that you're going to take a hands-off approach.

So I think legislation is needed in that arena. There are over 100 campaign finance reform bills that have been introduced. Everybody wants to have their name on a bill; they just don't want to have it passed.

And, you know, John McCain's been working hard on it, and it's something I think we have to come to grips with because it's going to be a battle of the wallets for influence. And, like I say, if I were running some other company and my competitors were spending money to get the attention of would-be legislators or actual legislators, it'd be very difficult to take some high and mighty position that I wasn't going to do it myself, and my board and my shareholders might ask me why I was taking that position.

We are lucky, basically, to be in a business that's relatively unaffected by legislation, although we are going to pay a lot of tax this year. I said two years ago that it would only take 2,000 entities in the whole United States—businesses, individuals, any kind of entity—to pay the same amount of taxes as Berkshire, and that would take care of the entire budget. You'd need no social security taxes; you need no nothing.

I think we're going to be able to say that again this year. I think that if you multiply our tax by 2,000, you will more than account for including social security and everything else.

So you might say, why aren't you in Washington lobbying for a capital gains rate or a capital gains rate at corporations? It's the same as individuals or something. But we basically haven't played that game.

We feel very fortunate. I'll say this: I would rather, in this country, be a huge taxpayer myself than be somebody who needed the other end of it—the government, the dispensary.

If anybody here is paying taxes and they want to, you know, if you'd like to shift positions with somebody in a veterans hospital or, or, you know, that has a couple of children by age 19 that's getting a check from the government, you know, I don’t want to shift positions. I'm happy to be paying the taxes!

Zone 11, please! I think 11 is probably the remote, yeah, so we're going to hear this from the overflow room. Are we there? Yes.

Good morning, Mr. Buffett. Mr. Munger, my name is Patrick Brown from Charlotte, North Carolina. And I've watched returns on equity for the banking sector in the U.S. go up a good bit over the last few years, and the returns on tangible equity for some of the major banks that have led the consolidation have gone up a good bit more. Leads me to wonder whether these returns are sustainable over either the near term or the longer term, five to ten years out.

Well, that's the 64 question because the returns on equity, and particularly tangible equity, as the gentleman mentioned, and particularly tangible equity in the banking sector, even those returns have hit numbers that are unprecedented.

And then the question is if they're unprecedented, are they unsustainable? Charlie and I would probably think that we would certainly prefer—we would not base our actions on the premise that they are sustainable—20+ returns on tangible equity or on book equity and much higher returns on tangible equity.

In the banking field, you have a number of enterprises that on tangible equity here are getting up close to the 30 percent range. Now can a system where the GDP in real terms is growing maybe three percent, where in nominal terms it grows four to five percent, can businesses consistently earn at 20 on equity? They certainly can't if they retain most of their earnings, because you would have corporate profits rising as a percentage of GDP to the point that would get ludicrous.

So under those conditions, you'd either have to have huge payouts either by repurchases of shares or by dividends or by takeovers that would keep the level of capital reasonably consistent among the industry, or because you couldn't sustain—let's just say every company retained all of its earnings and they earned 20 on equity—you could not have corporate profits growing at 20 as a part of the economy year after year.

This has been a better world than we foresaw in terms of returns, and so we've been wrong before, and we're not making a prediction now, but we would not want to buy things on the basis that these returns would be sustained. We told you last year if these returns are sustained and interest rates stayed at these levels or fell lower, then stock prices in aggregate are justified, and we still believe that.

But those are two big ifs, particularly the big if in my view is the one about returns on equity and on tangible assets. It goes against—certainly goes against classic economic theory to believe that they can be sustained.

Charlie, how do you feel about it? Well, I think a lot of the increase in return on equity has been caused by the increasing popularity of Jack Welch's idea that you can't be a leader in a line of business. Get out of it, and if you get fewer people in the business, while returns on equity can go up, then it's gotten way more popular to buy in shares even at very high prices per share.

And if you keep the equity low enough by buying shares back while you can make return on equity whatever you want. We've had to some extent a slow revolution in corporate attitudes, but Warren is right; you can't have massive accumulations of earnings that are retained and keep earning these rates of return. An interesting question is to think about it: if you had 500 Jack Welches, and they were running the Fortune 500 companies, would returns on equity for American business be higher or lower than they are presently?

I mean, if you have—if you have 500 sensational competitors, they can all be rational, but that doesn't—and they will be, and they'll be smart and they'll keep trying to do all the right things, but there's a self-neutralizing effect.

It's like having 500 expert chess players or 500 expert bridge players. You still have a lot of losers if they get together and play in a tournament, so it's not at all clear that if all American management were dramatically better, leaving out the competition against foreign enterprises, that returns on equity would be a lot better.

They might very well drive things down. That's what to some extent can easily happen in securities markets; it's way better to be in securities markets if you have a 100 IQ and everybody else operating has an 80 than if you have 140 and all the rest of them also have 140.

So it's the secret of life: weak competition. Somebody said how do you beat Bobby Fischer? You know, and you said you play him any game except chess.

Well, that's how you beat Jack Welch: you play him any game except business. Oh, he's a very good golfer.

I want to point out he shot a 69 one a few months ago, and I saw him at a very tough course.

Jack manages to play 70 or 80 rounds of golf a year and come in sub-par occasionally while still doing what he does at GE. He's a great manager, but 500 Jack Welches, I'm not at all sure, would make stocks more valuable in this country.

Zone one, I'm Ben Noel, and I'm from Minneapolis. First, I just wanted to thank you for providing your past annual letters to the shareholders and Mr. Munger for providing your speech to the graduate students at USC a couple of years ago. I've drawn a lot of insights from that, not only investing but also in my day job as a business manager and I'm wondering if you could help me with my summer reading list and provide some additional suggestions for reading in the fields of investing and management other than the standards of Graham, Fisher, so forth.

Charlie? Yeah, I have recently read a new book twice, which I very seldom do, and that book is Guns, Germs, and Steel by Jared Diamond. It's a marvelous book, and the way the guy's mind works would be useful in business.

He's got a mind that is always asking why, why, why, why, and he's very good at coming up with answers. I would say it's the best work of its kind I have ever read.

I read a little easier book recently. I'm not even sure of the title. I don't pay much attention to titles when I get into books, but it's something to the effect of The Quotable Einstein.

I mean, it's a lot of his commentary over the years, and it's great reading. The Fermat theorem was the book, but that wasn't the exact title either, it's a story of the discovery of the answer on that—that's a very interesting book.

One of our shareholders from Sweden gave me a copy of that when I was in New York, and I've enjoyed it.

Zone two, Mark Rabinoff, shareholder from Melbourne, Australia. Gentlemen, we have large holdings in Freddie Mac and Fannie Mae. As you both know, they were quite—well, they were hurt quite a lot when interest rates went up in the past.

Are wondering if you think they'll be hurt again when interest rates go up in the future?

Well, the question about Freddie Mac and Fannie Mae and on interest rates, they are not as interest rate sensitive as people formerly thought they were. But it would be the pattern.

You know, I have a feeling that if interest rates got extremely low, so that there was a huge turnover of the portfolio and then rates went up dramatically, that even though they have various ways of protecting themselves against interest rate scenarios, that might get very tough.

They may have good answers as to why that wouldn't happen, incidentally, because they certainly worry about every kind of interest rate scenario; that's their job.

But I think in a sense very low interest rates are more of a long-term problem because if you get a portfolio chock full of, say, four percent mortgages or something of the sort and then you had a huge move upward, that could—that would be quite painful for some period of time, no matter what you've done in the way of hedging.

Charlie? I've got nothing to add.

That's what happened to the savings and loans in effect, you see, 25 years ago or whenever it was. And Freddie and Fannie have other functions and they've got a lot of advantages, but they have a savings and loan type operation.

They just do it on a very big scale, and they get their money from in a very different manner than from millions of depositors, but the basic economics have some similarity.

Zone three, Jane Bell, Des Moines. Since I became a Berkshire Hathaway shareholder, I've been coming to these meetings. This is my second meeting. Mr. Buffett, I'm a partner and owner in a consulting business, and we tell our clients and potential clients that we design solutions for what keeps them awake at night.

Mr. Buffett, from your perspective as an investor, what keeps you awake at night?

Well, that's a good question, and that's one I always ask the managements of our subsidiaries as well as any new investment. I want to know what their nightmare is. Andy Grove, in his book Only the Paranoid Survive talks about the silver bullet for a competitor.

So in terms of if you only had one silver bullet, which competitor would you fire it at? And it's not a bad question.

And your question's a little broader: if you only had one worry that you could get rid of, what would it be? I would say that I would—Charlie, I think I speak for sure—I let him do it, but we really don't worry.

You know, we will do the best we can, and when we have capital allocated, sometimes it's very easy to do, sometimes it's almost impossible to do.

But we're not going to worry about it because, you know, the world changes, and if we had something we were worried about in the business, we would correct it. I'm not worried about anything.

I'm not really worried about, you know, we could lose a billion dollars on a California earthquake, but I'm not worried about it, although I have a sister who's in the audience that lives in California.

I've told her to call me quickly if the dogs start running in circles or anything like that. But there's, you know, if you're worried about something, the thing to do is get it corrected and get back to sleep.

And I can't think of anything I'm worried about at Berkshire. That doesn't mean that I have any good ideas as to what we should be doing with a whole lot of money that we have around.

But, you know, I can't do anything about that except keep looking for things that I might understand and do something with the money, and if they're there, they aren't there, and we'll see what happens tomorrow and next week and the next month and next year.

Charlie, what are you worried about?

Well, in the 30-some years I've been watching you, I would say what it takes to make you not sleep at night is an illness in the family.

Short of that, Warren likes the game. I like the game. Even in the periods that look tough to other people, it's a lot of fun. It's a lot of fun.

In fact, it probably is the most—it sort of is the most—I mean, we define tough times differently than other people would.

But our idea of tough times is like now, and our idea of—we don't feel as tough times when the market's going down a lot or anything, so we're having a good time then.

I mean, we don't want to sound like undertakers during a plague or anything, but they're really, you know, it makes no difference to us whether some—whether our—some—whether the price of Berkshire is going up or down.

We're trying to figure out ways to make the company worth more money years down the road, and if we figure that out, the stock will take care of itself.

And usually, when the stock is going down, it means other things are going down, and that it's a better chance for us to deploy capital, and that's our business.

So you will not see us worrying—then maybe we should—you know, what may worry—no.

Zone four. My name is Pill Yoon from LA, California. Mr. Warren Buffett, Mr. Munger, I'm one of the persons who highly admire you both. I have two questions.

Question one: your view on the world financial business environment in the next decade. Question two: U.S. position for economic competition in the next decade. Thank you.

Well, you've asked two big questions, but you're going to get very small answers, I'm afraid. And that's no disrespect, but we just don't think about those things very much.

We just—we just are looking for decent businesses. And incidentally, our views in the past wouldn't have been any good on those subjects.

And we try to think about two things. We try to think about things that are important and things that are knowable.

Now, there are things that are important that are not knowable, in our view. Those two questions that you raise fall in that. There are things that are knowable but not important.

We don't want to cut our minds up with those. So we say what is important and what is knowable and what, among the things that fall within those two categories, can we translate into some kind of an action that is useful for Berkshire.

And really, there are all kinds of important subjects that Charlie and I, we don't know anything about, and therefore we don't think about them.

So we have our view about what the world will look like over the next 10 years in business or competitive situations.

We're just no good. We do think we know something about what Coca-Cola is going to look like in 10 years or what Gillette's going to look like in 10 years or what Disney's going to look like in 10 years or what some of our operating subsidiaries are going to look like in 10 years.

We care a lot about that. We think a lot about that. We want to be right about that. If we're right about that, the other things get to be—they're just—they're less important.

And if we started focusing on those, we would miss a lot of big things.

I've used this example before, but Coca-Cola went public, I think, in 1919, and the first year, one share cost $40. The first year it went down a little over 50.

At the end of the year, it was down to $19. There were some problems with bottler contracts. There were problems with sugar; there were various kinds of problems.

If you'd had perfect foresight, you would have seen the world's greatest depression staring you in the face when when the social order even got questioned.

You would have seen World War II; you would have seen atomic bombs and hydrogen bombs. You would have seen all kinds of things, and you could always find a reason to postpone why you should buy that share of Coca-Cola.

But the important thing wasn't to see that. The important thing was to see they were going to be selling a billion eight-ounce servings of beverages a day this year or some large number and that the person who could make people happy a billion times a day around the globe ought to make a few bucks off doing it.

And so that $40, which went down to $19, I think with dividends reinvested has turned out to be well over $5 million now.

If you develop a view on these other subjects that in any way forestalls you acting on this more important specific narrow view about the future of the company, you would have missed a great ride.

So that's the kind of thing we focus on. Charlie?

Yeah, we're not predicting the currents that will come, just how some things will swim in the currents, whatever they are.

Zone five, please. Good morning, Mark Gerstein from Value Line. Mr. Buffett, considering the large amount of demands on your time, how do you go about reviewing the entire spectrum of choices in the equity markets?

Give me that last part again. I got the demands on my time and how do you and Mr. Munger manage to review the whole spectrum of choices in the equity markets?

A bad pitch coming up. But I don't mind it at all because the truth is that we get—I don't know what we even pay for Value Line, Charlie, and I both get it, but in our respective offices, but we get incredible value out of it because it gives us the quickest way to see a huge number of the key factors to tell us whether we're basically interested in the company.

Also gives us a very good way of sort of periodically keeping up to date. Value Line has 1,700 or so stocks they cover, and they do it every 13 weeks, so it's a good way to make sure that you haven't overlooked something if you just quickly review that.

But the snapshot it presents is an enormously efficient way for us to garner information about various businesses.

We don't care about the ratings. I mean, that doesn't make any difference to us. We're not looking for opinions; we're looking for facts.

But I have yet to see a better way, including fooling around on the internet or anything, that gives me the information as quickly. I can absorb the information on about a company.

Most of the key information you can get in probably doesn't take more than 30 seconds to glance through Value Line, and I don't have any other system that's as good.

Charlie? Well, I think the Value Line charts are a human triumph. It's hard for me to imagine a job being done any better than that is done in those charts.

An immense amount of information is put in very usable form. If I were running a business school, we would be teaching from Value Line charts.

And when Charlie says the charts, and he does not mean just the chart of the price behavior, it means all that information that really is listed under the charts that—oh yeah, that gives the detailed financial information.

You can run your eye across that. The chart is the chart of the price action doesn't mean a thing to us, although it may catch our eye just in terms of businesses that have done very well over time.

But that price action has nothing to do with any decision we make; price itself is all important. But whether a stock has gone up or down or what the volume is or any of that sort of thing, that is, as far as we're concerned, you know, those are chicken tracks, and we pay no attention to them.

But that information that's right below the chart in those 10 lines or so, 15 lines, if you have some understanding of business, that's a perfect snapshot to tell you very quickly what kind of a business you're looking at.

Zone six, please. David Winters from Mountain Lakes, New Jersey. With the consolidation in the insurance industry, how do you think that will affect Berkshire's insurance businesses and the long-term development of the float?

And if I may, not to encourage your dogma to run over your karma, but how do you think your policy of partnership and fair dealing has enhanced or detracted from your investment returns? Thank you.

Well, the consolidation taking place in insurance has been taking place for some time. There have been some big mergers over the years.

It should—there are developments in insurance. We mentioned the super cat bonds, which are not bonds at all, but that has an effect.

But I would say that there’s no merger that has taken place that I regard as being detrimental either to our Geico business or to our reinsurance business.

That has not been a factor, and I think if there were some more mergers, it would not be a factor. I see no way that any entities being put together would change the competitive situation in respect to Geico.

Geico operating just as it does independently is as competitive as can be, and it would not benefit by being part of any other organization.

And our reinsurance business is much more opportunistic, and it's not consolidation there. It's just lack of fear generally by competitors who can price particularly cat business at a rate that could be totally inadequate, as I used an illustration in the report.

But nevertheless, it could appear to be profitable for a long time, and there's probably more of that going on now, and there'll probably be a lot more going on in that arena.

We have some sensational insurance businesses, though, I have to tell you that you—I don't think you really have to worry too much about how we do insurance in the future.

We had a number of Geico people here today, and I hope you got a chance to meet them. Geico—and you saw Laura Davidson. I really was hoping he could be here, but Davy is 95 years old.

I went to visit him a few months ago, and it just isn't easy for him to get around, but he built a sensational company.

It stumbled once, Jack Byrne got it back on track, and Tony Nicely got it going down the track at about 100 miles an hour. It's getting faster all the time, so we've got a great business there.

Charlie, nothing—okay, zone seven. My name is Bill Ackman from New York. Is there a price at which it's inappropriate for a company to use its capital to buy back its stock?

Give me that example of Coca-Cola at 40 P. Is that a smart place for Coke to deploy capital?

Well, it sounds like a very high price when you name it in terms of a P/E to buy back the stock at that sort of number. But I would say this: Coca-Cola has been around 112 years now, and there are very few times in that 112 years, if any, when it would not have been smart for Coca-Cola to be repurchasing its shares.

Coca-Cola is probably, in my view, among businesses that I can understand, the best large business in the world. I mean, it is a fantastic business, and we love it when Coke repurchases shares and our interest goes up.

We owned 6.3 of Coca-Cola in 1988 when we bought in. We actually increased that a little bit a few years later, but if they had not repurchased shares, we probably would own about 6.7 or 0.8 percent of Coke now. As it is, we own a little over 8 percent.

Through repurchases, they're going to be about a billion eight-ounce servings of Coke sold around the world. Our Coca-Cola products sold around the world today, 8 percent of that is 80 million, and 6.8 percent of 68 million.

So they're 12 million extra servings for the account of Berkshire Hathaway being sold around the world, and they’re making a little over a penny a serving.

So, you know, that gets me kind of excited, and I think it all—I can tell you is I approve of Coke repurchasing shares.

I'd rather have them repurchasing shares at 15 times earnings, but when I look at other ways to use capital, I still think it's a very good use of capital.

And maybe the day will come when they can buy it at 20 times earnings, and if they can, I hope they go out and borrow a lot of money to buy a ton of it at those prices.

And I think we will be better off 20 years from now if Coke follows a consistent repurchase approach. I do not think that is true for many companies.

I mean, I think that repurchases have become in vogue and done for a lot of silly reasons, and so I don't think everybody's repurchase of shares is well-reasoned at all.

You know, we see companies that issue options by the ton, and then they repurchase shares much higher. You know, I started reading about investments when I was six, and I think the first thing that I read was, you know, buy low, sell high.

But these companies, through their options, you know, they sell low, and then they buy high, and they've got a different formula than I was taught.

So there are a number that we don't approve of. When we own stock in a wonderful business, we like the idea of repurchases even at prices that may give you nosebleeds.

It generally turns out to be a pretty good policy, Charlie. Well, I think the answer is that in any company, the stock could get to a price so high it would be foolish for the corporation to repurchase its shares.

Sure. And you can even get into gross abuse. Before the crash, the insult utilities were madly buying their own shares as a way of promoting the stock higher.

It was like a giant Ponzi scheme at the end. So there's all kinds of excess that's possible, but the really great companies that buy at a high price-earnings where that can be wise—our interest in Geico went from 33 to 50 without us laying out a dime because Geico was repurchasing its shares.

And we benefited substantially, but we benefited a lot more, obviously, when prices were lower. I mean, we would—we would—our interest in the Washington Post Company has gone from 9 and a fraction percent to 17 in a fraction percent over the years without us buying a single share.

But the Post or Coke or any number of companies don't get the bargain in repurchasing now that they used to. We still think it's probably the best use of money in many cases.

Zone eight, my name is Hutch Vernon. I'm from Baltimore, Maryland. My question has to do with float. You said in the annual report you've said in the past that float has had a greater value to Berkshire than an equal amount of equity.

I wondered if you could clarify that statement. Is that because the float has been generated at such a low cost relative to an imputed cost for equity, or is there something else behind that statement?

No, it's because the float, which is now, we'll say 7 billion, comes to us at a negative cost. We would not make that statement if our float was costing us a couple percent a year even though it would then be desirable, highly desirable.

But our float is even better than that—or it has been—and so it comes to us with a cost of less than zero. It comes to us with a profit attached.

So if we were to replace—if we were to get out of the insurance business and give up the 7 billion afloat and replace it with 7 billion of equity, we would have less going for us next year than under the present situation, even though our net worth would appear to be 7 billion higher.

I have said that if we were to make the decision—if we were offered the opportunity to go out of the insurance business and that 7 billion liability would, as part of that decision, would evaporate from our balance sheet so that our equity would go up whether tax implications—we would turn down that proposition.

So obviously, we think that 7 billion, which is shown as a liability, one is part of it viewed as part of an insurance business, is not a liability at all in terms of real economic value.

And of course, the key is not what the float is today and not what the cost is today. The key is what is the float going to be 10 or 15 years from now, and what is the cost going to be 10 or 15 years?

And you know, we will work very hard at both increasing the amount of float and keeping the cost down somewhere close to our present level.

That makes it a very attractive business when that can be done. Geico is a big part of doing that, but we've got other insurance operations that will be important in that too, and we may have others besides that in the future.

Charlie? Yeah, if the float keeps growing, that is a wonderful thing indeed. We really have a marvelous insurance business, in addition to having this remarkable earning power.

It's way less likely to get really clobbered than most insurance businesses.

So it's—I think it's safer on the downside and has a better upside. And it may sound strange, but we don't regard losing a billion dollars in the California quake as getting really clobbered.

I mean, that's part of the game. There are many companies that have greater exposures than that that really aren't getting paid for it, and you don't see it specifically.

But any company that has a ton of homeowners business in Florida or Long Island or along the coast of Texas may have exposures many times our billion and really not be getting paid appropriately for it.

Okay, area nine. Hi, my name is Mary Semler from Seattle, Washington. Japan is a major holder of U.S. Treasuries. Given the troubled Japanese economy, do you perceive Japan cashing in their U.S. investments to bail themselves out? Why or why not?

I thought I didn't get all that. I didn't get that. I was busy chewing here. But Japan is a major holder of U.S. Treasuries. Given the troubled Japanese economy, do you perceive Japan cashing in the U.S. investments to bail themselves out?

Why or why not?

It's very interesting. The whole—all the questions about what so-called foreigners do with investments. Let's just assume that the Japanese or any other country decides to sell some U.S. government holdings that they have.

If they sell, if they sell them to U.S. corporations or citizens or anything, what do they receive in exchange? They receive U.S. dollars. What do they do with the U.S. dollars?

You know, I mean, they can't get out of the system if they sell them to the French. You know, the French give them something in return.

Now the French own the government securities, but really, as long as we—the United States runs a deficit, a big deficit, a trade deficit, we are accepting goods and giving something in exchange to foreigners.

I mean, when they send us whatever that may be—and on balance—they send us more of that than we send over there. We give them something in exchange.

We give them—we may give them an I.O.U. We may give them a government bond, but we may give them an investment they make in the United States. But they have to be net investors in this country as long as we're net consumers of their goods.

It's a tautology. So I don't even know quite how a foreign government dumps its government bonds without getting some other type of asset in exchange that may have an effect on a different market.

The one question you always want to ask in economics is, and not a bad idea elsewhere too, but is, and then what? Because there's always a second side to a transaction, and just ask yourself if you are a Japanese bank and you sell a billion dollars worth of government bonds, U.S. government bonds, what do you receive in exchange, and what do you do with it?

And if you follow that through, I don't think you'll be worried about foreign governments selling U.S. bonds. It is not a threat.

Charlie? If I owned Japan, I would want a large holding of U.S. Treasuries on an island nation without much in the way of national resources. I think their policy is quite intelligent for Japan, and I'd be very surprised if they dumped all their Treasuries.

If they're an exporter too, so what choice do they have? And think about it: if they send over more goods to us than we send to them, which has been the case, they have to get something in exchange.

Now, for a while, they were taking movie studios in exchange. They were taking New York real estate in exchange.

I mean, they've got a choice of assets, but they don't have a choice as to whether—if they can send us more than they get from us, whether they get some investment asset in return.

It's amazing to me how little discussion there is about the fact that there are two sides to an equation, but it makes for better headlines, I guess, when read the other way.

Zone 10. This is John Bond from Detroit, Michigan. Nebraska's Senator Kerry has proposed private investment accounts for up to two percentage points of the current payroll tax.

His words were, and I quote, "People want more than just a transfer payment; they want wealth." Do you approve of this proposal? And if you do, would you recommend passive investing, i.e. index, or if you recommend active investing, would you and Charlie want to give it a shot?

Well, I've talked with Bob Kerry about that, and Bob does like the idea of giving everybody some piece of the American economy and an interest in it.

He's thought, as you know, he's proposed really sort of small grants to the three-and-a-half million or so children born every year and then some build-up of that account.

Senator Moynihan has come up with something recently in conjunction with Kerry. I personally would not like to see any major amount of Social Security, and one hand is talking about two percent.

And I actually I suggested the idea that maybe two percent out of the 12-and-a-fraction percent at the option of the beneficiary, Social Security participant, could be devoted to some other system.

But then they would only get five-sixths of the basic Social Security benefit. I don't think you could drop it below that because you wouldn't want people turning 65, or maybe more advanced age in the future, 70, and not having the safety net of Social Security.

So I wouldn't want to drop it below about five-sixths of the present benefits. I think it's a perfectly reasonable topic to discuss whether you want to take that two percent and then let people build up an account, perhaps tax-free, perhaps an IRA-type account, so they would have both wealth and the safety net.

But I wouldn't want to drop the safety net very far, and I think that I would not want to turn an army of salespeople loose on the American public with a mandatory two percent going in some direction.

I don't think that would be particularly healthy. Charlie?

I'm much less enthusiastic than you are. In other words, your negative or conservative attitude is way more affirmative than mine.

I think the idea of getting the government and the promoting the value of equities—in Japan we have a taste of that now; the Japanese government has been using the postal savings system to buy equities massively year after year after year.

I don't think we need to get the government into the equity market.

We're going to zone 11, please. I'm Dale Max from University Park, Illinois, and I've got a question for each of you: a short question for Charlie and a little maybe a little longer for Warren.

My question for Charlie is, in a business school sense, what is the cost of capital for Berkshire Hathaway?

And my question for Warren is, I've been on the internet, and I look at Yahoo, and they give you recommendations for companies, and when I search for Berkshire Hathaway, it shows that nobody is recommending Berkshire Hathaway, despite the fact that there are maybe a thousand people that are wearing signs saying I love Berkshire Hathaway, and of course I've got mine on too.

But what seems to be the problem in the lack of recommendations?

Well, we're not recommending Yahoo, incidentally, either. But [Applause] but I'll let—puzzle people for thousands of years, and then the way that is taught in most business schools now I find incoherent, and so I'm the one that asks that question and gets the incoherent answers.

I don't have a good answer to a question I consider kind of a stupid question: what is the cost of capital at Berkshire Hathaway?

When we keep drowning in this total torrent of cash, which they get to that, but you don't need a mathematical answer.

The first question is, when you have capital, is it better to keep it or return it to shareholders?

It's better to return it to shareholders when you cannot create more than a dollar of value with that capital. That's test number one.

And if you pass that threshold that you think you can achieve more than a dollar in value for every dollar retained, then you simply look around for the thing that you feel the surest about and that promises the greatest return, weighted for that certainty.

So our cost of capital is, in effect, is measured by the ability to create more than a dollar value for every dollar retained. If we're keeping dollar bills that are worth more in your hands than in our hands, then we've exceeded the cost of capital, as far as I'm concerned.

And once we think we can do that, then the question is, how do we do it to the best of our ability?

And frankly, all the stuff I see in business schools—I've not found any way to improve on that formula.

Now, the trouble that you may have is that many managements would be reluctant to distribute money to shareholders, even if they would rationalize that they would do better than they then actually do.

But that may be a danger on it, but that won't be solved by them hiring a bunch of people to come up with some cost of capital.

It also justifies them keeping the money because that's what they'll do otherwise.

The question about recommending the stock, we've very seldom had stock recommendations over the years. As I think back to 1965, I can't think of a lot of brokerage reports that have recommended Berkshire.

I'm not looking for any reports at all. We are not looking to have Berkshire sell at the highest possible price, and we're not looking to try to attract people to Berkshire who are buying stocks because somebody else recommends them to them.

We prefer people who figure out for themselves why they want to buy Berkshire because they're much more likely to stick around if they enter the restaurant because they decide it's the restaurant they want to eat at than if somebody has touted them on it.

And that's our approach. So we do nothing to encourage. But I think even if we did, we probably wouldn't generate a lot of recommendations.

It's not a great stock to get rich on if you're a broker.

I think the reason I think one of the main reasons why it's so little recommended in the institutional market is that it's perceived as hard to buy in quantity.

We prefer we've got some good institutions as holders, including one that's run by a very good friend of ours. But frankly, it's more fun for us to have a bunch of individual shareholders.

I mean, you see it—it translates if there's money made, it translates into changes in people's lives and not some change in somebody's performance figure for one quarter.

And we think that individuals are much more likely to join us with the idea of staying with us for as long as we stay around, and that's the way we look at the business.

Very few institutions look at investments that way, and frankly, we think they're often less rational holders than we get with individuals.

Number one. Good morning! Good morning, gentlemen. I'm Hugo Stevenson, a shareholder from Atlanta. My question involves the company's super cat reinsurance business. You've addressed some of this, but I would like for you to expound on it, please.

You've indicated that you think this is the most important business of the company, and my question is, what do you think the long-term impact of catastrophe bonds and catastrophe derivatives will be on the float and the growth and float of the company?

And I remember several years ago Mr. Buffett, you talked about how you could never be smarter than your dumbest competitor, right? And these are some potentially dumb competitors you've got.

I just want to put an asterisk on one thing we say: Insurance will be our most important business. We've not said the super cat business will be our most important. Super cat has been a significant part of our business and may well over the years remain a significant part.

But it is far less significant than Geico. And I'll mention a word or two about that. But the super cat business, you can price wrong, as I illustrated in my report.

You can be pricing it at half what it should be priced at. I used an illustration in the report of how you could misprice it. A policy that you should be getting, say, a million and a half for—namely, a $50 million policy on something that had one chance in 36 of happening—so you should get almost a million halfway.

I said if you priced it at a million a year, you know, you would think you were making money after 10 years, 70-odd percent of the time. The interesting thing about that is if you priced it for a dollar a year, you would have thought you made money 70-odd percent of the time.

It’s tough to misprice them and not know about them for a long time. Super cat bonds open up that field wide open. I mean, you’ve always had the problem of dumb competitors, but you have a much more chance of having dumb competitors when you have a whole bunch of people who, in the case of hedge funds, who bought some of these where the manager gets 20% of the profits in the year when there are profits.

And when there is, there happens to be a hurricane or an earthquake, he doesn't take the loss; his limited partners do. So it's very likely to be a competitive factor that brings our volume down a lot.

It won't change our prices. The thing to remember is, the earthquake doesn’t know the premium that you receive. I mean, the earthquake happens regardless, so it doesn't say, you know, you don't have somebody out there on the San Andreas Fault that says, "Well, he only charged a 1% premium, so we’re only going to do this once every 100 years," and it doesn't work that way.

So we will probably do a whole lot less volume in the next few years in the super cat business. We have these two policies that run for a couple of more years.

But in terms of new business, we will do a whole lot less. Geico is by far the most important part of our insurance business, though.

Geico, in the 12 months ended April 30th, had a 16.9% increase in policies in force year-end. I told you it was 16.0 a year ago. I told you it was 10 the year before that. I think it was six in a fraction. So its growth is accelerating, and it should be in a whole lot more homes around the country than it is now, you know, by a big factor.

And it will be, in my view. So that will be the big part of our insurance business.

But we may be in the insurance business in some other ways too, as time goes along. It's a business that, if you exercise discipline, you should find some ways to make money.

But it won't always be the same way.

Charlie? I've got nothing. Zone two, please.

Hi, I'm Alan Maxwell. I live in the wonderful tropical island of Omaha. That's right up there with a sarban — that's Nebraska spelled backward.

Everyone in this room has got to be wondering the same question: who, in your opinion, both of you, is the next Warren Buffett? Charlie, who's the next Charlie Munger?

Let's try that first. That's a more difficult question. There's not much demand! [Applause]

I don't think there's only one way to succeed in life, and our successors in due time may be