WealthEffect — Berkshire Hathaway Annual Meeting

Berkshire Hathaway Annual Meeting

Berkshire Hathaway Annual Stockholder Meeting
Saturday, April 28, 2001
Transcript by Jacqueline L. Henry

Question: As a three-year-old, what should I invest in now so I will be ready for college?

Warren Buffett, Chairman of Berkshire Hathaway: The opportunities include investment in outstanding operating businesses and marketable securities. Marketable securities are not as friendly. The preference of Berkshire Hathaway is to own operating companies that are well managed and have a competitive advantage.

If I trade 30 Berkshire Hathaway B shares for 1 Berkshire Hathaway A share is this considered a wash sale for tax purposes? Can you talk about the investment similarities between the pharmaceutical industry and the Internet?

WB:

The pharmaceutical industry is easier to predict and has a history of better returns. The tech sector is harder to predict. The two really are not comparable.

Charles Munger, Vice-Chairman of Berkshire Hathaway: Regarding your question of trading 30 B shares for 1 A share, this should not be a taxable event.

Since Berkshire Hathaway is considered a holding company, does this subject it to regulations and thereby impede its success?

WB:

Regulations have not impeded the success of Berkshire. The insurance regulations have not slowed transactions or very little, if any. The Public Utility Company Holding Act, PUCHA, 1935 causes more difficulties for acquisition of utility companies. These regulations were put in place because of the abuses of the 1920's. Congressional action surrounding PUCHA in the future may help with additional acquisitions of utilities for Berkshire Hathaway.

What is the most recent mistake you have made and why did it occur?

CM:

Mistakes of omission are the most troubling. They show up as lost opportunity costs, and we are mistaken not to take advantage of these opportunities. What really cost are these blown opportunities.

WB:

Errors of omission doesn't mean not buying stock in general, but not buying companies within our realm of business that we understand. This can happen when we stand and stare at an opportunity and do nothing with it. It is important to know the business and the opportunity because conventional accounting does not identify lost opportunities.

The tobacco industry has been under fire recently for its unhealthy products. Does this potential exist for Berkshire Hathaway holdings of Coca Cola, Dairy Queen and See's Candies? Is there a potential risk of loss of intrinsic value of these companies due to the current health concerns?

WB:

I have been living on these products for 70 years. It depends on how you feel about sugar. 20% of Americans consume something with sugar in it every day. The life span of Americans has increased. There is no worry of product liability but this is always a fertile field for plaintiffs. Berkshire Hathaway has passed on some opportunities because of the concern of product liability.

CM:

Perniciousness is the power of the plaintiff contingency.

WB:

Decisions are usually made with a pessimistic attitude and it is projected that the trend will continue to accelerate.

Some authors are saying that it is evil to hoard cash. What are your thoughts about being cash heavy?

WB:

Sometimes we are awash with cash and then sometimes we are not. We employ cash. We do not have cash around just to have cash. We want to have the money employed but not just to employ it. We do not like a lot of leverage — this is not the style of Berkshire Hathaway.

Could you give some specific numbers that relate to Coca Cola, Executive Jet, and some of the other acquisitions?

WB:

The businesses have different characteristics: Service businesses such as Executive Jet have costs that are human-resource and capital heavy. The carpet company has a large raw-material-buyer cost, and only 15% human-resource cost. The costs vary by business. The retail business costs include purchased goods and labor, and insurance has claims costs that can extend out over years. The important part of knowing the business is that we understand the cost structure and that the company has an enduring competitive advantage with top-notch management.

CM:

If the float can be 3% per annum with a 13% per annum return then this is a good business to be in.

[Editor's note: Berkshire Hathaway's Annual Shareholder Letters (www.berkshirehathaway.com/letters/letters.html) include discussions regarding float]

The large airlines have been having problems with the pilots' unions and labor costs, and they claim they cannot pass on labor costs to their customers. Does Executive Jet pass on this cost to the customer? Why, if this is happening, can they be successful and the big airlines cannot?

WB:

If the wage rates are out of touch with the competition, the company will have problems. The cost of airlines is based on cost of available seats per mile versus cost of the occupied seat per mile and is all taken into account with the capacity utilization. Then there are fuel and capital costs. If one company can be more cost-efficient than its competitors and not out of line with competitors, that is the most important. Net Jet does not compete with the big airlines such as United. Net Jet pays fairly and it may be important for the pilots to be able live where they want. The attraction to be part of Net Jet is different from the big airlines.

CM:

Airline unions are tough. Airlines cannot afford to be down long. A long strike is like playing a game of chicken. Unions are hard on a service business.

WB:

If the company is weak, this will put it out of business.

CM:

There must be a competitive advantage.

There are enormous long-term advantages in business but, with cash and prices decreasing, is this a good time to buy?

WB:

We consider this is a reasonable time to buy and we have advantages over other buyers. Our cheques always clear. We bought Manville because they were having financial difficulties. We buy the company and then let the people run the business as they did before. We want businesses and people who care about the business and want to see it continue as it has in the past. We do not consider ourselves under pressure to buy anything so we are not under pressure to do dumb things.

CM:

This is not a "hog heaven" time for Berkshire Hathaway. The inventory game is more complicated and we see no changes ahead.

WB:

People are ready and we are in a position to buy.

With regard to value and growth stocks, and distinguishing between the companies, is this the same coin — just opposite sides?

WB:

There is no such thing as growth stocks. Growth and positive value are created only when you add capital now and get more cash later on. It is calculated into the business so there is a future return on what is earned over time. What are the economics of growth? Capital is what is returned in the future. Anyone who talks about growth and value does not understand investing. They are not two different categories.

CM:

If we buy good businesses at a reasonable cost, we can plan to be prosperous for decades.

WB:

If we would ask Wall Street to classify Berkshire Hathaway as either a growth or value stock, we really do not know what they would say.

In the schools and colleges today, how would you educate children in investing?

WB:

There is a need for teachers that can explain the subject. The best investment at an early age is in yourself. We have no sweeping ideas for national education. We do participate in the Nebraska annual high school economic programs.

[Editor's Note: The Money & Investing section of WealthEffect.com's newest feature, iCampus (designed for high-school and college students) can be accessed at www.wealtheffect.com/icampus1b.htm]

CM:

Life is much more than getting rich early from passing paper or passive wealth accumulation.

How has the Internet affected Berkshire Hathaway holdings and has your view of the Internet changed?

WB:

We view the Internet as less of a threat to retailers than a year ago. Opportunities are available for certain of our businesses, such as GEICO and See's Candies. Very few turned wealthy from the Internet from cash results but rather from public investment.

CM:

Grocery delivery is an example. Costs of delivery are still there whether you do it with the Internet or with a pad and pencil.

WB:

The Internet captured the greed and dreams of people that were gullible to the promoters. This was a huge money trap for the public.

In the future or in twenty years, how do you see Berkshire Hathaway? What are some of the not-so-obvious problems that may be encountered?

WB:

Twenty years ago, the insurance business was the most significant. Employment is not the largest part of our business at this time but revenue is the largest from insurance. We will keep acquiring businesses and some years, it will be big and some years will be small — we have no master plan. We do not sit around and strategize. We look for opportunities that have durable competitive advantage and understand price sensitivities. Insurance will be bigger in twenty years but also will be dependent upon others. Now that we are bigger, there are fewer opportunities.

CM:

In twenty years we will have more strength and value then ever before but the rate of annual percentage increases will decrease.

What is your cholesterol, and do you worry about it or consider taking medicine to lower your cholesterol?

WB:

My doctor may say it is a little high and may request that I make a few changes. I have no stress in my life. I get to do the work I love to do and work with good people. I bought an exercise bike for my mother when she was 80, so my longevity based on family history is very good.

CM:

The book Genome by Matt Ridley describes many of the traits of Warren. Everyone should read it. If you believe the assumptions in that book, I believe you will find comfort that Warren should live a long life.

What are your thoughts on profit margins and return on equity in American businesses, and also what do you think of the inventory write-offs that are occurring today in businesses?

WB:

Corporate profits today are 4-6% of GDP. The rational and reasonable in the capitalist environment should be able to generate 6% GDP. In ten years, we will see a similar picture. We have no change in thoughts of the relationship of stock prices to profits. Earnings on stocks will be 6-7% over the next twenty years. Pension funds used to be 6% and the predictions are 9% now, which in our opinion is unrealistic. This is done mainly for the benefit of the financials. Inventory write-offs can be "big bath" charges and can reflect bad news for the year and can lead to deceptions in accounting.

CM:

Pension-fund accounting is drifting into scandal. Corporate management needs to address this and not drift along with the tide. It is like predicting an earthquake. We probably won't have one because we have not had one for a long time.

CM:

: In the key operating businesses, do you see Net Jet as a mature business at 5% and do you see the aggregate growth of 10% float in the insurance business?

WB:

Executive Jet will not mature for a long time. We can service 600 customers per year based on equipment availability. The insurance float would be 2.5 billion at 10% whereas the total U.S. float for property and casualty would be 300 billion. When we are as big as we are, it is difficult to sustain 10% but the focus is to remain low cost.

What are your views and plans for GEICO in Europe and Asia? It seems that money spent on advertising Coca-Cola in Japan is low. Is there an international strategy to improve or correct this, especially since Japan is the number-one consumer of the product?

WB:

While GEICO is a low-cost operator, the move to other areas is difficult. It is a drain on human resources to extend internationally and the gain is questionable. The international markets are hard to enter. We have given a lot of thought and consideration to this. At the present time, there is a high presence of Coca Cola in Japan and the use of vending machines is actually higher than the US. The CEO is currently working to draft a new campaign for Coke and this will probably include the increased advertising in Japan.

It has been the practice of Berkshire Hathaway to write large reinsurance but the liability is capped. Are the liabilities capped in companies that would have, for example, asbestos exposure?

WB:

To the best of our knowledge, we have no asbestos exposure except for a small USG. We have walked away from some opportunities because of potential asbestos exposure. Workers-comp insurance cannot be capped but re-insurance can be capped.

How do you control claims costs different than the competition?

WB:

Customers will figure out a service business. We do not have to worry about the competition. In insurance, such as GEICO and [its] underwriting, it is important to know the variables — for example, claims in relationship to miles driven. Questions are drafted to identify the propensity to claims. Actuarial judgments enable intelligent underwriting. Everyday, they look for variables that affect claims. Fast, fair settlement of claims is important as well as good management.

Why was Berkshire started as an investment partnership rather than a mutual fund?

WB:

I worked for a mutual-fund regulated investment company and then was invited to manage money for people and formed a partnership.

'56-'69 seem to have been your best results at 29%. Has your approach changed since that time? What approach do you use today?

WB:

We search for companies that sell at a decreased price relative to the cash that [they] will generate in the future. When dealing with large amounts of money, then the returns slow as compared to dealing with small sums of money (where larger returns can be found). The biggest money in Wall Street is not from performance but gained by promotion.

CM:

There is too much chasing of easy money.

The recording of stock options seems to not show up as a liability on the balance sheet or as an expense item on the income statement. Are you or would you consider developing accounting standards to accurately reflect stock-option transactions?

WB:

It has been written and talked about but the only way it will get changed is if 15 or 20 of the large institutional investors ban together. It probably will not be a voluntary change.

[Discussions by WealthEffect regarding stock options can be found at www.wealtheffect.com/stocks/b4b10.asp, www.wealtheffect.com/stocks/b8o.asp and www.wealtheffect.com/stocks/b8p.asp]

With regards to Gillette, did the 15%-growth earning goal cause the inventory problems?

WB:

It probably was a mistake to predict 15% — very few can compound at 15%. The problem with this is that it leads people to stretch on accounting.

CM:

It happens and will continue to happen. Predictions will continue to be high because that is what analysts want to hear.

WB:

Implications in some market calculations are made with no justification of expectation of the valuation of prediction.

CM:

It is kind of like Rembrandts. They can become irrational.

WB:

It creates its own constituency.

Do you expect an aggregate growth rate of 15%?

WB:

The probability of a 15% growth rate over a period of time or over the next few years is close to zero. We will have fun doing it and trying to do it but it will probably not happen. We will not be able to do it with the current businesses; we would have to add business to accomplish it. There are groups of good businesses with good management. If we add and do not increase outstanding shares, this is the best business model we can offer.

CM:

Fifteen percent extrapolated forward is impossible. If we can produce moderate expectations, we will do well for all of us.

How did you become comfortable enough to invest in USG based on the asbestos exposure?

CM:

No comment.

WB:

It is 1/10 of 1% of our business.

Have you ever expressed interest in Level III? If leverage is stripped out of the Berkshire Hathaway portfolio, what would be the effect on the cost of the float? How fast has Berkshire grown over the last few years?

WB:

Not 5-6 percentage points. Insurance is a huge asset to us. We look for every opportunity to increase the excess float. No other company has this advantage. No comment on Level III.

When distortions on financials are noted, are they attributable to high numbers on reports or are American businesses just higher performers than the European/Asian businesses?

WB:

American business returns are higher than European countries. They are well above average. Ameritocracy works best and people like Jack Welch have shown that this is true.

CM:

Deliberate financial practice may attribute to some of it. Write off everything - they remove the burden of the past cost for future earnings. Management can set out to paint a picture for the shareholders.

What investment advice would you have for young people of the age of 11?

WB:

Education and saving money. It is easier if parents help with education and then you can get an early stake. Read financial publications. Talk to local businesses. The accumulated knowledge database is always useful. Stay ahead of credit cards.

[Editor's Note: An iCampus discussion on credit cards can be accessed at www.wealtheffect.com/icampusb/ic-creditcards.htm]

The annual report has tables that demonstrate a decline in policies issued and in force at the end of 2000. Why is there a large difference in new versus renewable for 2000?

WB:

The retention rate is affected by two factors:

The mix between low and better business in the risk category - seventy-five percent in preferred category and growth has occurred in the standard business category. The retention rate in the lower categories has decreased. The second year is the time of loss.
In the last few years, the standard and non-standard business has increased.

Today the preferred is up and the standard and non-standard are down. The numbers reflect the age of the difference rather than what is going on and we will clarify that in the next annual report.

What graduate school would you recommend and whom would you recommend to study with in the area of investments?

WB:

I would recommend Bruce Greenwald, Columbia University. He brings practicality into the studies. University of Florida and the University of Missouri have a good curriculum. It is always good to check with recent graduates.

CM:

There are courses at Stanford with Jack MacDonald. They are a clan of their own and they are right but you learn a lot about things that Warren and I do not believe.

Have you ever considered concrete as an understandable business for investment purposes?

WB:

They would have advanced raw materials. How we value a business is what the game is all about. If you cannot value a business, you cannot value a stock. The efficient market theory equates to "nobody knows anything". Investment-finance teaching in the US needs to focus on and not miss the opportunity to promote thinking intelligently about how to invest — and in doing so, the person becomes a better manager.

Is there a concern that the American consumer is so far in debt? Is the trade deficit a problem?

WB:

There are two problems today — health and debt. It is too easy to borrow and the individual can get in over his/her head very quickly. There is a greater capacity to carry debt because we now have greater earning power. We should not start out behind the eight ball with credit-card debt. Borrowing money at 18% will not allow anyone to get ahead. It will not work. The trade deficit is where assets are traded for goods. Selling off part of the farm every year so a country can consume more than it produces requires a strong country. IOU's work if the country is strong. This is a significant negative for a country especially over the long term.

CM:

If it is a developing country it may be okay as the US did early on with the railroads.

Will we soon run out of private firms that will want to be part of Berkshire Hathaway and also firms that will provide benefit to Berkshire Hathaway?

WB:

We will always be looking for good businesses that want to remain company-run and have good management. We plan to do one to two yearly and maybe 10-15 over the next five to ten years. We are not interested in companies that go on auction. We want businesses that are looking for long-term advantages. They have to like the culture of Berkshire Hathaway. There is no one else like us out there.

CM:

There are enough businesses out there and there are other competitive buyers.

WB:

So far we have not had any luck internationally. We are actually waiting for the telephone to ring. Sometimes I do not think that they think of us. Acquisitions are made because another acquisition is successful and they are happy with what happened.

CM:

When I was an attorney, I always said that the best business-getter was work that was already on the desk. We should always do well with what we already have.

You sold your position in Freddie Mac. What risks did you see in these?

WB:

There were certain aspects of the business that we were uncomfortable with as the business unfolded. Government regulation was not the reason. The risk profile changed.

CM:

We are uncomfortable around financial institutions.

WB:

There is so much you do not know about financial institutions. It is very difficult to spot trouble. It is easier to spot trouble in the retail or product business.

You talk about wide and deep moats. Are the dynamic conditions of the external environment making it more difficult to forecast the sustainability of a good business and are they going to be harder to find?

WB:

Porter agrees with Berkshire Hathaway. The quantity and sustainability of moats have changed over the past 35-40 years.

CM:

Old moats are filled in and the new are harder to predict.

Are you comfortable with financial products that are in the derivatives business?

WB:

Mark Burn runs the derivatives business. Charlie and I do not have our minds totally around that book of products.

CM:

That is one of the oddball pastimes of Warren outside the common-stock fields. We like them less than most people that are in them.

WB:

It is dangerous to pay people for outcomes that are twenty years out. It is difficult to put people in that position.

CM:

It front-ends too much income. Intrinsically, it is an irresponsible position.

Last year, someone implored you to invest in the Internet and I am here this year to say thank you for not investing in the Internet. How do you measure and approach risk?

WB:

We look at the risk of the business in terms of permanent capital loss and inadequate return. Volatility is not part of it. See's Candies performance is an example. For the seasonal holidays, such as Easter, sales are high. During other times of the year, sales may be slow. They may make the majority of their revenues in certain quarters of the year.

How do you know if you have a big idea?

I just feel it. I have had a few. Now, big ideas have to be really big.

CM:

If we took the top 15 big ideas out of Berkshire Hathaway most people would not be here today. We must be able to recognize an idea when they are rarely presented. The saying is "Opportunity comes to the prepared mind."

What are your thoughts on selling securities short and what is your experience in doing this?

WB:

Buying techniques vary on securities and the individual can go broke selling short. The loss under this technique is unlimited. Stocks are more commonly undervalued. It is not easy to make money selling short. It is easier to make money on long-term holdings. Individuals cannot make really big money because they cannot handle the loss exposure.

I am concerned that one day I will read in the Wall Street Journal: 'Buffett Kicks Bucket'. What reassurances can you give us regarding the company on this issue?

WB:

Well, first of all, I hope it is stated more eloquently than that. I go to my managers and ask, "If you die tonight what will you wish you had told me." The answer to the succession planning for Berkshire Hathaway is that we both want it to succeed. We know who is in line for succession both in the marketable securities and the business operations. The culture is strong and it would be difficult to change. I feel good about the succession plan and I also feel good about the managers and the culture. There is an envelope with the necessary information inside. People who are involved know what is in the envelope. The first instruction in the envelope is, "Take my pulse again."

WB:

Assets will do well automatically. The managers are in place. The momentum will go on nicely.

Is it risky to participate in the utility markets?

CM:

The production of electricity is an enormous business. Additional acquisitions in the field are not inconceivable. Why would intelligent people ignore the fact that surplus of power is important?

WB:

There are three goals:

Efficient operations
Fair return to attract capital
Ample supply and a margin of safety

What do you do if business changes are recognized?

WB:

If a good business is doing dumb things with your money, it is wise to get out. The option is always there to try to persuade the business to change its mind but this is difficult. Investment techniques must be simpatico with all.

If two people had the same knowledge base but one had two-years experience and one had ten-years experience, which one would do a better job?

CM:

The scale of experience matters.

WB:

One of the things that would be helpful for the person with ten-years experience would be the ability to construct models on observations, and the ten-year veteran would have more observations than the two-year.

With regards to intrinsic value and being neither under- nor overvalued, it is difficult to value disparate pieces of Berkshire Hathaway. Would you consider guidance in the area?

WB:

We would not pay over or under intrinsic value based on implicit judgment. It is easier to value because we give you all of the information. The decision is how to employ capital in the future. It would be a big mistake to give recommendations whether to buy or sell Berkshire Hathaway stock.

What books do you recommend?

WB:

Genome by Matt Ridley as identified earlier. Herb Simon, Models of My Life; Personal History by Katherine Graham and Charlie's book Damn Right: Behind the Scenes at Berkshire Hathaway by Janet Lowe.

What are your views on campaign-finance reform? What are your thoughts on the principles of intrinsic value in the real-estate market?

WB:

Campaign finance reform is out of control. It is out of sync with Congress and the public. We are hopeful that the government will put it in check.

CM:

We prefer business investment to real-estate investment.

[Editor's Note: A transcript of the 2000 Berkshire Hathaway Annual Meeting can be accessed at www.wealtheffect.com/stocks/b10a.asp In addition, an overview of the latest Letter to Shareholders is available at www.wealtheffect.com/stocks/b8r.asp]