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Berkshire Hathaway Annual Meeting Notes

by Selena Maranjian

I had the pleasure of attending the May 4th annual meeting of Berkshire Hathaway (NYSE: BRK.A, BRK.B), featuring more than five hours of questions answered by Warren Buffett and Charlie Munger. Here are my notes. Some information and caveats:

-- The information below is my good faith attempt to convey what was said. But it's relying on the scribblings of someone not trained in shorthand. There were times when I lost track of a question or answer, as I was busy finishing jotting down the previous question and answer. I may have mischaracterized a statement or two, as well. But overall, I think it's a pretty fair account of what was said -- if not word for word, then at least in spirit.
-- Much of the information below does reflect Buffett's and Munger's actual words, but some of it captures the essence of what was said, missing some words and/or inserting others. I wasn't able to capture every sentence. I've marked with brackets some words of my own that are there to try and clarify or convey what I understood to have been said.
-- There are definitely words and thoughts of theirs that I didn't include because I didn't catch and scribble them down in time. Still, probably at least 75%, if not much more, of the content of the meeting is below. Enjoy!

BUFFETT: This is Charlie Munger. He can hear, I can see.

[A few minutes are taken up by voting for the board of directors and to accommodate a shareholder proposal that's rejected.]

BUFFETT: Insurance cost us a lot of money last year. There were some special events and we made mistakes, too. Not a record, though -- we ran into more difficulties in a period in the 1980s. We're doing okay. [Shows a slide of first quarter results.] Our float increased -- cost us nothing and produced a gain of $1.8 billion.

[Explained amortization of deferred charges] If you don't understand this, that's okay. You can still live a happy life -- maybe a happier life. We'll put this information on the Internet before Monday, so that everyone gets a chance to see it before the market reopens. [Reviews GEICO's recent results] There was an increase in policies in force. Retention rates are also increasing, and we're working on adding more inquiries.

[The question-and-answer period begins.]

QUESTION: Are you and Mr. Munger wearing [recent acquiree] Fruit of the Loom?

BUFFETT: Yes, I am. I'm not sure Charlie wears underwear.

MUNGER: I haven't bought new underwear in a long time, [so I'm not wearing Fruit of the Loom, unfortunately].

QUESTION: Regarding why they sold some stocks, like Disney, when they believe in hanging on to stocks for the long haul.

BUFFETT: We generally sell if we need money for something else. Forty years ago, not wanting to borrow money, I'd reluctantly sell something really cheap to buy something even cheaper. Then I had more ideas than money -- now the situation is reversed.

We bought [the stocks we've bought] because of competitive advantages. Now we think, with the companies we sell, that the advantages and strengths may have deteriorated somewhat -- or we might have made a mistake [in buying in the first place]. Take newspapers -- we thought they were impenetrable franchises, but they now seem less so.

[Explained that their selling a stock doesn't necessarily mean they think it's doomed or bad to hold -- just that it's no longer as compelling to them as it once was.]

QUESTION: Regarding the growth of float.

BUFFETT: We have a longer duration of float - it has less natural erosion. It's an oil field, but we're pumping it every day. If I had to bet if it would go higher or lower in a few years, I'd bet higher. There's nothing more important to Berkshire than for the float to grow.

MUNGER: Growing float at a good clip with low cost -- it's almost impossible. We intend to do it anyway.

QUESTION: Regarding asbestos liabilities.

BUFFETT: Asbestos is a big part of our liability, but it doesn't really matter if it's asbestos or something else -- our liability is caped. You're right -- many companies that thought they were immune from asbestos [problems are finding out they're not]. It all may produce some opportunities for Berkshire to buy companies without their asbestos liability. We may see more companies like Johns Manville get added to Berkshire. Asbestos is a cancer on the American corporate world.

MUNGER: There's an enormous amount of fraud, with the wrong people getting money, arranging fraud. Some injured people are getting little. It's not a good situation.

In five years, I would be surprised if there was a constructive solution. It's a big mess.

BUFFETT: It's a concern today when we buy businesses because we're a big pocket. It might not have been worth it to go after a small company, but [if we buy the small company]...

We will be very careful in our insurance and acquisitions.

You might have seen Ed McMahon is suing for millions due to mold in his house. I wish I had that mold.

MUNGER: You probably do.

BUFFETT: I meant in my house.

QUESTION: Regarding index funds and how to choose among them, and also what benchmark is best to use, since the S&P 500's P/E is high.

BUFFETT: Take the S&P 500 index, but not all at once. [In other words, buy in installments, over time.] Be careful about the costs involved. I think people who buy those funds will do better than funds charging higher fees. You may get a higher gross return [with an actively managed mutual fund], but a lower net return [after fees are taken out].

[Buffett highly recommended books by Vanguard founder John Bogle, the father of index fund investing.]

There's nothing wrong at all with not knowing how [to evaluate individual stocks?]. If you're reasonably sure that American business will do well over the long term, then invest for the long term in it.

I don't put much importance on P/E ratios, etc. It's just not that easy to understand, when to buy... you can't learn it easily. If you buy an index fund, you protect yourself from not knowing the answers to these questions.

Pick a broad index -- like the S&P 500.

MUNGER: I think [the questioner's] second worry is that common stocks may be so high that they'll not return much.

BUFFETT: But then you'd still get a return, just a smaller one. Pass the peanut brittle, Charlie. [Throughout the meeting, Buffett and Munger are eating See's candies and drinking Coca-Cola sodas -- Cherry Coke for Buffett, Diet Coke for Munger, if I recall correctly.]

MUNGER: Look at Japan, where there's a long-term negative return. Could it happen here? Yes.

BUFFETT: [They're having trouble opening the peanut brittle.] I must say, we have excellent packaging. The nature of butter is that it can deteriorate quickly, so the packaging has to be extraordinary...

QUESTION: From a 12-year old from California, who's at his fifth annual meeting, regarding how 9/11 has changed their lives and investing strategy.

BUFFETT: We've gone through wars without being too affected at home. I've long been worried about terrorist attacks. Humans have progressed enormously in how people can hurt one another. Before, if you didn't like someone, you could throw a rock at him. Now people can inflict a whole lot more damage.

It hasn't really changed my view. There are millions of people in the world who hate us. Most can't do anything about it, but the deranged have more opportunities.

Businesswise, the part of our business that it affects the most, by miles, is insurance. In the past we hadn't arranged to get paid for taking on terrorist risks and we hadn't excluded that risk. We do have some policies out there that aren't arranged as we'd want, but most have run off by now.

We've sold a lot of terrorist insurance, excluding nuclear, biological and chemical events. Some major nuclear events could wipe out the entire insurance industry. We take a few risks on nuclear, biological and chemical risks, but just a little. We can't afford to take a large loss on it.

Most don't realize it, but the World trade Center became the largest workers' com. loss. It wouldn't have been so if it had happened at a ballgame.

We have to be vigilant in how much risk we let aggregate in our policies. Now we have to attend to man-made aggregations of risks.

The social consequences are far greater than the business ones.

MUNGER: To the extent that 9/11 has caused us [the nation, I think] to be less weak and sloppy, [it's a benefit]. We now face reality with more intelligence. Tightening of immigration should have happened years ago.

BUFFETT: Insurance isn't rocket science. You have to be sensible, know probabilities.

QUESTION: Regarding the relative P/Es of banks vs. the S&P 500. They seem to be near 30-year lows relative to the S&P 500.

BUFFETT: People always want a formula that will make them a lot of money. You just want to estimate a company's cash flows over time, discount them back, and buy for less than that.

I wouldn't want a single yardstick like relative P/E. We look at banks. We'll probably buy some in the future, but we've known them to fail, too. Someone once said there are more banks than bankers.

MUNGER: You may be asking the wrong people. I think we've failed at understanding banks. We missed opportunities due to fear.

BUFFETT: Banks have earned a lot more than we thought they would. They've done it ways that wouldn't have thought prudent 20-30 years ago.

MUNGER: We've done poorly with banks. Worse than that, we haven't changed.

QUESTION: How do you ferret out fraud, and what books do you recommend?

MUNGER: You're asking for a lot if you want a way to avoid the frauds of the world. They're sophisticated. Partly it's a matter of gaining experience in life. I think there are whole fields you can avoid... The guy who defrauds us will not be the kind who defrauds others. It'll be a small person in a small office...

BUFFETT: ...carrying a biography of Ben Franklin. [That's a joke, referring to Munger's deep respect for Ben Franklin.]

Among those who talk about EBITDA (earnings before interest, taxes, depreciation and amortization) and those who don't, there are more frauds among those who do. Either they're trying to con you, or they're conning themselves.

Many companies -- Wal-Mart (NYSE: WMT), Microsoft (Nasdaq: MSFT), etc. -- never mention EBITDA. Telecoms -- they're spending every cent they have -- there's no EBITDA. You get depreciation by laying out money first -- the worst kind of expense. It's the opposite of float, where you get money at the beginning and pay out at the end.

It amazed me how many people use EBITDA. It's amazing how many frauds look like frauds. We've spotted them. They tell you things that can't be true. They have a smell about them.

MUNGER: Robert Maxwell of England was known as "the bouncing check" -- yet Salomon was pursuing business with him, with me and Warren on the board. It shows you how much influence directors have.

We didn't stop First Normandy, with me, Warren and Lou Simpson on the board. An embarrassing episode. We protested, but were told "the underwriting committee approved it."

QUESTION: Regarding what process Buffett uses when he buys companies after talking to management for just an hour or two, and whether he talk to suppliers and customers, and does background checks.

BUFFETT: That's a good way to go about it and we've done a fair amount of it before. There's a good book about it -- Phil Fisher's Common Stocks, Uncommon Profits.

The custom picture framing business was explained to me -- I knew nothing about it. I'd gotten pictures framed -- and got robbed. It's a small business. Craig Ponzio [of Larson-Juhl, the U.S. leader in custom-made picture frames] built an enormously successful business supplying some 18,000 framing businesses. He told me the business, gave me some numbers, and came out to see me two days later. We shook hands, he got his money. I've not been to their headquarters yet [-- I should do that soon]. Most businesses you can understand quickly -- except those you'll never understand. If you talk to a company's customers, suppliers, etc., you still won't know more about its future prospects.

MUNGER: We wait for the no-brainers. We're patient. We're so peculiar that a good number of businesses prefer dealing with us.

BUFFETT: I read of a major company -- it did 10 acquisitions, each with a lot of due diligence. All did not live up to expectations. Despite the quote unquote help of investment bankers and the like. They were buying what was being sold to them. It was fulfilling myths businesses have about themselves [presumably that they should be captains of industry, making deals left and right, acquiring other companies].

People come to us for a deal that's sure to close. Employees worry when their company is on the block -- [sealing a good deal reassures everyone].

MUNGER: Someone once defined hell [for the legal realm] as endless due process and no justice.

QUESTION: Regarding whether they'd consider cryonic suspension, to extend their lives.

BUFFETT: Just don't do it too early to me. There probably isn't much downside to it.

MUNGER: It would use a lot of electricity.

BUFFETT: We get electricity wholesale from MidAmerican. As long as I can lift the phone up, ours is a very easy business to conduct.

QUESTION: Regarding their philosophy of turnarounds.

BUFFETT: Fruit of the Loom got in trouble due to borrowing too much, among other things. Financially out of control, with operating problems, too. We were not going to inherit the existing operating system. We made a condition/proposal to the bankruptcy court -- we required John Holland to return to running the business. He'd run the company well before, and was willing to resume.

It's got big market share, is accepted by major retailers, has a good brand. It's a low-cost producer of apparel. We'd like to get more share in women and children...

It's a great business for us. A little like GEICO was for us -- mismanaged for a while, but with a great advantage.

MUNGER: Books I recommend: Ice Age [by John and Mary Gribbin, I believe]. The history of glaciation. The best book of scientific explanation that I've ever read. It's available in the U.K. [the link is to] and will be published in the U.S. soon.

And also How the Scots Invented the Modern World: The True Story of How Western Europe's Poorest Nation Created Our World and Everything in It by Arthur Herman. A marvelous book.

BUFFETT: This is self-serving, but I recommend Bob Miles' The Warren Buffett CEO. It talks about the people who are handling your capital. [The book profiles most of Berkshire's managers -- the people at the top of the various companies under the Berkshire umbrella. We profiled it earlier at the Fool.]

QUESTION: From a 12-year old, regarding how they remain friends and business partners and what advice they have for young people on friendship.

BUFFETT: We hit it off immediately. We've disagreed over the years, but we have never had an argument. It may have worked better because he's in California and I'm in Omaha [laughs].

MUNGER: Warren and I know many businessmen who have not a friend on earth -- and rightly so. Once you have friends and find friends, hang on to them.

BUFFETT: What do you admire in others? See which such qualities you can adopt. Do so and you'll attract others to you. Whatever repulses you in others, will repulse others if you have it. Cultivate habits that attract people when you're young.

MUNGER: Ben Franklin went after that goal like you went after money.

BUFFETT: They're not mutually exclusive.

QUESTION: Regarding how great investors learn from others and experience.

WEB - A great IQ isn't needed at all [for successful investing]. I've learned from Ben Graham first -- in a very big way. From 11 to 19, I was reading every book on investing and didn't do well at it. I had no philosophy. I had fun, and tried lots of things. Then I read Graham -- the Rosetta stone -- and learned to think of a stock as a part of a business. It's so obvious. That was a great foundation to continue learning on. There are certain matters of temperament that help - it's very important to be realistic, to define your circle of competence, and know what you don't know. Don't be greedy, as it overcomes rationality. The books I read that molded my thinking still hold up -- Graham and Fisher. I've seen little new that's as good.

Insulate yourself from popular opinion. It doesn't help and wastes time. Better to spend that time thinking. There were no analyst reports on custom frame makers. [In other words, he did just fine buying that company without referring to analysts' opinions.]

Read Graham and Fisher, read lots of annual reports -- and see which businesses you understand. Ignore those that you don't.

MUNGER: Ask why various things are happening.

BUFFETT: We've seen relatively little correlation between high IQs and investment success. It's more interesting to see why smart people don't succeed, and to avoid [those errors of theirs].

QUESTION: Regarding Coke losing some big contracts and PepsiCo (NYSE: PEP) gaining ground.

BUFFETT: Coke wants to be where people are happy -- sporting events, Disneyland, etc. Can you be everywhere at any price? No. Coke won Venezuela from Pepsi, which had 70% to 80% market share. It was a coup -- reversing the situation. They flew in 747s loaded with supplies, got the controlling family to switch brands.

[Regarding the University of Nebraska's pouring rates}, Pepsi came in and offered lots more money than Coke would have. Sometimes when one loses a big contract, one may overbid on the next one.

Kodak (NYSE: EK) made a big mistake letting Fuji sponsor the Olympics. You can overpay for some contracts, but it's foolish to think of getting them all. Mountain Dew is what's really helping Pepsi. Carbonated soft drinks are really growing, and coffee is shrinking, despite Starbucks. Water is rising a bit. [Coca-Cola CEO] Doug Daft is a lot like [former CEO] Don Keogh.

There have been huge gains in Dasani recently. Coke is a very powerful marketing organization. I don't think they've lost their focus in any way. Try Vanilla Coke -- it'll be out next month.

QUESTION: Regarding whether economic moats, competitive advantages, are usually built slowly or quickly, and how they're built.

BUFFETT: Sometimes you can develop them quickly -- look at Microsoft. But with See's, it couldn't be done sooner than decades. Wal-Mart did a fabulous job in quite a short period. There could be things in new industries -- look at NetJets. We have an advantage there and the industry was born in the mid-1980s.

With Coke, it took decades, and going through lots of competitors. In World War II, Eisenhower wanted Coke for servicemen, so bottling plants were built around the world. That was a powerful [development], but it was 60 years after the company's start.

Disney built a solid moat quickly in animated films.

MUNGER: You can also lose the advantage very fast -- look at Arthur Andersen. It was a very good name not so long ago.

BUFFETT: Snickers has been the top chocolate bar for decades. How do you displace it? It's tough. My guess is that it will still be No. 1 in 10 years. If you were chewing spearmint years ago, you're probably chewing it still.

If a company can gain an advantage quickly, you have to worry about it losing the advantage quickly.

QUESTION: Regarding whether Coke and Gillette are still "invincibles" and regarding American Express (NYSE: AXP), as well.

BUFFETT: I think I used the term "inevitables." I referred to the products, not the companies. Blades and razors... Gillette has 71% market share in the world. Five to 10 years from now, I'd be amazed if their share changes significantly. Coke is gaining yearly. When you have half the world and the world's population is growing at c. 2% annually... It's crazy to think that earnings will grow at 15%-18% per year when you have half the world already.

People get carried away by Wall Street and even company pronouncements. Most large companies can't grow that fast -- including Berkshire. Duracell wasn't a great acquisition for Gillette.

MUNGER: That's often the case. Two-thirds of the time, a great company buys another business that's not as good.

BUFFETT: Even GEICO did it, buying companies that weren't as good as it was. It's human to want to do that. Charlie and I have no urges like that. We don't want to prove our manhood like that.

Cigarette companies often bought businesses and fell on their faces.

MUNGER: A lot of people rise to the top of companies and it's natural to think in that position that you think you know everything.

QUESTION: Regarding how Darwin would write down anything he ran across that was contrary to what he though, lest his mind immediately push it out, and what feedback systems have been developed at Berkshire.

BUFFETT: It's valuable to have a partner to say "you're not thinking right." We're not perfect. We've made big mistakes because we've not looked afresh at things. The annual report preparation process is valuable. You want a partner who's not subservient.

The typical corporate organization is designed so the CEO's beliefs are reinforced at every turn. That's not going to produce helpful contrary thinking. If a CEO wants to buy a company, sycophants will help support his thinking, making him think he's smart. Very few boards of directors an successfully stand up against the CEO.

We've got a pretty good system -- most corporations don't have them.

[The following might be a response to a new question.]

MUNGER: It's perfectly obvious to me that to say that derivative accounting is sewage is an insult to sewage.

BUFFETT: [These might possibly be Munger's words] We're getting out of General Re's derivative book. You're seeing derivative accounting unwound at Enron.

No place is as good for creating fake income as in derivatives. So we decided to bite the bullet and report a related loss. If we didn't, we wouldn't have had that loss.

We've got a 40-year contract - the guy that put it together probably got paid that day. It takes a while to get out of it -- a little like hell: easy to get into, hard to get out of.

[Lunch break. Followed by Buffett showing a graph of Blue Chip Stamps revenues climbing steeply since he became director in 1971 -- from $46,000 to $120 million annually. Then he points out that the slide is reversed. Revenues actually fell from $120 million to $46,000.]

QUESTION: Regarding their philanthropy, the questioner salutes them.

BUFFETT: A lot of shareholders are doing a lot of good. A lot of good things have come out of Berkshire. Someone's working on a book on that.
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