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[I write a newsletter. The following are comments I put into this month's letter related to the BRK meeting. Warning, the post is a bit long.]


I just returned from my fifth Berkshire Hathaway annual meeting. About 10,000 people from all over the world were in attendance. As always, the event was both entertaining and very informative. I strongly recommend that all investors make the trip to Omaha to experience the meeting firsthand. Many people come away with a dramatically changed (and improved) attitude regarding what it means to be a stock investor.

Warren Buffett and his partner, Charlie Munger, spent six hours answering shareholders' questions. Of course, one topic that was discussed was the mania that exists in some areas of the market. Both men stated it is the biggest bubble they've ever witnessed. Buffett made the comment that while many companies with excessive valuations could not go out and get a bank loan for $100 million, many banks would gladly give the CEO a large personal loan based upon his stock holding in the same company. He not only found that interesting, but, I'm sure, potentially troublesome.

Berkshire Hathaway is now our largest holding. Berkshire in the late 1990s transitioned from being an organization that primarily owned stocks (like Coke and Gillette) to what is currently a large operating company. This was accomplished by the outright purchases of General Re, Geico and Dairy Queen, among others.

I think a significant reason behind Berkshire's current direction is the upward spiraling of many corporate compensation packages, which, of course, come at the expense of passive stock owners. I asked a question at the meeting related to the ever-increasing use of stock options for employee compensation. As many of you know, when stock options are used to compensate employees, the expense, albeit very real, is not recorded on the company's income statement. Though legal, this amounts to very misleading accounting, with technology companies being the largest abusers. For example, according to stock-option-related footnotes in company reports filed with the SEC last year, Cisco's earnings were in reality overstated by 24%, Qualcomm's earnings should have been presented as 26% lower, and Yahoo's $26 million income was actually a loss of $10 million.

In response to my question, Buffett stated that the option expenses mentioned in the footnotes are often understated. He said companies frequently make assumptions in an attempt to minimize even these unrecorded expenses. For example, in its last fiscal year, Cisco granted 107 million stock options. If Cisco had sold these options to the public, they would have been valued at $1.8 billion. If one expenses the actual value of the stock options granted, Cisco's earnings last year would have been reduced by 86%, not 24%, and Cisco's current P/E would be over 1000! By the way, Cisco has about 21,000 employees. Dividing $1.8 billion by 21,000, you get an average of $130,000 of option grants per Cisco employee. Great for the employees; not good for the owners of the business.

Passive minority investors have virtually no control over corporate compensation packages. And, of course, when option grants are ratcheted up, the CEOs of the corporations often receive a disproportionate percentage of the new options. Therefore, it is becoming increasingly important to identify companies whose CEOs are ethical and cognizant of shareholder interests. In addition to identifying good businesses run by able management, you need to also assess whether management is willing to work for reasonable pay.

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