DN BRK Quotes

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BERKSHIRE HATHAWAY’S KEY INVESTING QUOTES

Contents

Investing ................................................................................................... 2
Insight Development .................................................................................................................... 2
Temperament/Discipline .............................................................................................................. 7
Learning ...................................................................................................................................... 19
Stock Selection ....................................................................................... 23
Comprehension .......................................................................................................................... 23
Moat ........................................................................................................................................... 31
Reinvestment/Growth ................................................................................................................ 39
Management .............................................................................................................................. 45
Financial Strength ....................................................................................................................... 66
Valuation .................................................................................................................................... 72
Inflation ...................................................................................................................................... 83
Risk ............................................................................................................................................. 86
Industry .................................................................................................. 88
Banking ....................................................................................................................................... 88
Insurance .................................................................................................................................. 112
Life Insurance ........................................................................................................................... 126
Money Management ................................................................................................................ 127
Portfolio Management ......................................................................... 128

Source: 1970‐2010 BRK shareholder Letters, 1983‐2010 WSC Investor Letters, BRK/WSC Meeting Transcripts 1986‐2011,
Poor Charlie’s Almanac 3, Select Presentation Transcripts 1991‐, Buffett Partnership Letters 1956‐1970.
dreyfus.neenan@gmail.com Page 1 V3.0, 08/31/11

Dreyfus Neenan F:\Drey\Investing\Berkshire Hathaway Quotes.doc

Investing
Insight Development

“Severe change and exceptional returns usually don't mix.”
- BRK 1987 Letter

“Last year MidAmerican wrote off a major investment in a zinc recovery project that was initiated in 1998 and became
operational in 2002. Large quantities of zinc are present in the brine produced by our California geothermal operations,
and we believed we could profitably extract the metal. For many months, it appeared that commercially‐viable
recoveries were imminent. But in mining, just as in oil exploration, prospects have a way of “teasing” their developers,
and every time one problem was solved, another popped up. In September, we threw in the towel.

Our failure here illustrates the importance of a guideline – stay with simple propositions – that we usually apply in
investments as well as operations. If only one variable is key to a decision, and the variable has a 90% chance of going
your way, the chance for a successful outcome is obviously 90%. But if ten independent variables need to break
favorably for a successful result, and each has a 90% probability of success, the likelihood of having a winner is only 35%.
In our zinc venture, we solved most of the problems. But one proved intractable, and that was one too many. Since a
chain is no stronger than its weakest link, it makes sense to look for – if you’ll excuse an oxymoron – mono‐linked
chains.”
- BRK 2004 Letter

“[On pharmaceuticals] Buffett responded that ‘we generally look at businesses with the belief that change is going to
work against us. We try to find businesses where the basic demand for business is going to be the same, year after year.
Look at Gillette: they dominate their business so much that if they bring out a new product, men will automatically give
it a try. We think we know, in a general way, what the See’s, Coca‐Colas, and Gillette’s of the world will look like in ten or
twenty years.’ ‘Wall Street tells you that change will present you with opportunity. Frankly, that scares the hell out of us.
Why try betting on things we don’t know when we can bet on things we do know?’”
- Buffett, 1996 BRK Meeting

“I've heard Warren say since very early in his life that the difference between a good business and a bad one is that a
good business throws up one easy decision after another. whereas a bad one gives you horrible choices ‐ decisions that
are extremely hard to make: "Can it work?" "Is it worth the money?"
One way to determine which is the good business and which is the bad one is to see which one is throwing
management bloopers ‐ pleasant, no‐brainer decisions ‐ time after time after time. For example. it's not hard for us to
decide whether or not we want to open a See's store in a new shopping center in California. It's going to succeed. That's
a blooper.”
- Munger, 1998 BRK Meeting

“Shareholder: My question involves what Phil Fisher referred to as "scuttlebutt". When you identify a business you
believe warrants further investigation, how much time do you typically spend on it ‐ both in terms of total hours and in
terms of weeks or months during which time you perform your investigation?



Buffett: Well, now I spend practically none ‐ because I've done it in the past. One advantage of allocating capital is that
an awful lot of what you do is cumulative. So you get continuing benefits from what you've done before. And by now.
I'm probably fairly familiar with most of the businesses that might qualify for investment by Berkshire.
But when I started out, and for a long time, I used to do a lot of what Phil Fisher calls the ‘scuttlebutt’ method. And I
don't think you can do too much of it.

But it should be the last 20%. Don't chase every idea.

Buffett: Now the general premise of why you're interested in something should be 80% of it or thereabouts. You don't
want to be chasing down every idea. Therefore, you should have a strong presumption. You should be like a basketball
coach who runs into a 7‐footer on the street. You're interested to start with. Now you've got to find out if you can keep
him in school, if he's coordinated and all of that sort of thing. And that's the "scuttlebutt" aspect of it.
But it should be the last 20% or 10%. You don't want to get too impressed by that because you want to start with a
business where you think the economics are good ‐ where they look like 7‐footers. Then you want to go out and use the
scuttlebutt approach to test your original hypothesis.
So you may reject it. But if you confirm it, you may view it more strongly. That's what I did with American Express in
the '60s. And the scuttlebutt approach so reinforced my feelings about it that I kept buying more and more and more.

You're going to learn a lot. I recommend it.

Buffett: As you're acquiring knowledge about industries in general and companies specifically, there isn't anything like
first doing some reading about them and then getting out and talking to competitors and customers and suppliers and
past employees and current employees and whatever it may be. If you talk to a bunch of people in an industry and ask
them who they fear the most and why, who (in Andy Grove's words) they'd use the silver bullet on and so on, you're
going to learn a lot.
In fact, by the time you're through, you'll probably know more about the industry than most people in it. And that's
both because you'll be coming in with an independent perspective and because you'll have listened to everything
everyone says rather than listening primarily ‐ as is all too frequently the case ‐ to your own truths. And I do recommend
it.
- 1998 BRK Meeting

“GM was Charlie's biggest holding. He even made money.

Shareholder: Do you have any interest in investing in the auto industry? And if you're not interested, what could
change your mind about investing in it in the future
Buffett: As regards the auto industry. Charlie was big in General Motors in the early‐'60s. Right, Charlie? Wasn't it your
biggest commitment?
Munger: That's right. I had a temporary delusion. Luckily, it passed.
Buffett: You made money on it. It's interesting for us to follow. Many years ago, it was the dominant factor ‐ the
overwhelming factor ‐ in the economy. It's diminished a fair amount since, but it's still a very important industry.

“Buffett: That's a good question and one, incidentally, which I always ask the managers of our subsidiaries as well as the
managers of any new investment. I want to know what their nightmare is.

“We've been burned only when we've made mistakes in judging the future economics of a business ‐ which has nothing
to do with due diligence.

“Business judgment about economics ‐ a people, to some extent, but primarily business economic ‐ is 99% (…)”


- 1998 BRK Meeting

“A Rumor About Your Holdings

Shareholder: Is it true you hold a share of every company traded on the New York Stock
Exchange?

Buffett: ‘I used to hold one share of a great many companies ‐ and used piles of the dividend checks to pay off bridge
losses. Now, I actually hold a hundred shares of several hundred companies. They’re held in my foundation so I don’t go
crazy at tax time. I do it to keep tabs on competitors of my companies and to keep a constant flow of information
coming across my desk.’”
- 1999 BRK Meeting

“We don’t intentionally go into a business that we think will change in a big way.”

“Besides you won’t hold a checklist in your mind if somebody just tells it to you ex cathedra. It’s when you learn to
derive or induct it yourself … that the checklist gets slotted into your head so you can use it for the rest of your life.
Science education is so good because it forces convincing derivation after convincing derivation plus good induction
after good induction.”
- Munger, 2002 WSC Meeting

“Building Investment Knowledge

We read a lot: daily publications, annual reports, 10Ks, 10Qs, business magazines, etc.

Fortunately, the investment business is one where knowledge accumulates and builds into a knowledge base that’s
useful. There’s a lot to absorb over time. 40‐50 years ago, I visited a lot of companies, but haven’t done this in a long,
long time.”

“General

If we were to do it over again, we’d do it pretty much the same way. The world hasn’t changed that much. We’d read
everything in sight about businesses and industries we think we’d understand. And, working with far less capital, our
investment universe would be far broader than it is currently.

There’s nothing different, in my view, about analyzing securities today vs. 50 years ago.

“If you don’t keep learning, other people will pass you by. Temperament alone won’t do it – you need a lot of curiosity
for a long, long time.

“We think the best way to minimize risk is to think. Our default is [to have our capital] in short‐term instruments and
only do something when it makes sense.”



“Buffett: Most of the time, our actual decision [to buy] takes about two seconds. In the case of Anheuser‐Busch, I
bought 100 shares 25 years ago so that I would get the annual reports (you get the annual reports a little quicker if you
own the stock in your own name). So, I’ve been reading the company’s annual reports for 25 years.

Munger: In our situation, it’s rare that we can buy into a good company – we almost need a little unpleasantness.”
- 2005 BRK Meeting

“The proper thing to do looking back is to realize how stupid we all were. We all blow a fair amount of obvious
opportunity. By the way, Berkshire did do some fixed‐income arbitrage and distressed debt. It’s not like nothing at all
has gone on in recent years. But looking back, I would say that we were all a little bit brain blocked – we could have done
better in recent years. The right way to do it, of course, is to scan a broad area until you find something you understand
and that you’re sure will work and then load up hugely, after properly considering other opportunities. Most of us,
including the one speaking, didn’t scan enough. I didn’t try as hard as I did when I was young. We should have scanned a
little more intelligently and been a little more ambitious in the things we did.”

“There’s no substitute for devoting a lot of time to thinking.

Now, it’s better for the rest of us that many of the people who are too busy to think are that busy. They don’t do
that much thinking anyway – and you get more output out of them than if they’re thinking.
But if your ambition is to be a person of good general cognition so you’re likely to be reasonably wise compared
to other people under various tough situations, I don’t think there’s any substitute for devoting a lot of time to your
thinking…

One lesson we learned was to be very selective. I don’t think we’ve ever regretted not making a lot of easy money when
we declined to do it because we felt it was beneath us.”

“In the great majority of cases the lack of performance exceeding or even matching an unmanaged index in no way
reflects lack of either intellectual capacity or integrity. I think it much more the product of: (1) group decisions – my
perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of
any size with all parties really participating in decisions; (2) a desire to conform to the policies and (to an extent) the
portfolios of other large well‐regarded organizations; (3) an institutional framework whereby average is “safe” and the
personal rewards for independent action are in no way commensurate with the general risk attached to such action; (4)
an adherence to certain diversification practices which are irrational; and finally and importantly, (5) inertia.”
- “Observations on Performance,” From a letter to the Buffett Partnership, Omaha, Nebraska, Jan 1965

“…over the years, and in the aggregate, the return on (S&P500) book value tends to keep coming back to a level around
12 percent.”
- “How Inflation Swindles the Equity Investor,” Fortune, May 1977



“You don’t want to buy a dollar bill that’s sitting for 50 cents, and it demands positive capital, and it’s going to be a
dollar bill ten years from now. You want a dollar bill that’s going to compound at 12% for [a long time]. And, you want
to be around some competent people.”
‐ From Buffett’s Notre Dame lecture, Spring 1991



Temperament/Discipline

“A further related lesson: Easy does it. After 25 years of buying and supervising a great variety of businesses, Charlie and
I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we
have been successful, it is because we concentrated on identifying one‐foot hurdles that we could step over rather than
because we acquired any ability to clear seven‐footers.

The finding may seem unfair, but in both business and investments it is usually far more profitable to simply stick with
the easy and obvious than it is to resolve the difficult. On occasion, tough problems must be tackled as was the case
when we started our Sunday paper in Buffalo. In other instances, a great investment opportunity occurs when a
marvelous business encounters a one‐time huge, but solvable, problem as was the case many years back at both
American Express and GEICO. Overall, however, we've done better by avoiding dragons than by slaying them.”
- BRK 1989 Letter
“Granting the presence of perverse incentives, what are the operating mechanics that cause widespread bad loans
(where the higher interest rates do not adequately cover increased risk of loss) under our present system? After all, the
bad lending, while it has a surface plausibility to bankers under cost pressure, is, by definition, not rational, at least for
the lending banks and the wider civilization. How then does bad lending occur so often?
It occurs (partly) because there are predictable irrationalities among people as social animals. It is now pretty clear (in
experimental social psychology) that people on the horns of a dilemma, which is where our system has placed our
bankers, are extra likely to react unwisely to the example of other peoples' conduct, now widely called "social proof". So,
once some banker has apparently (but not really) solved his cost‐pressure problem by unwise lending, a considerable
amount of imitative "crowd folly", relying on the "social proof", is the natural consequence. Additional massive irrational
lending is caused by "reinforcement" of foolish behavior, caused by unwise accounting convention in a manner
discussed later in this letter. It is hard to be wise when the messages which drive you are wrong messages provided by a
mal‐designed system.”
- WSC 1990 Letter

“This brings to mind Ben Graham's paradoxical observation that good ideas cause more investment mischief than bad
ideas. He had it right. It is so easy for us all to push a really good idea to wretched excess, as in the case of the Florida
land bubble or the "nifty fifty" corporate stocks. Then mix in a little "social proof" (from other experts), and brains
(including ours) often turn to mush. It would be nice if great old models never tricked us, but, alas, "some dreams are
not to be." Even Einstein got tricked in his later years.”
- WSC 1990 Letter

“Under prevailing accounting, banks now ordinarily report increases in both earnings and equity capital during any
transition they make toward less conservative lending. And then, if more lending of that type is done, and is
accompanied by growth in institutional size, good reported figures will continue for an additional period. If an increase
in institutional size is deemed necessary, it is, of course, assured by the bank's access to the government's credit through
deposit insurance.


We think acculturated corporate nature, in American financial institutions, simply cannot, on average, handle
temptations implicit in this sort of accounting. Indeed, the succumbing to the temptations, in a manner not consistent
with long‐term institutional interest, often occurs through a subconscious process. The subconscious process includes
bad effects from both (1) "social proof", and (2) a "reality‐denial" mode that creates bias in people stimulated, honored
and paid in proportion to institutional size. Under our present system a Columbia Savings, and many less obscene
versions of its model, are almost inevitable.
Of course, a large minority, even a majority, of bankers will remain sound, despite the temptations. But this outcome is
not sufficient to protect the deposit insurer from unacceptable ultimate losses. In due course, given present conditions,
the deposit insurer will suffer from what some wag called the problem of there being so many more banks than
bankers.”
- WSC 1990 Letter

“Though we are delighted with what we own, we are not pleased with our prospects for committing incoming funds.
Prices are high for both businesses and stocks. That does not mean that the prices of either will fall ‐‐ we have absolutely
no view on that matter ‐‐ but it does mean that we get relatively little in prospective earnings when we commit fresh
money.
Under these circumstances, we try to exert a Ted Williams kind of discipline. In his book The Science of Hitting, Ted
explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his "best" cell,
he knew, would allow him to bat .400; reaching for balls in his "worst" spot, the low outside corner of the strike zone,
would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging
indiscriminately would mean a ticket to the minors.

If they are in the strike zone at all, the business "pitches" we now see are just catching the lower outside corner. If we
swing, we will be locked into low returns. But if we let all of today's balls go by, there can be no assurance that the next
ones we see will be more to our liking. Perhaps the attractive prices of the past were the aberrations, not the full prices
of today. Unlike Ted, we can't be called out if we resist three pitches that are barely in the strike zone; nevertheless, just
standing there, day after day, with my bat on my shoulder is not my idea of fun.”
- BRK 1997 Letter

“We made few portfolio changes in 1999. As I mentioned earlier, several of the companies in which we have large
investments had disappointing business results last year. Nevertheless, we believe these companies have important
competitive advantages that will endure over time. This attribute, which makes for good long‐term investment results, is
one Charlie and I occasionally believe we can identify. More often, however, we can't ‐‐ not at least with a high degree
of conviction. This explains, by the way, why we don't own stocks of tech companies, even though we share the general
view that our society will be transformed by their products and services. Our problem ‐‐ which we can't solve by
studying up ‐‐ is that we have no insights into which participants in the tech field possess a truly durable competitive
advantage.

Our lack of tech insights, we should add, does not distress us. After all, there are a great many business areas in which
Charlie and I have no special capital‐allocation expertise. For instance, we bring nothing to the table when it comes to
evaluating patents, manufacturing processes or geological prospects. So we simply don't get into judgments in those
fields.

If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are
approaching the perimeter. Predicting the long‐term economics of companies that operate in fast‐changing industries is


simply far beyond our perimeter. If others claim predictive skill in those industries ‐‐ and seem to have their claims
validated by the behavior of the stock market ‐‐ we neither envy nor emulate them. Instead, we just stick with what we
understand. If we stray, we will have done so inadvertently, not because we got restless and substituted hope for
rationality. Fortunately, it's almost certain there will be opportunities from time to time for Berkshire to do well within
the circle we've staked out.”
- BRK 1999 Letter

“Now, speculation ¾ in which the focus is not on what an asset will produce but rather on what the next fellow will pay
for it ¾ is neither illegal, immoral nor un‐American. But it is not a game in which Charlie and I wish to play. We bring
nothing to the party, so why should we expect to take anything home?

The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most
market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money.
After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball.
They know that overstaying the festivities ¾ that is, continuing to speculate in companies that have gigantic valuations
relative to the cash they are likely to generate in the future ¾ will eventually bring on pumpkins and mice. But they
nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave
just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.

Last year, we commented on the exuberance ¾ and, yes, it was irrational ¾ that prevailed, noting that investor
expectations had grown to be several multiples of probable returns. One piece of evidence came from a Paine Webber‐
Gallup survey of investors conducted in December 1999, in which the participants were asked their opinion about the
annual returns investors could expect to realize over the decade ahead. Their answers averaged 19%. That, for sure, was
an irrational expectation: For American business as a whole, there couldn’t possibly be enough birds in the 2009 bush to
deliver such a return.

Far more irrational still were the huge valuations that market participants were then putting on businesses almost
certain to end up being of modest or no value. Yet investors, mesmerized by soaring stock prices and ignoring all else,
piled into these enterprises. It was as if some virus, racing wildly among investment professionals as well as amateurs,
induced hallucinations in which the values of stocks in certain sectors became decoupled from the values of the
businesses that underlay them.

This surreal scene was accompanied by much loose talk about "value creation." We readily acknowledge that there has
been a huge amount of true value created in the past decade by new or young businesses, and that there is much more
to come. But value is destroyed, not created, by any business that loses money over its lifetime, no matter how high its
interim valuation may get.

What actually occurs in these cases is wealth transfer, often on a massive scale. By shamelessly merchandising birdless
bushes, promoters have in recent years moved billions of dollars from the pockets of the public to their own purses (and
to those of their friends and associates). The fact is that a bubble market has allowed the creation of bubble companies,
entities designed more with an eye to making money off investors rather than for them. Too often, an IPO, not profits,
was the primary goal of a company’s promoters. At bottom, the "business model" for these companies has been the old‐
fashioned chain letter, for which many fee‐hungry investment bankers acted as eager postmen.

But a pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learns some very old
lessons: First, many in Wall Street ¾ a community in which quality control is not prized ¾ will sell investors anything they
will buy. Second, speculation is most dangerous when it looks easiest.


At Berkshire, we make no attempt to pick the few winners that will emerge from an ocean of unproven enterprises.
We’re not smart enough to do that, and we know it. Instead, we try to apply Aesop’s 2,600‐year‐old equation to
opportunities in which we have reasonable confidence as to how many birds are in the bush and when they will emerge
(a formulation that my grandsons would probably update to "A girl in a convertible is worth five in the phonebook.").
Obviously, we can never precisely predict the timing of cash flows in and out of a business or their exact amount. We try,
therefore, to keep our estimates conservative and to focus on industries where business surprises are unlikely to wreak
havoc on owners. Even so, we make many mistakes: I’m the fellow, remember, who thought he understood the future
economics of trading stamps, textiles, shoes and second‐tier department stores.”
- BRK 2000 Letter

“And now it’s confession time: I’m sure I could have saved you $100 million or so, pre‐tax, if I had acted more promptly
to shut down Gen Re Securities. Both Charlie and I knew at the time of the General Reinsurance merger that its
derivatives business was unattractive.
Reported profits struck us as illusory, and we felt that the business carried sizable risks that could not effectively be
measured or limited. Moreover, we knew that any major problems the operation might experience would likely
correlate with troubles in the financial or insurance world that would affect Berkshire elsewhere. In other words, if the
derivatives business were ever to need shoring up, it would commandeer the capital and credit of Berkshire at just the
time we could otherwise deploy those resources to huge advantage. (A historical note: We had just such an experience
in 1974 when we were the victim of a major insurance fraud. We could not determine for some time how much the
fraud would ultimately cost us and therefore kept more funds in cash‐equivalents than we normally would have.

Absent this precaution, we would have made larger purchases of stocks that were then extraordinarily cheap.)

Charlie would have moved swiftly to close down Gen Re Securities – no question about that. I, however, dithered. As a
consequence, our shareholders are paying a far higher price than was necessary to exit this business.”
- BRK 2003 Letter

“Banking's a little like investing. You have to avoid folly.

Buffett: There's no magic to it. You just have to avoid doing something foolish. It's a little like investing. You don't have
to do anything very smart. You just have to avoid doing things that are ungodly dumb when looked at about a year later
‐ airlines and that sort of thing. That's the trick.
It is not some great crystal ball game where you look into the future and see all these things other people can't. After
all, what's complicated about Coca‐Cola or Gillette ‐ or Wells Fargo for that matter?
On the record, I'd say that Wells has done an exceptionally good job running its bank compared to other big banks.
And those two operations put together will be run a whole lot more efficiently than if First Interstate had been run on its
own.

So you really ought to invest with the idea that if you were going to take a trip for 20 years, you wouldn't feel bad
leaving the money with the company ‐ with no orders with your broker, no power of attorney or anything ‐ and you
knew that when you came back that it would still be a terribly strong company.”



“But the important thing is that when you do find one where you really do know what you are doing, you must buy in
quantity.... Charlie and I have made a dozen or so very big decisions relative to net worth, although not as big as they
should have been. And in each of those, we've known that we were almost certain to be right going in.”

“You could always find a reason not to buy Coca‐Cola....

Buffett: I've used this example before. But Coca‐Cola went public in ‐ I think it was ‐ 1919. One share cost $40. But in
the first year, it went down a little over 50%. At year end, it was down to $19. There were some problems with bottler
contracts, there were problems with sugar ‐ various kinds of problems.
And if you'd had perfect foresight, you'd have foreseen the world's greatest depression staring you in the face. 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 have always found a reason to postpone buying that
share of Coca‐Cola.

If you took your eye off the ball, you missed a treat ride.

Buffett: But the important thing was to see that they would be selling a billion 8‐oz. 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 world
ought to make a few bucks off doing it. So that $40 share that went down to $19, I think, with dividends reinvested
would be worth well over $5 million today.
If you developed a view on these other subjects that in any way forestalled your acting on this more important,
specific, narrow view about the future of the company, [then] you would have missed a great ride. So that's the kind of
thing we focus on. Charlie?
Munger: Yeah. We're not predicting the currents that will come just bow some things will swim whatever the currents
may be.

“ Munger: Yeah. You asked about quality versus price. The investment game always involves considering both quality
and price. And the trick is to get more quality than you pay for in price. It's just that simple.
Buffett: But not easy.
Munger: No, but not easy.”
- 1998 BRK Meeting

“It’s interesting to me that the top sixteen people in Long Term Capital Management were very smart ‐ higher IQs than
you’ll find in most places with a high percentage of their own net worth invested in the firm, and they were effectively
broke on that day in September. Why do smart, rich people risk so much to get just a little more?
It’s like Russian roulette: there’s no price at which the gamble makes sense. What’s two percentage points more when
the loss could be total failure?”
‐ Buffett, 1999 BRK Meeting

“All intelligent investing is value investing; acquire more than you are paying for. Investing is where you find a few great
companies and then sit on your ass.”



“You need to have a passionate interest in why things are happening. That cast of mind, kept over long periods,
gradually improves your ability to focus on reality. If you don’t have the cast of mind, you’re destined for failure even if
you have a high IQ.

“Few people with 80 IQs are whacking the cover off the ball [in investing], but all sorts of high IQ people don’t have
investment success. It would be interesting to analyze why.”

“Investment Mistakes

Buffett: If we start buying a stock, we want to go in heavy. I can’t think of a stock where we wanted to quit. We’ve made
some big mistakes starting to buy something that was cheap and within our circle of competence, but trickled off
because price went up a bit. Good ideas are too scarce to be parsimonious with.

Munger: After nearly making a terrible mistake not buying See’s, we’ve made this mistake many times. We are
apparently slow learners. These opportunity costs don’t show up on financial statements, but have cost us many
billions.”
- 2003 BRK Meeting

“Charlie and I are competent to make judgments on certain things, and not other things. We try to focus on what we can
understand, which is a reasonable amount.”

“The Importance of the Right Temperament

Munger: We read a lot. I don’t know anyone who’s wise who doesn’t read a lot. But that’s not enough: You have to have
a temperament to grab ideas and do sensible things. Most people don’t grab the right ideas or don’t know what to do
with them.

Buffett: The key is to have a ‘money mind,’ which is not IQ, and then you have to have the right temperament. If you
can’t control yourself, you’re going to have disasters. Charlie and I have seen it. The whole world in the late 1990s went
a little mad in terms of investments. How could that happen? Don’t people learn? What we learn from history is that
people don’t learn from history.”
- 2004 BRK Meeting

“How Has Berkshire Succeeded?

How does a little company in the textile business, sure to go blooey, [succeed on such a massive scale?] Textiles are
[little more than] congealed power, so if Warren had just stayed in the textile business, he would have been sure to go
bankrupt. But he wrung a little money out of it, invested it in insurance and many years later, a business with a $10
million market cap become one with $100 billion – and there aren’t a lot more shares outstanding.

How did this happen? If you took the top 15 decisions out, we’d have a pretty average record. It wasn’t hyperactivity,
but a hell of a lot of patience. You stuck to your principles and when opportunities came along, you pounced on them


with vigor. With all that vigor, you only made a decision every two years. We do more deals now, but it happened with a
relatively few decisions and staying the course for decades and holding our fire until something came along worth
doing.”

“I said, ‘We know the edge of our competency better than most.’ That’s a very worthwhile thing. It’s not a competency if
you don’t know the edge of it.”

“We’ve never eliminated the difficulty of that problem. And ninety‐eight percent of the time, our attitude toward the
market is… [that] we’re agnostics. We don’t know. Is GM valued properly vis‐à‐vis Ford? We don’t know.

We’re always looking for something where we think we have an insight which gives us a big statistical advantage. And
sometimes it comes from psychology, but often it comes from something else. And we only find a few – maybe one or
two a year. We have no system for having automatic good judgment on all investment decisions that can be made. Ours
is a totally different system.”

“We just look for no‐brainer decisions. As Buffett and I say over and over again, we don’t leap seven‐foot fences.
Instead, we look for one‐foot fences with big rewards on the other side. So we’ve succeeded by making the world easy
for ourselves, not by solving hard problems.
Q. Based on statistical analysis and insight?
Well, certainly when we do make a decision, we think that we have an insight advantage. And it’s true that some of the
insight is statistical in nature. However, again, we find only a few of those.”

“It doesn’t help us merely for favorable odds to exist. They have to be in a place where we can recognize them. So it
takes a mispriced opportunity that we’re smart enough to recognize. And that combination doesn’t occur often.”
‐A Lesson on Elementary, Worldly Wisdom, Revisited – Stanford Law School, 4/19/1996

As Jessie Livermore said, ‘ The big money is not in the buying and selling…but in the waiting” – Poor Charlie’s Almanac 3
P 60

“It’s not the bad ideas that do you in, it’s the good ideas. And you may say, that’s paradoxical. What Graham meant was
that if a thing was a bad idea, it’s hard to overdo. But where there is a good idea with a core of essential and important
truth, you can’t ignore it. And then its so easy to overdo it. So the good ideas are a wonderful way o suffer terribly if you
overdo them.”
‐Poor Charlie’s Almanac 3 P63.

“If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are
approaching the perimeter.”
‐WEB, Poor Charlie’s Almanac 3 P65

“I feel I’m not entitled to have an opinion unless I can state the arguments against my position better than the people
who are in opposition.”
– PCA3, p430.



“We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we
derive comfort if they don’t. A public opinion poll is no substitute for thought. When we really sit back with a smile on
our face is when we run into a situation we can understand, where the facts are ascertainable and clear, and the course
of action obvious. In that case – whether conventional or unconventional – whether others agree or disagree – we feel
we are progressing in a conservative manner.”
- “Observations on Performance,” From a letter to the Buffett Partnership, Jan 1965

“The future is never clear; you pay a very high price for a cheery consensus. Uncertainty actually is the friend of the
buyer of long‐term values.”

“It has more to do with his personality. He is very, very sure of his own judgments. He ignores everybody else.”
- Jack Byrne, former Geico Chairman, regarding Lou Simpson, “Geico’s Top Market Strategic Churning Out Profits,”
The Washington Post, May 11, 1987

“Simpson said that his biggest mistakes in the stock market have been that he sold stocks too early.”
- “Geico’s Top Market Strategic Churning Out Profits,” The Washington Post, May 11, 1987

“Last year at a Los Angeles party, Munger's dinner partner turned to him and coolly asked, ‘Tell me, what one quality
most accounts for your enormous success?’ Recalling this delicious moment later, Munger said, ‘Can you imagine such a
wonderful question? And so I looked at this marvelous creature ‐‐ whom I certainly hope to sit by at every dinner party ‐‐
and said, 'I'm rational. That's the answer. I'm rational.'”
- “The Inside Story of Warren Buffett,” Fortune, April 11, 1988

“The whole LTCM is really fascinating because if you take Larry Hillenbrand, Eric Rosenfeld, John Meriwether and the two
Nobel prize winners. If you take the 16 of them, they have about as high an IQ as any 16 people working together in one
business in the country, including Microsoft. An incredible amount of intellect in one room. Now you combine that with
the fact that those people had extensive experience in the field they were operating in. These were not a bunch of guys
who had made their money selling men’s clothing and all of a sudden went into the securities business. They had in
aggregate, the 16, had 300 or 400 years of experience doing exactly what they were doing and then you throw in the
third factor that most of them had most of their very substantial net worth’s in the businesses. Hundreds and hundreds
of millions of their own money up (at risk), super high intellect and working in a field that they knew. Essentially they
went broke. That to me is absolutely fascinating.”
- Buffet Lecture at the University of Florida, School of Business, Oct 15, 1998

“It is like Henry Kauffman said, “The ones who are going broke in this situation are of two types, the ones who know
nothing and the ones who know everything.”

“The interesting thing about investments for me and my partner, Charlie Munger, the biggest mistakes have not been
mistakes of commission, but of omission. They are where we knew enough about the business to do something and
where, for one reason or another, sat they're sucking out thumbs instead of doing something. And so we have passed


up things where we could have made billions and billions of dollars from things we understood, forget about things we
don’t understand.”

“We don’t want to pass up the chance to do something intelligent because of some prediction about something we are
no good on anyway.”

“I worked on Wall Street for a couple of years and I have my best friends on both coasts. I like seeing them. I get ideas
when I go there. But the best way to think about investments is to be in a room with no one else and just think. And if
that doesn’t work, nothing else is going to work. The disadvantage of being in any type of market environment like Wall
Street in the extreme is that you get over‐stimulated. You think you have to do something every day. The Chandler
family paid $2,000 for this company (Coke). You don’t have to do much else if you pick one of those. And the trick then
is not to do anything else. Even not to sell at 1919, which the family did later on. So what you are looking for is some
way to get one good idea a year. And then ride it to its full potential and that is very hard to do in an environment
where people are shouting prices back and forth every five minutes and shoving reports in front of your nose and all
that. Wall Street makes its money on activity. You make your money on inactivity.”

“How I got here is pretty simple in my case. It's not IQ, I'm sure you'll be glad to hear. The big thing is rationality. I
always look at IQ and talent as representing the horsepower of the motor, but that the output‐‐the efficiency with
which that motor works‐‐depends on rationality. A lot of people start out with 400‐horsepower motors but only get a
hundred horsepower of output. It's way better to have a 200‐horsepower motor and get it all into output.

So why do smart people do things that interfere with getting the output they're entitled to? It gets into the habits and
character and temperament, and behaving in a rational manner.”
- “The Bill and Warren Show,” Fortune July 20, 1998

“Incidentally, I would say that almost everybody I know in Wall Street has had as many good ideas as I have, they just
had a lot of [bad] ideas too. And I’m serious about that. I mean when I bought Western Insurance Security selling at $16
and earning $20 per share, I put half my net worth into it.”
- From Buffett’s Notre Dame lecture, Spring 1991

“Now if I had some rare insight about software, or something like that – I would say that, maybe, other people couldn’t
do that – or biotechnology, or something. And I’m not saying that every insight that I have is an insight that somebody
else could have, but there were all kinds of people that could have understood American Express Company as well as I
understood it in ‘62. They may have been...they may have had a different temperament than I did, so that they were
paralyzed by fear, or that they wanted the crowd to be with them, or something like that, but I didn’t know anything
about credit cards that they didn’t know, or about travelers checks. Those are not hard products to understand. But
what I did have was an intense interest and I was willing, when I saw something I wanted to do, to do it. And if I
couldn’t see something to do, to not do anything. By far, the most important quality is not how much IQ you’ve got. IQ
is not the scarce factor. You need a reasonable amount of intelligence, but the temperament is 90% of it. “


“The last thing I want to show you, before we get onto your questions, is an ad that was run June 16, 1969, for
1,000,000 shares of American Motors. This is a reproduction from the Wall Street Journal of that day. Now does
anybody notice anything unusual about that ad?

Everybody in that ad has disappeared. There are 37 investment bankers that sold that issue, plus American Motors, and
they are all gone. Maybe that’s why they call them tombstone ads. Now the average business of the New York Stock
exchange in 1969 was 11 million shares. Average volume now is fifteen times as large. Now here’s an industry whose
volume has grown 15 to 1 in 20 years. Marvelous growth in the financial world. And here are 37 out of 37, and those
are some of the biggest names on Wall Street, and some of them had been around the longest, and 37 out of 37 have
disappeared. And that’s why I say you ought to think about [the long‐term durability of a business?] because these
people obviously didn’t.

These were run by people with high IQs, by people that worked ungodly hard. They were people that had an intense
interest in success. They worked long hours. They all thought they were going to be leaders on Wall Street at some
point, and they all went around, incidentally, giving advice to other companies about how to run their business. That’s
sort of interesting.”

“Here are a group of 37. And the question is, how can you get a result like that? That is not a result that you get by
chance. How can people who are bright, who work hard, who have their own money in the business – these are not a
bunch of absentee owners – how can they get such a bad result? And I suggest that’s a good thing to think about before
you get a job and go out into the world.

I would say that if you had to pick one thing that did it more than anything else, it’s the mindless imitation of one’s
peers that produced this result. Whatever the other guy did, the other 36 were like a bunch of lemmings in terms of
following. That’s what’s gotten all the big banks in trouble for the past 15 years. Every time somebody big does
something dumb, other people can hardly wait to copy it. If you do nothing else when you get out of here, do things
only when they make sense to you. You ought to be able to write ‘I am going to work for General Motors because ... “I
am buying 100 shares of Coca Coals stock because...’ And if you can’t write an intelligent answer to those questions,
don’t do it.”

“It’s interesting why smart people go astray. That’s one of the most interesting things in business. I’ve seen all sorts of
people with terrific IQs that end up flopping in Wall Street or business because they beat themselves. They have 500
horsepower engines, and get 50 horsepower out of them. Or, worse than that, they have their foot on the brake and
the accelerator at the same time. They really manage to screw themselves up.
… I would suggest that the big successes I’ve met had a fair amount of Ben Franklin in them.”

“You can occasionally find small groups of bright people who can do well over time. These people will be distinguished
much more by temperament than IQ.”
- Warren Buffett, From a Columbia Business School Student’s trip to Omaha, March 26, 2006

“Attractive opportunities come from observing human behavior. In 1998, people behaved like frightened cavemen
(referring to the Long Term Capital Management meltdown). People make their own opportunities. They will be frozen


by fear, excited by greed and it doesn’t matter what their IQ, degrees etc is. Growth of 50% per year is with small
capitalization, not large cap. The point is I got rich looking for stock with strong earnings.

The last 50 years weren’t unique. It’s just capitalizing on human behavior. It’s people that make opportunities when
others are frozen by fear or excited by greed. Human behavior allows for success if you are able to detach yourself
emotionally.”
- From a meeting with Univ. of Georgia students, Jan 2007

“The Wall Street analysts are brilliant people; they are better at math, but we know more about human nature.”

“The important qualities you need are intelligence, patience, and interest, but the biggest thing is to be rational. In ‘97‐8,
people weren’t rational. People got caught up with what other people were doing. Don’t get caught up with what other
people are doing. Being a contrarian isn’t the key, but being a crowd follower isn’t either.

You need to detach yourself emotionally. You need to think about what is going on around you. Being in Omaha helps
me in that regard. When I was in NYC, I had 50 people whispering in my ear before noon.”

“Rationality is the only thing that helps you. One thing that could help would be to write down the reason you are
buying a stock before your purchase. Write down ‘I am buying Microsoft @ $300B because…’ Force yourself to write
this down. It clarifies your mind and discipline. This exercise makes you more rational.”

Approval, though, is not the goal of investing. In fact, approval is often counter‐productive because it sedates the brain
and makes it less receptive to new facts or a re‐examination of conclusions formed earlier. Beware the investment
activity that produces applause; the great moves are usually greeted by yawns.
‐BRK 2008 Letter.

“You will not be right simply because a large number of people momentarily agree with you. You will not be right simply
because important people agree with you. In many quarters the simultaneous occurrence of the two above factors is
enough to make a course of action meet the test of conservatism.
You will be right, over the course of many transactions, if your hypotheses correct, your facts are correct, and your
reasoning is correct. True conservatism is only possible through knowledge and reason.”
- Buffett Partnership Letter, January 24, 1962

“Truly conservative actions arise from intelligent hypotheses, correct facts and sound reasoning. These qualities may
lead to conventional acts, but there have been many times when they have led to unorthodoxy.”



“We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we
derive comfort if they don’t A public opinion poll is no substitute for thought. When we really sit back with a smile on
our face is when we run into a situation we can understand, where the facts are ascertainable and clear, and the course
of action obvious. In that case – whether conventional or unconventional – whether others agree or disagree – we feel
we are progressing in a conservative manner.”

“Don’t be afraid to move on and look for something easier.”
- ‐ WEB, 2009 BRK Shareholders meeting.

“If you are an investor and you have a 150 IQ, sell 30 points to somebody else. Being a genius can be a bad thing in this
business. You need an inner peace with your decisions, because they will be challenged. I don’t know how much of that
is innate and how much is taught, but it is a very good quality to have. Simple but not easy. No higher math. It’s not
complicated. But you need an emotional stability. If you have that you’ll do well over time.”

“if you have a 150 IQ and you think it is 160, you are a complete disaster!”

“It is a mistake to believe that rationality is going to be perfect, even in very capable people.”


Learning

“Outside science, it is amazing how little impact there can be from a powerful idea, published in a prominent place (such
as the Journal). Everyone's experience is that you teach only what a reader almost knows, and that seldom.
- WSC 1990 Letter

“Well, that’s a perfectly good question. But I can’t tell you when to buy some pork company. And it’s not because I know
and I’m holding back from you.
If you’re going to be an investor, you’re going to make some investments before you’ve learned the game as
well as you may eventually learn it. And if you just keep trying to get a little better all the time, it’s been my experience
that in due course, you start making some investments where you’re practically sure that the odds are overwhelmingly
in your favor. You get justified confidence through work, discipline and practice – ending with powerful habits.
There’s no shorthand way to get it by going to the master and whispering in his ear fro the solution. [Chuckling]
It’s like learning to play good golf. You’ve got to have some aptitude – and then work at it.”

“Cigar Butts vs. Quality Businesses; Learning from Constructive Criticism

Munger: If See’s Candy had asked $100,000 more [in the purchase price; Buffett chimed in, “$10,000 more”], Warren
and I would have walked ‐‐ that’s how dumb we were.

Ira Marshall said you guys are crazy ‐‐ there are some things you should pay up for, like quality businesses and people.
You are underestimating quality. We listened to the criticism and changed our mind. This is a good lesson for anyone:
the ability to take criticism constructively and learn from it. If you take the indirect lessons we learned from See’s, you
could say Berkshire was built on constructive criticism. Now we don’t want any more today.

Buffett: The qualitative [evaluating management, competitive advantage, etc.] is harder to teach and understand, so
why not just focus on the quantitative [e.g., cigar butt investing]? Charlie emphasized quality [of a business] much more
than I did initially. He had a different background.

It makes more sense to buy a wonderful business at a fair price. We’ve changed over the years in this direction. It’s not
hard to watch businesses over 50 years and learn where the big money can be made.”
- 2003 BRK Meeting

“Keys to Investment Success

Partly its temperament – most people are too fretful, they worry to much. Success means being very patient, but
aggressive when it’s time. And the more hard lessons you can learn vicariously rather than through your own hard
experience, the better.

I don’t know anyone who [learned to be a great investor] with great rapidity. Warren has gotten to be one hell of a lot
better investor over the period I’ve known him, so have I. So the game is to keep learning. You gotta like the learning
process.”
‐ Munger, 2004 WSC Meeting


“All you have to do is keep trying to learn at the temple of rationality and do things [when it makes sense]. I’m quite
prosperous even though I didn’t invest in K‐Mart’s bankruptcy. You can miss a lot. We bought 4% of Freddie Mac [many
years ago] yet none of Fannie Mae. How could the same mind have done that?! It wasn’t very smart.

But despite the many cognitive mistakes [we’ve made], we’re a lot richer now than we were then. I think you need to
constantly remember the mistakes of omission. We’re very good at this. Nobody remembers them – nobody thinks less
of me for missing K‐Mart – but I think about it every day. It’s a very [useful discipline to have].

Chris Davis [of Davis Advisors], who’s not here, has a temple of shame for mistakes. [It’s a wall in his office in which he
hangs stock certificates of the worst stocks he’s ever invested in.] But this is inadequate. You need the temple of shame
squared – great things you almost did and, had you been a little more rational, should have invested in. You’ll be a lot
better investor if you do this. You ought to remember boners of both kinds. Reality doesn’t distinguish – either way, in
10 years, you’re poorer. So why not celebrate your mistakes in both categories?”

“The ability to destroy your ideas rapidly instead of slowly when the occasion is right is one of the most valuable things.
You have to work hard on it. Ask yourself what are the arguments on the other side. It’s bad to have an opinion you’re
proud of if you can’t state the arguments for the other side better than your opponents. This is a great mental
discipline.”

“What explains the extraordinary success of Berkshire Hathaway?

You won’t have anything like the past to look forward to. Berkshire’s results have been so extreme that it’s hard to think
of a precedent in the history of the world. The balance sheet is gross considering the small beginnings of the place.

What has caused this extreme record to go on for such a long time? I would argue that it started with a young man
reading everything when he was 10 years old, becoming a learning machine. He started this long run early. Had he not
been learning all this time, our record would be a mere shadow of what it is. And he’s actually improved since he passed
the age at which most other people retire. Most people don’t even try this – it takes practice.

So it’s been a long run, with extraordinarily concentrated power by a man who is a ferocious learner. Our system ought
to be more copied than it is. The system of passing power from one old codger to another is not necessarily the right
system at all.”
‐ Munger, 2007 BRK Meeting

“I don’t have a simple checklist. You have to work at it a long long time. I still do dumb things after years of hard work.
The more big ideas you have the easier. We exclude a whole lot of things because they are in the too tough pile. If you
exclude, you do better.

“The second factor, obviously, was that Warren has been extremely interested in the subject at which he has achieved
so much. Peter Kaufman quotes Sir William Osler as saying, “It’s very hard to succeed in something unless you take the


first step – which is to become very interested in it.” There is no substitute for having a really intense interest in what
you’re trying to succeed at.”
- Munger 2008 WSC Meeting

“Warren’s one of the best learning machines around.
Another factor – and this is really crucial – is that Warren is one of the best learning machines that you’re ever
going to find on this earth. And that is really important. There are all kinds of bright graduates of great institutions who
go the shallows, while others who are not so bright have great achievement. The not‐so‐bright ones – who are like the
turtles that outrun the hares – are learning machines. They just keep learning and learning.
Other people have so much going for them that they stop. And when you stop learning in a competitive world,
why, the world just goes right by you. So Warren’s been an everlasting learning machine.

Try to name a committee that’s been successful at investing.
The next thing that happened is that the work was heavily concentrated in one mind. Sure, Warren’s had some
collaboration and has kept himself open to all kinds of input by talking to people. But basically, Berkshire Hathaway
reflects enormously the contributions of one single mind.
It’s hard to think of great committees who have been successful in the investment field or in business. In other
words, if you want to be good at something, I think it works better in this field if the power is concentrated in one
person for a long time.

So I would sell the best hour of the day to myself.
Warren kids me because I told him once along the way – recognizing that sitting down on my ass was so
important in making a man out of myself – that decided when my legal work was mundane, I would sell the best hour of
the day to myself. And only after improving my mind – only after I’d used my best hour improving myself – would I sell
my time to my professional clients. And I did that for a number of years. Now, when I was in a demanding situation, I
would of course make an exception.
If you want to make a man of yourself intellectually, I think you’ve got to work at it. I think hardly anybody is
smart enough to just do it automatically. I think Johnny von Neumann couldn’t just do it automatically. I think you have
to have time to think. And it’s so easy to get so busy that you no longer have time to think – and you pay a huge price for
that.” ‐ Munger, 2008 WSC Meeting

“However, both Warren and I are very good at changing our prior conclusions. We work at developing that facility
because, without it, disaster often comes.”

“I don’t want you to think we have any way of learning or behaving so you won’t make a lot of mistakes. I’m just saying
that you can learn to make fewer mistakes than other people – and how to fix your mistakes faster when you do make
them.”

“I read hundreds of annual reports every year. I don’t talk to any brokers – I don’t want to talk to brokers. People are
not going to give you great ideas.”



“I own 100 shares of almost every stock I can think of just so I know I’ll get all the reports(…)I probably spend five or six
hours a day on reading.”

“Q: So you think the sovereign wealth funds are getting the raw end of the deal when they buy into some of the
financials?
Buffett: I think that they are buying what is being sold to them, and in securities you should not buy what’s being sold to
you. You should buy what comes from your own analysis and looks the cheapest. The idea that somebody is going to
come and call on you and say, you know, ‘Buy $2 billion worth – this is the best thing to buy in the world,’ it isn’t the
best thing to buy in the world. The best thing to buy in the world is something that you’ve dug out and that people
aren’t talking about and that, you know, you find yourself. Securities that are being sold to you have a special push in it.
Usually, there’s extra commissions in them or all kinds of things. So I don’t – I don’t want to get ideas from other people,
basically. I want to get ideas from a bunch of facts that I uncover someplace.”
- From a CNBC interview with Buffett, Aug 22, 2008



Stock Selection
Comprehension

“Few, if any, investors have ever prospered mightily from investing in convertible preferred stocks of leading
corporations.”
- WSC 1989 Letter

“As we select mortgage‐backed securities, we will probably not be buying any complex instruments. Despite our love of
comedy, we are going to avoid the newest form of ‘Jump Z tranches in REMICS.’ This refers to a particular contractual
fraction ‐‐ the ‘Z Form’ ‐‐ of a pool of mortgages, now subdivided by obliging issuers, advised by obliging investment
bankers, into two new contractual fractions: (1) the ‘Sticky Jump Z.’ At this rate, subdivision will soon get down to
quarks.

We are deterred from buying such securities partly by our hatred of complexity. We also dread the prospect of state and
federal examiners, none of whom has a Ph.D. in physics, reviewing, one after the other, our choices for soundness and
billing us on cost‐plus basis to reflect value thus added. Some of the wonders of modern finance go on without us as we
yearn for a lost age when most reasonable people could, with effort, understood what was going on.”
- WSC 1990 Letter

“In studying the investments we have made in both subsidiary companies and common stocks, you will see that we
favor businesses and industries unlikely to experience major change. The reason for that is simple: Making either type
of purchase, we are searching for operations that we believe are virtually certain to possess enormous competitive
strength ten or twenty years from now. A fast‐changing industry environment may offer the chance for huge wins, but it
precludes the certainty we seek.”
- BRK 1996 Letter

“If our derivatives experience – and the Freddie Mac shenanigans of mind‐blowing size and audacity that were revealed
last year – makes you suspicious of accounting in this arena, consider yourself wised up. No matter how financially
sophisticated you are, you can’t possibly learn from reading the disclosure documents of a derivatives‐intensive
company what risks lurk in its positions. Indeed, the more you know about derivatives, the less you will feel you can
learn from the disclosures normally proffered you. In Darwin’s words, ‘Ignorance more frequently begets confidence
than does knowledge.’”
- BRK 2003 Letter

“Investors should understand that in all types of financial institutions, rapid growth sometimes masks major underlying
problems (and occasionally fraud). The real test of the earning power of a derivatives operation is what it achieves after
operating for an extended period in a no‐growth mode. You only learn who has been swimming naked when the tide
goes out.”
- BRK 2004 Letter



“Long ago, Mark Twain said: “A man who tries to carry a cat home by its tail will learn a lesson that can be learned in no
other way.” If Twain were around now, he might try winding up a derivatives business. After a few days, he would opt
for cats.

We lost $104 million pre‐tax last year in our continuing attempt to exit Gen Re’s derivative operation. Our aggregate
losses since we began this endeavor total $404 million.

Originally we had 23,218 contracts outstanding. By the start of 2005 we were down to 2,890. You might expect that our
losses would have been stemmed by this point, but the blood has kept flowing. Reducing our inventory to 741 contracts
last year cost us the $104 million mentioned above.

Remember that the rationale for establishing this unit in 1990 was Gen Re’s wish to meet the needs of insurance clients.
Yet one of the contracts we liquidated in 2005 had a term of 100 years! It’s difficult to imagine what “need” such a
contract could fulfill except, perhaps, the need of a compensation‐conscious trader to have a long‐dated contract on his
books. Long contracts, or alternatively those with multiple variables, are the most difficult to mark to market (the
standard procedure used in accounting for derivatives) and provide the most opportunity for “imagination” when
traders are estimating their value. Small wonder that traders promote them.

A business in which huge amounts of compensation flow from assumed numbers is obviously fraught with danger. When
two traders execute a transaction that has several, sometimes esoteric, variables and a far‐off settlement date, their
respective firms must subsequently value these contracts whenever they calculate their earnings. A given contract may
be valued at one price by Firm A and at another by Firm B.

You can bet that the valuation differences – and I’m personally familiar with several that were huge – tend to be tilted in
a direction favoring higher earnings at each firm. It’s a strange world in which two parties can carry out a paper
transaction that each can promptly report as profitable.

I dwell on our experience in derivatives each year for two reasons. One is personal and unpleasant. The hard fact is that I
have cost you a lot of money by not moving immediately to close down Gen Re’s trading operation. Both Charlie and I
knew at the time of the Gen Re purchase that it was a problem and told its management that we wanted to exit the
business. It was my responsibility to make sure that happened. Rather than address the situation head on, however, I
wasted several years while we attempted to sell the operation. That was a doomed endeavor because no realistic
solution could have extricated us from the maze of liabilities that was going to exist for decades. Our obligations were
particularly worrisome because their potential to explode could not be measured. Moreover, if severe trouble occurred,
we knew it was likely to correlate with problems elsewhere in financial markets.

So I failed in my attempt to exit painlessly, and in the meantime more trades were put on the books. Fault me for
dithering. (Charlie calls it thumb‐sucking.) When a problem exists, whether in personnel or in business operations, the
time to act is now.

The second reason I regularly describe our problems in this area lies in the hope that our experiences may prove
instructive for managers, auditors and regulators. In a sense, we are a canary in this business coal mine and should sing a
song of warning as we expire. The number and value of derivative contracts outstanding in the world continues to
mushroom and is now a multiple of what existed in 1998, the last time that financial chaos erupted.

Our experience should be particularly sobering because we were a better‐than‐average candidate to exit gracefully. Gen
Re was a relatively minor operator in the derivatives field. It has had the good fortune to unwind its supposedly liquid
positions in a benign market, all the while free of financial or other pressures that might have forced it to conduct the


liquidation in a less‐than‐efficient manner. Our accounting in the past was conventional and actually thought to be
conservative. Additionally, we know of no bad behavior by anyone involved.

It could be a different story for others in the future. Imagine, if you will, one or more firms (troubles often spread) with
positions that are many multiples of ours attempting to liquidate in chaotic markets and under extreme, and well‐
publicized, pressures. This is a scenario to which much attention should be given now rather than after the fact. The
time to have considered – and improved – the reliability of New Orleans’ levees was before Katrina.

When we finally wind up Gen Re Securities, my feelings about its departure will be akin to those expressed in a country
song, ‘My wife ran away with my best friend, and I sure miss him a lot.’”
- BRK 2005 Letter

“Buffett: It might be a bit too much to expect somebody would understand every business in the world. We find some
that are much harder for us to understand. When I say understand – my definition of understand is that you have to
have a pretty good idea of where it’s going to be in ten years. I just can’t get that conviction with a lot of businesses,
whereas I can get them with relatively few.”

Munger: Having flunked when we were young and strong at understanding some complex businesses, we’re not looking
to master what we earlier failed at in our latter years.”
- 1997 BRK Meeting

“Our criteria for selecting a stock are also our criteria for selecting a business. First, we're looking for a business we can
understand ‐ where we think we understand its product, the nature of its competition and what can go wrong over time.
Then, when we find that business. we try to figure out whether its economics ‐ meaning its earning power over the
next five or ten or fifteen years ‐ are likely to be good and getting better or poor and getting worse. And we try to
evaluate its future income stream.

Knowing what you don't know is important. Sometimes that's not easy. Seeing the future is impossible in many cases. in
our view, and difficult in others.

When we look at the future of businesses, we look at riskiness as being sort of a go/no‐go valve. In other words, if we
think that we simply don't know what's going to happen in the future, that doesn't mean it's risky for everyone. It means
we don't know ‐ that it's risky for us. It may not be risky for someone else who understands the business.
However, in that case, we just give up. We don't try to predict those things.

But we think it's also nonsense to get into situations ‐ or to try and evaluate situations ‐ where we don't have any
conviction to speak of as to what the future is going to look like. I don't think that you can compensate for that by having
a higher discount rate and saying, Well, it's riskier.”

“Some things we think we do know....

Buffett: We do think we know something about what Coca‐Cola's going to look like in 10 years or what Gillette, Disney
or 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, then the other things become less important. And if we're focusing on those other things,
then we'd miss a lot of big things.”
- 1998 BRK Meeting

“The fact that we don’t buy into tech companies isn’t based on religious belief. It’s just that we’ve never found a
business, as conventionally defined, where we think we know enough about what it will look like 10 years from now that
we can make a rational decision as to how much we should be willing to pay now for that business. In other words,
we’ve not been able to find a business where we believe we know what that bush will look like in 10 years and how
many birds will be in it so we know how many birds we can give up today to participate in its future.
There will be wonderful things, as Charlie so colorfully explained, that will evolve from many of these
companies. But we don’t know how to make that evaluation.”

“We will never buy anything we don’t think we understand. And our definition of understanding is thinking that we have
a reasonable probability of being able to assess where the business will be in 10 years.”

“Fannie and Freddie Mac

In 2000, Berkshire Hathaway sold its large, long‐term holding in Freddy Mac. When asked to explain why, Buffett said:
‘We felt uncomfortable with certain aspects of the business as they developed, though they may not hurt the company.
We did not sell because we were worried about more governmental regulation – the opposite if anything. We felt the
risk profile had changed.’

Munger added, ‘Maybe it’s unique to us, but we’re quite sensitive to financial risks.’

Buffett continued, ‘There are many things you don’t know by looking at a financial company’s financial statements.
We’ve seen enough to be wary. We can’t be 100% sure that we like what’s going on. With some types of companies, you
can spot problems early, but you spot troubles in financial institutions late.’

Munger: ‘Financial institutions make us nervous when they’re trying to do well.’”
- 1999 BRK Meeting

“Circle of Competence

There are a lot of things we pass on. We have three baskets: in, out and too tough. A lot of stuff goes into the “too
tough” basket. We can’t do that if it’s a problem at a Berkshire subsidiary company, but if we don’t own it, we just pass.

“I don’t know how people cope [trying to figure everything out].”

“The things that really destroy people are 5‐ or 6‐sigma events ‐‐ things that really aren’t supposed to happen. Financial
markets don’t do every well at modeling this. It works until it doesn’t. There are more theoretical 6‐sigma events than
any theory of probabilities will come up with. When you have gaps, markets close, etc., this is what causes companies to
go out of business. Derivative’s increase the chance of this happening and magnifying the damage if it does.


If anyone uses precise figures in finance, be careful.”

“It’s difficult if someone wants to protect against a 9.0 quake, which happens only once every 1,000 years. But in
investing, if it’s too hard, skip it.”

“There is no perfect measure of the size of a derivative position. The numbers sound large that are thrown around, but
you can talk about a $1 billion notional exposure in one derivative and have less risk than a $50 million derivative of
another type. I don’t think Wells Fargo is a really big derivatives player.”

“In our early days, we tended to overestimate the difficulties of regulation. We refrained by buying the stocks of
television stations because we thought it was peculiar that someone could ask to have the government pull your license
any year – and the government could do it.”

“Derivatives

I think a good litmus test of the mental and moral quality at any large institution [with significant derivatives exposure]
would be to ask them, ‘Do you really understand your derivatives book?’ Anyone who says yes is either crazy or lying.’”
‐ Munger, 2004 WSC Meeting

“Comments on Financial Companies

Buffett: Financial companies are more difficult to analyze than other companies. They can report whatever earnings they
want – it’s an easy game to play. For banks, earnings depend on loans and the reserves set aside. It’s easy to change and
manipulate the reserves.

With a company like WD‐40 or a brick company, the financials are easy to analyze. But with financial [companies] it’s
tough, especially when you throw in derivatives.

There were very high grade, financially sophisticated people who were on the boards of the GSEs and they were not
negligent, but it’s very tough [to detect the shenanigans that went on].

Charlie and I were on the board of Salomon and Charlie was on the audit committee, and [it’s just impossible to evaluate
thousands of transactions]. You’ll just have to accept that with insurance companies, banks and other financial
companies – it’s just a more dangerous field to analyze.

With GEICO it’s easier because the statistics are quite accurate – it’s short‐tailed insurance. It’s not like asbestos.

I wouldn’t fault the ratings agencies. Even the big‐name auditors didn’t catch it.


Munger: Where you have complexity, by nature you can have fraud and mistakes. You’ll have more of that than in a
company that shovels sand from a river and sells it. This will always be true of financial companies, including ones run by
governments. If you want accurate numbers from financial companies, you’re in the wrong world.”
- 2005 BRK Meeting

“It’s Tough to Make Money Investing in China

I think it’s very tough to make money in China. A lot of terrible things can happen to you and you have no good antidote.
China makes a lot of cheap well‐made goods, but it could be that we won’t have attractive investment opportunities in
China even though the country may prosper.”

“Approach to Buying Businesses

We favor businesses where we really think we know the answer. If we think the business’s competitive position is shaky,
we won’t try to compensate with price. We want to buy a great business, defined as having a high return on capital for a
long period of time, where we think management will treat us right. We like to buy at 40 cents on the dollar, but will pay
a lot closer to $1 on the dollar for a great business.”

“It’s too easy to miss something important w/o a checklist.

Q: Could you provide a checklist for the method of learning that you were talking about earlier? And could you also
discuss some personal beliefs that you’ve overturned recently?

A: Well, that’s a very hard question. I’m a great believer in solving hard problems by use of a checklist, because you
get all the issues in front of you that way – and otherwise it’s too easy to miss something important…

And reversing everything has worked my whole life.

As far as using checklists go, any time you catch something just barely, where if you hadn’t caught it you would
have been in terrible trouble, you are in esse3nce using sort of a checklist – maybe using an automatic checklist, just like
an automatic nervous system. Or you may use a conscious checklist…
And by the way, I’m about to do something that’s very common: answering the question I prefer answering
instead of the one you asked. The mental process that really has worked for me my whole life, and I use it all the time, is
turning everything in reverse. I figure out what I don’t like instead of figuring out what I like in order to get what I like. I
sometimes think straight forward too, of course. But thinking of what I didn’t like and how I avoid it has just worked
wonders for me…”

“We don’t even think about something that we can’t believe we know enough about to conclude that that opportunity is
better than something that we could buy more of right now. Think of the simplification that such consideration of edge
of competency and opportunity and cost gives to our life.”


-
“But if you don’t know enough to know about the business instantly, you won’t know enough in a month or in two
months. You have to have sort of the background of understanding and knowing what you do or don’t understand. That
is the key. It is defining your circle of competence.

Everybody has got a different circle of competence. The important thing is not how big the circle is, the important thing
is the size of the circle; the important thing is staying inside the circle. And if that circle only has 30 companies in it out
of 1000s on the big board, as long as you know which 30 they are, you will be OK.”

“The wonderful business—you can figure what will happen, you can’t figure out when it will happen. You don’t want to
focus too much on when but you want to focus on what. If you are right about what, you don’t have to worry about
when very much.”

“The fact I could have made billions of dollars from Microsoft doesn’t mean anything because I could never understand
Microsoft.”

“I don’t think about the macro stuff. What you really want to in investments is figure out what is important and
knowable. If it is unimportant and unknowable, you forget about it.”

“[In tech] I don't understand who is going to make the money in ten years. And that keeps me away.”

“I would say that the most important thing in business, and investments, which I regard as the same thing, from our
standpoint, is being able to accurately define your circle of competence. It isn’t a question of having the biggest circle of
competence. I’ve got friends who are competent in a whole lot bigger area than I am, but they stray outside of it.

In that book Father, Son & Co. [subtitle: My Life at IBM and Beyond] you may have read, that Tom Watson Junior
recently wrote, he quoted his father as saying ‘I’m no genius. I’m smart in spots but I stay around those spots.’ And
that’s all there is to it in investments…”

Improved “transparency” – a favorite remedy of politicians, commentators and financial regulators for averting future
train wrecks – won’t cure the problems that derivatives pose. I know of no reporting mechanism that would come close
to describing and measuring the risks in a huge and complex portfolio of derivatives. Auditors can’t audit these
contracts, and regulators can’t regulate them. When I read the pages of “disclosure” in 10‐Ks of companies that are
entangled with these instruments, all I end up knowing is that I don’t know what is going on in their portfolios (and then
I reach for some aspirin).
- BRK 2008 Letter


“I’ve looked over the 10‐K…the company [AIG] is too complicated. I don’t have enough confidence to do that. Look,
nothing is going to work with us, so don’t waste your time.”
‐ Buffett, Declining AIG’s solicited capital raise, from “Too Big To Fail”, P294.

“Charlie and I avoid businesses whose futures we can’t evaluate, no matter how exciting their products may be. In the
past, it required no brilliance for people to foresee the fabulous growth that awaited such industries as autos (in 1910),
aircraft (in 1930) and television sets (in 1950). But the future then also included competitive dynamics that would
decimate almost all of the companies entering those industries. Even the survivors tended to come away bleeding.

Just because Charlie and I can clearly see dramatic growth ahead for an industry does not mean we can judge what its
profit margins and returns on capital will be as a host of competitors battle for supremacy.”
- BRK 2009 Letter

“If you don’t understand 10Ks you shouldn’t invest. When we bought Gen Re they had 23,000 derivative contracts and I
couldn’t understand them so we sold them.”
- 2009 BRK Press Conference

“A black box like AIG financial products, they produce numbers but they don’t produce cash. Don’t be afraid to move on
and look for something easier.”

“The secret to being successful in any field is getting very interested in it.”

“Investment bankers have sold a lot of derivatives that have really hurt customers when things went wrong. Don’t trust
a salesman selling a new derivative.”


Moat

“We continue to feel that the ratio of operating earnings (before securities gains or losses) to shareholders’ equity with
all securities valued at cost is the most appropriate way to measure any single year’s operating performance.”
- BRK 1979 Letter

“You'll seldom see such a percentage anywhere, let alone at large, diversified companies with nominal leverage. Here's
a benchmark: In its 1988 Investor's Guide issue, Fortune reported that among the 500 largest industrial companies and
500 largest service companies, only six had averaged a return on equity of over 30% during the previous decade. The
best performer among the 1000 was Commerce Clearing House at 40.2%. “
- BRK 1987 Letter

“Experience, however, indicates that the best business returns are usually achieved by companies that are doing
something quite similar today to what they were doing five or ten years ago. That is no argument for managerial
complacency. Businesses always have opportunities to improve service, product lines, manufacturing techniques, and
the like, and obviously these opportunities should be seized. But a business that constantly encounters major change
also encounters many chances for major error. Furthermore, economic terrain that is forever shifting violently is ground
on which it is difficult to build a fortress‐like business franchise. Such a franchise is usually the key to sustained high
returns.

The Fortune study I mentioned earlier supports our view. Only 25 of the 1,000 companies met two tests of economic
excellence ‐ an average return on equity of over 20% in the ten years, 1977 through 1986, and no year worse than 15%.
These business superstars were also stock market superstars: During the decade, 24 of the 25 outperformed the S&P
500.

The Fortune champs may surprise you in two respects. First, most use very little leverage compared to their interest‐
paying capacity. Really good businesses usually don't need to borrow. Second, except for one company that is "high‐
tech" and several others that manufacture ethical drugs, the companies are in businesses that, on balance, seem rather
mundane. Most sell non‐sexy products or services in much the same manner as they did ten years ago (though in larger
quantities now, or at higher prices, or both). The record of these 25 companies confirms that making the most of an
already strong business franchise, or concentrating on a single winning business theme, is what usually produces
exceptional economics.“
- BRK 1987 Letter

“The property‐casualty insurance industry is not only subnormally profitable, it is subnormally popular. (As Sam Goldwyn
philosophized: “In life, one must learn to take the
bitter with the sour.”) One of the ironies of business is that many relatively‐unprofitable industries that are plagued by
inadequate prices habitually find themselves beat upon by irate customers even while other, hugely profitable industries
are spared complaints, no matter how high their prices.

Take the breakfast cereal industry, whose return on invested capital is more than double that of the auto insurance
industry (which is why companies like Kellogg and General Mills sell at five times book value and most large insurers sell
close to book). The cereal companies regularly impose price increases, few of them related to a significant jump in their
costs. Yet not a peep is heard from consumers. But when auto insurers raise prices by amounts that do not even match


cost increases, customers are outraged. If you want to be loved, it’s clearly better to sell high‐priced corn flakes than
low‐priced auto
insurance.”
- BRK 1988 Letter

“Some historical explanation for the current situation should be repeated here. When Wesco's parent corporation
acquired control, Wesco∙s activities were almost entirely limited to holding (1) some surplus cash, plus (2) a multi‐branch
savings and loan association which had many very long‐term, fixed‐rate mortgage, offset by interest‐bearing demand
deposits. The acquisition of this intrinsically disadvantageous position was unwisely made, alternative opportunities
considered, because the acquirer (including the signer of this letter) was overly influenced by a price considered to be
moderately below liquidating value. Under such circumstances, acquisitions have a way of producing, on average, for
acquirers who are not quick‐turn operators, low to moderate long‐term results. This happens because any advantage
from a starting ‘bargain’ gets swamped by effects from change‐resistant mediocrity in the purchased business. Such
normal effects have not been completely avoided at Wesco, despite some successful activities, including a large gain in
1985 from an investment in General Foods.”
- WSC 1988 Letter

“We attract business nationwide because we have several advantages that competitors can't match. The most
important item in the equation is our operating costs, which run about 18% of sales compared to 40% or so at the typical
competitor. (Included in the 18% are occupancy and buying costs, which some public companies include in "cost of
goods sold.") Just as Wal‐Mart, with its 15% operating costs, sells at prices that high‐cost competitors can't touch and
thereby constantly increases its market share, so does Borsheim's. What works with diapers works with diamonds.

Our low prices create huge volume that in turn allows us to carry an extraordinarily broad inventory of goods, running
ten or more times the size of that at the typical fine‐jewelry store. Couple our breadth of selection and low prices with
superb service and you can understand how Ike and his family have built a national jewelry phenomenon from an
Omaha location.”
- BRK 1990 Letter

“The simple, low‐cost(*), cream‐the‐market approach thus taken (or stumbled into) often works well in business. For
instance, look at (1) GEICO, a hugely successful auto insurer almost 50% owned by Wesco's parent corporation or (2)
various membership warehouse clubs, in the form invented by Sol Price, which are now clobbering retailing competitors
as they get total "markup" under 10%. And this approach, as would be expected, is working like gangbusters for the
money‐market funds, as you see in the graph from The Economist.”
- WSC 1990 Letter

“The fact is that newspaper, television, and magazine properties have begun to resemble businesses more than
franchises in their economic behavior. Let's take a quick look at the characteristics separating these two classes of
enterprise, keeping in mind, however, that many operations fall in some middle ground and can best be described as
weak franchises or strong businesses.

An economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by its customers to
have no close substitute and; (3) is not subject to price regulation. The existence of all three conditions will be
demonstrated by a company's ability to regularly price its product or service aggressively and thereby to earn high rates


of return on capital. Moreover, franchises can tolerate mis‐management. Inept managers may diminish a franchise's
profitability, but they cannot inflict mortal damage.

In contrast, "a business" earns exceptional profits only if it is the low‐cost operator or if supply of its product or service is
tight. Tightness in supply usually does not last long. With superior management, a company may maintain its status as a
low‐cost operator for a much longer time, but even then unceasingly faces the possibility of competitive attack. And a
business, unlike a franchise, can be killed by poor management.
- BRK 1991 Letter

“Leaving the question of price aside, the best business to own is one that over an extended period can employ large
amounts of incremental capital at very high rates of return. The worst business to own is one that must, or will, do the
opposite ‐ that is, consistently employ ever‐greater amounts of capital at very low rates of return. Unfortunately, the
first type of business is very hard to find: Most high‐return businesses need relatively little capital. Shareholders of such
a business usually will benefit if it pays out most of its earnings in dividends or makes significant stock repurchases.”
- BRK 1992 Letter

“Retailing is a tough business. During my investment career, I have watched a large number of retailers enjoy terrific
growth and superb returns on equity for a period, and then suddenly nosedive, often all the way into bankruptcy. This
shooting‐star phenomenon is far more common in retailing than it is in manufacturing or service businesses. In part,
this is because a retailer must stay smart, day after day. Your competitor is always copying and then topping whatever
you do. Shoppers are meanwhile beckoned in every conceivable way to try a stream of new merchants. In retailing, to
coast is to fail.

In contrast to this have‐to‐be‐smart‐every‐day business, there is what I call the have‐to‐be‐smart‐once business. For
example, if you were smart enough to buy a network TV station very early in the game, you could put in a shiftless and
backward nephew to run things, and the business would still do well for decades. You'd do far better, of course, if you
put in Tom Murphy, but you could stay comfortably in the black without him. For a retailer, hiring that nephew would be
an express ticket to bankruptcy.
- BRK 1995 Letter

“Any company's level of profitability is determined by three items: (1) what its assets earn; (2) what its liabilities cost;
and (3) its utilization of ‘leverage’ ‐ that is, the degree to which its assets are funded by liabilities rather than by equity.
Over the years, we have done well on Point 1, having produced high returns on our assets. But we have also benefitted
greatly ‐ to a degree that is not generally well‐understood ‐ because our liabilities have cost us very little. An important
reason for this low cost is that we have obtained float on very advantageous terms. The same cannot be said by many
other property and casualty insurers, who may generate plenty of float, but at a cost that exceeds what the funds are
worth to them. In those circumstances, leverage becomes a disadvantage.”
- BRK 1995 Letter

“Companies such as Coca‐Cola and Gillette might well be labeled ‘The Inevitables.’ Forecasters may differ a bit in their
predictions of exactly how much soft drink or shaving‐equipment business these companies will be doing in ten or
twenty years. Nor is our talk of inevitability meant to play down the vital work that these companies must continue to
carry out, in such areas as manufacturing, distribution, packaging and product innovation. In the end, however, no
sensible observer ‐ not even these companies' most vigorous competitors, assuming they are assessing the matter


honestly ‐ questions that Coke and Gillette will dominate their fields worldwide for an investment lifetime. Indeed, their
dominance will probably strengthen. Both companies have significantly expanded their already huge shares of market
during the past ten years, and all signs point to their repeating that performance in the next decade.

Obviously many companies in high‐tech businesses or embryonic industries will grow much faster in percentage terms
than will The Inevitables. But I would rather be certain of a good result than hopeful of a great one.

Of course, Charlie and I can identify only a few Inevitables, even after a lifetime of looking for them. Leadership alone
provides no certainties: Witness the shocks some years back at General Motors, IBM and Sears, all of which had enjoyed
long periods of seeming invincibility. Though some industries or lines of business exhibit characteristics that endow
leaders with virtually insurmountable advantages, and that tend to establish Survival of the Fattest as almost a natural
law, most do not. Thus, for every Inevitable, there are dozens of Impostors, companies now riding high but vulnerable
to competitive attacks. Considering what it takes to be an Inevitable, Charlie and I recognize that we will never be able
to come up with a Nifty Fifty or even a Twinkling Twenty. To the Inevitables in our portfolio, therefore, we add a few
‘Highly Probables.’”
- BRK 1996 Letter

“Businesses – The Great, the Good and the Gruesome

Let’s take a look at what kind of businesses turn us on. And while we’re at it, let’s also discuss what we wish to avoid.

Charlie and I look for companies that have a) a business we understand; b) favorable long‐term economics; c) able and
trustworthy management; and d) a sensible price tag. We like to buy the whole business or, if management is our
partner, at least 80%. When control‐type purchases of quality aren’t available, though, we are also happy to simply buy
small portions of great businesses by way of stock market purchases. It’s better to have a part interest in the Hope
Diamond than to own all of a rhinestone.

A truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital. The dynamics of
capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns.
Therefore a formidable barrier such as a company’s being the low cost producer (GEICO, Costco) or possessing a
powerful world‐wide brand (Coca‐Cola, Gillette, American Express) is essential for sustained success. Business history is
filled with ‘Roman Candles,’ companies whose moats proved illusory and were soon crossed.

Our criterion of ‘enduring’ causes us to rule out companies in industries prone to rapid and continuous change. Though
capitalism’s “creative destruction” is highly beneficial for society, it precludes investment certainty. A moat that must be
continuously rebuilt will eventually be no moat at all.

Additionally, this criterion eliminates the business whose success depends on having a great manager. Of course, a
terrific CEO is a huge asset for any enterprise, and at Berkshire we have an abundance of these managers. Their abilities
have created billions of dollars of value that would never have materialized if typical CEOs had been running their
businesses.

But if a business requires a superstar to produce great results, the business itself cannot be deemed great. A medical
partnership led by your area’s premier brain surgeon may enjoy outsized and growing earnings, but that tells little about
its future. The partnership’s moat will go when the surgeon goes. You can count, though, on the moat of the Mayo Clinic
to endure, even though you can’t name its CEO.



Long‐term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic
growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of
the business and use them to buy similar businesses elsewhere. There’s no rule that you have to invest money where
you’ve earned it. Indeed, it’s often a mistake to do so: Truly great businesses, earning huge returns on tangible assets,
can’t for any extended period reinvest a large portion of their earnings internally at high rates of return.”
- BRK 2007 Letter

“Law of economics. One shareholder asked Buffett what economic laws have worked best for Berkshire. Buffett
responded that it was all a matter of trying to find businesses with wide moats protecting a large castle occupied by an
honest lord. Moats might be a natural franchise, brand loyalty, or being a low‐cost producer. In a capitalistic society, all
moats are subject to attack: if you have a good castle, others will want it. What we want to figure out is what keeps the
castle standing and how smart is the lord. Munger added that they also like to look for low agency costs on that lord,
economies of scale and “economies of intelligence.” Buffett elaborated on the “economies of intelligence”: the idea is to
find businesses where you have to be smart only once instead of being smart forever. Retailing is a business where you
have to be smart forever or one where you have to be the smart once), Buffett advised, pick the great business – be
smart once.”

“So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary
criterion of a great business. And we tell our managers we want the moat widened every year. That doesn’t necessarily
mean the profit will be more this year than it was last year because it won’t be sometimes. However, if the moat is
widened every year, the business will do very well.

“If you’re evaluating a business year‐to‐year, the number one question you want to ask yourself is whether the
competitive advantage has been made stronger and more durable. And that’s more important than the P&L [profit and
loss statement] for a given year. So I would suggest that you read anything that you find that’s helpful.”

“Moats and sustainable competitive advantage.

Munger: “Old moats are getting filled in and new moats are harder to predict, so its getting harder.”

Buffett: “Regardless of how hard moats are to find and defend, that’s what it’s all about. We tell our managers to focus
on enlarging their moats. If you do this, everything else follows.”
- 1999 BRK Meeting

“Usually, if something can gain competitive advantage very quickly, it can lose it very quickly, so be careful of industries
in flux.”

“I think it’s dangerous to rely on special talents – it’s better to own lots of monopolistic businesses with unregulated
prices.



“… I learned that the best way to make money is to buy great businesses that earn high returns on capital over long
periods of time.”

“Coca Cola’s Inevitability

When I talked about Coca Cola being an “inevitable,” I talked about the probabilities that
Coke will dominate the global market for soft drinks. I don’t think anything will change that. It has a huge distribution
system and position in people’s minds worldwide. They’ll make a little more profit per drink sold over time as well. I
don’t know how anyone could dethrone them.”

“It’s always a good idea to go with the low‐cost producer over time. Being the low‐cost producer of something that
people need is a good business.”

“Untapped Pricing Power

We like buying businesses with some untapped pricing power. For example, when we bought See’s for $25 million, I
asked myself, “If we raised prices by 10 cents per pound, would sales fall off a cliff?” The answer was obviously no. You
can determine the strength of a business over time by the amount of agony they go through in raising prices.

A good example is newspapers. The local daily paper controlled the market and every year they raised the [advertising]
rates and circulation prices – it was almost a big yawn. They didn’t worry about losing big advertisers like Sears, JC
Penney or Wal‐Mart, or losing subscribers. They increased prices whether the price of newsprint went up or down.
Now, they agonize over price increases because they worry about driving people to other mediums. That world has
changed.

You can learn a lot about the durable economics of a business by watching price behavior. The beer industry is able to
raise prices, but it’s getting tougher.”

“The Best Business

The best businesses can maintain their earnings without continued reinvestment, whereas in the worst you have to keep
pouring money into a money‐losing business.

The best business is being the best surgeon in town. You don’t have to do any reinvestment – the investment was the
education. The surgeon will retain his earnings power, regardless of inflation.”

“…because in terms of which businesses succeed and which businesses fail, advantages of scale are ungodly important.



For example, one great advantage of scale taught in all of the business schools of the world is cost reductions along the
so‐called experience curve. Just doing something complicated in more and more volume enables human beings, who are
trying to improve and are motivated by the incentives of capitalism, to do it more and more efficiently.”
‐A Lesson on Elementary, Worldly Wisdom as it Relates to Investment Management and Business, USC Marshall,
4/14/1994

“The social proof phenomenon, which comes right out of psychology, gives huge advantages of scale – for example, with
very wide distribution, which of course is hard to get. One advantage of Coca‐Cola is that it’s available almost
everywhere in the world.

Well, suppose you have a little soft drink. Exactly how do you make it available all over the Earth? The worldwide
distribution setup – which is slowly won by a big enterprise – gets to be a huge advantage… And if you think about it,
once you get enough advantages of that type, it can become very hard for anybody to dislodge you.”
4/14/1994

“We’ve really made the money out of high‐quality businesses. (…) And most of the other people who’ve made a lot of
money have done so in high‐quality businesses.”

“Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the
business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much
different than a six percent return – even if you originally buy it at a huge discount. Conversely, if a business earns
eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking prices, you’ll end up with
one hell of a result.”
4/14/1994

“If you are in a lousy business for a long time, you will get a lousy result even if you buy it cheap. If you are in a
wonderful business for a long time, even if you pay a little bit too much going in you will get a wonderful result if you
stay in a long time.”

“A couple of fast tests about how good a business is. First question is ‘how long does the management have to think
before they decide to raise prices?’ You’re looking at marvelous business when you look in the mirror and say ‘mirror,
mirror on the wall, how much should I charge for Coke this fall?’ [And the mirror replies, ‘More.’] That’s a great
business. When you say, like we used to in the textile business, when you get down on your knees, call in all the priests,
rabbis, and everyone else, [and say] ‘just another half cent a yard.’ Then you get up and they say ‘We won’t pay it.’”

“The ability to raise prices – the ability to differentiate yourself in a real way, and a real way means you can charge a
different price – that makes a great business.

I’ll try this on the students later: What’s the highest price of a daily newspaper in the United States? [Pause] [This is
what he said to the students later: Most of you are familiar with it. The highest priced daily newspaper in the United
States, with any circulation at all, is the Daily Racing Form. It sells about 150,000 copies a day, and it has for about 50
years, and it’s either $2.00 or $2.25 (they keep raising prices) and it’s essential. If you’re heading to the racetrack and
you’ve got a choice between betting on your wife’s birthday, and Joe’s Little Green Sheet, and the Daily Racing Form, if


you’re a serious racing handicapper, you want The Form. You can charge $2.00 for The Form, you can charge $1.50, you
can charge $2.50 and people are going to buy it. It’s like selling needles to addicts, basically. It’s an essential business. It
will be an essential business five or 10 years from now. You have to decide whether horse racing will be around five or
10 years from now, and you have to decide whether there’s any way people will get their information about past
performances of different horses from different sources. But you’ve only got about two questions to answer, and if you
answer them, you know the business will make a lot of money. The Form has huge profit margins, incidentally. Wider
than any other newspaper. They charge what they want to basically. It’s an easy to understand business – so easy to
understand.]

There are products like that, and there are products like sheet steel. And they’re night and day.”

“The most important thing with me in evaluating businesses is figuring out how big the moat is around the business. I
want to know how big the capital is on the inside and then I want to know how big the moat is around it. What you love
is big capital and a big moat.”

“The durability and strength of the franchise is the most important thing in figuring out [whether it’s a good business]. If
you think a business is going to be around 10 or 20 years from now, and that they’re going to be able to price
advantageously, that’s going to be a good business. And if somebody has to have a prayer session every time they want
to raise the price a dollar a pound on whatever they’re selling, that’s not going to be a good business.”

“When we invest we ask one question, how long do you have to wait to raise the prices? If you are an airline today and
you try to raise your prices, an hour later, you will be lowering them because of competition. Not the case with a good
brand like See’s.”
‐ From a meeting with Univ. of Georgia students, Jan 2007



Reinvestment/Growth

“Our acquisition preferences run toward businesses that generate cash, not those that consume it. As inflation
intensifies, more and more companies find that they must spend all funds they generate internally just to maintain their
existing physical volume of business. There is a certain mirage‐like quality to such operations. However attractive the
earnings numbers, we remain leery of businesses that never seem able to convert such pretty numbers into no‐strings‐
attached cash.”
- BRK 1980 Letter

“Last year in this section I ran a small ad to encourage acquisition candidates. In our communications businesses we tell
our advertisers that repetition is a key to results (which it is), so we will again repeat our acquisition criteria.

We prefer:
(1) large purchases (at least $5 million of after‐tax earnings),
(2) demonstrated consistent earning power (future projections are of little interest to
us, nor are “turn‐around” situations),
(3) businesses earning good returns on equity while employing little or no debt,
(4) management in place (we can’t supply it),
(5) simple businesses (if there’s lots of technology, we won’t understand it),
(6) an offering price (we don’t want to waste our time or that of the seller by talking,
even preliminarily, about a transaction when price is unknown).”
- BRK 1983 Letter

“Obviously, the future results of a business earning 23% annually and retaining it all are far more affected by today’s
capital allocations than are the results of a business earning 10% and distributing half of that to shareholders.

“In a company adding only, say, 5% to net worth annually, capital‐allocation decisions, though still important, will
change the company’s economics far more slowly.”
- BRK 1986 Letter

“I've told you that over time look‐through earnings must increase at about 15% annually if our intrinsic business value is
to grow at that rate. Our look‐through earnings in 1992 were $604 million, and they will need to grow to more than
$1.8 billion by the year 2000 if we are to meet that 15% goal. For us to get there, our operating subsidiaries and
investees must deliver excellent performances, and we must exercise some skill in capital allocation as well.

We cannot promise to achieve the $1.8 billion target. Indeed, we may not even come close to it. But it does guide our
decision‐making: When we allocate capital today, we are thinking about what will maximize look‐through earnings in
2000.

We do not, however, see this long‐term focus as eliminating the need for us to achieve decent short‐term results as
well. After all, we were thinking long‐range thoughts five or ten years ago, and the moves we made then should now be
paying off. If plantings made confidently are repeatedly followed by disappointing harvests, something is wrong with


the farmer. (Or perhaps with the farm: Investors should understand that for certain companies, and even for some
industries, there simply is no good long‐term strategy.) Just as you should be suspicious of managers who pump up
short‐term earnings by accounting maneuvers, asset sales and the like, so also should you be suspicious of those
managers who fail to deliver for extended periods and blame it on their long‐term focus.”
- BRK 1992 Letter

“Leaving the question of price aside, the best business to own is one that over an extended period can employ large
amounts of incremental capital at very high rates of return. The worst business to own is one that must, or will, do the
opposite ‐ that is, consistently employ ever‐greater amounts of capital at very low rates of return. Unfortunately, the
first type of business is very hard to find: Most high‐return businesses need relatively little capital. Shareholders of such
a business usually will benefit if it pays out most of its earnings in dividends or makes significant stock repurchases.”
- BRK 1992 Letter

“Earlier I mentioned the financial results that could have been achieved by investing $40 in The Coca‐Cola Co. in 1919.
In 1938, more than 50 years after the introduction of Coke, and long after the drink was firmly established as an
American icon, Fortune did an excellent story on the company. In the second paragraph the writer reported: "Several
times every year a weighty and serious investor looks long and with profound respect at Coca‐Cola's record, but comes
regretfully to the conclusion that he is looking too late. The specters of saturation and competition rise before him."

Yes, competition there was in 1938 and in 1993 as well. But it's worth noting that in 1938 The Coca‐Cola Co. sold 207
million cases of soft drinks (if its gallonage then is converted into the 192‐ounce cases used for measurement today) and
in 1993 it sold about 10.7 billion cases, a 50‐fold increase in physical volume from a company that in 1938 was already
dominant in its very major industry. Nor was the party over in 1938 for an investor: Though the $40 invested in 1919 in
one share had (with dividends reinvested) turned into $3,277 by the end of 1938, a fresh $40 then invested in Coca‐Cola
stock would have grown to $25,000 by yearend 1993.

I can't resist one more quote from that 1938 Fortune story: "It would be hard to name any company comparable in size
to Coca‐Cola and selling, as Coca‐Cola does, an unchanged product that can point to a ten‐year record anything like
Coca‐Cola's." In the 55 years that have since passed, Coke's product line has broadened somewhat, but it's remarkable
how well that description still fits.”
‐ BRK 1993 Letter

“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily‐understandable
business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time,
you will find only a few companies that meet these standards ‐ so when you see one that qualifies, you should buy a
meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren't willing to
own a stock for ten years, don't even think about owning it for ten minutes. Put together a portfolio of companies
whose aggregate earnings march upward over the years, and so also will the portfolio's market value.”
- BRK 1996 Letter

“Let’s look at the prototype of a dream business, our own See’s Candy. The boxed‐chocolates industry in which it
operates is unexciting: Per‐capita consumption in the U.S. is extremely low and doesn’t grow. Many once‐important
brands have disappeared, and only three companies have earned more than token profits over the last forty years.


Indeed, I believe that See’s, though it obtains the bulk of its revenues from only a few states, accounts for nearly half of
the entire industry’s earnings.

At See’s, annual sales were 16 million pounds of candy when Blue Chip Stamps purchased the company in 1972. (Charlie
and I controlled Blue Chip at the time and later merged it into Berkshire.) Last year See’s sold 31 million pounds, a
growth rate of only 2% annually. Yet its durable competitive advantage, built by the See’s family over a 50‐year period,
and strengthened subsequently by Chuck Huggins and Brad Kinstler, has produced extraordinary results for Berkshire.
We bought See’s for $25 million when its sales were $30 million and pre‐tax earnings were less than $5 million. The
capital then required to conduct the business was $8 million. (Modest seasonal debt was also needed for a few months
each year.) Consequently, the company was earning 60% pre‐tax on invested capital. Two factors helped to minimize the
funds required for operations. First, the product was
sold for cash, and that eliminated accounts receivable. Second, the production and distribution cycle was short, which
minimized inventories.

Last year See’s sales were $383 million, and pre‐tax profits were $82 million. The capital now required to run the
business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical
growth – and somewhat immodest financial growth – of the business. In the meantime pre‐tax earnings have totaled
$1.35 billion. All of that, except for the $32 million, has been sent to Berkshire (or, in the early years, to Blue Chip). After
paying corporate taxes on the profits, we have used the rest to buy other attractive businesses. Just as Adam and Eve
kick‐started an activity that led to six billion humans, See’s has given birth to multiple new streams of cash for us. (The
biblical command to “be fruitful and multiply” is one we take seriously at Berkshire.)

There aren’t many See’s in Corporate America. Typically, companies that increase their earnings from $5 million to $82
million require, say, $400 million or so of capital investment to finance their growth. That’s because growing businesses
have both working capital needs that increase in proportion to sales growth and significant requirements for fixed asset
investments.

A company that needs large increases in capital to engender its growth may well prove to be a satisfactory investment.
There is, to follow through on our example, nothing shabby about earning $82 million pre‐tax on $400 million of net
tangible assets. But that equation for the owner is vastly different from the See’s situation. It’s far better to have an
ever‐increasing stream of earnings with virtually no major capital requirements. Ask Microsoft or Google.

One example of good, but far from sensational, business economics is our own FlightSafety. This company delivers
benefits to its customers that are the equal of those delivered by any business that I know of. It also possesses a durable
competitive advantage: Going to any other flight‐training provider than the best is like taking the low bid on a surgical
procedure.

Nevertheless, this business requires a significant reinvestment of earnings if it is to grow. When we purchased
FlightSafety in 1996, its pre‐tax operating earnings were $111 million, and its net investment in fixed assets was $570
million. Since our purchase, depreciation charges have totaled $923 million. But capital expenditures have totaled
$1.635 billion, most of that for simulators to match the new airplane models that are constantly being introduced. (A
simulator can cost us more than $12 million, and we have 273 of them.) Our fixed assets, after depreciation, now
amount to $1.079 billion. Pre‐tax operating earnings in 2007 were $270 million, a gain of $159 million since 1996. That
gain gave us a good, but far from See’s‐like, return on our incremental investment of $509 million.

Consequently, if measured only by economic returns, FlightSafety is an excellent but not extraordinary business. Its put‐
up‐more‐to‐earn‐more experience is that faced by most corporations. For example, our large investment in regulated


utilities falls squarely in this category. We will earn considerably more money in this business ten years from now, but
we will invest many billions to make it.”
- BRK 2007 Letter

“Now let’s move to the gruesome. The worst sort of business is one that grows rapidly, requires significant capital to
engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has
proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty
Hawk, he would have done his successors a huge favor by shooting Orville down.

The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money
into a bottomless pit, attracted by growth when they should have been repelled by it. And I, to my shame, participated
in this foolishness when I had Berkshire buy U.S. Air preferred stock in 1989. As the ink was drying on our check, the
company went into a tailspin, and before long our preferred dividend was no longer being paid. But we then got very
lucky. In one of the recurrent, but always misguided, bursts of optimism for airlines, we were actually able to sell our
shares in 1998 for a hefty gain. In the decade following our sale, the company went bankrupt. Twice.

To sum up, think of three types of “savings accounts.” The great one pays an extraordinarily high interest rate that will
rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are
added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at
those disappointing returns.”
- BRK 2007 Letter

“A shareholder asked about the allocation of capital: Buffett had stated in the past that he’s interested in firms that buy
their own shares. When a stock price is high relative to intrinsic value, what good are share buybacks? Buffett responded
that it’s harmful to shareholders, just as issuing shares at less than intrinsic value is harmful to shareholders. ‘Look at
Coke,’ he said, ‘the price may appear high relative to earnings or book value, but their repurchases are not harmful
because intrinsic value is so great. We tend to develop higher intrinsic values for great businesses than other folks do:
when we see a truly great business, we applaud it. Many criticized Coke buybacks at times, but those folks just didn’t
understand the business.’”

“The $64,000 question....

Shareholder: Banking stocks have gone up a lot the last few years. And returns on tangible equity at some of the major
banks that have led that consolidation have gone up a good bit more. Do you think those returns are sustainable over
either the near term or the longer term?
Buffett: Well, that's the $64,000 question because returns on equity ‐ particularly returns on tangible equity
particularly in the banking sector ‐ have hit numbers that are unprecedented. And, then, the question is, "If they're
unprecedented are they unsustainable?"

Sustained 20% ROEs are impossible ‐ absent repurchases.

Buffett: ...We wouldn't base our actions on the premise of returns of 20%+ on book equity and much higher returns
on tangible equity being sustainable. In the banking field you have a number of enterprises whose returns on tangible
equity are getting up close to 30%.


In a system where the GDP is growing maybe 3% in real terms and something around 4‐5% in nominal terms, can
businesses consistently earn 20% on equity? Well, they certainly can't if they retain most of their earnings ‐ because you
would have corporate profits rising as a percentage of GDP to a point that would get ludicrous.
So under those conditions, you'd either have to have huge payouts ‐ either by repurchases of shares, by dividends or
by takeovers actually ‐ that would keep the level of capital reasonably consistent because those returns couldn't be
sustained....
For example, let's just say that every company earned 20% on equity and retained all of its earnings. You could not
have corporate profits growing at 20% year after year and not have it become a disproportionately large part of the
economy.”
- 1998 BRK Meeting

“The Ideal Business

The ideal business is one that generates very high returns on capital and can invest that capital back into the business at
equally high rates. Imagine a $100 million business that earns 20% in one year, reinvests the $20 million profit and in the
next year earns 20% of $120 million and so forth. But there are very very few businesses like this. Coke has high returns
on capital, but incremental capital doesn’t earn anything like its current returns. We love businesses that can earn high
rates on even more capital than it earns. Most of our businesses generate lots of money, but can’t generate high returns
on incremental capital ‐‐ for example, See’s and Buffalo News. We look for them [areas to wisely reinvest capital], but
they don’t exist.”

“Thinking About Growth Rates When Estimating Valuation

Buffet: When the [long term] growth rate is higher than the discount rate, then [mathematically] the value is infinity.
This is the St Petersburg Paradox, written about by Durant 30 years ago.

Some managements think this [that the value of their company is infinite]. It gets very dangerous to assume high growth
rates to infinity – that’s where people get into a lot of trouble. The idea of projecting extremely high growth rates for a
long period of time has cost investors an awful lot of money. Go look at top companies 50 years ago: how many have
grown at 10% for a long time? And [those that have grown] 15% is very rarified.

Charlie and I are rarely willing to project high growth rates. Maybe we’re wrong sometimes and that costs us, but we like
to be conservative.

Munger: If your growth rate is so high that you conclude the business has an infinite valuation, you have to use more
realistic numbers. What could anyone else do?”
- 2004 BRK Meeting

“Within the growth stock model, there’s a sub‐position: There are actually businesses that you will find a few times in a
lifetime where any manager could raise the return enormously just by raising prices – and yet they haven’t done it. So
they have huge untapped pricing power that they’re not using. That is the ultimate no‐brainer.

That existed in Disney. It’s such a unique experience to take your grandchild to Disneyland. You’re not doing it that
often. And there are lots of people in the country. And Disney found that it could raise those prices a lot, and the
attendance stayed right up.


So a lot of the great record of Eisner and Wells was utter brilliance but the rest came from just raising prices at
Disneyland and Disneyworld and through video cassette sales of classic animated movies.

At Berkshire Hathaway, Warren and I raised the prices of See’s Candy a little faster than others might have. And, of
course, we invested in Coca‐Cola – which had some untapped pricing power. And it had brilliant management. So a
Goizueta and Keough could do much more than raise prices. It was perfect.”

“You will get a few opportunities to profit from finding under pricing. There are actually people out there who don’t
price everything as high as the market will easily stand. And once you figure that out, it’s like finding money in the street
– if you have the courage of your convictions.”
4/14/1994

“There is a third, more subjective, element to an intrinsic value calculation that can be either positive or negative: the
efficacy with which retained earnings will be deployed in the future. We, as well as many other businesses, are likely to
retain earnings over the next decade that will equal, or even exceed, the capital we presently employ. Some companies
will turn these retained dollars into fifty‐cent pieces, others into two‐dollar bills.

This “what‐will‐they‐do‐with‐the‐money” factor must always be evaluated along with the “what‐do‐we‐have‐now”
calculation in order for us, or anybody, to arrive at a sensible estimate of a company’s intrinsic value. That’s because an
outside investor stands by helplessly as management reinvests his share of the company’s earnings. If a CEO can be
expected to do this job well, the reinvestment prospects add to the company’s current value; if the CEO’s talents or
motives are suspect, today’s value must be discounted. The difference in outcome can be huge. A dollar of then‐value in
the hands of Sears Roebuck’s or Montgomery Ward’s CEOs in the late 1960s had a far different destiny than did a dollar
entrusted to Sam Walton.”
- BRK 2010 Letter


Management

“As we have noted, we evaluate single‐year corporate performance by comparing operating earnings to shareholders’
equity with securities valued at cost. Our long‐term yardstick of performance, however, includes all capital gains or
losses, realized or unrealized. We continue to achieve a long‐term return on equity that considerably exceeds the
average of our yearly returns. The major factor causing this pleasant result is a simple one: the retained earnings of
those non‐controlled holdings we discussed earlier have been translated into gains in market value.”
- BRK 1980 Letter

“In fairness, we should acknowledge that some acquisition records have been dazzling. Two major categories stand out.

The first involves companies that, through design or accident, have purchased only businesses that are particularly well
adapted to an inflationary environment. Such favored business must have two characteristics: (1) an ability to increase
prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of
either market share or unit volume, and (2) an ability to accommodate large dollar volume increases in business (often
produced more by inflation than by real growth) with only minor additional investment of capital. Managers of ordinary
ability, focusing solely on acquisition possibilities meeting these tests, have achieved excellent results in recent decades.
However, very few enterprises possess both characteristics, and competition to buy those that do has now become
fierce to the point of being self‐defeating.

The second category involves the managerial superstars ‐ men who can recognize that rare prince who is disguised as a
toad, and who have managerial abilities that enable them to peel away the disguise. We salute such managers as Ben
Heineman at Northwest Industries, Henry Singleton at Teledyne, Erwin Zaban at National Service Industries, and
especially Tom Murphy at Capital Cities Communications (a real managerial “twofer”, whose acquisition efforts have
been properly focused in Category 1 and whose operating talents also make him a leader of Category 2). From both
direct and vicarious experience, we recognize the difficulty and rarity of these executives’ achievements. (So do they;
these champs have made very few deals in recent years, and often have found repurchase of their own shares to be the
most sensible employment of corporate capital.)”
- BRK 1981 Letter

“Currently, we find values most easily obtained through the open‐market purchase of fractional positions in companies
with excellent business franchises and competent, honest managements. We never expect to run these companies, but
we do expect to profit from them.

We expect that undistributed earnings from such companies will produce full value (subject to tax when realized) for
Berkshire and its shareholders. If they don’t, we have made mistakes as to either: (1) the management we have elected
to join; (2) the future economics of the business; or (3) the price we have paid.

We have made plenty of such mistakes ‐ both in the purchase of non‐controlling and controlling interests in businesses.
Category (2) miscalculations are the most common.”
- BRK 1981 Letter



“Berkshire’s economic goal remains to produce a long‐term rate of return well above the return achieved by the average
large American corporation.”
- BRK 1982 Letter

“o Our long‐term economic goal (subject to some qualifications mentioned later) is to maximize the average annual
rate of gain in intrinsic business value on a per‐share basis.

o Our preference would be to reach this goal by directly owning a diversified group of businesses that generate cash
and consistently earn above‐average returns on capital.

o We rarely use much debt and, when we do, we attempt to structure it on a long‐term fixed rate basis.”
‐ BRK 1983 Letter

“Mutual Savings has adapted in its own way to the dramatic changes which have occurred in recent years in interest
rates and the regulatory structure of the banking and savings and loan industries. At Mutual Savings, as well as the rest
of the savings and loan industry, the standard practice used to be to borrow short from savers while lending long on
fixed‐rate mortgages, to have high financial leverage for shareholders' equity and to grant mortgagors easy prepayment
terms. The practice was profitable for decades but always involved something like a "hurricane risk," and the equivalent
of a hurricane came in 1981‐82 as interest rates rose to unprecedented levels and caused widespread losses. Results
were good for shareholders before 1981‐82 only because interest rates were stable or rose slowly as mortgage‐loan
portfolios steadily and rapidly expanded under a regulatory structure which both fostered growth and protected
operating margins by requiring that on all insured savings accounts fixed rates be paid that were slightly higher than the
low rates specified for banks. Thus a small deposit‐attracting rate advantage over banks was given to savings and loan
associations, while competitive pressure was dampened for both types of institution.

Although interest rates have subsided from the 1981‐82 peak, the low and slowly changing interest rates of former years
are plainly gone with the wind, as are the former government‐decreed limits on interest rate competition for savings
accounts and the favoritism for savings and loan associations over banks. But an agency of the U.S. government
(F.S.L.I.C.) continues to insure savings accounts in the savings and loan industry, just as it did before. The result may well
be bolder and bolder conduct by many savings and loan associations. A sort of Gresham's Law ("bad loan practice drives
out good") may take effect for fully competitive but deposit‐insured institutions, through increased copying by cautious
institutions of whatever apparent‐high‐yield loan and investment strategies seem to allow competitors to bid away their
savings accounts and yet report substantial earnings. If so, if "bold conduct drives out conservative conduct," there
eventually could be widespread insolvencies caused by bold credit extensions come to grief.

And if serious credit‐quality troubles come to the savings and loan industry, they will merely add to troubles from the
borrowed‐short, lent‐long‐at‐fixed‐rates problem, which is far from completely removed, and which destroys
shareholder wealth at startling speed whenever interest rates are rising rapidly, even when the credit quality of
mortgagors or other borrowers is excellent.

Developing a short‐term operating plan for Mutual Savings which would sharply increase its reported earnings next year
would be a near‐absolute cinch. For instance, savings accounts could be expanded greatly by paying a high rate of
interest on "jumbo" deposits in $100,000 multiples, and proceeds plus cash equivalents on hand could be placed in
long‐term mortgages at a substantial current interest spread while, in addition, some origination fees could be "front‐
ended" into income. However, taking long‐term risks into account, it is much harder to find a sound operating plan.
Money is the ultimate fungible commodity. In the new order of things, an association is not only in a tough, competitive,


commodity‐type business on the lending side but also finds that, with decontrol of government‐insured rates paid
savers, every competitive association has virtually unlimited credit to fund increased lending, by paying premiums over
interest rates generally prevailing on savings accounts. Under such conditions, when all risks are considered, including
those created by that portion of competitors motivated primarily by short‐term effects, it is quite naturally difficult to
earn over a long period an attractive return on shareholders' equity. How could it be otherwise?

A few years ago, about the same time Mutual Savings reacted to new conditions by curtailing lending, most other
associations decided instead to keep lending aggressively but under new adjustable‐rate mortgages under which some
portion (but far from all) of the interest rate‐fluctuation risk is shifted to the homeowner. Despite widespread use of
these new adjustable‐rate mortgages, savings and loan industry earnings remain dependent to a material extent, as they
always were, on an interest rate spread attributable to: (1) borrowing short while lending long, and/or (2) making loans
which can be priced high enough to provide a profit only because they involve very material credit risk, compared to the
risk of owning government‐backed securities of comparable maturity.

Under present conditions of strong competition from bold competitors accompanied by high interest‐rate‐fluctuation
risk, the results tend to be that each year of reported attractive earnings occurs only in the absence of two now much
more likely events: (1) sharply rising interest rates, and (2) widespread credit losses. Thus, each good year reported is a
lot like the year when a Texas hurricane insurer reports satisfactory earnings because there have been no hurricanes.
Mutual Savings has considerable share of this uncomfortable position and will continue to have it. It has not yet
developed a long‐term operating strategy with which it is satisfied, and continues to seek one. Just as Mutual Savings
has been idiosyncratic in the past as it sold branch offices in 1980 (a practice now being adopted to some extent by
other savings and loan associations and major banks), it will probably be idiosyncratic in the future. It will seek some
non‐standard way of rendering socially constructive service while operating with acceptable profits accompanied by an
acceptable level of risk for shareholders' capital, likely gains considered.

Eventually, by maintaining unusual capital strength and liquidity, and by having a parent corporation which does
likewise, Mutual Savings hopes to stand in particular favor with federal and state regulatory authorities and be in a
position soundly to expand again, perhaps dramatically, and perhaps involving additional shareholder investment in
Mutual Savings by the parent corporation.

As part of a program for the anticipated eventual sound expansion of the savings and loan business, Mutual Savings in
1983, without heaving promotion or advertising, consistently paid about 1/2% per annum more than most competitors
on so‐called "money market rate accounts" of moderate size. This type of savings account is repayable on demand
without penalty and allows up to three withdrawals by check each month. Most of Mutual Savings' "money market rate
accounts" are in the range of $10,000 to $100,000. Mutual Savings' practice of bidding up slightly for this one type of
account penalized 1983 earnings to a small extent and caused the bulk of the reported $36 million growth in savings.”
- WSC 1983 Letter

“Wesco's consolidated balance sheet retains a strength befitting a company whose consolidate net worth supports large
outstanding promises to others.”
- WSC 1983 Letter

“I have been asked by a number of people just what secrets the Blumkins bring to their business. These are not very
esoteric. All members of the family: (1) apply themselves with an enthusiasm and energy that would make Ben Franklin
and Horatio Alger look like dropouts; (2) define with extraordinary realism their area of special competence and act
decisively on all matters within it; (3) ignore even the most enticing propositions failing outside of that area of special


competence; and, (4) unfailingly behave in a high‐grade manner with everyone they deal with. (Mrs. B boils it down to
‘sell cheap and tell the truth’.)”
- BRK 1984 Letter

“In judging whether managers should retain earnings, shareholders should not simply compare total incremental
earnings in recent years to total incremental capital because that relationship may be distorted by what is going on in a
core business. During an inflationary period, companies with a core business characterized by extraordinary economics
can use small amounts of incremental capital in that business at very high rates of return (as was discussed in last year’s
section on Goodwill). But, unless they are experiencing tremendous unit growth, outstanding businesses by definition
generate large amounts of excess cash. If a company sinks most of this money in other businesses that earn low returns,
the company’s overall return on retained capital may nevertheless appear excellent because of the extraordinary
returns being earned by the portion of earnings incrementally invested in the core business. The situation is analogous
to a Pro‐Am golf event: even if all of the amateurs are hopeless duffers, the team’s best‐ball score will be respectable
because of the dominating skills of the professional.

Many corporations that consistently show good returns both on equity and on overall incremental capital have, indeed,
employed a large portion of their retained earnings on an economically unattractive, even disastrous, basis. Their
marvelous core businesses, however, whose earnings grow year after year, camouflage repeated failures in capital
allocation elsewhere (usually involving high‐priced acquisitions of businesses that have inherently mediocre economics).
The managers at fault periodically report on the lessons they have learned from the latest disappointment. They then
usually seek out future lessons. (Failure seems to go to their heads.)

In such cases, shareholders would be far better off if earnings were retained only to expand the high‐return business,
with the balance paid in dividends or used to repurchase stock (an action that increases the owners’ interest in the
exceptional business while sparing them participation in subpar businesses). Managers of high‐return businesses who
consistently employ much of the cash thrown off by those businesses in other ventures with low returns should be held
to account for those allocation decisions, regardless of how profitable the overall enterprise is.”
- BRK 1984 Letter

“My conclusion from my own experiences and from much observation of other businesses is that a good managerial
record (measured by economic returns) is far more a function of what business boat you get into than it is of how
effectively you row (though intelligence and effort help considerably, of course, in any business, good or bad). Some
years ago I wrote: “When a management with a reputation for brilliance tackles a business with a reputation for poor
fundamental economics, it is the reputation of the business that remains intact.” Nothing has since changed my point of
view on that matter. Should you find yourself in a chronically‐leaking boat, energy devoted to changing vessels is likely
to be more productive than energy devoted to patching leaks.”
- BRK 1985 Letter

“Moreover, comparison of post‐1984 financial results for Mutual Savings with results for many other and more typical
savings and loan associations in California leave Mutual Savings looking inferior, to put it mildly. As interest rates went
down these other associations, which have greater financial leverage and operated less fearfully than Mutual Savings
during former high‐interest periods, came to have loan and investment portfolios which (1) now are worth more on
average than book value and (2) now operating expenses and interest to account holders at present rates. Any Wesco
shareholder who thinks Mutual Savings has any expertise in predicting and profiting from interest rate changes can look
at the 1985 record and despair.”


- WSC 1985 Letter

“With money being the ultimate fungible commodity, it seems to us that the rules create a super‐competitive,
commodity‐type business, in which (1) economic law probably destines most careful associations, like other fungible‐
commodity dealers, to realize very modest returns on shareholders’ equity over extended time periods, yet (2) good
financial results can nonetheless usually be reported in each near‐term period by managers‐in charge through
aggressive deposit‐expanding, lending and investing measures which increase risk, while (3) the importance and rewards
of managers, who usually have little downside risk as owners are tied mostly to institutional size and recently reported
numbers. With managers mostly being non‐owners, a sort of Gresham’s law of competitive‐yet‐deposit‐insured banking,
“bad loans drive out good,” tends to work with extra force as managers fear being left out of whatever activity allows
competing managers to report high profits while bidding high for deposits. We see no reason for assuming that ethical,
intelligent managers in the savings and loan industry are immune from effects similar to those which caused similar
managers of all major U.S. banks to place significant portions of assets in now‐regretted foreign loans, rather than stand
apart from the crowd. If our diagnosis is correct, a lot of serious trouble lies ahead (perhaps far ahead) for U.S. savings
and loans associations.

The present design, we think, would probably also be a flunking design in a surgery course, where the wise practice is to
remove some healthy cells along with cancerous cells, based on margin‐of‐safety principles. We hope we are wrong
about the present design of the savings and loan system, but we fear increased, widespread adversity, ultimately
reaching housing borrowers and would‐be housing borrowers, whose interests we consider important. Any such
adversity would probably be followed by changes in the rules. No doubt, our judgment as to the probably temporary
nature of present savings and loan industry structure and practices has helped deter us from direct lending of a
conventional sort which otherwise would have occurred. Our attitude, right or wrong, during recent tumultuous changes
in the savings and loan industry, has been roughly that of the French grandfather who replied when asked what he did in
the great revolution: ‘I got through.’ We also think something good could eventually happen to Mutual Savings because
future trouble in the savings and loan business may create opportunities worth seizing.”
- WSC 1985 Letter

“Wesco is trying more to profit from always remembering the obvious than from grasping the esoteric (including much
modern ‘strategic planning’ and ‘portfolio theory’). Such an approach, while it has worked fairly well on average in the
past and will probably work fairly well over the long‐term future, is bound to encounter period of dullness and
disadvantage as it limits action. Moreover, the approach is being applied to no great base position. Wesco is sort of
scrambling through the years without owning a single business, even a small one, with enough commercial advantage in
place to pretty well assure high future returns on its capital. In contrast, Berkshire Hathaway, Wesco’s parent
corporation, owns three such high return business.”
- WSC 1985 Letter

“Charlie and I know that the right players will make almost any team manager look good. We subscribe to the
philosophy of Ogilvy & Mather’s founding genius, David Ogilvy: "If each of us hires people who are smaller than we are,
we shall become a company of dwarfs. But, if each of us hires people who are bigger than we are, we shall become a
company of giants."
- BRK 1986 Letter



“I would say that the controlled company offers two main advantages. First, when we control a company we get to
allocate capital, whereas we are likely to have little or nothing to say about this process with marketable holdings. This
point can be important because the heads of many companies are not skilled in capital allocation. Their inadequacy is
not surprising. Most bosses rise to the top because they have excelled in an area such as marketing, production,
engineering, administration or, sometimes, institutional politics.

Once they become CEOs, they face new responsibilities. They now must make capital allocation decisions, a critical job
that they may have never tackled and that is not easily mastered. To stretch the point, it's as if the final step for a
highly‐talented musician was not to perform at Carnegie Hall but, instead, to be named Chairman of the Federal
Reserve.

The lack of skill that many CEOs have at capital allocation is no small matter: After ten years on the job, a CEO whose
company annually retains earnings equal to 10% of net worth will have been responsible for the deployment of more
than 60% of all the capital at work in the business.

“In the end, plenty of unintelligent capital allocation takes place in corporate America. (That's why you hear so much
about "restructuring.") Berkshire, however, has been fortunate. At the companies that are our major non‐controlled
holdings, capital has generally been well‐deployed and, in some cases, brilliantly so.”
- BRK 1987 Letter

“Over the long term, a corporation like Wesco, with no significant proportion of intrinsic value in great businesses, is like
a tortoise in a race of hares. And as noted above, this particular tortoise faces the race with an unoriginal and
conservative approach.

However, there are respectable precedents for our approach. The novelist Hardy, who believed that the natural
outcome of ambition was getting clobbered, advocated the logical preventative of aiming low. And people known for
outcomes far too good to have been expected by Hardy have mined a branch of the same vein. Consider this statement
from Newton: ‘If I have seen further than other men, it is by standing on the shoulders of giants’. And this from Mozart
(as approving quoted advertising creator, David Ogilvy): ‘I never tried to compose anything original in my life’.

It is occasionally possible for a tortoise, content to assimilate proven insights of his best predecessors, to outrun hares
which seek originality or don’t wish to be left out of some crowd folly which ignores the best work of the past. This
happens as the tortoise stumbles on some particularly effective way to apply the best previous work, or simply avoids
standard calamities. Anyway, we hope so. And so should recent purchasers of Wesco stock who have not only bet on a
tortoise but also, by paying prices in the mid forties, given odds.”
- WSC 1987 Letter

“That leads right into a related lesson: Good jockeys will do well on good horses, but not on broken‐down nags. Both
Berkshire's textile business and Hochschild, Kohn had able and honest people running them. The same managers
employed in a business with good economic characteristics would have achieved fine records. But they were never going
to make any progress while running in quicksand.

I've said many times that when a management with a reputation for brilliance tackles a business with a reputation for
bad economics, it is the reputation of the business that remains intact. I just wish I hadn't been so energetic in creating
examples. My behavior has matched that admitted by Mae West: "I was Snow White, but I drifted."
- BRK 1989 Letter


“My most surprising discovery: the overwhelming importance in business of an unseen force that we might call "the
institutional imperative." In business school, I was given no hint of the imperative's existence and I did not intuitively
understand it when I entered the business world. I thought then that decent, intelligent, and experienced managers
would automatically make rational business decisions. But I learned over time that isn't so. Instead, rationality
frequently wilts when the institutional imperative comes into play.

For example: (1) As if governed by Newton's First Law of Motion, an institution will resist any change in its current
direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up
available funds; (3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate‐of‐
return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are
expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.

Institutional dynamics, not venality or stupidity, set businesses on these courses, which are too often misguided. After
making some expensive mistakes because I ignored the power of the imperative, I have tried to organize and manage
Berkshire in ways that minimize its influence. Furthermore, Charlie and I have attempted to concentrate our
investments in companies that appear alert to the problem.”
- BRK 1989 Letter

“After some other mistakes, I learned to go into business only with people whom I like, trust, and admire. As I noted
before, this policy of itself will not ensure success: A second‐class textile or department‐store company won't prosper
simply because its managers are men that you would be pleased to see your daughter marry. However, an owner ‐ or
investor ‐ can accomplish wonders if he manages to associate himself with such people in businesses that possess
decent economic characteristics. Conversely, we do not wish to join with managers who lack admirable qualities, no
matter how attractive the prospects of their business. We've never succeeded in making a good deal with a bad person.”
- BRK 1989 Letter

“It is assumed by many business school graduates, and by almost all consultants, that a corporation can easily improve
its outcome by purchasing unrelated or tenuously related businesses. According to this widely shared view, if only the
obvious steps had been taken, if the right ‘mission statement’ had been adopted and the right ‘experts’ hired, then each
railroad, instead of remaining bound in chains by new forms of competition and obsolete and hostile laws and union
rules would have become another Federal Express, another United Parcel Service, or even another brilliant performer in
the mode of Emerson Electric.

Our experience, both actual and vicarious, makes us less optimistic about easy solutions through business acquisition.
We think undue optimism arises because successful records draw too much attention. Many people then reason as I
would if I forecasted good prospects in big‐time tennis after observation limited to Ivan Lendl and Steffi Graf, or good
prospects in the California lottery after limiting observation to winners. The converse is also true, only more so. Far too
little attention is given to the terrible effects on shareholders (or other owners) of the worst examples of corporate
acquisitions such as CBS‐DuMont, Xerox‐Scientific Data Systems, General
Electric‐Utah International, Exxon‐Reliance Electric, Sohio‐Kennecott, First Interstate Bancorp‐Allied Bancshares, Arizona
Public Service‐MeraBank, USX‐Texas Oil & Gas, Prudential Insurance‐Bache, Mobil Oil‐Montgomery Ward, General
Motors‐Hughes Aircraft, and Avon Products‐Practically Anybody. The list ends here for want of space, not a shortage of
additional examples. The acquiring corporations listed are great enterprises, honorably run. In fact, their greatness


augments then utility as examples as they show how hard it is, even for managers promoted to power through
meritocratic procedures at admired corporations, to advance by acquisition the interests of owners.

The full implications of the worst examples are lost, in part, because the conventions of corporate reporting cause
managers to present data in a manner which obscures both facts and implications. Horrible results are obscured, and
mediocre results are made to look fine. Techniques for masking the truth include (1) mixing bad or mediocre results into
other good results which would have been much better, absent the mixture, and (2) taking several poor results off the
stage at once through the ‘big bath’ technique. The ‘big bath’ technique, in turn, is often accompanied by some
extraordinary gain elsewhere which is cashed on a time schedule designed for obfuscation. Or a loss is mixed into a
‘restructuring,' adopting word usage which would explain Napoleon's outcome at Waterloo as a thoughtful
strengthening of France.

As we appraise it, the corporate mode of ‘solving your problems by acquisition’ far more often ends in the mediocre
‘follow‐the‐fad‐of‐the‐year’ record of a Peter Grace than in the wonderful record of a Dover Corporation. Nor does the
avoidance of dubious methodology guarantee success. It is hard to win at the game, even if one (1) does not rely on the
valuation judgment of outside acquisition ‘experts’ paid per transaction recommended and closed, and (2) does not
create the in‐house equivalent of the outside adviser who must buy to thrive, namely the internal department which has
no function except acquisitions and often bears a label including ‘planning,’ or even ‘strategic planning.’

Perhaps more instructive than the rarity of good corporate acquisition records is the striking rarity of important
acquisitions within the few good records. Most winners act as a wise baseball hitter would if permitted to pass as many
pitches as he wished before swinging.

For instance, among the best acquisition records is that of Tom Murphy and Dan Burke at Capital Cities/ABC. Yet the
major acquisitions, which accounted for more than 80% of ending economic value for continuing shareholders, occurred
less often than once each two years. This slow pace occurred even though they were in full control, were (and are) two
of the quickest learners and actors around, did all the important work themselves, and were located in the midst of a
profit‐ laden and long‐lasting communications revolution (television broadcasting) wherein rapid change churned out
opportunities for the acute at an above‐normal rate. (The writer has to believe that the opportunities seized by Murphy
and Burke were recognizable only by the acute. This follows from the writer's participation in rejecting a television‐
station opportunity, long ago given by Murphy and Burke when they were barred by law from purchase. The price was
less than one‐tenth of present‐day value.)

A particularly depressing lesson, for the action‐prone, might also be extracted from the business acquisition record of
Wesco's ultimate parent, Berkshire Hathaway. Over 24 years, Berkshire transformed a small, doomed New England
textile enterprise into a large and diversified company, without ending up with many more shares outstanding. Yet if you
removed from Berkshire’s record the six most significant acquisitions, extracting occurrences averaging one every four
years, the record would not now be mentioned here, or anywhere else.

It has always been easy (indeed, one attracts scores of helpers) to make disadvantageous business purchases in a hurry
with corporate cash. And it has been even easier to cause disadvantage if one is unwise enough, like General Electric in
the Utah International merger, or Xerox in the merger with scientific Data Systems, nor to be super‐sensitive to the
probability that any attainable stock‐for‐stock rnerger will transfer more intrinsic business value than is acquired. On the
other hand, advantageous business purchases, not involving competitors or branded products which can be sold
through the acquirer's present sales system, are difficult to find.

It is not just the Peter Principle which makes corporate acquisition records so bad, on average, although that Principle
does especially intense damage in the acquisition field. (This occurs because, when you promote the General Sales


Manager to CEO making unrelated business acquisitions, you naturally cause more trouble than you earlier did when
you made a less substantive change by promoting the Sales Manager of some territory to General Sales Manager.) Even
a CEO with good acquisition judgment is lucky if, in his remaining career, he finds one large opportunity which tempts
rational response.

The scarcity of good acquisition transactions, of course, does not imply that no wonderful businesses are ever for sale. It
is just that, in a finite, competitive world, no business is so wonderful that it can't be ruined as an acquisition candidate
by increasing the price. When this happens, many corporations buy anyway, for reasons Columbia's great philosopher,
Charles Frankel, so well understood. The system is so constructed (irresponsibly, Frankel would say) that the corporate
manager gains even though the shareholder loses. (Incidentally, Frankel was mugged to death in a final inadvertent
contribution to the study of irresponsible systems, reminding many conservative social critics of Socrates.)

At this point, a last question remains: If successful corporate business acquisition is so hard, how does one explain the
widespread recent success of most of the leveraged‐buy‐out (‘LBO’) operators who have purchased corporations? A
huge part of the answer comes from income‐tax effects and other simple effects. When, in a typical LBO, the typical
mostly equity corporate capitalization was replaced by 90% debt plus a new 10%‐of‐capitalization common stock
position:

(1) the combined market value of all the new common stock plus all the new debt became much higher than the
previous market value of all the old common stock, because the existing stream of pre‐tax earnings was no longer
shared with corporate income tax collectors who, in many cases, had previously received more cash each year than
shareholders; and

(2) even after the value‐enhancing effect of the corporate tax reduction was shared with former shareholders by
paying them extra‐high prices to leave, a retained residue of value‐enhancing tax effect made the new common stock
(which now became much like a speculative warrant with good terms) worth considerably more than cost as the ink
dried on acquisition papers; and

(3) the new ‘owners’ then resorted to strategies, difficult neither to conceive nor implement, including the
following:

(a) they eliminated many of the easily removable costs (largely personnel costs) and sub‐par segments
which in some mix (i) bedevil successful corporations (including ours) with sloth and folly and (ii) create their
humane grace and, through present sacrifice, good long‐term prospects, justifying sacrifice endured; and
(b) they sold off a few operations at super‐high prices, sometimes exercising the easiest microeconomic
insight by selling to a direct competitor and sometimes selling to a surprisingly easy‐to‐find non‐competitive
corporate buyer, not owned by its managers, willing to pay almost as high a price as a competitor would; and

(4) the new ‘owners’ then profited, in due course, not only from the tax effect and other simple reshuffling
activities described above, but also from the wonderful upside effects of extreme financial leverage during a long
business boom accompanied by a rising stock market.

Whether the country wants a large number (or even any) of its large corporations to have extremely leveraged
capitalizations, except through occasional adversity, presents interesting social questions. Is one social function of
corporations to be financially strong so they act as shock absorbers, protecting dependent employees, suppliers and
customers from part of the volatility implicit in capitalism? Was Ben Franklin right when he included the following folk
Wisdom in Poor Richard’s Almanac: ‘It is hard for an empty sack to stand upright.’ Is a weak corporation, borrowed to
the hilt, the social equivalent of a bridge with an inadequate reserve of structural strength? Granting that leveraged


buyouts have some favorable effects (as well as unfavorable effects) on long term efficiency, how many thousands of
able people do we wish to attract into promotional corporate recapitalization activity (1) reduces corporate income
taxes, (2) often tests the limits of antitrust law, and (3) focuses business attention on short‐term cash generation to pay
down oppressive levels of debt? Finally, as Columbia Law School's Professor Lou Lowenstein puts it (more or less): ‘Do
we really want entire corporate businesses, as important social institutions, continuously traded like pork belly
contracts?’

However the social questions are answered, three aspects of the present situation are clear. First, the corporate tax
effect is so large in LBO transactions that easy success in such transactions does not imply that success is easy in
ordinary corporate acquisitions. Second, the hordes of leveraged‐buy‐out operators now with us raise the general level
of acquisition prices to the detriment of other would‐be acquirers, including Wesco, which are not willing to maximize
tax benefits through maximized borrowing. And, third, the LBO operators will not go away so long as present permissive
laws last. The operators have a real advantage under such laws, not just a fig leaf aiding promotion. Even though failure
and disgrace will reduce their number, and prices paid in leveraged‐buy‐out transactions will fall, the capitalized value of
reducing the corporate income tax will remain. Therefore, plenty of rational incentive will remain for transactions. The
LBO genie will encounter reverses, but he is not going back in the bottle unless ordered to do so by new laws.

It should also be noted that the LBO operators' incentives to bid high do not end with real advantages derived from tax
law and willingness to reshuffle businesses with much speed and few scruples. Additional incentives for high bids come
from typical structures in which general partners of LBO partnerships risk little of their own money (often less than none
after fees are taken into account), yet share significantly in gains. Such arrangements are similar to the system of the
race track tout. And who has ever seen a tout who didn't want his backer to make a lot of bets?

To Wesco, as a non‐LBO operator, the good‐corporate‐acquisition game was always tough. And that game in each recent
year has become more like fishing for muskies at Leech Lake, in Minnesota, where the writer’s earliest business partner,
Ed Hoskins, had the following conversation with his Indian guide:

‘Are any muskies caught in this lake?’

‘More muskies are caught in this lake than in any other lake in Minnesota. This
lake is famous for muskies.’

‘How long have you been fishing here?’

‘19 years.’

‘And how many muskies have you caught?’

‘None.’

When a management has our point of view, infrequency of business acquisition may safely be predicted. Whether this
happens, as we like to believe, because the game is hard for almost everyone, or merely because the game is hard for
us, the result for Wesco shareholders is the same: less worthwhile activity than we all would like. But there may be one
consolation: A series of big incorrectable acquisition troubles, with no meaningful salvage, is seldom caused by people
who think the acquisition game is like fishing for muskies at Leech Lake. One terrible acquisition result is, of course, quite
possible. For instance, Wesco would cheerfully invest $75 million tomorrow, with a 60% chance of total loss, provided
the pay‐off for winning was large enough to cause statistical expectation to provide a handsome return.
- WSC 1989 Letter


“The banking business is no favorite of ours. When assets are twenty times equity ‐ a common ratio in this industry ‐
mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the
rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last
year when discussing the "institutional imperative:" the tendency of executives to mindlessly imitate the behavior of
their peers, no matter how foolish it may be to do so. In their lending, many bankers played follow‐the‐leader with
lemming‐like zeal; now they are experiencing a lemming‐like fate.
Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in
purchasing shares of a poorly‐managed bank at a "cheap" price. Instead, our only interest is in buying into well‐managed
banks at fair prices.”
- BRK 1990 Letter

“Despite Freddie Mac's strong competitive position, its stock declined in market value by 27% in 1990 (from $67.12 per
share to $48.75 per share, in trading on the New York Stock Exchange). One reason for the decline was unanticipated
losses from apartment house loans, particularly in New York and Atlanta. As a result, Freddie Mac wisely discontinued
the most obviously dangerous part of its apartment house loan buying program. But it remains the guarantor or owner
of some old loans (fortunately a small portion of total apartment house loans and a really tiny portion of total loans) that
will create misery for years. It was probably ill‐advised for Freddie Mac, given its position and financial leverage and the
nation's needs, (1) ever to finance anything except owner‐occupied, single‐family, non‐vacation houses, for which
substantial down payments had been made by credit‐worthy people, and (2) ever to deal with anyone other than
mortgage originators and services of obvious integrity and competence. Just as it is unwise for an individual to risk losing
what he has and needs in an effort to gain what he doesn't have and doesn't need, it seems unwise for Freddie Mac to
stretch its leveraged resources beyond purchase from obviously responsible people of carefully selected first mortgages
on individual houses. Each lender, including the one writing this letter, seems destined to learn through painful, personal
experience two obvious lessons from the past:

(1) The first chance you have to avoid a loss from a foolish loan is by refusing to make it; there is no second chance.

(2) As you occupy some high‐profit niche in a competitive order, you must know how much of your present prosperity is
caused by talents and momentum assuring success in new activities, and how much merely reflects the good fortune of
being in your present niche.

In common experience, including ours, lesson (1) is eventually learned, but lessons (2) resists learning, despite high pain
inflicted by multiple reverses.

As nearly as we can foretell, Freddie Mac's troubles with apartment house loans are endurable in scale and will no more
significantly impair its long‐term prospects than the salad oil swindle of 1963 impaired the long‐term prospects of
American Express. Moreover, the present managers and directors of Freddie Mac all seem to have absorbed a catechism
appropriate for Freddie Mac and to be willing to endure political friction burns as necessary to keep operations sound.
We like our large position.”
- WSC 1990 Letter

“Corporate Governance



At our annual meetings, someone usually asks "What happens to this place if you get hit by a truck?" I'm glad they
are still asking the question in this form. It won't be too long before the query becomes: "What happens to this place if
you don't get hit by a truck?"

Such questions, in any event, raise a reason for me to discuss corporate governance, a hot topic during the past year.
In general, I believe that directors have stiffened their spines recently and that shareholders are now being treated
somewhat more like true owners than was the case not long ago. Commentators on corporate governance, however,
seldom make any distinction among three fundamentally different manager/owner situations that exist in publicly‐held
companies. Though the legal responsibility of directors is identical throughout, their ability to effect change differs in
each of the cases. Attention usually falls on the first case, because it prevails on the corporate scene. Since Berkshire
falls into the second category, however, and will someday fall into the third, we will discuss all three variations.

The first, and by far most common, board situation is one in which a corporation has no controlling shareholder. In that
case, I believe directors should behave as if there is a single absentee owner, whose long‐term interest they should try
to further in all proper ways. Unfortunately, "long‐term" gives directors a lot of wiggle room. If they lack either integrity
or the ability to think independently, directors can do great violence to shareholders while still claiming to be acting in
their long‐term interest. But assume the board is functioning well and must deal with a management that is mediocre
or worse. Directors then have the responsibility for changing that management, just as an intelligent owner would do if
he were present. And if able but greedy managers over‐reach and try to dip too deeply into the shareholders' pockets,
directors must slap their hands.

In this plain‐vanilla case, a director who sees something he doesn't like should attempt to persuade the other directors
of his views. If he is successful, the board will have the muscle to make the appropriate change. Suppose, though, that
the unhappy director can't get other directors to agree with him. He should then feel free to make his views known to
the absentee owners. Directors seldom do that, of course. The temperament of many directors would in fact be
incompatible with critical behavior of that sort. But I see nothing improper in such actions, assuming the issues are
serious. Naturally, the complaining director can expect a vigorous rebuttal from the unpersuaded directors, a prospect
that should discourage the dissenter from pursuing trivial or non‐rational causes.

For the boards just discussed, I believe the directors ought to be relatively few in number ‐ say, ten or less ‐ and ought to
come mostly from the outside. The outside board members should establish standards for the CEO's performance and
should also periodically meet, without his being present, to evaluate his performance against those standards.

The requisites for board membership should be business savvy, interest in the job, and owner‐orientation. Too often,
directors are selected simply because they are prominent or add diversity to the board. That practice is a mistake.
Furthermore, mistakes in selecting directors are particularly serious because appointments are so hard to undo: The
pleasant but vacuous director need never worry about job security.

The second case is that existing at Berkshire, where the controlling owner is also the manager. At some companies, this
arrangement is facilitated by the existence of two classes of stock endowed with disproportionate voting power. In
these situations, it's obvious that the board does not act as an agent between owners and management and that the
directors cannot effect change except through persuasion. Therefore, if the owner/manager is mediocre or worse ‐ or is
over‐reaching ‐ there is little a director can do about it except object. If the directors having no connections to the
owner/manager make a unified argument, it may well have some effect. More likely it will not.

If change does not come, and the matter is sufficiently serious, the outside directors should resign. Their resignation will
signal their doubts about management, and it will emphasize that no outsider is in a position to correct the
owner/manager's shortcomings.


The third governance case occurs when there is a controlling owner who is not involved in management. This case,
examples of which are Hershey Foods and Dow Jones, puts the outside directors in a potentially useful position. If they
become unhappy with either the competence or integrity of the manager, they can go directly to the owner (who may
also be on the board) and report their dissatisfaction. This situation is ideal for an outside director, since he need make
his case only to a single, presumably interested owner, who can forthwith effect change if the argument is persuasive.
Even so, the dissatisfied director has only that single course of action. If he remains unsatisfied about a critical matter,
he has no choice but to resign.

Logically, the third case should be the most effective in insuring first‐class management. In the second case the owner is
not going to fire himself, and in the first case, directors often find it very difficult to deal with mediocrity or mild over‐
reaching. Unless the unhappy directors can win over a majority of the board ‐ an awkward social and logistical task,
particularly if management's behavior is merely odious, not egregious ‐ their hands are effectively tied. In practice,
directors trapped in situations of this kind usually convince themselves that by staying around they can do at least some
good. Meanwhile, management proceeds unfettered.

In the third case, the owner is neither judging himself nor burdened with the problem of garnering a majority. He can
also insure that outside directors are selected who will bring useful qualities to the board. These directors, in turn, will
know that the good advice they give will reach the right ears, rather than being stifled by a recalcitrant management. If
the controlling owner is intelligent and self‐confident, he will make decisions in respect to management that are
meritocratic and pro‐shareholder. Moreover ‐ and this is critically important ‐ he can readily correct any mistake he
makes.”
- BRK 1993 Letter

“Nevertheless, Berkshire's ownership may make even the best of managers more effective. First, we eliminate all of the
ritualistic and nonproductive activities that normally go with the job of CEO. Our managers are totally in charge of their
personal schedules. Second, we give each a simple mission: Just run your business as if: 1) you own 100% of it; 2) it is the
only asset in the world that you and your family have or will ever have; and 3) you can't sell or merge it for at least a
century. As a corollary, we tell them they should not let any of their decisions be affected even slightly by accounting
considerations. We want our managers to think about what counts, not how it will be counted.

Very few CEOs of public companies operate under a similar mandate, mainly because they have owners who focus on
short‐term prospects and reported earnings. Berkshire, however, has a shareholder base ‐‐ which it will have for
decades to come ‐‐ that has the longest investment horizon to be found in the public‐company universe. Indeed, a
majority of our shares are held by investors who expect to die still holding them. We can therefore ask our CEOs to
manage for maximum long‐term value, rather than for next quarter's earnings. We certainly don't ignore the current
results of our businesses ‐‐ in most cases, they are of great importance ‐‐ but we never want them to be achieved at the
expense of our building ever‐greater competitive strengths.

I believe the GEICO story demonstrates the benefits of Berkshire's approach. Charlie and I haven't taught Tony a thing ‐‐
and never will ‐‐ but we have created an environment that allows him to apply all of his talents to what's important. He
does not have to devote his time or energy to board meetings, press interviews, presentations by investment bankers or
talks with financial analysts. Furthermore, he need never spend a moment thinking about financing, credit ratings or
"Street" expectations for earnings per share. Because of our ownership structure, he also knows that this operational
framework will endure for decades to come. In this environment of freedom, both Tony and his company can convert
their almost limitless potential into matching achievements.”
‐ BRK 1998 Letter


“It’s almost impossible, for example, in a boardroom populated by well‐mannered people, to raise the question of
whether the CEO should be replaced. It’s equally awkward to question a proposed acquisition that has been endorsed by
the CEO, particularly when his inside staff and outside advisors are present and unanimously support his decision. (They
wouldn’t be in the room if they didn’t.) Finally, when the compensation committee – armed, as always, with support
from a high‐paid consultant – reports on a megagrant of options to the CEO, it would be like belching at the dinner table
for a director to suggest that the committee reconsider.

These “social” difficulties argue for outside directors regularly meeting without the CEO – a reform that is being
instituted and that I enthusiastically endorse. I doubt, however, that most of the other new governance rules and
recommendations will provide benefits commensurate with the monetary and other costs they impose.

The current cry is for “independent” directors. It is certainly true that it is desirable to have directors who think and
speak independently – but they must also be business‐savvy, interested and shareholderoriented. In my 1993
commentary, those are the three qualities I described as essential.”
‐ BRK 2002 Letter

“The Audit Committee

Audit committees can’t audit. Only a company’s outside auditor can determine whether the earnings that a
management purports to have made are suspect. Reforms that ignore this reality and that instead focus on the structure
and charter of the audit committee will accomplish little.

As we’ve discussed, far too many managers have fudged their company’s numbers in recent years, using both
accounting and operational techniques that are typically legal but that nevertheless materially mislead investors.
Frequently, auditors knew about these deceptions. Too often, however, they remained silent. The key job of the audit
committee is simply to get the auditors to divulge what they know.

To do this job, the committee must make sure that the auditors worry more about misleading its members than about
offending management. In recent years auditors have not felt that way. They have instead generally viewed the CEO,
rather than the shareholders or directors, as their client. That has been a natural result of day‐to‐day working
relationships and also of the auditors’ understanding that, no matter what the book says, the CEO and CFO pay their
fees and determine whether they are retained for both auditing and other work. The rules that have been recently
instituted won’t materially change this reality. What will break this cozy relationship is audit committees unequivocally
putting auditors on the spot, making them understand they will become liable for major monetary penalties if they don’t
come forth with what they know or suspect.

In my opinion, audit committees can accomplish this goal by asking four questions of auditors, the answers to which
should be recorded and reported to shareholders. These questions are:

1. If the auditor were solely responsible for preparation of the company’s financial statements, would they have in
any way been prepared differently from the manner selected by management? This question should cover both
material and nonmaterial differences. If the auditor would have done something differently, both
management’s argument and the auditor’s response should be disclosed. The audit committee should then
evaluate the facts.



2. If the auditor were an investor, would he have received – in plain English – the information essential to his
understanding the company’s financial performance during the reporting period?

3. Is the company following the same internal audit procedure that would be followed if the auditor himself were
CEO? If not, what are the differences and why?

4. Is the auditor aware of any actions – either accounting or operational – that have had the purpose and effect of
moving revenues or expenses from one reporting period to another?

If the audit committee asks these questions, its composition – the focus of most reforms – is of minor importance. In
addition, the procedure will save time and expense. When auditors are put on the spot, they will do their duty. If they
are not put on the spot . . . well, we have seen the results of that.

The questions we have enumerated should be asked at least a week before an earnings report is released to the public.
That timing will allow differences between the auditors and management to be aired with the committee and resolved.
If the timing is tighter – if an earnings release is imminent when the auditors and committee interact – the committee
will feel pressure to rubberstamp the prepared figures. Haste is the enemy of accuracy. My thinking, in fact, is that the
SEC’s recent shortening of reporting deadlines will hurt the quality of information that shareholders receive. Charlie and
I believe that rule is a mistake and should be rescinded.

The primary advantage of our four questions is that they will act as a prophylactic. Once the auditors know that the
audit committee will require them to affirmatively endorse, rather than merely acquiesce to, management’s actions,
they will resist misdoings early in the process, well before specious figures become embedded in the company’s books.
Fear of the plaintiff’s bar will see to that.”
- BRK 2002 Letter

“Three suggestions for investors: First, beware of companies displaying weak accounting. If a company still does not
expense options, or if its pension assumptions are fanciful, watch out. When managements take the low road in aspects
that are visible, it is likely they are following a similar path behind the scenes. There is seldom just one cockroach in the
kitchen.

Trumpeting EBITDA (earnings before interest, taxes, depreciation and amortization) is a particularly pernicious practice.
Doing so implies that depreciation is not truly an expense, given that it is a “non‐cash” charge. That’s nonsense. In truth,
depreciation is a particularly unattractive expense because the cash outlay it represents is paid up front, before the
asset acquired has delivered any benefits to the business. Imagine, if you will, that at the beginning of this year a
company paid all of its employees for the next ten years of their service (in the way they would lay out cash for a fixed
asset to be useful for ten years). In the following nine years, compensation would be a “non‐cash” expense – a reduction
of a prepaid compensation asset established this year. Would anyone care to argue that the recording of the expense in
years two through ten would be simply a bookkeeping formality?

Second, unintelligible footnotes usually indicate untrustworthy management. If you can’t understand a footnote or
other managerial explanation, it’s usually because the CEO doesn’t want you to. Enron’s descriptions of certain
transactions still baffle me.

Finally, be suspicious of companies that trumpet earnings projections and growth expectations. Businesses seldom
operate in a tranquil, no‐surprise environment, and earnings simply don’t advance smoothly (except, of course, in the
offering books of investment bankers).


Charlie and I not only don’t know today what our businesses will earn next year – we don’t even know what they will
earn next quarter. We are suspicious of those CEOs who regularly claim they do know the future – and we become
downright incredulous if they consistently reach their declared targets. Managers that always promise to “make the
numbers” will at some point be tempted to make up the numbers.”
- BRK 2002 Letter

“What we’ve had going for us is a managerial mindset that most insurers find impossible to replicate. Take a look at the
facing page. Can you imagine any public company embracing a business model that would lead to the decline in revenue
that we experienced from 1986 through 1999? That colossal slide, it should be emphasized, did not occur because
business was unobtainable. Many billions of premium dollars were readily available to NICO had we only been willing to
cut prices. But we instead consistently priced to make a profit, not to match our most optimistic competitor. We never
left customers – but they left us.

Most American businesses harbor an “institutional imperative” that rejects extended decreases in volume. What CEO
wants to report to his shareholders that not only did business contract last year but that it will continue to drop? In
insurance, the urge to keep writing business is also intensified because the consequences of foolishly‐priced policies may
not become apparent for some time. If an insurer is optimistic in its reserving, reported earnings will be overstated, and
years may pass before true loss costs are revealed (a form of self‐deception that nearly destroyed GEICO in the early
1970s).

“Finally, there is a fear factor at work, in that a shrinking business usually leads to layoffs. To avoid pink slips, employees
will rationalize inadequate pricing, telling themselves that poorly‐priced business must be tolerated in order to keep the
organization intact and the distribution system happy. If this course isn’t followed, these employees will argue, the
company will not participate in the recovery that they invariably feel is just around the corner.

To combat employees’ natural tendency to save their own skins, we have always promised NICO’s workforce that no one
will be fired because of declining volume, however severe the contraction. (This is not Donald Trump’s sort of place.)
NICO is not labor‐intensive, and, as the table suggests, can live with excess overhead. It can’t live, however, with
underpriced business and the breakdown in underwriting discipline that accompanies it. An insurance organization that
doesn’t care deeply about underwriting at a profit this year is unlikely to care next year either.

Naturally, a business that follows a no‐layoff policy must be especially careful to avoid overstaffing when times are good.
Thirty years ago Tom Murphy, then CEO of Cap Cities, drove this point home to me with a hypothetical tale about an
employee who asked his boss for permission to hire an assistant. The employee assumed that adding $20,000 to the
annual payroll would be inconsequential. But his boss told him the proposal should be evaluated as a $3 million decision,
given that an additional person would probably cost at least that amount over his lifetime, factoring in raises, benefits
and other expenses (more people, more toilet paper). And unless the company fell on very hard times, the employee
added would be unlikely to be dismissed, however marginal his contribution to the business.

It takes real fortitude – embedded deep within a company’s culture – to operate as NICO does. Anyone examining the
table can scan the years from 1986 to 1999 quickly. But living day after day with dwindling volume – while competitors
are boasting of growth and reaping Wall Street’s applause – is an experience few managers can tolerate. NICO, however,
has had four CEOs since its formation in 1940 and none have bent. (It should be noted that only one of the four
graduated from college. Our experience tells us that extraordinary business ability is largely innate.)”
- BRK 2004 Letter



“Every day, in countless ways, the competitive position of each of our businesses grows either weaker or stronger. If we
are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength. But
if we treat customers with indifference or tolerate bloat, our businesses will wither. On a daily basis, the effects of our
actions are imperceptible; cumulatively, though, their consequences are enormous.

When our long‐term competitive position improves as a result of these almost unnoticeable actions, we describe the
phenomenon as “widening the moat.” And doing that is essential if we are to have the kind of business we want a
decade or two from now. We always, of course, hope to earn more money in the short‐term. But when short‐term and
long‐term conflict, widening the moat must take precedence. If a management makes bad decisions in order to hit
short‐term earnings targets, and consequently gets behind the eight‐ball in terms of costs, customer satisfaction or
brand strength, no amount of subsequent brilliance will overcome the damage that has been inflicted. Take a look at the
dilemmas of managers in the auto and airline industries today as they struggle with the huge problems handed them by
their predecessors. Charlie is fond of quoting Ben Franklin’s “An ounce of prevention is worth a pound of cure.” But
sometimes no amount of cure will overcome the mistakes of the past.

Our managers focus on moat‐widening – and are brilliant at it. Quite simply, they are passionate about their businesses.
Usually, they were running those long before we came along; our only function since has been to stay out of the way. If
you see these heroes – and our four heroines as well – at the annual meeting, thank them for the job they do for you.”
- BRK 2005 Letter

“Fanciful Figures – How Public Companies Juice Earnings

Former Senator Alan Simpson famously said: “Those who travel the high road in Washington need not fear heavy
traffic.” If he had sought truly deserted streets, however, the Senator should have looked to Corporate America’s
accounting.

An important referendum on which road businesses prefer occurred in 1994. America’s CEOs had just strong‐armed the
U.S. Senate into ordering the Financial Accounting Standards Board to shut up, by a vote that was 88‐9. Before that
rebuke the FASB had shown the audacity – by unanimous agreement, no less – to tell corporate chieftains that the stock
options they were being awarded represented a form of compensation and that their value should be recorded as an
expense.

After the senators voted, the FASB – now educated on accounting principles by the Senate’s 88 closet CPAs – decreed
that companies could choose between two methods of reporting on options. The preferred treatment would be to
expense their value, but it would also be allowable for companies to ignore the expense as long as their options were
issued at market value.

A moment of truth had now arrived for America’s CEOs, and their reaction was not a pretty sight. During the next six
years, exactly two of the 500 companies in the S&P chose the preferred route. CEOs of the rest opted for the low road,
thereby ignoring a large and obvious expense in order to report higher “earnings.” I’m sure some of them also felt that if
they opted for expensing, their directors might in future years think twice before approving the mega‐grants the
managers longed for.

It turned out that for many CEOs even the low road wasn’t good enough. Under the weakened rule, there remained
earnings consequences if options were issued with a strike price below market value.



No problem. To avoid that bothersome rule, a number of companies surreptitiously backdated options to falsely indicate
that they were granted at current market prices, when in fact they were dished out at prices well below market.”
- BRK 2007 Letter

“Once we see ability, we like to see how they treat their shareholders. Tom Murphy
is a good example of a great manager.”

“We look for how a company deals with adversity.”

“Berkshire’s Compensation Systems

When a business requires no capital, we reward the manager on earnings. If it does [require capital], then we add a
charge for the cost of capital. We don’t have one compensation system.”
Buffett, 2003 BRK Meeting

“Buffett: National Indemnity was a no‐name company when we bought it, and has no copyrights, patents, etc. to
distinguish it, but they have a record like no‐one else because they had discipline.

You can’t run an auto or steel company this way, but it’s the best way to run an insurance company.

Munger: Nobody else does it, but to me it’s obviously the only way to go. A lot about Berkshire is like this. Being
controlling owners is key – it would be hard for a committee to make these kinds of decisions.
- 2004 BRK Meeting

“We look for people who have a passion for their business.

“We also look for three things: intelligence, energy and integrity. If you don’t have the latter, then you should hope they
don’t have the first two either. If someone doesn’t have integrity, then you want them to be dumb and lazy.”
- Buffet, 2005 BRK Meeting

“The only duty of corporate executive is to widen the moat. We must make it wider.”

“We finally learned enough to stretch for the right people.
And there you had an example of an ability to learn things. When we were young, we didn’t know which things
to stretch for. But by the time we reached Iscar, which we never would have bought before, we had learned enough to
stretch for the right people. And they are wonderful people. It’s also a hell of a business. Everything about it is good.”


“The great defect of scales, of course, which makes the game interesting – so that the big people don’t always win – is
that as you get big, you get the bureaucracy. And with the bureaucracy comes the territoriality – which is again
grounded in human nature.

And the incentives are perverse. For example, if you worked for AT&T in my day, it was a great bureaucracy. Who in the
hell was really thinking about the shareholder or anything else? And in a bureaucracy, you thing the work is done when
it goes out of your in‐basket into somebody else’s in‐basket. But of course, it isn’t. It’s not done until AT&T delivers what
it’s supposed to deliver. So you get big, fat, dumb, unmotivated bureaucracies.”

“So people go to stratagems. They create little decentralized units and fancy motivation and training programs. For
example, for a big company, General Electric has fought bureaucracy with amazing skill. But that’s because they have a
combination of a genius and a fanatic running it. And they put him in young enough so he gets a long run. Of course,
that’s Jack Welch.”
4/14/1994

Occasionally, you’ll find a human being who’s so talented that he can do things that ordinary skilled mortals can’t. I
would argue that Simon Marks – who was second generation in Marks & Spencer of England – was such a man.
Patterson was such a man at National Cash Register. And Sam Walton was such a man.

These people do come along – and, in many cases, they’re not all that hard to identify. If they’ve got a reasonable hand –
with the fanaticism and intelligence and so on that these people generally bring to the party – then management can
matter much.

However, averaged out, betting on the quality of a business is better than betting on the quality of management. In
other words, if you have to choose one, bet on the business momentum, not the brilliance of the manager.

But, very rarely, you find a manager who’s so good that you’re wise to follow him into what looks like a mediocre
business.”
4/14/1994

“When I look at our managers, I’m not trying to look at the guy who wakes up at night and says ‘E = MC 2’ or something.
I am looking for people that function very, very well. And that means not having any weak links. The two biggest weak
links in my experience: I’ve seen more people fail because of liquor and leverage – leverage being borrowed money.
Donald Trump failed because of leverage. He simply got infatuated with how much money he could borrow, and he did
not give enough thought to how much money he could pay back.”

“You do not want energetic people in a lousy business.”



“CEOs who have concocted their own valuations for esoteric financial instruments have seldom erred on the side of
conservatism.”
‐ BRK 2008 Letter

“You have to incentivize mgt not just to do the right thing but NOT to do the wrong thing. It’s not that hard, but CEO’s
often don’t want a rational system if the irrational system pays more. I don’t think there should be a comp committee,
the whole BOD should thrash it out.”
- WEB, 2009 BRK Shareholders meeting.

” We would rather suffer the visible costs of a few bad decisions than incur the many invisible costs that come from
decisions made too slowly – or not at all – because of a stifling bureaucracy.”
- BRK 2009 Letter

“Charlie and I believe that a CEO must not delegate risk control. It’s simply too important.”
- BRK 2009 Letter

“In my view a board of directors of a huge financial institution is derelict if it does not insist that its CEO bear full
responsibility for risk control. If he’s incapable of handling that job, he should look for other employment.”
- BRK 2009 Letter

“When the compensation is an important part of a director’s well‐being, that director is not independent.”

“Our final advantage is the hard‐to‐duplicate culture that permeates Berkshire. And in businesses, culture counts.

To start with, the directors who represent you think and act like owners. They receive token compensation: no options,
no restricted stock and, for that matter, virtually no cash. We do not provide them directors and officers liability
insurance, a given at almost every other large public company. If they mess up with your money, they will lose their
money as well. Leaving my holdings aside, directors and their families own Berkshire shares worth more than $3 billion.
Our directors, therefore, monitor Berkshire’s actions and results with keen interest and an owner’s eye. You and I are
lucky to have them as stewards.

This same owner‐orientation prevails among our managers. In many cases, these are people who have sought out
Berkshire as an acquirer for a business that they and their families have long owned. They came to us with an owner’s
mindset, and we provide an environment that encourages them to retain it. Having managers who love their businesses
is no small advantage.

Cultures self‐propagate. Winston Churchill once said, “You shape your houses and then they shape you.” That wisdom
applies to businesses as well. Bureaucratic procedures beget more bureaucracy, and imperial corporate palaces induce
imperious behavior. (As one wag put it, “You know you’re no longer CEO when you get in the back seat of your car and it
doesn’t move.”)”
- BRK 2010 Letter

“’The other guy is doing it so we must as well’ spells trouble in any business, but none more so than insurance.”
- BRK 2010 Letter



“Sometimes your associates will say “Everybody else is doing it.” This rationale is almost always a bad one if it is the
main justification for a business action. It is totally unacceptable when evaluating a moral decision. Whenever somebody
offers that phrase as a rationale, in effect they are saying that they can’t come up with a good reason. If anyone gives
this explanation, tell them to try using it with a reporter or a judge and see how far it gets them.”
- BRK 2010 Letter


Financial Strength

“Our consistently‐conservative financial policies may appear to have been a mistake, but in my view were not. In
retrospect, it is clear that significantly higher, though still conventional, leverage ratios at Berkshire would have
produced considerably better returns on equity than the 23.8% we have actually averaged. Even in 1965, perhaps we
could have judged there to be a 99% probability that higher leverage would lead to nothing but good. Correspondingly,
we might have seen only a 1% chance that some shock factor, external or internal, would cause a conventional debt
ratio to produce a result falling somewhere between temporary anguish and default.

We wouldn't have liked those 99:1 odds ‐ and never will. A small chance of distress or disgrace cannot, in our view, be
offset by a large chance of extra returns. If your actions are sensible, you are certain to get good results; in most such
cases, leverage just moves things along faster. Charlie and I have never been in a big hurry: We enjoy the process far
more than the proceeds ‐ though we have learned to live with those also.”
- BRK 1989 Letter

“Wesco's practice has been to do a certain amount of long‐term borrowing in advance of specific need, in order to have
maximum financial flexibility to face both hazards and opportunities.”
- WSC 1983 Letter

“Any company's level of profitability is determined by three items: (1) what its assets earn; (2) what its liabilities cost;
and (3) its utilization of "leverage" ‐ that is, the degree to which its assets are funded by liabilities rather than by equity.
Over the years, we have done well on Point 1, having produced high returns on our assets. But we have also benefitted
greatly ‐ to a degree that is not generally well‐understood ‐ because our liabilities have cost us very little. An important
reason for this low cost is that we have obtained float on very advantageous terms. The same cannot be said by many
other property and casualty insurers, who may generate plenty of float, but at a cost that exceeds what the funds are
worth to them. In those circumstances, leverage becomes a disadvantage.
- BRK 1995 Letter

“Derivatives

Charlie and I are of one mind in how we feel about derivatives and the trading activities that go with them: We view
them as time bombs, both for the parties that deal in them and the economic system.

Having delivered that thought, which I’ll get back to, let me retreat to explaining derivatives, though the explanation
must be general because the word covers an extraordinarily wide range of financial contracts. Essentially, these
instruments call for money to change hands at some future date, with the amount to be determined by one or more
reference items, such as interest rates, stock prices or currency values. If, for example, you are either long or short an
S&P 500 futures contract, you are a party to a very simple derivatives transaction – with your gain or loss derived from
movements in the index. Derivatives contracts are of varying duration (running sometimes to 20 or more years) and
their value is often tied to several variables.



Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness
of the counterparties to them. In the meantime, though, before a contract is settled, the counterparties record profits
and losses – often huge in amount – in their current earnings statements without so much as a penny changing hands.

The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen). At
Enron, for example, newsprint and broadband derivatives, due to be settled many years in the future, were put on the
books. Or say you want to write a contract speculating on the number of twins to be born in Nebraska in 2020. No
problem – at a price, you will easily find an obliging counterparty.

When we purchased Gen Re, it came with General Re Securities, a derivatives dealer that Charlie and I didn’t want,
judging it to be dangerous. We failed in our attempts to sell the operation, however, and are now terminating it.

But closing down a derivatives business is easier said than done. It will be a great many years before we are totally out of
this operation (though we reduce our exposure daily). In fact, the reinsurance and derivatives businesses are similar:
Like Hell, both are easy to enter and almost impossible to exit. In either industry, once you write a contract – which may
require a large payment decades later – you are usually stuck with it. True, there are methods by which the risk can be
laid off with others. But most strategies of that kind leave you with residual liability.

Another commonality of reinsurance and derivatives is that both generate reported earnings that are often wildly
overstated. That’s true because today’s earnings are in a significant way based on estimates whose inaccuracy may not
be exposed for many years.

Errors will usually be honest, reflecting only the human tendency to take an optimistic view of one’s commitments. But
the parties to derivatives also have enormous incentives to cheat in accounting for them. Those who trade derivatives
are usually paid (in whole or part) on “earnings” calculated by mark‐to‐market accounting. But often there is no real
market (think about our contract involving twins) and “mark‐to‐model” is utilized. This substitution can bring on large‐
scale mischief. As a general rule, contracts involving multiple reference items and distant settlement dates increase the
opportunities for counterparties to use fanciful assumptions. In the twins scenario, for example, the two parties to the
contract might well use differing models allowing both to show substantial profits for many years. In extreme cases,
mark‐to‐model degenerates into what I would call mark‐to‐myth.

Of course, both internal and outside auditors review the numbers, but that’s no easy job. For example, General Re
Securities at yearend (after ten months of winding down its operation) had 14,384 contracts outstanding, involving 672
counterparties around the world. Each contract had a plus or minus value derived from one or more reference items,
including some of mind‐boggling complexity. Valuing a portfolio like that, expert auditors could easily and honestly have
widely varying opinions.

The valuation problem is far from academic: In recent years, some huge‐scale frauds and near‐frauds have been
facilitated by derivatives trades. In the energy and electric utility sectors, for example, companies used derivatives and
trading activities to report great “earnings” – until the roof fell in when they actually tried to convert the derivatives‐
related receivables on their balance sheets into cash. “Mark‐to‐market” then turned out to be truly “mark‐to‐myth.”

I can assure you that the marking errors in the derivatives business have not been symmetrical. Almost invariably, they
have favored either the trader who was eyeing a multi‐million dollar bonus or the CEO who wanted to report impressive
“earnings” (or both). The bonuses were paid, and the CEO profited from his options. Only much later did shareholders
learn that the reported earnings were a sham.



Another problem about derivatives is that they can exacerbate trouble that a corporation has run into for completely
unrelated reasons. This pile‐on effect occurs because many derivatives contracts require that a company suffering a
credit downgrade immediately supply collateral to counterparties. Imagine, then, that a company is downgraded
because of general adversity and that its derivatives instantly kick in with their requirement, imposing an unexpected
and enormous demand for cash collateral on the company. The need to meet this demand can then throw the company
into a liquidity crisis that may, in some cases, trigger still more downgrades. It all becomes a spiral that can lead to a
corporate meltdown.

Derivatives also create a daisy‐chain risk that is akin to the risk run by insurers or reinsurers that lay off much of their
business with others. In both cases, huge receivables from many counterparties tend to build up over time. (At Gen Re
Securities, we still have $6.5 billion of receivables, though we’ve been in a liquidation mode for nearly a year.) A
participant may see himself as prudent, believing his large credit exposures to be diversified and therefore not
dangerous. Under certain circumstances, though, an exogenous event that causes the receivable from Company A to go
bad will also affect those from Companies B through Z. History teaches us that a crisis often causes problems to
correlate in a manner undreamed of in more tranquil times.

In banking, the recognition of a “linkage” problem was one of the reasons for the formation of the Federal Reserve
System. Before the Fed was established, the failure of weak banks would sometimes put sudden and unanticipated
liquidity demands on previously‐strong banks, causing them to fail in turn. The Fed now insulates the strong from the
troubles of the weak. But there is no central bank assigned to the job of preventing the dominoes toppling in insurance
or derivatives. In these industries, firms that are fundamentally solid can become troubled simply because of the travails
of other firms further down the chain. When a “chain reaction” threat exists within an industry, it pays to minimize links
of any kind. That’s how we conduct our reinsurance business, and it’s one reason we are exiting derivatives.

Many people argue that derivatives reduce systemic problems, in that participants who can’t bear certain risks are able
to transfer them to stronger hands. These people believe that derivatives act to stabilize the economy, facilitate trade,
and eliminate bumps for individual participants. And, on a micro level, what they say is often true. Indeed, at Berkshire, I
sometimes engage in large‐scale derivatives transactions in order to facilitate certain investment strategies.

Charlie and I believe, however, that the macro picture is dangerous and getting more so. Large amounts of risk,
particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition
trade extensively with one other. The troubles of one could quickly infect the others. On top of that, these dealers are
owed huge amounts by non‐dealer counterparties. Some of these counterparties, as I’ve mentioned, are linked in ways
that could cause them to contemporaneously run into a problem because of a single event (such as the implosion of the
telecom industry or the precipitous decline in the value of merchant power projects). Linkage, when it suddenly
surfaces, can trigger serious systemic problems.

Indeed, in 1998, the leveraged and derivatives‐heavy activities of a single hedge fund, Long‐Term Capital Management,
caused the Federal Reserve anxieties so severe that it hastily orchestrated a rescue effort. In later Congressional
testimony, Fed officials acknowledged that, had they not intervened, the outstanding trades of LTCM – a firm unknown
to the general public and employing only a few hundred people – could well have posed a serious threat to the stability
of American markets. In other words, the Fed acted because its leaders were fearful of what might have happened to
other financial institutions had the LTCM domino toppled. And this affair, though it paralyzed many parts of the fixed‐
income market for weeks, was far from a worst‐case scenario.

One of the derivatives instruments that LTCM used was total‐return swaps, contracts that facilitate 100% leverage in
various markets, including stocks. For example, Party A to a contract, usually a bank, puts up all of the money for the


purchase of a stock while Party B, without putting up any capital, agrees that at a future date it will receive any gain or
pay any loss that the bank realizes.

Total‐return swaps of this type make a joke of margin requirements. Beyond that, other types of derivatives severely
curtail the ability of regulators to curb leverage and generally get their arms around the risk profiles of banks, insurers
and other financial institutions. Similarly, even experienced investors and analysts encounter major problems in
analyzing the financial condition of firms that are heavily involved with derivatives contracts. When Charlie and I finish
reading the long footnotes detailing the derivatives activities of major banks, the only thing we understand is that we
don’t understand how much risk the institution is running.

The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and
number until some event makes their toxicity clear. Knowledge of how dangerous they are has already permeated the
electricity and gas businesses, in which the eruption of major troubles caused the use of derivatives to diminish
dramatically. Elsewhere, however, the derivatives business continues to expand unchecked. Central banks and
governments have so far found no effective way to control, or even monitor, the risks posed by these contracts.

Charlie and I believe Berkshire should be a fortress of financial strength – for the sake of our owners, creditors,
policyholders and employees. We try to be alert to any sort of megacatastrophe risk, and that posture may make us
unduly apprehensive about the burgeoning quantities of long‐term derivatives contracts and the massive amount of
uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass
destruction, carrying dangers that, while now latent, are potentially lethal.”
- BRK 2002 Letter

“Freddie Mac

“We held that stock for a great many years, and of course made a great deal of money.

“Warren and I get nervous with vast amounts of leverage unless we’re 100% confident that risk‐taking won’t creep into
the culture.”

“Avoid Leverage

The most dramatic way we protect ourselves is we don’t use leverage. We believe almost anything can happen in
financial markets. The only way smart people can get clobbered is [if they use] leverage. If you can hold them [the
positions you own during a crisis], then you’re OK. But even smart people can get clobbered with leverage – it’s the one
thing that can prevent you from playing out your hand.”

“Bad Accounting and Derivatives
Any accounting that gives people a rationale to reduce reserves even further is bad. There such a tendency to reduce
reserves for long‐tailed [insurance] policies – to understate them – especially if the CEO is retiring or options are
vesting.”



“More on the Risk of Derivatives
I regard the counterparty risk as extreme. But no‐one cares about this because the accounting statements assume it
away. If you look at the trading sheets on Wall Street, there’s no line for counterparty risk. The person who is supposed
to think about this would be very unpopular [if he tried to add this]. Pulling away the punch bowl at the party has never
been a way to prosperity and popularity.

If you look at derivative markets enough, you think it was scandalous. That doesn’t mean it can’t go on for along time,
however. Look at Japan. Great civilizations can withstand a lot of terrible behavior. It’s a good thing. Lord knows, we’ll
need it.

Look at Berkshire’s Gen Re derivative book. It was valued at $400 million on the balance sheet [but when he reached for
the money, it wasn’t there]. Imagine an balance sheet item labeled: ‘Asset – good until reached for!’”

“You need – if you run an institution with enormous leverage, you need somebody with a fiduciary gene running it.”

“We will never become dependent on the kindness of strangers. Too‐big‐to‐fail is not a fallback position at Berkshire.
Instead, we will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed
by our own liquidity. Moreover, that liquidity will be constantly refreshed by a gusher of earnings from our many and
diverse businesses.”
- BRK 2009 Letter

“There are three factors to measure and price risk whether it be an insurance policy or derivative contract or options; 1.)
do you understand the risk, 2.) do you get a premium or rate greater than the probability of loss, and 3.) make sure you
do not take on too much aggregated loss events. The way our derivative contracts are set up is fundamentally the same
business as insurance. We assess the risk and if we feel that we are being adequately compensated we will write the
contract, whether it is insurance or a derivative. Where people have a hard time is understanding why the accounting
for derivatives is completely different causing wide volatility in financial statements but not in cash transactions. If they
are mis‐priced and good for Berkshire shareholders they’ll continue to write the business. We never have too much
exposure and are careful to avoid correlation with other risks we have underwritten. Even though we have taken
advantage of the ability to write derivative contracts we would vote against their use if asked because of their general
misuse.”
- 2009 BRK Press Conference

“You can get in a lot of trouble with leverage. If you go 20‐1 levered, you better be right.”

“The fundamental principle of auto racing is that to finish first, you must first finish. That dictum is equally applicable to
business and guides our every action at Berkshire.”
- BRK 2010 Letter

“any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero.
History tells us that leverage all too often produces zeroes, even when it is employed by very smart people.



Leverage, of course, can be lethal to businesses as well. Companies with large debts often assume that these obligations
can be refinanced as they mature. That assumption is usually valid. Occasionally, though, either because of company‐
specific problems or a worldwide shortage of credit, maturities must actually be met by payment. For that, only cash will
do the job.

Borrowers then learn that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is
missing, that’s all that is noticed. Even a short absence of credit can bring a company to its knees. In September 2008, in
fact, its overnight disappearance in many sectors of the economy came dangerously close to bringing our entire country
to its knees.”
- BRK 2010 Letter

“We agree with investment writer Ray DeVoe’s observation, “More money has been lost reaching for yield than at the
point of a gun.” At Berkshire, we don’t rely on bank lines, and we don’t enter into contracts that could require postings
of collateral except for amounts that are tiny in relation to our liquid assets.”
- BRK 2010 Letter


Valuation

“Book value tells you what has been put in; intrinsic business value estimates what can be taken out.”
- BRK 1983 Letter

“Appendix

Goodwill and its Amortization: The Rules and The Realities

This appendix deals only with economic and accounting Goodwill – not the goodwill of everyday usage. For example, a
business may be well liked, even loved, by most of its customers but possess no economic goodwill. (AT&T, before the
breakup, was generally well thought of, but possessed not a dime of economic Goodwill.) And, regrettably, a business
may be disliked by its customers but possess substantial, and growing, economic Goodwill. So, just for the moment,
forget emotions and focus only on economics and accounting.
When a business is purchased, accounting principles require that the purchase price first be assigned to the fair value of
the identifiable assets that are acquired. Frequently the sum of the fair values put on the assets (after the deduction of
liabilities) is less than the total purchase price of the business. In that case, the difference is assigned to an asset account
entitled "excess of cost over equity in net assets acquired". To avoid constant repetition of this mouthful, we will
substitute "Goodwill".
Accounting Goodwill arising from businesses purchased before November 1970 has a special standing. Except under rare
circumstances, it can remain an asset on the balance sheet as long as the business bought is retained. That means no
amortization charges to gradually extinguish that asset need be made against earnings.

Blue Chip Stamps bought See’s early in 1972 for $25 million, at which time See’s had about $8 million of net tangible
assets. (Throughout this discussion, accounts receivable will be classified as tangible assets, a definition proper for
business analysis.) This level of tangible assets was adequate to conduct the business without use of debt, except for
short periods seasonally. See’s was earning about $2 million after tax at the time, and such earnings seemed
conservatively representative of future earning power in constant 1972 dollars.
Thus our first lesson: businesses logically are worth far more than net tangible assets when they can be expected to
produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess
return is economic Goodwill.

In 1972 (and now) relatively few businesses could be expected to consistently earn the 25% after tax on net tangible
assets that was earned by See’s – doing it, furthermore, with conservative accounting and no financial leverage. It was
not the fair market value of the inventories, receivables or fixed assets that produced the premium rates of return.
Rather it was a combination of intangible assets, particularly a pervasive favorable reputation with consumers based
upon countless pleasant experiences they have had with both product and personnel.

Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its
production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic
Goodwill. Other sources include governmental franchises not subject to profit regulation, such as television stations, and
an enduring position as the low cost producer in an industry.

Let’s return to the accounting in the See’s example. Blue Chip’s purchase of See’s at $17 million over net tangible assets
required that a Goodwill account of this amount be established as an asset on Blue Chip’s books and that $425,000 be
charged to income annually for 40 years to amortize that asset. By 1983, after 11 years of such charges, the $17 million


had been reduced to about $12.5 million. Berkshire, meanwhile, owned 60% of Blue Chip and, therefore, also 60% of
See’s. This ownership meant that Berkshire’s balance sheet reflected 60% of See’s Goodwill, or about $7.5 million.

In 1983 Berkshire acquired the rest of Blue Chip in a merger that required purchase accounting as contrasted to the
"pooling" treatment allowed for some mergers. Under purchase accounting, the "fair value" of the shares we gave to (or
"paid") Blue Chip holders had to be spread over the net assets acquired from Blue Chip. This "fair value" was measured,
as it almost always is when public companies use their shares to make acquisitions, by the market value of the shares
given up.

The assets "purchased" consisted of 40% of everything owned by Blue Chip (as noted, Berkshire already owned the
other 60%). What Berkshire "paid" was more than the net identifiable assets we received by $51.7 million, and was
assigned to two pieces of Goodwill: $28.4 million to See’s and $23.3 million to Buffalo Evening News.

After the merger, therefore, Berkshire was left with a Goodwill asset for See’s that had two components: the $7.5
million remaining from the 1971 purchase, and $28.4 million newly created by the 40% "purchased" in 1983. Our
amortization charge now will be about $1.0 million for the next 28 years, and $.7 million for the following 12 years, 2002
through 2013.
In other words, different purchase dates and prices have given us vastly different asset values and amortization charges
for two pieces of the same asset. (We repeat our usual disclaimer: we have no better accounting system to suggest. The
problems to be dealt with are mind boggling and require arbitrary rules.)

Another reality is that annual amortization charges in the future will not correspond to economic costs. It is possible, of
course, that See’s economic Goodwill will disappear. But it won’t shrink in even decrements or anything remotely
resembling them. What is more likely is that the Goodwill will increase – in current, if not in constant, dollars – because
of inflation.

That probability exists because true economic Goodwill tends to rise in nominal value proportionally with inflation. To
illustrate how this works, let’s contrast a See’s kind of business with a more mundane business. When we purchased
See’s in 1972, it will be recalled, it was earning about $2 million on $8 million of net tangible assets. Let us assume that
our hypothetical mundane business then had $2 million of earnings also, but needed $18 million in net tangible assets
for normal operations. Earning only 11% on required tangible assets, that mundane business would possess little or no
economic Goodwill.

A business like that, therefore, might well have sold for the value of its net tangible assets, or for $18 million. In contrast,
we paid $25 million for See’s, even though it had no more in earnings and less than half as much in "honest‐to‐God"
assets. Could less really have been more, as our purchase price implied? The answer is "yes" – even if both businesses
were expected to have flat unit volume – as long as you anticipated, as we did in 1972, a world of continuous inflation.

To understand why, imagine the effect that a doubling of the price level would subsequently have on the two
businesses. Both would need to double their nominal earnings to $4 million to keep themselves even with inflation. This
would seem to be no great trick: just sell the same number of units at double earlier prices and, assuming profit margins
remain unchanged, profits also must double.

But, crucially, to bring that about, both businesses probably would have to double their nominal investment in net
tangible assets, since that is the kind of economic requirement that inflation usually imposes on businesses, both good
and bad. A doubling of dollar sales means correspondingly more dollars must be employed immediately in receivables
and inventories. Dollars employed in fixed assets will respond more slowly to inflation, but probably just as surely. And


all of this inflation‐required investment will produce no improvement in rate of return. The motivation for this
investment is the survival of the business, not the prosperity of the owner.

Remember, however, that See’s had net tangible assets of only $8 million. So it would only have had to commit an
additional $8 million to finance the capital needs imposed by inflation. The mundane business, meanwhile, had a burden
over twice as large – a need for $18 million of additional capital.

After the dust had settled, the mundane business, now earning $4 million annually, might still be worth the value of its
tangible assets, or $36 million. That means its owners would have gained only a dollar of nominal value for every new
dollar invested. (This is the same dollar‐for‐dollar result they would have achieved if they had added money to a savings
account.)

See’s, however, also earning $4 million, might be worth $50 million if valued (as it logically would be) on the same basis
as it was at the time of our purchase. So it would have gained $25 million in nominal value while the owners were
putting up only $8 million in additional capital – over $3 of nominal value gained for each $1 invested.

Remember, even so, that the owners of the See’s kind of business were forced by inflation to ante up $8 million in
additional capital just to stay even in real profits. Any unleveraged business that requires some net tangible assets to
operate (and almost all do) is hurt by inflation. Businesses needing little in the way of tangible assets simply are hurt the
least.
And that fact, of course, has been hard for many people to grasp. For years the traditional wisdom – long on tradition,
short on wisdom – held that inflation protection was best provided by businesses laden with natural resources, plants
and machinery, or other tangible assets ("In Goods We Trust"). It doesn’t work that way. Asset‐heavy businesses
generally earn low rates of return – rates that often barely provide enough capital to fund the inflationary needs of the
existing business, with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses.

In contrast, a disproportionate number of the great business fortunes built up during the inflationary years arose from
ownership of operations that combined intangibles of lasting value with relatively minor requirements for tangible
assets. In such cases earnings have bounded upward in nominal dollars, and these dollars have been largely available for
the acquisition of additional businesses. This phenomenon has been particularly evident in the communications
business. That business has required little in the way of tangible investment – yet its franchises have endured. During
inflation, Goodwill is the gift that keeps giving.

But that statement applies, naturally, only to true economic Goodwill. Spurious accounting Goodwill – and there is
plenty of it around – is another matter. When an overexcited management purchases a business at a silly price, the
same accounting niceties described earlier are observed. Because it can’t go anywhere else, the silliness ends up in the
Goodwill account. Considering the lack of managerial discipline that created the account, under such circumstances it
might better be labeled "No‐Will". Whatever the term, the 40‐year ritual typically is observed and the adrenalin so
capitalized remains on the books as an "asset" just as if the acquisition had been a sensible one.
* * * * *
We believe managers and investors alike should view intangible assets from two perspectives:
1. In analysis of operating results – that is, in evaluating the underlying economics of a business unit – amortization
charges should be ignored. What a business can be expected to earn on unleveraged net tangible assets,
excluding any charges against earnings for amortization of Goodwill, is the best guide to the economic
attractiveness of the operation. It is also the best guide to the current value of the operation’s economic
Goodwill.


2. In evaluating the wisdom of business acquisitions, amortization charges should be ignored also. They should be
deducted neither from earnings nor from the cost of the business. This means forever viewing purchased
Goodwill at its full cost, before any amortization. Furthermore, cost should be defined as including the full
intrinsic business value – not just the recorded accounting value – of all consideration given, irrespective of
market prices of the securities involved at the time of merger and irrespective of whether pooling treatment
was allowed. For example, what we truly paid in the Blue Chip merger for 40% of the Goodwill of See’s and the
News was considerably more than the $51.7 million entered on our books. This disparity exists because the
market value of the Berkshire shares given up in the merger was less than their intrinsic business value, which is
the value that defines the true cost to us.
Operations that appear to be winners based upon perspective
1. may pale when viewed from perspective
2. A good business is not always a good purchase – although it’s a good place to look for one.”
- BRK 1983 Letter

“As we discussed last year, the gain in per‐share intrinsic business value is the economic measurement that really
counts.”
- BRK 1984 Letter

“Some historical explanation for the current situation becomes appropriate here. When Wesco’s parent corporation
acquired control, Wesco’s activities were almost entirely limited to holding (1) some surplus cash, plus (2) a multi‐branch
savings and loan association which had many very long‐term, fixed‐rate mortgages, offset by interest‐bearing demand
deposits. The acquisition of this intrinsically disadvantageous position was unwisely made, alternative opportunities
considered, because the acquirer was overly influenced by a price considered to be moderately below liquidating value.
Under such circumstances, acquisitions have a way of producing on average, for acquirers who are not quick‐turn
operators, low to moderate long‐term results. This happens because any advantage from a starting ‘bargain’ gets
swamped by effects from change‐resistant mediocrity in the purchased business swamped by effects from change‐
resistant mediocrity in the purchased business. Such normal effects have not completely avoided at Wesco, despite
some successful activities, including recent investment in General Foods.”
- WSC 1987 Letter

“We try to price, rather than time, purchases. In our view, it is folly to forego buying shares in an outstanding business
whose long‐term future is predictable, because of short‐term worries about an economy or a stock market that we know
to be unpredictable. Why scrap an informed decision because of an uninformed guess?”
- BRK 1995 Letter

“Though we are delighted with what we own, we are not pleased with our prospects for committing incoming funds.
Prices are high for both businesses and stocks. That does not mean that the prices of either will fall ‐‐ we have absolutely
no view on that matter ‐‐ but it does mean that we get relatively little in prospective earnings when we commit fresh
money.
Under these circumstances, we try to exert a Ted Williams kind of discipline. In his book The Science of Hitting, Ted
explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his "best" cell,
he knew, would allow him to bat .400; reaching for balls in his "worst" spot, the low outside corner of the strike zone,


would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging
indiscriminately would mean a ticket to the minors.

If they are in the strike zone at all, the business "pitches" we now see are just catching the lower outside corner. If we
swing, we will be locked into low returns. But if we let all of today's balls go by, there can be no assurance that the next
ones we see will be more to our liking. Perhaps the attractive prices of the past were the aberrations, not the full prices
of today. Unlike Ted, we can't be called out if we resist three pitches that are barely in the strike zone; nevertheless, just
standing there, day after day, with my bat on my shoulder is not my idea of fun.”
- BRK 1997 Letter

“Right now, the prices of the fine businesses we already own are just not that attractive. In other words, we feel much
better about the businesses than their stocks. That's why we haven't added to our present holdings. Nevertheless, we
haven't yet scaled back our portfolio in a major way: If the choice is between a questionable business at a comfortable
price or a comfortable business at a questionable price, we much prefer the latter. What really gets our attention,
however, is a comfortable business at a comfortable price.

Our reservations about the prices of securities we own apply also to the general level of equity prices. We have never
attempted to forecast what the stock market is going to do in the next month or the next year, and we are not trying to
do that now. But, as I point out in the enclosed article, equity investors currently seem wildly optimistic in their
expectations about future returns.

We see the growth in corporate profits as being largely tied to the business done in the country (GDP), and we see GDP
growing at a real rate of about 3%. In addition, we have hypothesized 2% inflation. Charlie and I have no particular
conviction about the accuracy of 2%. However, it's the market's view: Treasury Inflation‐Protected Securities (TIPS) yield
about two percentage points less than the standard treasury bond, and if you believe inflation rates are going to be
higher than that, you can profit by simply buying TIPS and shorting Governments.

If profits do indeed grow along with GDP, at about a 5% rate, the valuation placed on American business is unlikely to
climb by much more than that. Add in something for dividends, and you emerge with returns from equities that are
dramatically less than most investors have either experienced in the past or expect in the future. If investor expectations
become more realistic ‐‐ and they almost certainly will ‐‐ the market adjustment is apt to be severe, particularly in
sectors in which speculation has been concentrated.

Berkshire will someday have opportunities to deploy major amounts of cash in equity markets ‐‐ we are confident of
that. But, as the song goes, "Who knows where or when?" Meanwhile, if anyone starts explaining to you what is going
on in the truly‐manic portions of this "enchanted" market, you might remember still another line of song: "Fools give
you reasons, wise men never try."
- BRK 1999 Letter

“Leaving aside tax factors, the formula we use for evaluating stocks and businesses is identical. Indeed, the formula for
valuing all assets that are purchased for financial gain has been unchanged since it was first laid out by a very smart man
in about 600 B.C. (though he wasn’t smart enough to know it was 600 B.C.).

The oracle was Aesop and his enduring, though somewhat incomplete, investment insight was "a bird in the hand is
worth two in the bush." To flesh out this principle, you must answer only three questions. How certain are you that
there are indeed birds in the bush? When will they emerge and how many will there be? What is the risk‐free interest
rate (which we consider to be the yield on long‐term U.S. bonds)? If you can answer these three questions, you will


know the maximum value of the bush ¾ and the maximum number of the birds you now possess that should be offered
for it. And, of course, don’t literally think birds. Think dollars.

Aesop’s investment axiom, thus expanded and converted into dollars, is immutable. It applies to outlays for farms, oil
royalties, bonds, stocks, lottery tickets, and manufacturing plants. And neither the advent of the steam engine, the
harnessing of electricity nor the creation of the automobile changed the formula one iota ¾ nor will the Internet. Just
insert the correct numbers, and you can rank the attractiveness of all possible uses of capital throughout the universe.

Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have
nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and
from the business. Indeed, growth can destroy value if it requires cash inputs in the early years of a project or enterprise
that exceed the discounted value of the cash that those assets will generate in later years. Market commentators and
investment managers who glibly refer to "growth" and "value" styles as contrasting approaches to investment are
displaying their ignorance, not their sophistication. Growth is simply a component ¾ usually a plus, sometimes a minus ¾
in the value equation.

Alas, though Aesop’s proposition and the third variable ¾ that is, interest rates ¾ are simple, plugging in numbers for the
other two variables is a difficult task. Using precise numbers is, in fact, foolish; working with a range of possibilities is the
better approach.

Usually, the range must be so wide that no useful conclusion can be reached. Occasionally, though, even very
conservative estimates about the future emergence of birds reveal that the price quoted is startlingly low in relation to
value. (Let’s call this phenomenon the IBT ¾ Inefficient Bush Theory.) To be sure, an investor needs some general
understanding of business economics as well as the ability to think independently to reach a well‐founded positive
conclusion. But the investor does not need brilliance nor blinding insights.

At the other extreme, there are many times when the most brilliant of investors can’t muster a conviction about the
birds to emerge, not even when a very broad range of estimates is employed. This kind of uncertainty frequently occurs
when new businesses and rapidly changing industries are under examination. In cases of this sort, any capital
commitment must be labeled speculative.”
- BRK 2000 Letter

“The aversion to equities that Charlie and I exhibit today is far from congenital. We love owning common stocks – if they
can be purchased at attractive prices. In my 61 years of investing, 50 or so years have offered that kind of opportunity.
There will be years like that again. Unless, however, we see a very high probability of at least 10% pre‐tax returns (which
translate to 6½‐7% after corporate tax), we will sit on the sidelines. With short‐term money returning less than 1% after‐
tax, sitting it out is no fun. But occasionally successful investing requires inactivity.”
- BRK 2002 Letter

“Decades of option‐accounting nonsense have now been put to rest, but other accounting choices remain – important
among these the investment‐return assumption a company uses in calculating pension expense. It will come as no
surprise that many companies continue to choose an assumption that allows them to report less‐than‐solid “earnings.”
For the 363 companies in the S&P that have pension plans, this assumption in 2006 averaged 8%. Let’s look at the
chances of that being achieved.



The average holdings of bonds and cash for all pension funds is about 28%, and on these assets returns can be expected
to be no more than 5%. Higher yields, of course, are obtainable but they carry with them a risk of commensurate (or
greater) loss.

This means that the remaining 72% of assets – which are mostly in equities, either held directly or through vehicles such
as hedge funds or private‐equity investments – must earn 9.2% in order for the fund overall to achieve the postulated
8%. And that return must be delivered after all fees, which are now far higher than they have ever been.

How realistic is this expectation? Let’s revisit some data I mentioned two years ago: During the 20th Century, the Dow
advanced from 66 to 11,497. This gain, though it appears huge, shrinks to 5.3% when compounded annually. An investor
who owned the Dow throughout the century would also have received generous dividends for much of the period, but
only about 2% or so in the final years. It was a wonderful century.

Think now about this century. For investors to merely match that 5.3% market‐value gain, the Dow – recently below
13,000 – would need to close at about 2,000,000 on December 31, 2099. We are now eight years into this century, and
we have racked up less than 2,000 of the 1,988,000 Dow points the market needed to travel in this hundred years to
equal the 5.3% of the last.

It’s amusing that commentators regularly hyperventilate at the prospect of the Dow crossing an even number of
thousands, such as 14,000 or 15,000. If they keep reacting that way, a 5.3% annual gain for the century will mean they
experience at least 1,986 seizures during the next 92 years. While anything is possible, does anyone really believe this is
the most likely outcome?

Dividends continue to run about 2%. Even if stocks were to average the 5.3% annual appreciation of the 1900s, the
equity portion of plan assets – allowing for expenses of .5% – would produce no more than 7% or so. And .5% may well
understate costs, given the presence of layers of consultants and highpriced managers (‘helpers’).

Naturally, everyone expects to be above average. And those helpers – bless their hearts – will certainly encourage their
clients in this belief. But, as a class, the helper‐aided group must be below average. The reason is simple: 1) Investors,
overall, will necessarily earn an average return, minus costs they incur; 2) Passive and index investors, through their very
inactivity, will earn that average minus costs that are very low; 3) With that group earning average returns, so must the
remaining group – the active investors. But this group will incur high transaction, management, and advisory costs.
Therefore, the active investors will have their returns diminished by a far greater percentage than will their inactive
brethren. That means that the passive group – the ‘know‐nothings’ – must win.

I should mention that people who expect to earn 10% annually from equities during this century – envisioning that 2% of
that will come from dividends and 8% from price appreciation – are implicitly forecasting a level of about 24,000,000 on
the Dow by 2100. If your adviser talks to you about double digit returns from equities, explain this math to him – not
that it will faze him. Many helpers are apparently direct descendants of the queen in Alice in Wonderland, who said:
“Why, sometimes I’ve believed as many as six impossible things before breakfast.” Beware the glib helper who fills your
head with fantasies while he fills his pockets with fees.

Some companies have pension plans in Europe as well as in the U.S. and, in their accounting, almost all assume that the
U.S. plans will earn more than the non‐U.S. plans. This discrepancy is puzzling:
Why should these companies not put their U.S. managers in charge of the non‐U.S. pension assets and let them work
their magic on these assets as well? I’ve never seen this puzzle explained. But the auditors and actuaries who are
charged with vetting the return assumptions seem to have no problem with it.



What is no puzzle, however, is why CEOs opt for a high investment assumption: It lets them report higher earnings. And
if they are wrong, as I believe they are, the chickens won’t come home to roost until long after they retire.

After decades of pushing the envelope – or worse – in its attempt to report the highest number possible for current
earnings, Corporate America should ease up. It should listen to my partner, Charlie: ‘If you’ve hit three balls out of
bounds to the left, aim a little to the right on the next swing.’”
- BRK 2007 Letter

“As Bill Gates says, it's illogical to hold things at some price.

Shareholder: Berkshire owns stock in several companies called "permanent holdings". In the early 1970s, we had a
two‐tier market ‐ with one‐decision stocks selling at 50‐60 times earnings. If that were to reappear, would Berkshire's
companies still be "permanent"? Or is there a price for everything?
Buffett: There are things we think there's no price for ‐ and we've been tested sometimes and haven't sold 'em. But
my friend, Bill Gates, says that it has to be illogical at some point. At some price, you have to be willing to sell something
that's a marketable security ‐ forgetting about our controlled businesses.
If our companies sell at P/Es of 60‐70, keep an eye on me.
Buffett: I doubt if we'll ever get tested ‐ and there are only a couple of them in that category. Actually, there's well, I
won't comment on that....
We really have a great reluctance to sell businesses where we like both the businesses and the people. So I don't think
I'd count on seeing many sales. But if you ever attend a meeting here and they're at 60‐70 times earnings, keep an eye
on me. Charlie?
The main problem with the two‐tiered market wasn't price.”
- 1996 BRK Meeting

“Munger: The so‐called "two‐tier market" created difficulties primarily because a lot of companies were called Tier 1
when they really weren't. They just had been Tier 1 at some time. If you're right about the companies, you can hold
them at pretty high values.
Buffett: You can hold them at extraordinary levels.”
- 1996 BRK Meeting

“We'd rather just pretend the stock market doesn't exist.

Buffett: They're too hard to find. You're not going to find businesses as good. So then you have to ask, "Am I going to
get a chance to buy the same business at a lot lower price or am I going to buy something that's almost as good at a lot
lower price?"

We probably value wonderful businesses higher than most.

Buffett: So if a management wishes to intensify our ownership of a wonderful business by repurchasing shares, we
applaud. We favor using funds that are generated by a wonderful business to make it even more wonderful by
repurchasing shares if those shares are below intrinsic value.
So if you're trying to decide on the wisdom of share repurchases or share issuances, I urge you not to think in terms of
book value, P/Es or any little model. [Instead], pick businesses you can understand and then think what you'd really pay
to be in those businesses. What counts over time is whether the repurchases are made at a discount from that figure.


However, there's a lot more to intrinsic value than book value and P/E ratios. Anytime anybody gives you some
simplified formula for figuring out intrinsic value, forget it. You have to understand the business.
And I would say that if it's a really wonderful business, we probably come up with higher intrinsic values than most
people do. Over the years, Charlie and I have developed enormous respect for the power of a really outstanding
business. We recognize how scarce they are.”
- 1996 BRK Meeting

“By and large, in most companies, the depreciation charge is not inappropriate to use as a proxy for required capital
expenditures. And that's why we think that the sum of reported earnings plus amortization of intangibles usually
provides a pretty good indication of true earnings.”

“Investment Hurdle Rates

Buffet: ‘10% is the figure we quit on ‐‐ we don’t want to buy equities when the real return we expect is less than 10%,
whether interest rates are 6% or 1%. It’s arbitrary. 10% is not that great after tax.’

Munger: ‘We’re guessing at our future opportunity cost. Warren is guessing that he’ll
have the opportunity to put capital out at high rates of return, so he’s not willing to put it
out at less than 10% now. But if we knew interest rates would stay at 1%, we’d change.
Our hurdles reflect our estimate of future opportunity costs.’”
- 2003 BRK Meeting

“Approach to Buying Businesses
We favor businesses where we really think we know the answer. If we think the business’s competitive position is shaky,
we won’t try to compensate with price. We want to buy a great business, defined as having a high return on capital for a
long period of time, where we think management will treat us right. We like to buy at 40 cents on the dollar, but will pay
a lot closer to $1 on the dollar for a great business.”

“A great business at a fair price is superior to a fair business at a great price.”
– Poor Charlie’s Almanac 3 P60.

“To raise that return on equity, corporations would need at least one of the following:
1) an increase in turnover, i.e., in the ratio between sales and total assets employed in the business;
2) cheaper leverage;
3) more leverage;
4) lower income taxes;
5) wider operating margins on sales.”



“The best buys have been when the numbers almost tell you not to. Because then you feel so strongly about the
product.”

“The way to look at a business is this going to keep producing more and more money over time? And if the answer to
that is yes, you don’t need to ask any more questions.”

“Bear in mind‐‐this is a critical fact often ignored‐‐that investors as a whole cannot get anything out of their businesses
except what the businesses earn.”
- “Mr. Buffett on the Stock Market,” Fortune November 22, 1999

If merely looking up past financial data would tell you what the future holds, the Forbes 400 would consist of librarians.)
‐BRK 2008 letter

Investors should be skeptical of history‐based models.
‐BRK 2008 letter

“Beware the intrinsically cyclical business trading at a cyclical high”
‐Charlie Munger, December 2009 [private meeting]. CTM specifically mentioned BRK’s carpet business along with many
others including some financial. He noted that a long expansion can make a cyclical company look like a growth
business. Buying it at a cyclical high makes you vulnerable to falling earnings/falling ROE and therefore a falling p/e.

“book value at most companies understates intrinsic value”
- BRK 2009 Letter

“If we wouldn’t dream of selling Berkshire in its entirety at the current market price, why in the world should we “sell” a
significant part of the company at that same inadequate price by issuing our stock in a merger?

In evaluating a stock‐for‐stock offer, shareholders of the target company quite understandably focus on the market price
of the acquirer’s shares that are to be given them. But they also expect the transaction to deliver them the intrinsic
value of their own shares – the ones they are giving up. If shares of a prospective acquirer are selling below their
intrinsic value, it’s impossible for that buyer to make a sensible deal in an all‐stock deal. You simply can’t exchange an
undervalued stock for a fully‐valued one without hurting your shareholders.”
- BRK 2009 Letter

“Let me quantify Tony’s achievement. When, in 1996, we bought the 50% of GEICO we didn’t already own, it cost us
about $2.3 billion. That price implied a value of $4.6 billion for 100%. GEICO then had tangible net worth of $1.9 billion.

The excess over tangible net worth of the implied value – $2.7 billion – was what we estimated GEICO’s “goodwill” to be
worth at that time. That goodwill represented the economic value of the policyholders who were then doing business
with GEICO. In 1995, those customers had paid the company $2.8 billion in premiums. Consequently, we were valuing
GEICO’s customers at about 97% (2.7/2.8) of what they were annually paying the company. By industry standards, that
was a very high price. But GEICO was no ordinary insurer: Because of the company’s low costs, its policyholders were
consistently profitable and unusually loyal.



Today, premium volume is $14.3 billion and growing. Yet we carry the goodwill of GEICO on our books at only $1.4
billion, an amount that will remain unchanged no matter how much the value of GEICO increases. (Under accounting
rules, you write down the carrying value of goodwill if its economic value decreases, but leave it unchanged if economic
value increases.) Using the 97%‐of‐premium‐volume yardstick we applied to our 1996 purchase, the real value today of
GEICO’s economic goodwill is about $14 billion. And this value is likely to be much higher ten and twenty years from
now. GEICO – off to a strong start in 2011 – is the gift that keeps giving.”
- BRK 2010 Letter



Inflation

“High rates of inflation create a tax on capital that makes much corporate investment unwise ‐ at least if measured by
the criterion of a positive real investment return to owners. This “hurdle rate” the return on equity that must be
achieved by a corporation in order to produce any real return for its individual owners ‐ has increased dramatically in
recent years. The average tax‐paying investor is now running up a down escalator whose pace has accelerated to the
point where his upward progress is nil.

For example, in a world of 12% inflation a business earning 20% on equity (which very few manage consistently to do)
and distributing it all to individuals in the 50% bracket is chewing up their real capital, not enhancing it. (Half of the 20%
will go for income tax; the remaining 10% leaves the owners of the business with only 98% of the purchasing power they
possessed at the start of the year ‐ even though they have not spent a penny of their “earnings”). The investors in this
bracket would actually be better off with a combination of stable prices and corporate earnings on equity capital of only
a few per cent.

Explicit income taxes alone, unaccompanied by any implicit inflation tax, never can turn a positive corporate return into
a negative owner return. (Even if there were 90% personal income tax rates on both dividends and capital gains, some
real income would be left for the owner at a zero inflation rate.) But the inflation tax is not limited by reported income.
Inflation rates not far from those recently experienced can turn the level of positive returns achieved by a majority of
corporations into negative returns for all owners, including those not required to pay explicit taxes. (For example, if
inflation reached 16%, owners of the 60% plus of corporate America earning less than this rate of return would be
realizing a negative real return ‐ even if income taxes on dividends and capital gains were
eliminated.)

Of course, the two forms of taxation co‐exist and interact since explicit taxes are levied on nominal, not real, income.
Thus you pay income taxes on what would be deficits if returns to stockholders were measured in constant dollars.”
- BRK 1980 Letter

“Equity Value‐Added

An additional factor should further subdue any residual enthusiasm you may retain regarding our long‐term rate of
return. The economic case justifying equity investment is that, in aggregate, additional earnings above passive
investment returns ‐ interest on fixed‐income securities ‐ will be derived through the employment of managerial and
entrepreneurial skills in conjunction with that equity capital. Furthermore, the case says that since the equity capital
position is associated with greater risk than passive forms of investment, it is “entitled” to higher returns. A “value‐
added” bonus from equity capital seems natural and certain.

But is it? Several decades back, a return on equity of as little as 10% enabled a corporation to be classified as a “good”
business ‐ i.e., one in which a dollar reinvested in the business logically could be expected to be valued by the market at
more than one hundred cents. For, with long‐term taxable bonds yielding 5% and long‐term tax‐exempt bonds 3%, a
business operation that could utilize equity capital at 10% clearly was worth some premium to investors over the equity
capital employed. That was true even though a combination of taxes on dividends and on capital gains would reduce
the 10% earned by the corporation to perhaps 6%‐8% in the hands of the individual investor.



Investment markets recognized this truth. During that earlier period, American business earned an average of 11% or so
on equity capital employed and stocks, in aggregate, sold at valuations far above that equity capital (book value),
averaging over 150 cents on the dollar. Most businesses were “good” businesses because they earned far more than
their keep (the return on long‐term passive money). The value‐added produced by equity investment, in aggregate, was
substantial.

That day is gone. But the lessons learned during its existence are difficult to discard. While investors and managers
must place their feet in the future, their memories and nervous systems often remain plugged into the past. It is much
easier for investors to utilize historic p/e ratios or for managers to utilize historic business valuation yardsticks than it is
for either group to rethink their premises daily. When change is slow, constant rethinking is actually undesirable; it
achieves little and slows response time. But when change is great, yesterday’s assumptions can be retained only at
great cost. And the pace of economic change has become breathtaking.

During the past year, long‐term taxable bond yields exceeded 16% and long‐term tax‐exempts 14%. The total return
achieved from such tax‐exempts, of course, goes directly into the pocket of the individual owner. Meanwhile, American
business is producing earnings of only about 14% on equity. And this 14% will be substantially reduced by taxation
before it can be banked by the individual owner. The extent of such shrinkage depends upon the dividend policy of the
corporation and the tax rates applicable to the investor.

Thus, with interest rates on passive investments at late 1981 levels, a typical American business is no longer worth one
hundred cents on the dollar to owners who are individuals. (If the business is owned by pension funds or other tax‐
exempt investors, the arithmetic, although still unenticing, changes substantially for the better.) Assume an investor in a
50% tax bracket; if our typical company pays out all earnings, the income return to the investor will be equivalent to that
from a 7% tax‐exempt bond. And, if conditions persist ‐ if all earnings are paid out and return on equity stays at 14% ‐
the 7% tax‐exempt equivalent to the higher‐bracket individual investor is just as frozen as is the coupon on a tax‐exempt
bond. Such a perpetual 7% tax‐exempt bond might be worth fifty cents on the dollar as this is written.

If, on the other hand, all earnings of our typical American business are retained and return on equity again remains
constant, earnings will grow at 14% per year. If the p/e ratio remains constant, the price of our typical stock will also
grow at 14% per year. But that 14% is not yet in the pocket of the shareholder. Putting it there will require the payment
of a capital gains tax, presently assessed at a maximum rate of 20%. This net return, of course, works out to a poorer
rate of return than the currently available passive after‐tax rate. Unless passive rates fall, companies achieving 14% per
year gains in earnings per share while paying no cash dividend are an economic failure for their individual shareholders.
The returns from passive capital outstrip the returns from active capital. This is an unpleasant fact for both investors and
corporate managers and, therefore, one they may wish to ignore. But facts do not cease to exist, either because they
are unpleasant or because they are ignored.

Most American businesses pay out a significant portion of their earnings and thus fall between the two examples. And
most American businesses are currently “bad” businesses economically ‐ producing less for their individual investors
after‐tax than the tax‐exempt passive rate of return on money. Of course, some high‐return businesses still remain
attractive, even under present conditions. But American equity capital, in aggregate, produces no value‐added for
individual investors.

It should be stressed that this depressing situation does not occur because corporations are jumping, economically, less
high than previously. In fact, they are jumping somewhat higher: return on equity has improved a few points in the past
decade. But the crossbar of passive return has been elevated much faster. Unhappily, most companies can do little but
hope that the bar will be lowered significantly; there are few industries in which the prospects seem bright for
substantial gains in return on equity.


Inflationary experience and expectations will be major (but not the only) factors affecting the height of the crossbar in
future years. If the causes of long‐term inflation can be tempered, passive returns are likely to fall and the intrinsic
position of American equity capital should significantly improve. Many businesses that now must be classified as
economically “bad” would be restored to the “good” category under such circumstances.

A further, particularly ironic, punishment is inflicted by an inflationary environment upon the owners of the “bad”
business. To continue operating in its present mode, such a low‐return business usually must retain much of its earnings
‐ no matter what penalty such a policy produces for shareholders.

Reason, of course, would prescribe just the opposite policy. An individual, stuck with a 5% bond with many years to run
before maturity, does not take the coupons from that bond and pay one hundred cents on the dollar for more 5% bonds
while similar bonds are available at, say, forty cents on the dollar. Instead, he takes those coupons from his low‐return
bond and ‐ if inclined to reinvest ‐ looks for the highest return with safety currently available. Good money is not
thrown after bad.

What makes sense for the bondholder makes sense for the shareholder. Logically, a company with historic and
prospective high returns on equity should retain much or all of its earnings so that shareholders can earn premium
returns on enhanced capital. Conversely, low returns on corporate equity would suggest a very high dividend payout so
that owners could direct capital toward more attractive areas. (The Scriptures concur. In the parable of the talents, the
two high‐earning servants are rewarded with 100% retention of earnings and encouraged to expand their operations.
However, the non‐earning third servant is not only chastised ‐ “wicked and slothful” ‐ but also is required to redirect all
of his capital to the top performer. Matthew 25: 14‐30)

But inflation takes us through the looking glass into the upside‐down world of Alice in Wonderland. When prices
continuously rise, the “bad” business must retain every nickel that it can. Not because it is attractive as a repository for
equity capital, but precisely because it is so unattractive, the low‐return business must follow a high retention policy. If
it wishes to continue operating in the future as it has in the past ‐ and most entities, including businesses, do ‐ it simply
has no choice.

For inflation acts as a gigantic corporate tapeworm. That tapeworm preemptively consumes its requisite daily diet of
investment dollars regardless of the health of the host organism.
Whatever the level of reported profits (even if nil), more dollars for receivables, inventory and fixed assets are
continuously required by the business in order to merely match the unit volume of the previous year. The less
prosperous the enterprise, the greater the proportion of available sustenance claimed by the tapeworm.

Under present conditions, a business earning 8% or 10% on equity often has no leftovers for expansion, debt reduction
or “real” dividends. The tapeworm of inflation simply cleans the plate. (The low‐return company’s inability to pay
dividends, understandably, is often disguised. Corporate America increasingly is turning to dividend reinvestment plans,
sometimes even embodying a discount arrangement that all but forces shareholders to reinvest. Other companies sell
newly issued shares to Peter in order to pay dividends to Paul. Beware of “dividends” that can be paid out only if
someone promises to replace the capital distributed.)”
- BRK 1981 Letter

“The appropriate multiple for a business compared to the S&P 500 depends on its return on equity and return on
incremental invested capital.”


Risk

“Any minority‐position investment with such extreme financial leverage (in effect buying with a 2% down payment),
involving a troubled company in a demanding environment, can fairly be called a venture‐capital type investment for
Wesco. In our judgment, the prospect for gain justified the risk of loss. The investment involves a small portion (about
5%) of Wesco’s consolidated net worth. We consider it financially conservative to risk 3½% of Wesco’s net worth, which
is roughly the after‐tax exposure involved, if we believe a hundred similar bets would, in aggregate, be almost sure to
work out successfully.”
- WSC 1985 Letter

“The ratio of Wesco’s annual reported consolidated net income to reported consolidated sahreholders’ equity, about
21% in 1983‐85, was dependent to a very large extent on securities gains, irregular by nature. The recent ratio is almost
certain to decline, quite probably very sharply. Neither possible future acquisitions of other businesses nor possible
future securities gains appear likely to cause the recent ratio to continue. The business acquisition game is now crowded
with optimistic players who usually force prices for low‐leverage acquirers like Wesco to levels where return‐on‐
investment prospects are modest. And, as discussed earlier, the great contribution of 1985 securities gains to Wesco’s
recent return on shareholders’ equity contained a big fluke element. Such fluke gain, rare in any event, tends to come to
an investor like Wesco mostly as an unanticipated by‐product of an obviously sound i8nvestment which does not require
any fluke to work out well. Because securities generally traded lower several years ago than they do now, relative to the
intrinsic values of the businesses represented by the securities, creating more obviously sound investment then than
now, and because prospects for above‐average returns tend to go down as assets managed go up, it is now easy to
predict less desirable future results. It is also easy for any sophisticated Wesco shareholder, reviewing Wesco
marketable securities disclosed in the 1985 Annual Report, to diagnose (correctly) that the decision‐makers are dry of
good investment ideas.”
- WSC 1985 Letter

“I wish I knew where I was going to die, and then I’d never go there.”
‐Harvard School Commencement Speech – June 13, 1986

“Mutual Savings’ ‘normal’ net operating income of $2,895,000 in 1987 represented an increase of 34% from the
$2,159,000 figure the previous year.

However, this ‘normal’ figure of $2,895,000 for Mutual Savings’ 1987 earnings is created by ignoring as abnormal an
after‐tax charge of $1,935,000 from writeoff of prepayments of deposit‐insurance premiums. The premiums had been
prepaid in the previous years to FSLIC, the U.S. agency which insures accounts in savings and loan associations. Since
FSLIC has been grievously impaired by widespread failure of insured associations and continues to be insolvent, and
since its long‐term source of support is collection of premiums which the savings and loan industry is compelled to pay, it
may well be questioned whether FSLIC‐related charges far in excess of past experience should on that account now be
excluded from the ‘normal’ as we do in this explanatory letter. Mutual Savings’ position, relative to FSLIC, is like that of
the owner of a concrete pier, mostly underwater, compelled to buy fire insurance on a pooled‐rate basis with a group of
oily‐rag collectors, many of whom have already had but not reported their fires, with the result that no provision for
such fires has yet been made in pooled‐basis premium rates. Such an owner probably has not yet had his last unpleasant


surprise form his insurance costs. Even so, we chose ‘unusual’ classification for the FSLIC special charge in 1987, because
it is not certain to be repeated.”
- WSC 1987 Letter

“We don’t have huge returns in mind, but we do have in mind not losing anything.”

“The big things are not what you do, they’re what you don’t do. Basically, we’ve had very few things we’ve lost money
on. We’ve had no more good ideas than other people. But we’ve not made big mistakes – that I learned from Ben
Graham. He used to say there are two rules in investing. The first: don’t lose. The second: don’t forget the first.”

“If you go 20:1 levered, you’d better be right.”

“‘All I want to know is where I’m going to die, so I’ll never go there.’”
- BRK 2009 Letter



Industry
Banking

“The savings and loan association described in the foregoing paragraphs, quite different form most other associations
for a long time, added a significant new abnormality during 1988. Mutual Savings increased its position in preferred
stock of Federal Home Loan Mortgage Corporation (widely known as ‘Freddie Mac’) to 2,400,000 when‐issued shares.
This is 4% of the total shares outstanding, the legal limit for any one holder. As this letter is written, all of these
2,400,000 have been issued and paid for. Mutual Savings’ average cost is $29.89 per share, compared to a price of
$50.50 per share in trading on the New York Stock Exchange at the end of 1988. Thus, based on 1988 yearend trading
prices, Mutual Savings had an unrealized pre‐tax profit in Freddie Mac shares of about $49.5 million. At current tax rates
the potential after‐tax profit is about $29.2 million, or $4.10 per Wesco share outstanding.

Freddie Mac is a hybrid, run by a federal agency (the Federal Home Loan Bank Board), but now owned privately, largely
by institutional investors. Freddie Mac supports housing primarily by purchasing housing mortgage loans for immediate
transmutation into mortgage‐backed securities that it guarantees and promptly sells. In the process Freddie Mac earns
fee, and 'spreads’ while avoiding most interest rate‐change risk. This is a much better business, than that carried on by
most (or indeed most of the top 10% of) savings and loan associations, as demonstrated by Freddie Mac's remarkable
percentage returns earned on equity capital in recent years.

At Freddie Mac's current dividend rate ($1.60 per annum per share), Mutual
Savings' pre‐tax yield is only 5.35% on its $29.89 average cost per share. Post‐tax, the dividend yield is only 4.4%. But
Freddie Mac has a very creditable history of raising it, earnings and dividend rate, thus contributing to increases in the
market price of its stock. The market price increases because Freddie Mac's ‘preferred’ stock in substance is equivalent
to common stock. Here are figures for 1985‐1939:
Freddie Mac’s
Year‐End Return Earned
Earnings Dividends Market Price on all
Year Ended 12/31 per Share per Share per Share Average Equity
1985 ……………………………………. $2.98 $.53 $9.19 30.0%
1986 ……………………………………. 3.72 1.13 15.17 28.5
1987 ……………………………………. 4.53 1.10 12.13 28.2
1988 ……………………………………. 5.73 1.25 50.50 27.5
1989 ……………………………………. ? 1.60 ? ?

The above numbers are unusually good for a stock selling at only $50.00 per share at the end of 1988. We think the
probably cause of substandard investor response is some combination of (1) lack of familiarity with Freddie Mac among
investors and (2) fear that the federal officials who control Freddie Mac will mismanage it or not deal fairly with Freddie
Mac's private owners, perhaps under pressure from Congress.

There is, of course, ,one risk that Freddie Mac will ruin its remarkable business by fiduciary duties to new private
owners, or reducing credit standards, or making bets on the future course of interest rates, But we consider such
outcomes unlikely. The tendency to consider them likely rests largely in those who think ill of federal officials because of
the dramatic, multi‐billion‐dollar insolvency of FSLIC (the U.S. agency which insures depositor accounts in savings and
loan associations). This reaction is natural as it becomes ever more clear that the final FSLIC insolvency was augmented
by regulatory failure to intervene early to solve easily diagnosed problems which were getting worse at a rapid rate.


But FSLIC and Freddie Mac are two separate entities, and the circumstances affecting the business of each are radically
different. As the world changed, the troubles of FSLIC had roughly the following history and causes:

(1) In its early decades, the savings and loan industry lived under a system ordained by legislation in the 1930s.
Interest rates paid by both banks and associations were fixed by law at low levels, but with (i) a deposit‐attracting
advantage of ¼% more per annum which could be paid by associations and (ii) tax advantages for associations,
compared with banks. The interest rate controls were created to dampen competition in an effort to prevent recurrence
of the widespread failure of deposit‐taking institutions which had followed the aggressive banking practices of the
1920s. In return for the cartel‐like advantages granted and federal deposit insurance, associations were required to
concentrate assets in home lending and to be conservative in risking losses from non‐repayment of loans. The standard
practice of associations was then to borrow short (by taking demand deposits) and to lend long (by making long‐term
mortgage loans at fixed rates). Associations lived on an approximate two‐percentage‐point ‘spread’ between the
mortgage interest rate and the mandated low interest rate on deposits.

(2) This system always had a built‐in risk that interest rates would generally and sharply rise, in which case the
government would be forced to raise interest rates on deposits in order to enable associations to hold deposits. Then
associations would be squeezed into losses because they were hooked by contract to fixed interest rates on old
mortgages. But associations accommodated this risk, during periods of low inflation and slowly rising, government‐fixed
interest rates on deposits, by continuously ‘growing their way’ out of profit‐margin trouble.
Associations simply ‘averaged up’ the rate of interest on the whole mortgage portfolio by making ever larger amounts of
new mortgage loans at higher interest rates. The necessary continuous growth, despite mandated low interest rates for
savers, was made possible, of course, by the ¼% per annum deposit‐attracting rate advantage possessed by associations.
The system contained much wise and constructive cynicism, akin to that of the country's founding fathers. The system's
creators wanted associations not to cause losses to FSLIC, the federal deposit‐insurer, while helping the citizenry by
favoring housing. So, knowing like Ben Franklin that ‘it is hard for an empty sack to stand upright,’ the creators simply
gave associations significant competitive and tax advantage that made it easy for executives to do well while doing right.
Also, because the creator, admired ‘cooperative,’ workers'‐self‐help models and, looking back at the excesses of the
1920s, feared losses from capitalistic ambition more than they feared inefficiency from a more socialized process, all
federally‐chartered and most state‐chartered associations were ‘mutual’ institutions. Such institutions are ‘owned’ by
depositors and are therefore not capable of making any shareholder rich. In the early decades, this system, relying on
carrot as well as stick, was, like the FHA, one of the most successful systems in U.S. history. It did a world of good at a
trifling cost.

(3) Naturally, the few state‐chartered, shareholder‐owned associations (including Mutual Savings, which was
"mutual" in name only) in due course became more aggressive than their "mutual" brethren and used their government‐
mandated competitive advantage to make their shareholders rich. This process was aided by their emphasizing high‐
yielding tract‐housing loans in the faster‐growing parts of the country during a long boom. And envy plus logic then
caused many ‘conversions’ of formerly ‘mutual’ associations to shareholder ownership, which, featuring different
incentives, increased managements’ proclivity to endure risk in the hope of above‐normal reward. The heavy‐risk‐taking‐
attitude finally spread throughout a large percentage of the savings and loan industry, including formerly conservative
‘mutual’ institutions that remained ‘mutual’ institutions.

(4) But, eventually, the tendencies of government to escalate currency debasement and of interest rates to rise
sharply with sharp inflation combined to reduce the prosperity of the savings and loan industry, now structured more to
produce extra profit when much went wrong. As interest rose, even associations holding only high‐grade, long‐term,
fixed‐rate mortgages suffered large losses. Most gamier associations became hopelessly insolvent.



(5) In this new high‐interest‐rate environment, it proved impossible for most associations to "grow their way"
out of trouble. Suddenly, the former bank and association duopoly faced new competition from ‘ money market funds’
that paid higher interest and also provided check‐writing privileges, as well as from U.S. Treasury obligations that were
more conveniently available. Not only could deposits not be increased; they could not be kepi from shrinking.

(6) To prevent continuation of deposit outflows, which then tended to cripple housing, legislators decontrolled
interest rates on all savings accounts. Next, after an irrational delay, the legislators allowed housing lending at interest
rates that fluctuated with the market, a wise practice long standard in England. Even so, many associations remained
insolvent ‘basket cases,’ because interest rates that had ratcheted upward on liabilities were matched against fixed and
outdated rates on assets. Less impaired but still solvent associations had difficulty maintaining adequate equity capital
without the ‘edge’ possessed by the industry in its early years.

(7) In this period of trouble it also seemed logical to Congress and state legislatures, responding to non‐apposite
use of ‘free‐market’ labels and requests from savings and loan operators, to try to relieve the financial pressure by
‘helping’ associations so that they could attempt to widen ‘spreads’ by engaging in much more risky and difficult‐to‐
manage deployments of assets that promised high yields if everything worked right. Deposit insurance was retained.

(8) But the coexistence of deposit insurance, liberalized asset deployment rules, and uncontrolled rates of
interest which could be paid to savers had terrible consequences. The new system (despite minor impediments from
some new anti‐growth rules) enabled almost any association, even if small and remote and run by a crook or fool, to
expand fast and almost without limit. When any association could use the government’s credit and also promise to pay
as high an interest rate as was required to bring in any desired amount of savings, the only remaining limitation on size
was the requirement that a small percentage of savings be matched with net worth. This was not much of a problem for
growth‐minded associations. The government, accommodatingly, reduced the percentage of net worth required. And
when, after this help, growth was so great that more net worth was required to meet the relaxed general standard, such
net worth could easily be provided, on paper, for a long time during expansion. After all, it is child's play to make any
bank or savings and loan association report high profits for a while, thereby rapidly augmenting reported net worth, by
making loans (or other asset deployments) providing both (i) high initial interest or profit accruals and (ii) probably high
ultimate but delayed losses caused by the risks assumed. There are always real estate operators willing to sign any sort
of promise or make any sort of protection in exchange for cash. The real estate crowd is notoriously optimistic and also
includes a significant fraction of people like those who caused Mark Twain to define a mine as ‘a hole in the ground
owned by a liar.’ Also, good short‐term results are often available, in modern times, from merely committing money to
sound borrowers for a very long time at a fixed rate, thus substituting lethal risk from interest rate change for lethal risk
imposed by bad credit quality. Using one or more of the short‐term, high‐profit‐reporting strategies, many minor
associations soon grew to gargantuan size, often paying stockbrokers (and other brokers) commissions to bring in the
massive amounts of deposits desired. The practice of using brokers to gain deposits had a high correlation with later
insolvencies.

(9) The new system included a ‘runaway‐feedback mode,’ exactly what every wise engineer or businessman
Iearns to dread. It could and did entice into inappropriate conduct not only those always prone to bad behavior but also
some associations that had formerly been admirable but were now suffering from bad luck, Once you were a loser and
insolvent, for any reason, and very likely doomed, the system still granted you an opportunity to risk as much you
wished of the government's money (your money was gone) in some massive gamble, on interest rates or business
outcome, that had a chance of returning you to health. And, if the first gamble didn't work, you could always ‘double
up.’ Such were the ‘parlay’ possibilities for losers.

The losers' ‘parlays’ were, quite predictably, made much quicker to arrange and much grander in scope by the
availability of brokers who were paid to solicit government‐insured deposits at above‐normal interest rate, (not a hard


sale). The result was right out of Alice in Wonderland. For perhaps the first time in the history of regulation of deposit‐
taking institutions, the government (in the wry words of John Liscio of Barron's was creating widespread ‘runs of money
into small problem institutions and in the practices turning them into big problem institutions. "

For initial winners, shrewd or lucky in making risky investments, the ‘parlay’ possibilities were immensely better. One
instant‐centimillionaire savings‐and‐loan family tried to gild the lily under such winning circumstances. The association
involved proposed payment to a family executive of total compensation pushing $10 million per year. Then, after
government regulators objected, the family satisfied itself with ordinary compensation (including bonus and special
retirement contribution) of a mere $5 million or so. But the reduced ordinary compensation was supplemented by a
lion's share of a huge new ‘incentive’ to pay attention to business. Executives were granted rights to buy at attractive
prices options or other securities of ‘junk bond’ issuers which were available to the association at those attractive prices
only in return for purchase of ‘junk bonds’. (‘Junk bonds’ are bonds with high interest rates and grossly substandard
credit backing that banks are pretty well forbidden to buy under their less permissive regulatory system. In recent years
a large proportion of ‘junk bonds’ were issued to help finance highly leveraged acquisitions and restructurings of
corporations fearing or suffering from ‘raids’ by hostile‐takeover artists. Current practice is for deposit‐insured banks to
finance the most secured portion of massive corporate debt, which portion is maximized to a point which makes bank
regulators sullen and fretful but not mutinous, Then some deposit‐insured associations [and others] take loan positions
so junior to many layers of senior debt [including but not limited to debt to banks] that language is strained when one
calls them ‘loan positions.’ This anomaly in the total regulation of insured institutions is made possible [along with many
other anomalies] by the division of total regulation into four systems [state and federal systems for both associations
and banks] with some system, further subdivided to provide additional Balkanization.)

Such extraordinary success, in turn, had runaway‐feedback possibilities of its own as examples of ‘parlayed’ success
became more widely known and envied, an enlightenment aided by brokers earning commissions or ‘spreads’ by selling
risky investments. In many cases, the end of the rapidly spreading winner's ‘parlay’ game has not yet come. All we know
is that the early phases look like many a speculative bubble which, in due course, was followed by a big bust.

There were other important consequences of the ‘parlay’ games made possible by coexistence of decontrol and deposit
insurance. The high interest rates promised by associations trying to ‘grow their way’ out of trouble, or bent on instant‐
centimillionaire glory, tended to ‘bid up’ the prices paid for savings by less ambitious associations in the would‐be‐
conservative category. These institutions were therefore almost forced to consider high‐rate, high‐risk assets, so that
they might have some chance of obtaining a moderate margin over costs. And thus was born the suggestion of a new
sort of Gresham's law for deposit‐insured, unlimited‐interest‐rate banking: ‘Bad lending drives out good.’

The basic problem underlying this new form of Gresham's law may be impossible to solve, given the probable legislative
premises that virtually unlimited deposit insurance, uncontrolled interest rates, wide discretion in deploying assets, and
long grace periods when trouble comes, are each sacred. The problem is grounded deep in the nature of things, in the
principle that in a complex system you can never ‘do merely one thing.’ When one variable is maximized other variables
often get minimized in an undesired way. In this case in making money ultra‐easy for everyone to get and invest in any
amount and way desired, thus maximizing the availability of investable money, Congress changed the savings and loan
system in a way that made it harder for associations to reloan the money safely at interest rates that covered costs.
Congress thus minimized the opportunities for earning profits safely. As Garrett Hardin, the biologist, (or perhaps
George Stigler, the economist) might say: ‘How could it be otherwise?’ At any rate, the result as we observe it seems to
be, roughly, that every form of savings and loan operation that is safe and simple, so that ordinary executives can
manage it, avoiding both all net interest‐rate‐change risk and all net credit risk, will provide no net profit. Therefore
every association that wishes to continue to exist is forced to either to be remarkably prescient or to endure some
combination of net credit risk and net interest‐rate‐change risk. This, in turn, makes normal earnings at strong
associations like those of an earthquake insurer in a year when there is no earthquake. (Remember, upward fluctuation,


in interest rates on modern home loans are typically ‘capped’ a mere 2 ½ percentage points over the mortgage interest
rate prevailing when the loans were made.) Also, weak associations, guided by the less able, less honest, or less lucky,
after exhausting shareholders’ equity, tend to cause big losses to the government agency which insures savings
accounts. These losses may exceed resources provided by deposit‐insurance premiums.

Indeed, a government agency that tries to depend on 100% of its thinly capitalized deposit‐insurance patrons being of
above‐average ability in unrestricted asset management, unrestricted scale, would be ‘bonkers’ not to expect large
insurance losses. The system we now have is not ‘free market’ economics. It is non‐economics.

[At this point it is logical to inquire: If the foregoing reasoning is correct, why doesn't it apply to banks and why is the
FDIC, which insures bank deposits, now in so much better shape than FSLIC? We think the answers are (i) that the
fundamental reasoning does apply to banks, and we note that irresponsible bank lending, bank losses and FDIC losses all
escalated dramatically after the installation of unlimited interest rates in a banking system already containing deposit
insurance, and (Ii) that the FDIC losses are, so far, lower than FSLIC losses for reasons including the following:

a) the profit‐shortage pressure has been lower at banks because of favorable momentum effects
from the past particularly including the banks' long monopoly in checking accounts, difficulties
faced by would‐be new entrants into banking, and traditional bank avoidance, through
continuous repricing of loans, of most risk from interest rate change; and
b) there is much tougher regulation, including better domestic‐asset‐quality controls, under the
bank regulatory apparatus.

The second factor is particularly important. Tougher regulation clearly limits damage to the deposit‐insurer. Indeed, if
the toughness of bank regulation could be doubled and redoubled, so that it closed banks summarily when liquidating
value of equity was impaired but not exhausted, like the clearing system of a stock or commodity exchange, little would
remain of expectancy of deposit‐insurer loss from idiosyncratic high risk taking. It does not follow, however, that banks,
even under such toughened regulation, would refrain from forms of high risk taking which became so conventional that
trouble, if came, would sink everyone at once. Under such circumstances, the regulated have a tendency to appraise
regulatory threat as a paper tiger. Banking institutions (perhaps wisely) believe that the regulator which must close all
banks will close none. Something like this has already occurred with respect to unwise foreign lending, where the
regulatory response would, very likely, have been much tougher if only one big bank had been involved. Instead, with
virtually all big banks threatened by huge holdings of dubious foreign loans, bank regulators are now much tougher on
domestic loans worth 70¢ on the dollar than on foreign loans worth 40C on the dollar.

(10) All of the foregoing happened to coincide with a general nationwide increase in wheeler‐dealer activity,
often with a fraud component. In this environment the new system attracted precisely the wrong sort of people into the
savings and loan business as if designed for this purpose. It would have been hard to invent a system more irresponsible
than the one that allowed any half‐plausible group to control a savings and loan charter carrying the right to use the
government’s credit in the prompt attraction of multiple millions, or even billions. This was the financial equivalent of
distributing free machine guns in cocaine alley, and many billions of dollars of fraud losses naturally followed.

(11) There also was a grand collapse in oil prices creating the worst depression since the 1930s in oil‐production‐
dependent areas, which caused many conservative home loans to go into default. Thus, FSLIC would have suffered large
(but probably not lethal) losses even if inflation and legislators had never changed the savings and loan system.

(12) To be sure, even under the new system some possibilities remained for regulators or accountants to stop
some FSLlC hemorrhages earlier than they actually did. But the accountants were selected and paid by the associations
and had professional loyalties to clients as well as concepts. They were understandably loath to enforce death sentences


until the negative aspects of complex situations became abundantly clear. And the regulators were overwhelmed by
horror cases, being suddenly given the working conditions and triage problems of a M.A.S.H. unit, while receiving
modest salaries. Moreover, the medical analogy fits when stretched further, FSLlC was not allowed by Congress to take
much appropriate early corrective action. Just like certain savings and loan managements, Congress did not want to face
the consequences ‐ for instance, increased taxes ‐ of honest bookkeeping and rational action. Indeed, many legislators
intervened directly with the Federal Home Loan Bank system to protect particular fools or crooks, or merely unlucky
savings and loan operators, from unpleasant consequences of insolvency. Thus FSLlC was not only like a doctor working
under M.A.S.H.‐unit conditions but also like such a doctor forbidden to cause new pain, however brief, or make any
blood transfusions (as distinguished from promises regarding future blood transfusions).

(13) The final result for FSLIC could easily be a Ioss of over $100 billion in a continuously unfolding financial mess
that is among the greatest in U.S. history. Even some recently ‘rescued’ associations, with new owners, are likely to
cause new FSLIC losses at some later time ‐ losses caused by the speculative temperaments of new managements
attracted by loose asset‐deployment rules.

While the Federal Home Loan Bank Board failed to prevent the insolvency at FSLIC, that insolvency was probably
unpreventable, given its macroeconomic origin and subsequent conduct of legislators. FSLIC’s ‘rescues,’ although
imperfect, were probably as wise as could be expected under M.A.S.H.‐unit conditions with no new blood available.
There is an O. Henry short story in which God treats as a false arrest the bringing before Him of a miscreant young
woman and sends the Heavenly Policeman back to bring in the real culprit, the neglectful father who raised her wrong.
So also with the FSLIC mess. The important miscreants are not the crooks and fools who are always with us or the
overburdened industry regulators. The real culprits are the ignorant, self‐absorbed industry executives and state and
federal legislators who should have known better than to let the system be crafted as it was. They also should have
acted earlier to correct obvious errors, instead of becoming accessories after the fact.

In retrospect, it is clear that some of the very worst behavior of all, in the years when the FSLIC mess was created, was
that of the United States League of Savings Institutions. The league combined a blind loyalty to silly ideas with a blind
loyalty to member associations ‐ a loyalty which usually treated the admirable and the despicable as if they were the
same. Acting with such ‘loyalty to a fault’, the League was an effective foe of proper regulatory and legislative response.
We are ashamed to report that during the whole period Mutual Savings paid its league dues promptly and voiced little
objection to league conduct. This paragraph is a minor effort at atonement.

By silence we acquiesced wrongly as the League took antisocial position, which it incorrectly believed consistent with
the long‐term Interest of the savings and loans industry. Our future behavior will be a little better. If the league does not
act more responsibly in the future, Mutual Savings will resign.

It does not follow, we think, from FSLICs troubles that federal controllers are likely to ruin Freddie Mac. FSLlC was very
sick from causes outside the regulators' control, whereas Freddie Mac is flourishing. And Congress, better late than
never, is now plainly chary of further loosening, and in fact desires to tighten, asset quality standards in the savings and
loan industry and its regulatory apparatus.

Freddie Mac is now regarded in the mortgage, mortgage‐securities and debt‐issuing markets as a virtually risk‐free
government agency, even though its obligations are not technically backed by the full faith and credit of the United
States. With this enormous advantage, Freddie Mac’s controllers can almost always get socially constructive and
financially rewarding results, provided they refrain from taking significant risk of ruining Freddie Mac’s credit. The
annual dividend to private owners is peanuts, a small fraction of 1%, compared to the financing Freddie Mac provides to
buyer of housing. The need for the dividend's safety and growth disciplines the system in exactly the right way. There is
no reason to change course. Moreover, the right course, involving continued tough credit standards, has been clearly


demonstrated by the recent terrible home loan experience in oil‐production‐dependent areas. Conventionally‐sound
home loans then went sour in massive quantities, despite having been made by wise and honorable lenders to home
buyers with good jobs and loan‐payment histories who made substantial down payments. Such experience reinforces
the margin‐of‐safety principle required of highly leveraged institutions that guarantee credit. Just as bank credit
standards remained sound for a long time after the horrors of the 1930s, home lending standards enforced by Freddie
Mac may remain sound for a Iong time after the good‐home‐loan losses of the 1980s. If so, and if interest‐ rate‐change
risk is scrupulously minimized, Freddie Mac stock could be a good long‐term investment for Mutual Saving.

Our discussion of reasoning regarding investment in Freddie Mac is an anomaly within the Berkshire Hathaway group.
Normally, we do not disclose such reasoning. We fear bad effects on future investment buying or investment selling.
(We also avoid display of our frequent mental inadequacies, but that is not the reason or the policy.) We depart from
usual practice only because we have acquired a full investment position and we do not anticipate an increase in the legal
limit which prevents us from buying more stock of Freddie Mac. Under these conditions, we are aII for disclosure. But
we are not recommending that Wesco shareholders purchase Freddie Mac stock. We never want to encourage Wesco
shareholders to copy Wesco in their own personal accounts.

The first attempt at resolution by the federal government of the FSLIC insolvency will be made when new laws are
enacted in 1989. The new laws will probably contain a combination of elements selected from the following list:

(1) sharp increase in deposit‐insurance premiums payable to FSLIC;

(2) higher equity capital requirements for associations, with no credit for intangibles, and with prompt asset
reduction required when the equity‐capital minimum is breached;

(3) drastic reduction in investment powers to limit risky assets (including ‘junk bonds’), plus close monitoring of
risk‐prone associations;

(4) strict limits on annual growth of savings deposits;

(5) bans on use of brokers to bring in deposits;

(6) tougher accounting standards, including more bans on ‘front‐ending’ into reported income of fees paid in
exchange for long‐term commitments;

(7) tougher, more summary close‐out procedures for associations, including those that are impaired but not
insolvent;

(8) more insulation of regulation and close‐out cases from interference by individual members of Congress;

(9) changes in control of regulation within the federal bureaucracy, aimed at toughening of regulatory' practice,
including more concentration of resources on obvious high‐risk cases;

(10) a moratorium on approvals of new saving and loan charters; and

(11) more override of state law by federal law.

All the foregoing, except sharply higher deposit‐insurance premiums, would clearly tend to reduce future FSLIC losses
and should, as a minimum, be included in any half‐sensible 1989 attempt to fix FSLlC. Payment to FSLIC of sharply higher


deposit‐insurance premiums would provide mixed results. On the one hand, FSLIC would get new revenue to help
discharge liability from foolish insurance practices in the past. On the other hand, it is not clear how much net new
revenue would be available. Sharply higher deposit‐insurance premiums would also increase future FSLlC losses by
increasing pressure on association, to acquire higher‐risk assets promising the higher yields necessary to cover higher
premiums. If deposit‐insurance premiums are increased by ¼% per annum on total liabilities (which could happen) it will
sound trifling and not very threatening to solvency. But associations’ net worth, where it exists, is not owned by the
government and may be withdrawn by its owners from the savings and loan industry. And, ignoring revenue from assets
matching net worth, many associations now look at net profits vs. total liabilities at the rate of ¼% per annum as an
unattainable dream. After all, the associations face aggressive competing institutions which either have lower costs, like
money‐market funds
(which do not pay deposit‐insurance premium), or have more experience in maximizing safe yields, like banks. Starting
from this not‐so‐hot competitive position and seeking not‐so‐obvious ways to stretch yields by ¼% per annum, many
associations would, almost surely, be pressed into significant incremental losses. Others would quit the savings and loan
business because of below‐market returns being earned on shareholders’ equity, and any equity capital withdrawn from
the system would no longer ‘buffer’ FSLIC against losses.

The would‐be FSLlC fixers as they set increased deposit‐insurance premiums will face the same basic question faced by a
keeper of sheep. But, unlike the sheepkeeper, the government lacks knowledge to guide prediction of the point at which
additional closeness of shearing will be contrary to the interests of the shearer. This leaves an important question: When
you don't know for sure what the sheep can stand, how much safety margin do you leave before you set the shears,
shear the whole herd, and send it forth to fare as it will?

The politics of the current scene seem to us to create more wishful thinking than sound thinking, We do not believe that
the legislation adopted in 1989 will be likely to prevent recurrence of big trouble at FSLlC.

First, consider again the record of our modem legislators, the would‐be FSLlC fixers. They started with a system designed
to limit association insolvencies by both:

(1) protecting associations from full competition (a brutal force in a fungible commodity business,
with money being the ultimate fungible commodity) and full taxes; and
(2) requiring associations to deploy assets in a very low‐risk way.

Despite noting that this combination of carrot and stick kept the donkey under reasonable control for a long time, as it
was designed to do after the insolvencies which followed excesses in the 1920s, the modern legislator, actually removed
the stick from the loss‐control system in an attempt to compensate for the loss of the carrot, They also neglected, for a
considerable period after interest rates of liabilities were unleashed, the obvious need to allow floating interest rates on
home loan assets. And they acted, while they did this, as if they preferred to entice new thieves and megalomaniacs into
coverage by federal deposit insurance and also to expand, as fast as possible, the operations of thieves and
megalomaniacs already insured. Then, as FSLlC losses mounted, $10 billion or so at a time, the legislators delayed, and
delayed, while going along with almost every form of foolish, paper‐it‐over expediency. And now, finally, we hear many
cries for scapegoats in the ‘anyone but me’ category. We hear almost no cries for re‐examination of assumptions
(including re‐examination in the form of (i) study of savings and loan systems which have worked better, like England's
and (ii) consideration of alternatives such as forcing the private pension system, a huge savings pool which still possesses
the carrot of tax exemption and can better bear interest rate crunches, to commit a share of assets to home loans,
instead of high‐turnover stock trading and the super‐Ieveraging of corporate America, and {iii) consideration of other
more extreme alternatives which fit modern facts). lnstead, the first proposal, meeting tacit acceptance, is that any
federal fix must qualify for mickey‐mouse, off‐budget accounting which will increase ultimate federal cost. This is not a
fixing record which creates confidence in the fixers.


Second, consider the difficulty of the problem faced. As suggested earlier, that problem may well be a ‘lalapaloosa’
which would not yield to the efforts of fixers much better than those we have. When you mix certain elements in a
certain way you get sulfuric acid, wish it or not, and there are similar ‘impotency principles’ in microeconomic systems.
Under modern conditions it is quite conceivably impossible to create a deposit‐insured savings and loan system,
successful over the long term, which includes all the elements (for instance capped interest rates, for borrowers in long‐
term loans), that a politically sensitive body will want to preserve. Thus the legislative fix attempted in 1989 may be only
a more sophisticated version of the attempt of the rustic legislator, aiming at facilitation of education, who proposed a
law rounding Pi to an even three. The derision of this, example is aimed not so much at our legislators as at the normal
working of the human mind. In the presence of complexity the ability to unlearn a once successful idea is seldom found.
Max Planck, the Nobel laureate, noted that even in physics, wherein the ablest of mankind are sworn as their highest
duty to improve ideas to fit facts, you never really changed the minds of most of the old professors. Instead, the wide
acceptance of correct new ideas had to wait for new professors who had less to unlearn.

Our views are that the problem faced is hard and that everyone has ‘unlearning difficulty.’ These views, of course, may
have been shaped by our own thinking record. If the problem is not difficult, and if unlearning is easy, we would have
difficulty excusing ourselves for the clobbering Mutual Savings took from interest rate change in the early 1980s.

If our predictions are right, Wesco shareholders can pretty well count on Mutual Savings being harmed not only in 1989
but also at a second and later time. In each case we will face both new deposit‐insurance costs and reductions of
investment powers caused by insolvencies of a type Mutual Savings never got near.

As legislature changes are made Mutual Savings is likely to be hurt by all three of the following:

(1) wise changes in laws;

(2) unwise changes caused by the problems being more difficult than contentious legislative bodies are able
or willing to think through; and

(3) unwise changes caused by vindictive legislative reaction to the size of the mess.

We fear changes in the last category because we so often see verifications of the iron prediction (roughly recalled) of the
Victorian prime minister: ‘Those who will not face improvements because they are changes will face changes that are
not improvements.’

At least as we operate it, Mutual Savings, ex its investment in Freddie Mac, continues to have mediocre long‐term
prospects.”
- WSC 1988 Letter

“\When Wesco's annual report went to press last year, Congress was midcourse in considering revisions to the savings
and loan laws. But it was clear that associations were shortly to be ‘re‐regulated’ into some mode Iess likely to cause a
fresh torrent of deposit‐insurance losses, borne by taxpayers. Provoking that legislative action was a previous torrent of
losses which now seems likely to exceed S150 billion. These losses were caused by a combination (I) competitive
pressure on the ‘spread’ between interest paid and interest received put on associations and banks when federal
deposit Insurance is provided to entities free to pay any interest rates they wish in order to attract deposits, (2) loose
asset deployment rules for associations, (3) admission and retention of crooks and fools as managers of associations
without regulatory objection, (4) general real estate calamities in certain big regions, and (5) continuous irresponsible


protection and enhancement of unsoundness by the savings and loan lobby and certain members of Congress beholden
to the most despicable savings and loan operators.

The new laws, under the acronym FIRREA, were composed and enacted with a speed caused by congressional
indignation, (A recent example of such indignation, employing remarkable comparisons, is provided by the words of
Congressman Jim Leach: ‘[If certain allegations are true] Charles Keating is a financiopath of obscene proportions ‐ the
Reverend Jim Bakker of American commerce, given a license to steal by a bank board headed by the Neville Chamberlain
of regulation – a cheerleader who saw little evil and thus spoke little truth.’)

Mutual Savings modestly contributed to tough legislative action by resigning from the U.S. League of Savings
institutions, using a letter of resignation which drew widespread media attention despite its understated criticism. A
copy of this letter of resignation is appended at the end of this letter to shareholders.

Mutual Savings, desiring to act responsibly, supported virtually all the law revisions made by FIRREA, even though many
of them will hurt Mutual Savings' profits.

For example:

(1) In stages, by July 1, 1994, Mutual Savings (and its service corporation subsidiary) must dispose of:

(a) High‐quality public utility preferred stocks, having lax‐advantaged dividend rate averaging about
10.8% per annum, with a carrying value of S41.4 million at yearend 1989, and a market value then higher by
about $8.7 million; and

(b) High‐quality convertible preferred stock of Salomon Inc, bearing a tax‐advantaged dividend rate of
9% per annum, with a carrying value of $26 million, believed to be below the amount which could be realized in
the event of sale.

(2) In stages, by the same date, July 1, 1994, Mutual Savings must write down to zero, in computing net worth
for regulatory purposes, its 2,400,000 shares of Freddie Mac, which had a carrying value of $71.7 million at yearend
1989, and, as reported above, a market value then higher by about S89.4 million.

(3) All new asset commitments, fitting Mutual Savings' proclivities and tax position, are pretty well restricted to
(a) housing loans (including indirect loans in the form of mortgage‐backed securities and (b) debt instruments of the U.S.
Government or its agencies.

(4) In stages, designed to create compliance during a two‐year period commencing July 1, 1991, Mutual savings
will have to increase ‘qualified thrift lender’ assets by 10 percentage points to a 70%‐of‐assets level, using a new and
more limited definition of such ‘qualified thrift lender" assets which, to our surprise, does not include Freddie Mac stock.
If the new test had been in full effect at December 31, 1989, Mutual Savings would have complied by disposing of about
S74 million of non‐home‐loan assets (including some cash equivalents) and placing the proceeds in home loans
(including indirect home loans in the form of short‐term mortgage‐backed securities).

(5) Deposit‐insurance premiums have been increased. Short term, Mutual Savings is protected by credits of a
nonrecurring nature. But by the mid 1990s the new premium rates will reduce Mutual Savings' annual earning power by
about $200,000 from the level which would have occurred if it were still paying at the O.083%‐of‐deposits rate which
was in effect for years, instead of the new rate of O.23%. The adverse effect of the higher deposit insurance cost, on
percentage return on shareholders' equity is much lower at Mutual Savings than at almost all other associations, which


suffer substantially. The cause of Mutual Savings advantage is its much larger percentage of equity, compared to
deposits. This is a ‘one‐time' advantage related to one ratio; on an incremental dollar of savings Mutual Savings faces
the same damage as everyone else.

These combined effects will reduce Mutual Savings’ normal earning power. While conservatively operated, Mutual
Savings has been scrambling through recent years in its own way, obtaining a modest success made possible largely by
the wide variety of asset deployment options available under pre‐FIRREA law. Consequently, FIRREA will adversely affect
Mutual Savings, however wise the new restrictions, public needs considered. Nevertheless, it is probable that Mutual
Savings' normal earning power will not be much reduced in 1990 and 1991.

We predict this deferment of decline in normal earnings because:

(1) FIRREA's asset‐mix effects are phased in, subject to wide regulatory discretion; and

(2) We anticipate that regulators will be wise enough to exercise their discretion to allow extra‐strong
associations, with easy‐to‐sell assets, the same forbearance which will be granted to weak associations with hard‐to‐sell
assets.

If we prove wrong in our prediction about regulators, Mutual Savings' wisest alternative will probably be withdrawal
from the savings and loan business and the related obligation to pay deposit‐insurance premiums.

(1) During the next few years, Mutual Savings is almost certain to make a pre‐tax profit of a nonrecurring nature
as it disposes of the Santa Barbara property It acquired through foreclosure in 1966; and

(2) Mutual Savings will retain prospects for gain from its Freddie Mac stock if, as anticipated, Freddie Mac pays
ever‐higher dividends and the price of the stock also rises.

Long term, Mutual Savings hopes to find within the savings and loan business some constructive, continuing role which
is not dependent on either of the foregoing anticipated near‐term prospects. Until the right long‐term role is found, our
policy is simply to ‘stagger through.’

The FIRREA law revision, while greatly improving the savings and loan system from the taxpayers' point of view, took an
approach which can fairly be described as ‘all stick and no carrot.’ This is no way to create felicity for the donkey, but we
deserve our share of the beating because we were previously so passive in the presence of obvious error and evil.
Moreover, the safety‐enhancing features of the law revision fell short in one fundamental respect which leaves profits
under pressure: banks and associations remain free, within wide Iimits, to attract government‐insured deposits at any
interest rate they wish, while they must resell the ultimate fungible commodity, the use of money, into a brutally
competitive market. The resulting squeeze on interest‐rate ‘spread’ safely attainable, combined with normal
competitive disadvantages of associations, leaves the average well‐run association with a likely future which should not
excite its owners.

The normal competitive disadvantages of the average association, compared with the average bank, now include the
following: higher deposit‐insurance costs, more confusing new regulation, and less experience and momentum in
various important remunerative activities. As a result, even a superbly run conventional association, like the owned by
H. F. Ahmanson & Co., sells in the stock market at a much lower price‐to‐book‐value ratio than a superbly run bank. And
the average savings and loan branch office probably now offers more incremental value to an experienced bank than it
provides to its present owner.



Moreover, the average association does not now compete only with banks. Also gathering ‘deposits’ are the money‐
market funds which:

(1) pay no deposit‐insurance premiums, saving 0.23% of deposits each year, compared to associations;

(2) are required to employ exactly no capital from profit‐earning proprietors (‘management companies’ in fund
parlance), while capital requirements for associations have been raised;

(3) have lower‐cost regulation (from an understaffed SEC) than associations;

(4) maintain no expensive branch offices, although they provide check‐writing privileges and accept frequent
deposits, using fast, low‐cost systems which are better adapted in many ways to the new order than the systems of the
average association; and,

(5) as a result of all the foregoing advantages, have total annual costs (before proprietors' profits), as a
percentage of assets, which are more than 50% lower than annual costs of the most efficient association.

Thus, the natural ‘almost‐no‐brainer,’ non‐home‐mortgage, deposit‐gathering niche is now occupied by a competing,
better‐adapted new species. This leaves associations in roughly the position of the original rabbit‐like mammals which
lost ecological market share when the rabbit was introduced into Australia. The adjustable‐home‐mortgage niche may
now provide a decent home for some large, extremely efficient loan originators like Home Savings, but, as we seem to
say each year, we have not yet found for Mutual Savings a permanent lending niche which is attractive, as distinguished
from bearable. In the mortgage business we thus constantly confirm Samuel Johnson’s observation that: ‘Life is a state
in which much is to be endured and little to be enjoyed.’

Left in place in the revised savings and loan system is a significant (although much reduced) structural risk for the federal
government as deposit insurer. Associations retain a considerable residue of temptation to act imprudently. The
temptation, in response to the profit‐pressure which is a natural consequence of the structure of the system, is the same
one which caused troubles in the past: the temptation to seek an acceptable interest rate ‘spread,’ not available any
other way, by bearing undue risk from either (1) mismatched maturities of loans and deposits or (2) losses through
defaults of a gamier class of borrowers willing to promise extra‐high interest rates. It is almost impossible to have asset
deployment controls so tough that a bank or association can't look good for a while (and give the appearance of
justifying higher compensation of management) as it takes risks which will in due course destroy its owners’ equity and
also cause deposit insurance losses. The ‘all stick’ method of control is much better than nothing, but it is far from ideal
when it is the exclusive method for prevention of losses borne by the deposit insurer. In contrast, when, long ago, the
federal deposit insurer had low losses the savings and loan system used both carrots and stick, so that the average
savings and loan operator could do well without exceptional luck or ability. (The carrots were very low income taxation
plus interest‐rate controls which reduced cost of holding deposits while giving an advantage over banks in attracting
deposits.) We think the present, revised system continues to impose more risk than taxpayers should bear, with high
deposit‐insurance costs contributing to the risk as well as compensating for it.

Housing is now less assisted than before by the existence of savings and loan associations. An example of the drift away
from housing assistance is provided by FIRREA's new restriction preventing large loans to any one house builder. The
new requirement is that an association loan no more than 15% of owners' equity to one customer with exceptions
permitted up to 30% for adequately capitalized associations with good records. The new requirement would have
greatly reduced the profits and housing contributions of Mutual Savings in its early days when it concentrated resources
in development loans while trusting only a few housebuilders. And the new requirement now has the same general
effect. It will significantly restrict availability of house‐building loans in many regions of the country. This result


demonstrates the impossibility of revising a complex system without undesired ‘by‐product’ effects. The first law of
ecology and the first law of legislation are one and the same: ‘You can never do merely one thing.’

Of course, a ‘by‐product’ of law revision sometimes helps, instead of hurts, some participant in a market. New ‘risk‐
based’ capital requirements under FIRREA have such an effect, as they give associations new incentives to transfer
monies they otherwise would have earned to Freddie Mac, through exchange of mortgages for credit‐enhanced,
mortgage‐backed securities. (Although the securities then provide less income, they help satisfy regulatory capital
requirements, because the securities require less owners' equity to hold.) This income‐transfer effect should help
Mutual Savings, through its large shareholding position in Freddie Mac.”
‐ WSC 1989 Letter

“The banking business is no favorite of ours. When assets are twenty times equity ‐ a common ratio in this industry ‐
mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the
rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last
year when discussing the "institutional imperative:" the tendency of executives to mindlessly imitate the behavior of
their peers, no matter how foolish it may be to do so. In their lending, many bankers played follow‐the‐leader with
lemming‐like zeal; now they are experiencing a lemming‐like fate.
Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in
purchasing shares of a poorly‐managed bank at a "cheap" price. Instead, our only interest is in buying into well‐managed
banks at fair prices.”
- BRK 1990 Letter

“The present situation, with its many insolvent and almost‐insolvent institutions, is such a mess that further legislation
seems inevitable. We can predict neither the changes, nor whether the changes will make matters better or worse. But
we do have some opinions. These opinions are almost totally out of step with current thinking in academia, among
government officials, among banking executives and, most of all, among banking lobbyists. Despite this
unconventionality, our opinions are now given to Wesco shareholders because they may provide some insight into our
institutional nature and likely future action. We also hope, but only slightly, that the opinions, set forth below, will have
a wider, civic utility.
First, let us turn to banking, after which we will consider the savings and loan business.
The sum of all deposit‐insurance losses in banking will probably be much lower than the $200 billion or so recently
caused by savings and loan associations. But there are a lot of very sick banks, and deposit‐insurance losses are sure to
be large. Moreover, even if there had been no such losses, there would be much to regret in the nature of our modern
banks as they have increasingly emphasized lending for consumption (even lending at 20% for vacations in Tahiti) and
lending to financial promoters and real estate developers. We have come a long way from an ideal emphasizing the
banker's provision, to both big and small businesses, of what Pierre DuPont provided to General Motors. Plainly, we
have a two‐forked banking problem, with a questionable shift in priorities accompanying rising insolvencies.
Let us attempt to diagnose the causes of our problem. By and large, our problem did not come because banks couldn't
branch across state lines, sell insurance, or underwrite corporate securities. Instead, it came because banks "reached"
for higher yields on assets as they faced higher interest costs that came from (1) decontrol of interest rates paid by
insured institutions plus (2) pressure from new competitors, including money‐market funds possessing a large
competitive edge.


Exactly how great is the money‐market funds' competitive edge? To see, compare the average heavily regulated bank,
paying high deposit‐insurance premiums, with what has been created in an extreme form of uninsured money‐market
fund. In the fiscal year ended June 30, 1990 one such $4 billion fund (The Common Fund for Short Term Investments) did
all of the following:
(1) kept its assets in liquid short‐term obligations of the U.S. government and other creditworthy entities;
(2) furnished efficient checkwriting privileges and wire transfer service to its depositors;
(3) kept its total operating costs under two‐tenths of 1% of deposits per annum as it avoided costs of maintaining branch
offices, deposit insurance, etc.;
(4) furnished no capital of its own as a cushion supporting promises to depositors; and
(5) paid very competitive rates on its interest‐bearing accounts, as a result of which it grew 27% in size.
This example demonstrates the raw competitive power of keeping things simple. Indeed, in this example all costs
combined have been controlled so as to be roughly equal to what the average local bank pays for federal deposit
insurance alone. We are not dealing with some minor competitive advantage. The new competition is a juggernaut.
How important has the new competitor become? Naturally, the competitor has taken a huge bite out of the market
formerly served by banks (and savings and loan associations) burdened by much higher costs. How could it be
otherwise? Here is a dramatic graph reprinted from what is surely among the best magazines in the world, England's The
Economist:
[GRAPH OMITTED: "From nowhere, Amounts outstanding, December, Source: Federal Reserve"]
The money‐market funds are, in substance, "non‐bank" banks, furnishing interest‐bearing savings and checking
accounts. And, by an odd stroke of good fortune, their light regulation by an overburdened SEC has turned out to be
more advantageous than no regulation at all. The rules of the SEC force investment largely confined to reasonably safe
and liquid categories. This has spawned simple operations with very low costs.
The simple, low‐cost(*), cream‐the‐market approach thus taken (or stumbled into) often works well in business. For
instance, look at (1) GEICO, a hugely successful auto insurer almost 50% owned by Wesco's parent corporation or (2)
various membership warehouse clubs, in the form invented by Sol Price, which are now clobbering retailing competitors
as they get total "markup" under 10%. And this approach, as would be expected, is working like gangbusters for the
money‐market funds, as you see in the graph from The Economist.
What were the effects on banks as these new and successful, low‐cost competitors took more and more of the market
while, at the same time, each bank's banking competitors could bid as they wished for funds, using the government's
credit? Well, naturally, almost every bank, being inherently saddled with much higher costs, and not wanting to go out
of business, tried to get higher contractual interest rates on its loans. And this caused greater emphasis on loans for
consumption and loans to financial promoters and real estate developers. Indeed, many of our most decisive bankers,
quite logically, stopped trying to make loans to their most creditworthy customers, accepting the disappearance of any
important linkage between our best banks and our best businesses. The banks had been forced into an entirely different
market niche (which already had some occupants): high‐interest‐rate lending.


And what can be expected when virtually all banks become specialists in high‐interest‐rate lending? It is hard to know
for sure, because, throughout the past, high‐interest‐rate lending was hard to fund since it came from skeptical sources,
instead of from government‐insured deposits. Really large‐scale, high‐interest‐rate lending is a comparatively recent
phenomenon, made possible by governmental support in the form of deposit insurance used by banks with altered
natures. But such experience as exists gives a likely answer: many bank insolvencies will come. Just as the simple, low‐
cost, cream‐the‐market strategy is a common business winner, the opposite strategy, involving high costs and high
prices, is a common loser. High interest rate lending as a field has usually provided (1) some winners and (2) many
casualties, often coming in bunches after periods of "follow‐the‐leader" asset‐quality debasement. (Remember the
widespread disasters in R.E.I.T. lending.) And the past bad experience should naturally worsen as the high‐interest‐rate
lending field both expands and becomes overcrowded, driven by governmental support.
We are not alone in our diagnosis. Here is an excerpt from a recent Wall Street Journal editorial: "When more efficient,
uninsured and less regulated financial institutions creamed off profitable lines of business, the [Bank of New England]
was left concentrated in commercial real estate. This artificially diverted money into Boston's building boom, which
inevitably became a bust."
(*) Total costs are low, even though they include fees containing a substantial profit element that are paid by the "non‐
bank" banks to the "non‐independent" independent managing companies employed in conformity with mutual fund
practice. While Lewis Carroll might have liked the consistency of the nomenclature just used, it is not clear that it befits a
banking system. "Pretending" under misleading labels is not a good idea in banks. All "pretending" habits tend to spread.
Granting the presence of perverse incentives, what are the operating mechanics that cause widespread bad loans
(where the higher interest rates do not adequately cover increased risk of loss) under our present system? After all, the
bad lending, while it has a surface plausibility to bankers under cost pressure, is, by definition, not rational, at least for
the lending banks and the wider civilization. How then does bad lending occur so often?
It occurs (partly) because there are predictable irrationalities among people as social animals. It is now pretty clear (in
experimental social psychology) that people on the horns of a dilemma, which is where our system has placed our
bankers, are extra likely to react unwisely to the example of other peoples' conduct, now widely called "social proof". So,
once some banker has apparently (but not really) solved his cost‐pressure problem by unwise lending, a considerable
amount of imitative "crowd folly", relying on the "social proof", is the natural consequence. Additional massive irrational
lending is caused by "reinforcement" of foolish behavior, caused by unwise accounting convention in a manner
discussed later in this letter. It is hard to be wise when the messages which drive you are wrong messages provided by a
mal‐designed system.
In chemistry, if you mix items that explode in combination, you always get in trouble until you learn not to allow the
mixture. So also, in the American banking system. To us, a lot of foolish, unproductive lending and many bank
insolvencies are the natural consequences, given existing American banking culture, of the combination of the following
two elements alone:
(1) virtually unlimited deposit insurance; and
(2) uncontrolled interest rates on insured deposits.
These two elements combine to create a Gresham's law effect, in which "bad lending tends to drive out good." Then, if
factor (3) below is added to an already unsound combination, we think deposit‐insurance troubles are sure to be further
expanded ‐‐ and not by a small amount:


(3) relatively unregulated, non‐insured, low‐cost "non‐bank" banks.
Moreover, when the government starts suffering big deposit‐insurance losses, if it continuously responds (in a natural,
unthinking reaction) by raising deposit‐insurance prices, we think it creates a "runaway‐feedback" mode and makes its
problems worse. This happens because the government, by adding even more cost pressure on banks, increases the
cause of the troubles it is trying to cure. The price‐raising "cure" is the equivalent of trying to extinguish a fire with
kerosene.
Many eminent "experts" would not agree with our notions about systemic irresponsibility from combining (1) "free‐
market" pricing of interest rates with (2) government guarantees of payment. If many eminent "experts" are wrong, how
could this happen? Our explanation is that the "experts" are over‐charmed with an admirable, powerful, predictive
model, coming down from Adam Smith. Those discretionary interest rates on deposits have a "free‐market" image,
making it easy to conclude, automatically, that the discretionary rates, like other freemarket processes, must be good.
Indeed, they are appraised as remaining good even when combined with governmental deposit insurance, a radical non‐
free‐market element.
Such illogical thinking, displays the standard folly bedeviling the "expert" role in any soft science: one tends to use only
models from one's own segment of a discipline, ignoring or underweighing others. Furthermore, the more powerful and
useful is any model, the more error it tends to produce through overconfident misuse.
This brings to mind Ben Graham's paradoxical observation that good ideas cause more investment mischief than bad
ideas. He had it right. It is so easy for us all to push a really good idea to wretched excess, as in the case of the Florida
land bubble or the "nifty fifty" corporate stocks. Then mix in a little "social proof" (from other experts), and brains
(including ours) often turn to mush. It would be nice if great old models never tricked us, but, alas, "some dreams are
not to be." Even Einstein got tricked in his later years.
We may be right or wrong. But, if we are right, if there are deep, structural faults in the American banking system, it
follows that merely giving banks the right to branch across state lines, to sell insurance, or to enter investment banking
(or all of the above) is not going to end our troubles.
Instead, a good long‐term fix can come only after the government considers more extreme modifications in the system,
each of which has powerful, vocal opponents. What are the more extreme modifications to consider? We think the list
includes:
(1) greatly reducing deposit insurance;
(2) eliminating money‐market funds;
(3) bringing back some form of controls on interest paid on insured deposits;
(4) intensifying regulatory control of bank lending in an attempt to reduce loan losses;
(5) forcing more conservative accounting covering bank lending;
(6) forcing weak banks into other hands before the weak banks become insolvent; and
(7) forcing insolvent banks into competing local banks, or entirely out of business, instead of into strong, out‐of‐state
banks.


Let us next attempt a brief discussion of the merits and/or political prospects of each of these seven government
options.
Option (1): greatly reducing deposit insurance:
To many people, remembering former banking panics, this option, adopted fully, seems like trying to solve the
overcrowding problem by bringing back cholera. Accordingly, proponents of this option typically would limit its effects
by (1) bringing back bank "runs" only for small banks (big banks, regardless of law, are "too big to fail" in all advanced
countries) and (2) bringing back deposit losses only to some rich depositors. Because voters don't like bank "runs" of any
size, and small banks don't like discrimination, it seems unlikely that reductions in deposit insurance are going to be
made on a scale that solves the structural defect problem. Conceivably, "brokered" deposits could be removed from
insurance coverage, in a move driven by legislative remembrance of many abuses involving stockbroker‐assisted
financing of despicable insured institutions. (Many stockbrokers could easily see that the insured certificates of deposit
they were paid to sell were issued by institutions managed by knaves and fools, presiding over piles of junk loans and
junk securities. The stockbrokers thus knew, or should have known, that their government was being robbed. To sell
certificates under such conditions was a lot like finding currency in a post office bag and deciding it was ethical to keep
it.)
Option (2): eliminating the money‐market funds:
This option is almost never discussed. This seems peculiar. The money‐market funds came into being without public
policy input when some clever person combined (1) mutual fund status under the S.E.C. with (2) purchase, under
subcontract, of services from a bank. What was created was, in essence, a virtually unregulated, uninsured bank
furnishing interest‐bearing savings and checking accounts. The creation of such entities would probably not have been
authorized if new legislation had been necessary. Where else do we have virtually identical regulated and unregulated
entities operating on the same scale, side by side? If new legislation had been needed, the following questions might
have been raised:
(1) What do money‐market funds do for "community" lending, lifetime services to the elderly, etc.?
(2) Are they fair to existing institutions?
(3) Won't the new "non‐bank" banks make it harder for the Federal Reserve System to render constructive economic
service?
(4) Since the public is already on the hook as guarantor of solvency of existing institutions, is it wise for the guarantor to
risk losses from allowing uninsured, cream‐the‐market, more efficient operators to add to the competition? (This
question would not be hard to answer in a private setting. If you were guarantor of all obligations of your brother‐in‐
law's hamburger joint, you would consider it very foolish to allow McDonald's to commence operations by his side when
you possessed the ability to prevent it.)
(5) Considering all of the above (and more), are the money‐market funds in the long‐term interest of the soundness and
service of the total banking system?
These questions are still good questions. But possession is strength under law. The money‐market genie is now out of
the bottle. And, considering his size, it would be hard to put him back. The prospects of rebottling are plainly remote.
Option (3): bringing back some form of controls on interest paid on insured deposits:


This option, too, is now seldom discussed. Again, this seems peculiar. It is among the first things you or I would consider
if we had to guarantee all obligations of that hamburger joint owned by a brother‐in‐law. We would no more guarantee
an 11% obligation for him, when we could easily borrow at 8%, than we would burn currency in the fireplace. In fact, we
would suspect dishonorable "monkey business" if an 11% transaction occurred.
One reason for present lack of legislative interest in interest‐rate controls lies in the knowledge that a former version of
such controls constricted housing credit when interest rates rose to high levels. No one now seems interested in trying
to develop new controls, more flexible in form and practice that would avoid former defects. Nor is anyone much
interested in the success the Japanese (or the United States) had during a long period of control of interest rates paid by
banks. The interest‐rate‐control option, at the moment, seems dead.
Option (4): intensifying regulatory control of bank lending in an attempt to reduce loan losses:
This option is already being exercised ‐‐ erratically ‐‐ with effects both good and bad. It certainly has successful
counterparts in non‐banking businesses. For instance, take McDonald's franchised restaurants. If you want to use the
McDonald's authenticating name and arches on your restaurant, you have to operate in a very limited, foolproof way.
Moreover, the McDonald's approach once worked in banking. When deposit insurance first came in, and long thereafter,
most insured banks operated in simple, sound fashion, often through ill‐paid employees. But, based on all recent
precedents, the government won't now act like McDonald's, or itself in a former era. (If it wished to do that, it might
now give deposit insurance to all the simple, sound money‐market funds, lending to big business through purchases of
commercial paper, and take deposit insurance away from all the banks and savings and loan associations) Government,
instead, will probably take the more limited approach of concurrently: (1) leaving banking over‐stressed by competition,
(2) leaving banking very complicated, (3) trying to prevent problems by writing massive, hard‐to‐understand regulations
that create more work for lawyers, and then (4) monitoring bank operations through overburdened civil servants. These
limited remedies may be better than nothing, but their prospects for causing a real banking fix seem poor. It is almost a
general rule of American life that, when incentives are all wrong, controls (even criminal‐law controls) can't fix our
troubles. We can expect limited good effects from Option 4 and the continuation of important, basic problems.
Option (5): forcing more conservative accounting covering bank lending:
Bank accounting is a hot current topic, but conservatism is not the goal. Everyone is wondering how much to delay loan
write‐offs, when loans go sour, so as not to over‐correct weak banks. We are not going to enter the lists on that
problem.
The almost‐never‐discussed problem that interests us is that presented by newly made loans, bearing high interest
rates, that under current bank accounting tend to be treated as "born good." The result is that all interest accrued, and
sometimes some up‐front fees, are treated as fully earned, even though the final outcome of the whole loan transaction
is far from clear. To us, this is counterproductive accounting, even though we use it ourselves when pushed by
convention.
We think current accounting for many high‐interest‐rate loans has terrible consequences in the banking system. In
essence, it "front ends" into reported income revenues that would have been deferred until much later, after risky bets
were more clearly won, if more conservative accounting had been employed. This practice turns many a banker into a
human version of one of B.F. Skinner's pigeons, since he is "reinforced" into continuing and expanding bad lending
through the pleasure of seeing good figures in the short term. The good figures substitute nicely in the mind for
nonexistent underlying institutional good, partly through the process, originally demonstrated by Pavlov, wherein we
respond to a mere association because it has usually portended a reality that would make the response correct.


Under prevailing accounting, banks now ordinarily report increases in both earnings and equity capital during any
transition they make toward less conservative lending. And then, if more lending of that type is done, and is
accompanied by growth in institutional size, good reported figures will continue for an additional period. If an increase
in institutional size is deemed necessary, it is, of course, assured by the bank's access to the government's credit through
deposit insurance.
We think acculturated corporate nature, in American financial institutions, simply cannot, on average, handle
temptations implicit in this sort of accounting. Indeed, the succumbing to the temptations, in a manner not consistent
with long‐term institutional interest, often occurs through a subconscious process. The subconscious process includes
bad effects from both (1) "social proof", and (2) a "reality‐denial" mode that creates bias in people stimulated, honored
and paid in proportion to institutional size. Under our present system a Columbia Savings, and many less obscene
versions of its model, are almost inevitable.
Of course, a large minority, even a majority, of bankers will remain sound, despite the temptations. But this outcome is
not sufficient to protect the deposit insurer from unacceptable ultimate losses. In due course, given present conditions,
the deposit insurer will suffer from what some wag called the problem of there being so many more banks than bankers.
What should now be considered are mandatory accounting changes, including changes in accounting to shareholders,
designed to force "back‐ending" into reported income of revenue from various types of gamy lending (and letters of
credit), in lieu of allowing "front‐ending" to continue. The changes would cause American bank accounting, by fiat, to
imitate what some of the best European bankers have long done by choice. Eventually, credibility might be returned to
banks' audited financial statements, now often regarded as fairy tales.
Despite the obvious (to us) accounting defects that bedevil our system, we don't think any wise and important
accounting changes will be made. Typical bank reaction to such proposals is, at best, that of the man who asked, well
before his ultimate sainthhood: "God, give me chastity, but not yet." Also, time periods for accomplishing even the
simplest, "no‐brainer" changes in accounting convention tend to stretch into years.
Option (6): forcing weak banks into other hands before the weak banks become insolvent:
This option is also a hot topic. Usual governmental practice at the moment is to force merger only when all shareholders'
equity is gone and the deposit insurer has a large loss. This is "bonkers," due process gone mad. It seems entirely logical
now to commence the forced merger or closure of many of the nation's 13,000 banks and to do it in many cases before
a weak bank is insolvent. Because the need is so obvious, laws and customs may possibly change to cause more of this to
happen. And interstate branching may be allowed in order to enlarge the number of potential bank buyers.
While these steps seem helpful, they won't fix the problem of deep structural fault in the system ‐‐ at least within any
acceptable time period. Look at the present carnage in airlines. Even when we are down to fewer than a dozen
significant operators, messy airline failures continue. If we wait for an airline‐style solution in banking, we will have to
endure years, maybe decades, of suffering.
Option (7): forcing insolvent banks into competing local banks, or entirely out of business, instead of into strong out‐of‐
state banks:
According to Martin Mayer, writing recently in The Wall Street Journal, the FDIC now typically deals with an insolvent
bank by choosing between two options:


(1) forcing the insolvent bank into a competing local bank, or entirely out of business, thus dampening local competition;
or
(2) first, replacing all the insolvent bank's bad assets with good assets, and, second, selling it to some skillfull out‐of‐state
buyer, after which process the new bank can help clobber the remaining also‐weak‐and‐also‐insured banks in the area.
Mayer believes it was "insane" for the FDIC to do as it did in many instances, which was to select option (2). Accordingly
to Mayer, the FDIC thus arranged that "overcapacity was rigorously maintained." Mayer raises an interesting question.
Coming back to the analogy earlier used, if you or I were really unlucky and were guarantor for seven local brothers‐in‐
law, each with a troubled hamburger joint, what would we do when the first one went broke? We would surely reject
the idea, of, first, fixing up the defunct joint so that it was better than the others, and, second, guaranteeing the
obligations of a new and more skillfull out‐of‐state operator who wanted to enter the market by taking over the
improved facility.
Mayer is right insofar as he implies that there are too many banks and bank branches, just as there were formerly too
many filing stations, sometimes three or four at an intersection. The departed filling stations "never will be missed," so
perhaps the FDIC should "have a little list," like the bloodthirsty figure in the Mikado.
Beyond that, we are not certain that Mayer's conclusions will always prove right. The basic banking system is right out of
Alice in Wonderland, so maybe it's like non‐Euclidean geometry and only Alice‐in‐Wonderland‐type cures really fit in.
After all, the scenario which troubles Mayer has a perverse beauty, at least to a government. The bank failures cascade,
on and on, refreshed by new governmental acts, so that the FDIC can be saving a large part of the banking system each
year for a long time.
And we must admit that, if we were the FDIC and were thus forced to participate heavily in our present banking system,
like it or not, we would occasionally do what Mayer finds objectionable, in those rare cases when we saw a chance for
greatly improving banking culture in some community. We would, for instance, occasionally sell a sick bank to John
McCoy (of Banc One), even when this brought a new bank to a state full of troubled banks, if every in‐state bank seemed
too weak or foolish to be selected as an alternative buyer. We would figure that (1) some subsequent insolvencies of
other local banks were in our long‐term interest, (2) we were supporting a sound model, and (3) eventually, as the
example spread, our troubles as deposit‐insurer of a silly system would be reduced. We would then have a pleasant lull
before the silly system caused new troubles to pop up, maybe even under McCoy's successors at Banc One.
While Mayer's subject is interesting, we probably don't have to worry much about worldly consequences. Outside
science, it is amazing how little impact there can be from a powerful idea, published in a prominent place (such as the
Journal). Everyone's experience is that you teach only what a reader almost knows, and that seldom.
If our foregoing comments about systemic irresponsibility and chances for a rational cure are right, or substantially right,
it is hard to be optimistic about coming legislative "reform" of banking. Perhaps the best we can hope for is Menckenian
reform where old error is replaced, not by truth, but by new error. It is also possible that we will see exactly the same
old systemic error repeated, but bearing bells and whistles in the form of new bank powers. This outcome is roughly
what is recommended by the banking lobby, which has evidently learned nothing from the history of the savings and
loan laws.
Let us next turn to the savings and loan field. Here, faced with a more disastrous mess, the legislators were so outraged
that they attempted what they thought was extreme reform: FIRREA. This legislation took a "back‐to‐basics" approach


and has since been interpreted by regulators who seem to believe, understandably, that they must act as though they
were tough "bouncers," given the job of bringing order to a drunken brawl (a description that understates what the
regulators faced).
This regulatory approach is now squeezing out (1) much folly, and (2) some non‐folly needed to keep institutions
healthy. Most executives we know at other associations concentrate only on the negative side and are outraged at
instances of regulatory elimination of non‐folly.
They tend to construe present FIRREA enforcement as the equivalent of Mark Twain's prescription for preventing
children's stuttering: "Remove the lower jaw."
Our view is different, even though we are much harmed by FIRREA. We think the system needed new rules, interpreted
by tough "bouncers," and that the "bouncing" process, done with sufficient vigor, inevitably involves some lumps for the
undeserving. There may even be some deaths from "friendly fire." Nonetheless, the process must go on.
What concerns us is the most important question of all. Did our legislators, through FIRREA, even with their "never
again" mindset, fix the most important systemic error in the savings and loan industry? We think not.
As the dust has cleared, the best savings and loan associations are clearly worse businesses than the best banks (which
themselves have plenty of troubles). This conclusion is supported by both (1) stock market prices and (2) action of
governmental liquidators in response to market conditions. Stocks of the best associations now sell at much lower
price/book‐value ratios than stocks of the best banks. And governmental liquidators are constantly selling association
branches to banks while almost never selling bank branches to associations. FIRREA has not made associations, on
average, as desirable for owners as banks. The two institutional types remain different and unequal, while quite
comparable in essential residual function, now that Fannie Mae and Freddie Mac exist to perform a lion's share of the
finance function supporting housing.
The savings and loan system, in a modern era in which the government is always a large net borrower, still tries to use
short‐term savings accounts to finance long‐term housing lending. This is, in essence, a very bad idea, violating the logic
of an elementary prescription: "If a thing isn't worth doing at all, it isn't worth doing well."
To be sure, some fix of systemic maturity‐mismatch risk is now attempted, through encouragement of variable‐rate
loans. But the variable‐rate loans typically "cap" interest rate escalation at a few percentage points, which must be done
for moderate‐income borrowers to prevent both (1) unacceptable hardship and (2) sudden falls in non‐housing
spending. This compromise is like having building codes in California protect only up to 5 points on the Richter
earthquake scale. The compromise is almost sure to bring back, probably at a remote date, another horrible collapse of
the savings and loan system.
As we say this, we are not critical of the best California associations, such as Home Savings, Great Western Savings and
World Savings. These people have logical operations bearing one big systemic risk that cannot be avoided by permanent
players. If we had to play forever under current rules, we would try to imitate them. But we would have a big
disadvantage: "we don't know how to get there from here," because they have such momentum in systems, particularly
in loan origination. Fortunately, no one is sentencing us to play forever in a game with a systemic risk we don't like and
in which we are at a big disadvantage. Instead, we have temporized with a different, acceptable "there" in a form
combining (1) a big holding of Freddie Mac, with (2) financial flexibility to adapt as we choose to new conditions.


So much for ridicule, pessimistic speculations, and excuses for our defects, always easy to provide. As any responsible
calamity‐howler should, we will now risk playing the fool in public by attempting to say what we would do with the
bank/money‐market fund/savings and loan system if we were Congress:
(1) Because we have a help‐housing bias, we would keep government‐assisted housing finance for low‐to‐moderate‐
income people. We would do this by forcing pension funds to maintain a significant portion of their assets in housing‐
related assets in the form of Freddie Mac and Fannie Mae mortgage‐backed securities representing interests in fixed‐
rate mortgages. This requirement strikes us as fair, given the tax exemption possessed by the pension funds. And the
pension funds are the logical suppliers of housing finance because they by nature have (a) massive assets, and (b)
liabilities with maturities matching homeowners' needs for long‐term, fixed‐rate credit. Our reason for specifying
Freddie Mac and Fannie Mae securities as a conduit for housing assistance is our belief that these entities would assure
loan quality better and more cheaply than would any government bureaucracy. In quantitative terms, we would leave
housing finance more assisted than it is now, particularly for first‐time home buyers who have won their spurs.
(2) We would merge the banks, money‐market funds and savings and loan associations into one banking system, with
insured deposits. The new banking system would be separate from both (a) industry and (b) the part of investment
banking likely to disappoint investors. It would have the following characteristics:
(i) There would be one federal regulator that also served as deposit‐insurer, in lieu of the truly crazy, inefficient
Balkanization of our present regulatory and insurance apparatus. (Eliminating Balkanization would do more than reduce
costs, delays, confusion and competition in laxity. There is a system‐design advantage in making the deposit‐insurance
loss payer and the bank‐controlling loss preventer one and the same. The system then becomes more "responsible" in
the Frankelian sense, requiring that systems be organized, to the extent feasible, so that decision‐makers, not others,
bear consequences of decisions.)
(ii) There would be no bank‐holding companies, but the new banks would have a monopoly in offering check‐writing
privileges, debit cards and credit cards, except for credit cards offered on behalf of a single vendor. (The new law would
permit tax‐free spinoffs of existing banks, newly organized banks, and non‐banks to help existing corporations come into
compliance. Spun‐off non‐banks could include specialists in high‐interest‐rate lending to businesses.)
(iii) Flexible, government‐regulatory‐run controls would set a ceiling on interest that could be paid on bank accounts. (If
you are going to guarantee the credit of an entire industry, there is a limit to the competition that is desirable. Besides,
many banks will behave badly in their important function when they are under the extreme cost pressure, not normal in
business, that occurs when one's competitors are all financed without limit by the government, through deposit
insurance.)
(iv) All capital satisfying regulatory requirements would have to be in the form of stock, either common or preferred,
except for "grandfathered" debt. (v) Stockbrokers (and others) could buy for customers all the insured certificates of
deposit they wished, but they could not, in exchange, receive commissions or other advantages from the banks issuing
the certificates. ("Abuse it and lose it," is our motto.)
(vi) The federal regulator would have clear power, exercisable without an excess of "due process" or "second guessing,"
to close out or force sale or merger of weak banks well before they became insolvent. Banks could ordinarily avoid such
calamities, after a first warning, by raising new capital through "rights" issues, or in some other way. (There is nothing
novel in such a system. Close‐out orders, issued well short of insolvency, have long been standard practice under
regulatory practice governing securities and currency traders.)


(vii) Bank accounting for all purposes would count much revenue as profit only after all significant risk had been
removed from the transactions generating the revenues. Bank dividends, of course, could be paid only from the more
conservatively reported profits.
Income tax would be deferred on the deferred revenues required by this new conservatism in accounting. (It is a terrible
mistake, a novice's mistake to try to control important behavior with an all‐stick‐and‐no‐carrot approach. Therefore, the
carrot‐providing tax deferment would be wise.)
(viii) There would be no 2,000‐page mass of government regulations. But there would be some rule for business and real
estate loans such as: loan as you wish, but no new loans count as bank assets unless supported by substantial equity, a
stipulation that would create a large margin of safety.
(ix) Deposit‐insurance rates would promptly be lowered from present levels, but under a new system so tough that risk
of loss to the deposit insurer would be reduced, even after taking into account the effects from lower rates.
(x) The whole system would be designed to have the best businesses small and large, again become intimate with the
best banks. The banks would again concentrate on being (1) relatively low‐interest‐rate lenders to high‐quality
businesses, and (2) lenders to consumers who are not "fiscaholics". High‐interest‐rate lending, to people with weak
credit, would be forced into non‐banking systems retaining no common‐management or common‐premises links with
banking.
There is, no doubt, much wrong with our recommendations. But there is also much wrong with our present system,
which has helped cause a questionable shift in banking priorities and a big mess, with every prospect for more of the
same. In contrast, there is little in history to suggest that our recommendations would be as bad. And even if the new
system had serious faults, it would probably be a better way station on the path to a banking system befitting a great
country.
In recent years the government has tried to maintain a useful, relatively trouble‐free banking system by making the
banking business bear increased competitive burdens, and, when the system has responded by working worse, the
government has increased both the burdens and the permitted scope of banks' activities. After such revisions the
system has again worked worse. Surely it is time to reverse our approach. We should act like the artillery officer who,
when he has put one shell over the target, next tries to put a shell clearly short, expecting to get the desired result in
due course.
Some people might worry that banking would get too profitable under the system we recommend. To this worry there
are three answers:
(1) The prospect of better profits, with less risk, would tend to (a) reduce governmental losses as many billions of dollars
worth of foreclosed thrift and bank assets are sold off by the FDIC, and (b) enable the government, through tough capital
standards, to cause eager private augmentation of banking capital by shareholders, precisely what is needed.
(2) Based on past experience, the nation's bankers (including us) may, on average, be up to the challenge of not earning
excessive profits, even in an easier system.
(3) If excessive profits came, they could easily be reduced in due course by a new governmental tax, charge or burden.
We now quitclaim legislative reform to those who make it their business. We also assure Wesco shareholders that this
reform‐minded section of our letter to shareholders is an unlikely‐to‐be‐repeated aberration. It was caused, in part, by a


combination of (1) overwhelming disgust with the present scene, and (2) long association by the writer with an eccentric
fellow who may not share all the notions herein expressed but who encourages this kind of writing.
This eccentric, who heads Berkshire Hathaway, Wesco's parent corporation, believes for some reason that accumulated
wealth should never be spent on oneself or one's family, but instead should merely serve, before it is given to charity, as
an example of a certain approach to life and as a didactic platform. These uses, plus use in building the platform higher,
are considered the only honorable ones not only during life but also after death. Shareholders who continue in such
peculiar company are hereby warned by our example in writing this section: some of the eccentricities of this fellow are
contagious, at least if association is long continued.”
- WSC 1990 Letter



Insurance

“Insurance companies offer standardized policies which can be copied by anyone. Their only products are promises. It
is not difficult to be licensed, and rates are an open book. There are no important advantages from trademarks, patents,
location, corporate longevity, raw material sources, etc., and very little consumer differentiation to produce insulation
from competition. It is commonplace, in corporate annual reports, to stress the difference that people make.
Sometimes this is true and sometimes it isn’t. But there is no question that the nature of the insurance business
magnifies the effect which individual managers have on company performance. We are very fortunate to have the
group of managers that are associated with us.”
- BRK 1977 Letter

“GEICO was designed to be the low‐cost operation in an enormous marketplace (auto insurance) populated largely by
companies whose marketing structures restricted adaptation. Run as designed, it could offer unusual value to its
customers while earning unusual returns for itself.

“The insurance industry’s underwriting picture continues to unfold about as we anticipated, with the combined ratio
(see definition on page 37) rising from 100.6 in 1979 to an estimated 103.5 in 1980. It is virtually certain that this trend
will continue and that industry underwriting losses will mount, significantly and progressively, in 1981 and 1982. To
understand why, we recommend that you read the excellent analysis of property‐casualty competitive dynamics done
by Barbara Stewart of Chubb Corp. in an October 1980 paper. (Chubb’s annual report consistently presents the most
insightful, candid and well‐written discussion of industry conditions; you should get on the company’s mailing list.) Mrs.
Stewart’s analysis may not be cheerful, but we think it is very likely to be accurate.

And, unfortunately, a largely unreported but particularly pernicious problem may well prolong and intensify the coming
industry agony. It is not only likely to keep many insurers scrambling for business when underwriting losses hit record
levels ‐ it is likely to cause them at such a time to redouble their efforts.

This problem arises from the decline in bond prices and the insurance accounting convention that allows companies to
carry bonds at amortized cost, regardless of market value. Many insurers own long‐term bonds that, at amortized cost,
amount to two to three times net worth. If the level is three times, of course, a one‐third shrink from cost in bond prices
‐ if it were to be recognized on the books ‐ would wipe out net worth. And shrink they have. Some of the largest and
best known property‐casualty companies currently find themselves with nominal, or even negative, net worth when
bond holdings are valued at market.
Of course their bonds could rise in price, thereby partially, or conceivably even fully, restoring the integrity of stated net
worth. Or they could fall further. (We believe that short‐term forecasts of stock or bond prices are useless. The
forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.)

It might strike some as strange that an insurance company’s survival is threatened when its stock portfolio falls
sufficiently in price to reduce net worth significantly, but that an even greater decline in bond prices produces no
reaction at all. The industry would respond by pointing out that, no matter what the current price, the bonds will be
paid in full at maturity, thereby eventually eliminating any interim price decline. It may take twenty, thirty, or even forty
years, this argument says, but, as long as the bonds don’t have to be sold, in the end they’ll all be worth face value. Of
course, if they are sold even if they are replaced with similar bonds offering better relative value ‐ the loss must be
booked immediately.
And, just as promptly, published net worth must be adjusted downward by the amount of the loss.


Under such circumstances, a great many investment options disappear, perhaps for decades. For example, when large
underwriting losses are in prospect, it may make excellent business logic for some insurers to shift from tax‐exempt
bonds into taxable bonds. Unwillingness to recognize major bond losses may be the sole factor that prevents such a
sensible move.

But the full implications flowing from massive unrealized bond losses are far more serious than just the immobilization
of investment intellect. For the source of funds to purchase and hold those bonds is a pool of money derived from
policyholders and claimants (with changing faces) ‐ money which, in effect, is temporarily on deposit with the insurer.
As long as this pool retains its size, no bonds must be sold. If the pool of funds shrinks ‐ which it will if the volume of
business declines significantly ‐ assets must be sold to pay off the liabilities. And if those assets consist of bonds with big
unrealized losses, such losses will rapidly become realized, decimating net worth in the process.

Thus, an insurance company with a bond market value shrinkage approaching stated net worth (of which there are now
many) and also faced with inadequate rate levels that are sure to deteriorate further has two options. One option for
management is to tell the underwriters to keep pricing according to the exposure involved ‐ “be sure to get a dollar of
premium for every dollar of expense cost plus expectable loss cost”.

The consequences of this directive are predictable: (a) with most business both price sensitive and renewable annually,
many policies presently on the books will be lost to competitors in rather short order; (b) as premium volume shrinks
significantly, there will be a lagged but corresponding decrease in liabilities (unearned premiums and claims payable); (c)
assets (bonds) must be sold to match the decrease in liabilities; and (d) the formerly unrecognized disappearance of net
worth will become partially recognized (depending upon the extent of such sales) in the insurer’s published financial
statements.

Variations of this depressing sequence involve a smaller penalty to stated net worth. The reaction of some companies at
(c) would be to sell either stocks that are already carried at market values or recently purchased bonds involving less
severe losses. This ostrich‐like behavior ‐ selling the better assets and keeping the biggest losers ‐ while less painful in
the short term, is unlikely to be a winner in the long term.

The second option is much simpler: just keep writing business regardless of rate levels and whopping prospective
underwriting losses, thereby maintaining the present levels of premiums, assets and liabilities ‐ and then pray for a
better day, either for underwriting or for bond prices. There is much criticism in the trade press of “cash flow”
underwriting; i.e., writing business regardless of prospective underwriting losses in order to obtain funds to invest at
current high interest rates. This second option might properly be termed “asset maintenance” underwriting ‐ the
acceptance of terrible business just to keep the assets you now have.

Of course you know which option will be selected. And it also is clear that as long as many large insurers feel compelled
to choose that second option, there will be no better day for underwriting. For if much of the industry feels it must
maintain premium volume levels regardless of price adequacy, all insurers will have to come close to meeting those
prices. Right behind having financial problems yourself, the next worst plight is to have a large group of competitors
with financial problems that they can defer by a “sell‐at‐any‐price” policy.

We mentioned earlier that companies that were unwilling ‐ for any of a number of reasons, including public reaction,
institutional pride, or protection of stated net worth ‐ to sell bonds at price levels forcing recognition of major losses
might find themselves frozen in investment posture for a decade or longer. But, as noted, that’s only half of the
problem.


Companies that have made extensive commitments to long‐term bonds may have lost, for a considerable period of time,
not only many of their investment options, but many of their underwriting options as well.

Our own position in this respect is satisfactory. We believe our net worth, valuing bonds of all insurers at amortized
cost, is the strongest relative to premium volume among all large property‐casualty stockholder‐owned groups. When
bonds are valued at market, our relative strength becomes far more dramatic. (But lest we get too puffed up, we remind
ourselves that our asset and liability maturities still are far more mismatched than we would wish and that we, too, lost
important sums in bonds because your Chairman was talking when he should have been acting.)

Our abundant capital and investment flexibility will enable us to do whatever we think makes the most sense during the
prospective extended period of inadequate pricing. But troubles for the industry mean troubles for us. Our financial
strength doesn’t remove us from the hostile pricing environment now enveloping the entire property‐casualty insurance
industry. It just gives us more staying power and more options.”
- BRK 1980 Letter

“Note in the table below the year‐over‐year gain in industry‐wide premiums written and the impact that it has on the
current and following year’s level of underwriting profitability. The result is exactly as you would expect in an
inflationary world. When the volume gain is well up in double digits, it bodes well for profitability trends in the current
and following year. When the industry volume gain is small, underwriting experience very shortly will get worse, no
matter how unsatisfactory the current level.

The Best’s data in the table reflect the experience of practically the entire industry, including stock, mutual and
reciprocal companies. The combined ratio indicates total operating and loss costs as compared to premiums; a ratio
below 100 indicates an underwriting profit, and one above 100 indicates a loss.

Yearly Change Yearly Change Combined Ratio
in Premium in Premium after Policy‐
Written (%) Earned (%) holder Dividends
‐‐‐‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
1972 ............... 10.2 10.9 96.2
1973 ............... 8.0 8.8 99.2
1974 ............... 6.2 6.9 105.4
1975 ............... 11.0 9.6 107.9
1976 ............... 21.9 19.4 102.4
1977 ............... 19.8 20.5 97.2
1978 ............... 12.8 14.3 97.5
1979 ............... 10.3 10.4 100.6
1980 ............... 6.0 7.8 103.1
1981 ............... 3.6 4.1 105.7

Source: Best’s Aggregates and Averages.

“And, of course the twin inflations, monetary and “social” (the tendency of courts and juries to stretch the coverage of
policies beyond what insurers, relying upon contract terminology and precedent, had expected), are unstoppable. Costs
of repairing both property and people ‐ and the extent to which these repairs are deemed to be the responsibility of the
insurer
‐ will advance relentlessly.


Absent any bad luck (catastrophes, increased driving, etc.), an immediate industry volume gain of at least 10% per year
probably is necessary to stabilize the record level of underwriting losses that will automatically prevail in mid‐1982.
(Most underwriters expect incurred losses in aggregate to rise at least 10% annually; each, of course, counts on getting
less than his share.) Every percentage point of annual premium growth below the 10% equilibrium figure quickens the
pace of deterioration. Quarterly data in 1981 underscore the conclusion that a terrible underwriting picture is
worsening at an accelerating rate.”
- BRK 1981 Letter

“In insurance, as elsewhere, the reaction of weak managements to weak operations is often weak accounting. (“It’s
difficult for an empty sack to stand upright.”)

“What finally determines levels of long‐term profitability in such industries is the ratio of supply‐tight to supply‐ample
years. Frequently that ratio is dismal. (It seems as if the most recent supply‐tight period in our textile business ‐ it
occurred some years back ‐ lasted the better part of a morning.)

“In some industries, however, capacity‐tight conditions can last a long time. Sometimes actual growth in demand will
outrun forecasted growth for an extended period. In other cases, adding capacity requires very long lead times because
complicated manufacturing facilities must be planned and built.

But in the insurance business, to return to that subject, capacity can be instantly created by capital plus an underwriter’s
willingness to sign his name. (Even capital is less important in a world in which state‐sponsored guaranty funds protect
many policyholders against insurer insolvency.) Under almost all conditions except that of fear for survival ‐ produced,
perhaps, by a stock market debacle or a truly major natural disaster ‐ the insurance industry operates under the
competitive sword of substantial overcapacity. Generally, also, despite heroic attempts to do otherwise, the industry
sells a relatively undifferentiated commodity‐type product. (Many insureds, including the managers of large businesses,
do not even know the names of their insurers.) Insurance, therefore, would seem to be a textbook case of an industry
usually faced with the deadly combination of excess capacity and a “commodity” product.”
- BRK 1982 Letter

“Finally, a word should be said about the “double whammy” effect upon owners of the acquiring company when value‐
diluting stock issuances occur. Under such circumstances, the first blow is the loss of intrinsic business value that occurs
through the merger itself. The second is the downward revision in market valuation that, quite rationally, is given to
that now‐diluted business value. For current and prospective owners understandably will not pay as much for assets
lodged in the hands of a management that has a record of wealth‐destruction through unintelligent share issuances as
they will pay for assets entrusted to a management with precisely equal operating talents, but a known distaste for anti‐
owner actions. Once management shows itself insensitive to the interests of owners, shareholders will suffer a long
time from the price/value ratio afforded their stock (relative to other stocks), no matter what assurances management
gives that the value‐diluting action taken was a one‐of‐a‐kind event.

Those assurances are treated by the market much as one‐bug‐in‐the‐salad explanations are treated at restaurants. Such
explanations, even when accompanied by a new waiter, do not eliminate a drop in the demand (and hence market
value) for salads, both on the part of the offended customer and his neighbors pondering what to order. Other things
being equal, the highest stock market prices relative to intrinsic business value are given to companies whose managers
have demonstrated their unwillingness to issue shares at any time on terms unfavorable to the owners of the business.”
- BRK 1982 Letter


“For a number of years, we have told you that an annual increase by the industry of about 10% per year in premiums
written is necessary for the combined ratio to remain roughly unchanged. We assumed in making that assertion that
expenses as a percentage of premium volume would stay relatively stable and that losses would grow at about 10%
annually because of the combined influence of unit volume increases, inflation, and judicial rulings that expand what is
covered by the insurance policy.

Our opinion is proving dismayingly accurate: a premium increase of 10% per year since 1979 would have produced an
aggregate increase through 1984 of 61% and a combined ratio in 1984 almost identical to the 100.6 of 1979. Instead,
the industry had only a 30% increase in premiums and a 1984 combined ratio of 117.7. Today, we continue to believe
that the key index to the trend of underwriting profitability is the year‐to‐year percentage change in industry premium
volume.”
- BRK 1984 Letter

“The profit improvement, however, is likely to be of short duration. Two economic principles will see to that. First,
commodity businesses achieve good levels of profitability only when prices are fixed in some manner or when capacity is
short. Second, managers quickly add to capacity when prospects start to improve and capital is available.

In my 1982 report to you, I discussed the commodity nature of the insurance industry extensively. The typical
policyholder does not differentiate between products but concentrates instead on price. For many decades a cartel‐like
procedure kept prices up, but this arrangement has disappeared for good. The insurance product now is priced as any
other commodity for which a free market exists: when capacity is tight, prices will be set remuneratively; otherwise,
they will not be.”
- BRK 1985 Letter

“However, Wesco’s optimism about quality of Fireman’s Fund, quality of this reinsurance contract, and possible short‐
term, industry‐wide cyclical improvement, is tempered by a larger and longer view of the reinsurance business. That
business has the defect of being too attractive looking to new entrants for its own good and therefore will always tend
to be more or less the opposite of, say, the old business of gathering and rendering dead horses, which tended to
contain few and prosperous participants.

Troubles, losses, and insolvencies can come fast as the apparent attractions of the reinsurance business, including its
seductive receive‐pay‐in‐advance aspects, lure new entrants and encourage expansions by old occupants. The business
was a disaster area in recent years, adversely affected by prices which would have been too low in a stable world, plus
inflation, new judicial notions tending to augment insurance coverage beyond limits contemplated when policies were
issued, and not‐minor degradation of commercial behavior.

No doubt recent commercial behavior degradation, particularly noticeable in the reinsurance business on both sides of
the purchase counter, was accelerated by general hardship, demonstrating once again the wisdom of Poor Richard’s
Almanac: ‘It is hard for an empty sack to stand upright.’

Insurance company subsidiaries of Wesco’s parent corporation, Berkshire Hathaway, long active in reinsurance, did
continue proper commercial behavior during the recent period of industry‐wide problems, but financial results from
reinsurance were terrible. Thus Wesco shareholders are being led not only into an extra‐hazardous place but also by
people who met severe reverses on the last trip.


Is there any reasonable hope for Wesco shareholders that its reinsurance business, whatever its short‐term merits, will
provide an advantageous long‐term journey? Yes, one reason for long‐term optimism is present. With recent defaults by
reinsurers causing everyone to worry more about quality in promisors, Wes‐FIC and Berkshire Hathaway expect that
their old‐fashioned, engineering type attitudes and financial practices will help create for Wes‐FIC an unusual,
commercially‐useful reputation for issuing trustworthy promises in one or more markets or submarkets wherein most
buyers will accept nothing less. Thus, the absence of federal insurance for reinsurance liabilities may create for Wes‐FIC
a reputation‐based competitive advantage which is denied to Mutual Savings by FSLIC’s support of all Mutual Savings’
competitors through insuring their accounts.”
- WSC 1985 Letter

“At Berkshire, we work to escape the industry's commodity economics in two ways. First, we differentiate our product
by our financial strength, which exceeds that of all others in the industry. This strength, however, is limited in its
usefulness. It means nothing in the personal insurance field: The buyer of an auto or homeowners policy is going to get
his claim paid even if his insurer fails (as many have). It often means nothing in the commercial insurance arena: When
times are good, many major corporate purchasers of insurance and their brokers pay scant attention to the insurer's
ability to perform under the more adverse conditions that may exist, say, five years later when a complicated claim is
finally resolved. (Out of sight, out of mind ‐ and, later on, maybe out‐of‐pocket.)

Periodically, however, buyers remember Ben Franklin's observation that it is hard for an empty sack to stand upright and
recognize their need to buy promises only from insurers that have enduring financial strength. It is then that we have a
major competitive advantage. When a buyer really focuses on whether a $10 million claim can be easily paid by his
insurer five or ten years down the road, and when he takes into account the possibility that poor underwriting
conditions may then coincide with depressed financial markets and defaults by reinsurer, he will find only a few
companies he can trust. Among those, Berkshire will lead the pack.

Our second method of differentiating ourselves is the total indifference to volume that we maintain. In 1989, we will be
perfectly willing to write five times as much business as we write in 1988 ‐ or only one‐fifth as much. We hope, of
course, that conditions will allow us large volume. But we cannot control market prices. If they are unsatisfactory, we
will simply do very little business. No other major insurer acts with equal restraint.

Three conditions that prevail in insurance, but not in most businesses, allow us our flexibility. First, market share is not
an important determinant of profitability: In this business, in contrast to the newspaper or grocery businesses, the
economic rule is not survival of the fattest. Second, in many sectors of insurance, including most of those in which we
operate, distribution channels are not proprietary and can be easily entered: Small volume this year does not preclude
huge volume next year. Third, idle capacity ‐ which in this industry largely means people ‐ does not result in intolerable
costs. In a way that industries such as printing or steel cannot, we can operate at quarter‐speed much of the time and
still enjoy long‐term prosperity.

We follow a price‐based‐on‐exposure, not‐on‐competition policy because it makes sense for our shareholders. But
we're happy to report that it is also pro‐social. This policy means that we are always available, given prices that we
believe are adequate, to write huge volumes of almost any type of property‐casualty insurance. Many other insurers
follow an in‐and‐out approach. When they are "out" ‐ because of mounting losses, capital inadequacy, or whatever ‐ we
are available. Of course, when others are panting to do business we are also available ‐ but at such times we often find
ourselves priced above the market. In effect, we supply insurance buyers and brokers with a large reservoir of standby
capacity.“
- BRK 1987 Letter


“We are sure to have an exceptional amount of float compared to premium volume, and that augurs well for profits. In
1989 and 1990 we expect our float/premiums ratio to be at least three times that of the typical property/casualty
company.”
- BRK 1988 Letter

“In long‐tail situations a combined ratio of 115 (or even more) can prove profitable, since earnings produced by the float
will exceed the 15% by which claims and expenses overrun premiums. The catch, though, is that "long‐tail" means
exactly that: Liability business written in a given year and presumed at first to have produced a combined ratio of 115
may eventually smack the insurer with 200, 300 or worse when the years have rolled by and all claims have finally been
settled.

The pitfalls of this business mandate an operating principle that too often is ignored: Though certain long‐tail lines may
prove profitable at combined ratios of 110 or 115, insurers will invariably find it unprofitable to price using those ratios
as targets. Instead, prices must provide a healthy margin of safety against the societal trends that are forever springing
expensive surprises on the insurance industry. Setting a target of 100 can itself result in heavy losses; aiming for 110 ‐
115 is business suicide.
All of that said, what should the measure of an insurer's profitability be? Analysts and managers customarily look to the
combined ratio ‐ and it's true that this yardstick usually is a good indicator of where a company ranks in profitability. We
believe a better measure, however, to be a comparison of underwriting loss to float developed.

This loss/float ratio, like any statistic used in evaluating insurance results, is meaningless over short time periods:
Quarterly underwriting figures and even annual ones are too heavily based on estimates to be much good. But when the
ratio takes in a period of years, it gives a rough indication of the cost of funds generated by insurance operations. A low
cost of funds signifies a good business; a high cost translates into a poor business.”
- BRK 1990 Letter

“In the insurance business, there is no statute of limitations on stupidity.”
- BRK 1990 Letter

“As interest rates have fallen, however, the value of float has substantially declined. Therefore, the data that we have
provided in the past are no longer useful for year‐to‐year comparisons of industry profitability. A company writing at
the same combined ratio now as in the 1980's today has a far less attractive business than it did then.

Only by making an analysis that incorporates both underwriting results and the current risk‐free earnings obtainable
from float can one evaluate the true economics of the business that a property‐casualty insurer writes. Of course, the
actual investment results that an insurer achieves from the use of both float and stockholders' funds is also of major
importance and should be carefully examined when an investor is assessing managerial performance. But that should
be a separate analysis from the one we are discussing here. The value of float funds ‐ in effect, their transfer price as
they move from the insurance operation to the investment operation ‐ should be determined simply by the risk‐free,
long‐term rate of interest.

“As you can see, in our insurance operation last year we had the use of $2.6 billion at no cost; in fact we were paid $31
million, our underwriting profit, to hold these funds. This sounds good ‐ is good ‐ but is far from as good as it sounds.


We temper our enthusiasm because we write a large volume of "super‐cat" policies (which other insurance and
reinsurance companies buy to recover part of the losses they suffer from mega‐catastrophes) and because last year we
had no losses of consequence from this activity. As that suggests, the truly catastrophic Midwestern floods of 1993 did
not trigger super‐cat losses, the reason being that very few flood policies are purchased from private insurers.

It would be fallacious, however, to conclude from this single‐year result that the super‐cat business is a wonderful one,
or even a satisfactory one. A simple example will illustrate the fallacy: Suppose there is an event that occurs 25 times in
every century. If you annually give 5‐for‐1 odds against its occurrence that year, you will have many more winning years
than losers. Indeed, you may go a straight six, seven or more years without loss. You also will eventually go broke.

At Berkshire, we naturally believe we are obtaining adequate premiums and giving more like 3 1/2‐for‐1 odds. But there
is no way for us ‐ or anyone else ‐ to calculate the true odds on super‐cat coverages. In fact, it will take decades for us to
find out whether our underwriting judgment has been sound.

What we do know is that when a loss comes, it's likely to be a lulu. There may well be years when Berkshire will suffer
losses from the super‐cat business equal to three or four times what we earned from it in 1993. When Hurricane
Andrew blew in 1992, we paid out about $125 million. Because we've since expanded our super‐cat business, a similar
storm today could cost us $600 million.

So far, we have been lucky in 1994. As I write this letter, we are estimating that our losses from the Los Angeles
earthquake will be nominal. But if the quake had been a 7.5 instead of a 6.8, it would have been a different story.

Berkshire is ideally positioned to write super‐cat policies. In Ajit Jain, we have by far the best manager in this business.
Additionally, companies writing these policies need enormous capital, and our net worth is ten to twenty times larger
than that of our main competitors. In most lines of insurance, huge resources aren't that important: An insurer can
diversify the risks it writes and, if necessary, can lay off risks to reduce concentration in its portfolio. That isn't possible
in the super‐cat business. So these competitors are forced into offering far smaller limits than those we can provide.
Were they bolder, they would run the risk that a mega‐catastrophe ‐ or a confluence of smaller catastrophes ‐ would
wipe them out.

One indication of our premier strength and reputation is that each of the four largest reinsurance companies in the
world buys very significant reinsurance coverage from Berkshire. Better than anyone else, these giants understand that
the test of a reinsurer is its ability and willingness to pay losses under trying circumstances, not its readiness to accept
premiums when things look rosy.”
- BRK 1993 Letter

“The Economics of Property‐Casualty Insurance

With the acquisition of General Re ‐‐ and with GEICO's business mushrooming ‐‐ it becomes more important than ever
that you understand how to evaluate an insurance company. The key determinants are: (1) the amount of float that the
business generates; (2) its cost; and (3) most important of all, the long‐term outlook for both of these factors.

To begin with, float is money we hold but don't own. In an insurance operation, float arises because premiums are
received before losses are paid, an interval that sometimes extends over many years. During that time, the insurer
invests the money. Typically, this pleasant activity carries with it a downside: The premiums that an insurer takes in
usually do not cover the losses and expenses it eventually must pay. That leaves it running an "underwriting loss," which


is the cost of float. An insurance business has value if its cost of float over time is less than the cost the company would
otherwise incur to obtain funds. But the business is a lemon if its cost of float is higher than market rates for money.

A caution is appropriate here: Because loss costs must be estimated, insurers have enormous latitude in figuring their
underwriting results, and that makes it very difficult for investors to calculate a company's true cost of float. Errors of
estimation, usually innocent but sometimes not, can be huge. The consequences of these miscalculations flow directly
into earnings. An experienced observer can usually detect large‐scale errors in reserving, but the general public can
typically do no more than accept what's presented, and at times I have been amazed by the numbers that big‐name
auditors have implicitly blessed. As for Berkshire, Charlie and I attempt to be conservative in presenting its underwriting
results to you, because we have found that virtually all surprises in insurance are unpleasant ones.

The table that follows shows the float generated by Berkshire's insurance operations since we entered the business 32
years ago. The data are for every fifth year and also the last, which includes General Re's huge float. For the table we
have calculated our float ‐‐ which we generate in large amounts relative to our premium volume ‐‐ by adding net loss
reserves, loss adjustment reserves, funds held under reinsurance assumed and unearned premium reserves, and then
subtracting agents balances, prepaid acquisition costs, prepaid taxes and deferred charges applicable to assumed
reinsurance. (Got that?)

Year Average Float
(in $ millions)
1967 17
1972 70
1977 139
1982 221
1987 1,267
1992 2,290
1997 7,093
1998 22,762 (yearend)

Impressive as the growth in our float has been ‐‐ 25.4% compounded annually ‐‐ what really counts is the cost of this
item. If that becomes too high, growth in float becomes a curse rather than a blessing.

At Berkshire, the news is all good: Our average cost over the 32 years has been well under zero. In aggregate, we have
posted a substantial underwriting profit, which means that we have been paid for holding a large and growing amount
of money. This is the best of all worlds. Indeed, though our net float is recorded on our balance sheet as a liability, it has
had more economic value to us than an equal amount of net worth would have had. As long as we can continue to
achieve an underwriting profit, float will continue to outrank net worth in value.

During the next few years, Berkshire's growth in float may well be modest. The reinsurance market is soft, and in this
business, relationships change slowly. Therefore, General Re's float ‐‐ 2/3rds of our total ‐‐ is unlikely to increase
significantly in the near term. We do expect, however, that our cost of float will remain very attractive compared to that
of other insurers.”
- BRK 1998 Letter

“Principles of Insurance Underwriting



When property/casualty companies are judged by their cost of float, very few stack up as satisfactory businesses. And
interestingly ¾ unlike the situation prevailing in many other industries ¾ neither size nor brand name determines an
insurer's profitability. Indeed, many of the biggest and best‐known companies regularly deliver mediocre results. What
counts in this business is underwriting discipline. The winners are those that unfailingly stick to three key principles:

1. They accept only those risks that they are able to properly evaluate (staying within their circle of competence)
and that, after they have evaluated all relevant factors including remote loss scenarios, carry the expectancy of
profit. These insurers ignore market‐share considerations and are sanguine about losing business to competitors
that are offering foolish prices or policy conditions.

2. They limit the business they accept in a manner that guarantees they will suffer no aggregation of losses from a
single event or from related events that will threaten their solvency. They ceaselessly search for possible
correlation among seemingly‐unrelated risks.

3. They avoid business involving moral risk: No matter what the rate, trying to write good contracts with bad
people doesn't work. While most policyholders and clients are honorable and ethical, doing business with the
few exceptions is usually expensive, sometimes extraordinarily so.

The events of September 11th made it clear that our implementation of rules 1 and 2 at General Re had been
dangerously weak. In setting prices and also in evaluating aggregation risk, we had either overlooked or dismissed the
possibility of large‐scale terrorism losses. That was a relevant underwriting factor, and we ignored it.

In pricing property coverages, for example, we had looked to the past and taken into account only costs we might expect
to incur from windstorm, fire, explosion and earthquake. But what will be the largest insured property loss in history
(after adding related business‐interruption claims) originated from none of these forces. In short, all of us in the industry
made a fundamental underwriting mistake by focusing on experience, rather than exposure, thereby assuming a huge
terrorism risk for which we received no premium.

Experience, of course, is a highly useful starting point in underwriting most coverages. For example, it's important for
insurers writing California earthquake policies to know how many quakes in the state during the past century have
registered 6.0 or greater on the Richter scale. This information will not tell you the exact probability of a big quake next
year, or where in the state it might happen. But the statistic has utility, particularly if you are writing a huge statewide
policy, as National Indemnity has done in recent years.

At certain times, however, using experience as a guide to pricing is not only useless, but actually dangerous. Late in a
bull market, for example, large losses from directors and officers liability insurance ("D&O") are likely to be relatively
rare. When stocks are rising, there are a scarcity of targets to sue, and both questionable accounting and management
chicanery often go undetected. At that juncture, experience on high‐limit D&O may look great.

But that's just when exposure is likely to be exploding, by way of ridiculous public offerings, earnings manipulation,
chain‐letter‐like stock promotions and a potpourri of other unsavory activities. When stocks fall, these sins surface,
hammering investors with losses that can run into the hundreds of billions. Juries deciding whether those losses should
be borne by small investors or big insurance companies can be expected to hit insurers with verdicts that bear little
relation to those delivered in bull‐market days. Even one jumbo judgment, moreover, can cause settlement costs in later
cases to mushroom. Consequently, the correct rate for D&O "excess" (meaning the insurer or reinsurer will pay losses
above a high threshold) might well, if based on exposure, be five or more times the premium dictated by experience.



Insurers have always found it costly to ignore new exposures. Doing that in the case of terrorism, however, could
literally bankrupt the industry. No one knows the probability of a nuclear detonation in a major metropolis this year (or
even multiple detonations, given that a terrorist organization able to construct one bomb might not stop there). Nor can
anyone, with assurance, assess the probability in this year, or another, of deadly biological or chemical agents being
introduced simultaneously (say, through ventilation systems) into multiple office buildings and manufacturing plants. An
attack like that would produce astronomical workers' compensation claims.

Here's what we do know:
a. The probability of such mind‐boggling disasters, though likely very low at present, is not zero.

b. The probabilities are increasing, in an irregular and immeasurable manner, as knowledge and materials
become available to those who wish us ill. Fear may recede with time, but the danger won't ¾ the war
against terrorism can never be won. The best the nation can achieve is a long succession of stalemates.
There can be no checkmate against hydra‐headed foes.

c. Until now, insurers and reinsurers have blithely assumed the financial consequences from the
incalculable risks I have described.

d. Under a "close‐to‐worst‐case" scenario, which could conceivably involve $1 trillion of damage, the
insurance industry would be destroyed unless it manages in some manner to dramatically limit its
assumption of terrorism risks. Only the U.S. Government has the resources to absorb such a blow. If it is
unwilling to do so on a prospective basis, the general citizenry must bear its own risks and count on the
Government to come to its rescue after a disaster occurs.

Why, you might ask, didn't I recognize the above facts before September 11th? The answer, sadly, is that I did ¾ but I
didn't convert thought into action. I violated the Noah rule: Predicting rain doesn't count; building arks does. I
consequently let Berkshire operate with a dangerous level of risk ¾ at General Re in particular. I'm sorry to say that
much risk for which we haven't been compensated remains on our books, but it is running off by the day.

At Berkshire, it should be noted, we have for some years been willing to assume more risk than any other insurer has
knowingly taken on. That's still the case. We are perfectly willing to lose $2 billion to $2½ billion in a single event (as we
did on September 11th) if we have been paid properly for assuming the risk that caused the loss (which on that occasion
we weren't).

Indeed, we have a major competitive advantage because of our tolerance for huge losses. Berkshire has massive liquid
resources, substantial non‐insurance earnings, a favorable tax position and a knowledgeable shareholder constituency
willing to accept volatility in earnings. This unique combination enables us to assume risks that far exceed the appetite
of even our largest competitors. Over time, insuring these jumbo risks should be profitable, though periodically they will
bring on a terrible year.

The bottom‐line today is that we will write some coverage for terrorist‐related losses, including a few non‐correlated
policies with very large limits. But we will not knowingly expose Berkshire to losses beyond what we can comfortably
handle. We will control our total exposure, no matter what the competition does.

“I have known the details of almost every policy that Ajit has written since he came with us in 1986, and never on even a
single occasion have I seen him break any of our three underwriting rules. His extraordinary discipline, of course, does
not eliminate losses; it does, however, prevent foolish losses. And that's the key: Just as is the case in investing, insurers
produce outstanding long‐term results primarily by avoiding dumb decisions, rather than by making brilliant ones.”


- BRK 2001 Letter

“Here’s one footnote to GEICO’s 2002 earnings that underscores the need for insurers to do business with only the
strongest of reinsurers. In 1981‐1983, the managers then running GEICO decided to try their hand at writing commercial
umbrella and product liability insurance. The risks seemed modest: the company took in only $3,051,000 from this line
and used almost all of it – $2,979,000 – to buy reinsurance in order to limit its losses. GEICO was left with a paltry
$72,000 as compensation for the minor portion of the risk that it retained. But this small bite of the apple was more
than enough to make the experience memorable. GEICO’s losses from this venture now total a breathtaking $94.1
million or about 130,000% of the net premium it received. Of the total loss, uncollectable receivables from deadbeat
reinsurers account for no less than $90.3 million (including $19 million charged in 2002). So much for “cheap”
reinsurance.”
- BRK 2002 Letter

“Insurance

Since Berkshire purchased National Indemnity (“NICO”) in 1967, property‐casualty insurance has been our core business
and the propellant of our growth. Insurance has provided a fountain of funds with which we’ve acquired the securities
and businesses that now give us an ever‐widening variety of earnings streams. So in this section, I will be spending a
little time telling you how we got where we are.

The source of our insurance funds is “float,” which is money that doesn’t belong to us but that we temporarily hold.
Most of our float arises because (1) premiums are paid upfront though the service we provide – insurance protection – is
delivered over a period that usually covers a year and; (2) loss events that occur today do not always result in our
immediately paying claims, because it sometimes takes many years for losses to be reported (asbestos losses would be
an example), negotiated and settled. The $20 million of float that came with our 1967 purchase has now increased –
both by way of internal growth and acquisitions – to $46.1 billion.

Float is wonderful – if it doesn’t come at a high price. Its cost is determined by underwriting results, meaning how the
expenses and losses we will ultimately pay compare with the premiums we have received. When an underwriting profit
is achieved – as has been the case at Berkshire in about half of the 38 years we have been in the insurance business –
float is better than free. In such years, we are actually paid for holding other people’s money. For most insurers,
however, life has been far more difficult: In aggregate, the property‐casualty industry almost invariably operates at an
underwriting loss. When that loss is large, float becomes expensive, sometimes devastatingly so.

Insurers have generally earned poor returns for a simple reason: They sell a commodity‐like product. Policy forms are
standard, and the product is available from many suppliers, some of whom are mutual companies (“owned” by
policyholders rather than stockholders) with profit goals that are limited. Moreover, most insureds don’t care from
whom they buy. Customers by the millions say “I need some Gillette blades” or “I’ll have a Coke” but we wait in vain for
“I’d like a National Indemnity policy, please.” Consequently, price competition in insurance is usually fierce. Think airline
seats.

So, you may ask, how do Berkshire’s insurance operations overcome the dismal economics of the industry and achieve
some measure of enduring competitive advantage? We’ve attacked that problem in several ways. Let’s look first at
NICO’s strategy.



When we purchased the company – a specialist in commercial auto and general liability insurance – it did not appear to
have any attributes that would overcome the industry’s chronic troubles. It was not well‐known, had no informational
advantage (the company has never had an actuary), was not a low‐cost operator, and sold through general agents, a
method many people thought outdated. Nevertheless, for almost all of the past 38 years, NICO has been a star
performer. Indeed, had we not made this acquisition, Berkshire would be lucky to be worth half of what it is today.”
- BRK 2004 Letter

“The current managerial star – make that superstar – at NICO is Don Wurster (yes, he’s “the graduate”), who has been
running things since 1989. His slugging percentage is right up there with Barry Bonds’ because, like Barry, Don will
accept a walk rather than swing at a bad pitch. Don has now amassed $950 million of float at NICO that over time is
almost certain to be proved the negative‐cost kind. Because insurance prices are falling, Don’s volume will soon decline
very significantly and, as it does, Charlie and I will applaud him ever more loudly.”
- BRK 2004 Letter

“Another way to prosper in a commodity‐type business is to be the low‐cost operator. Among auto insurers operating
on a broad scale, GEICO holds that cherished title. For NICO, as we have seen, an ebb‐and‐flow business model makes
sense. But a company holding a low‐cost advantage must pursue an unrelenting foot‐to‐the‐floor strategy. And that’s
just what we do at GEICO.

A century ago, when autos first appeared, the property‐casualty industry operated as a cartel. The major companies,
most of which were based in the Northeast, established “bureau” rates and that was it. No one cut prices to attract
business. Instead, insurers competed for strong, well‐regarded agents, a focus that produced high commissions for
agents and high prices for consumers.

In 1922, State Farm was formed by George Mecherle, a farmer from Merna, Illinois, who aimed to take advantage of the
pricing umbrella maintained by the high‐cost giants of the industry. State Farm employed a “captive” agency force, a
system keeping its acquisition costs lower than those incurred by the bureau insurers (whose “independent” agents
successfully played off one company against another). With its low‐cost structure, State Farm eventually captured about
25% of the personal lines (auto and homeowners) business, far outdistancing its once‐mighty competitors. Allstate,
formed in 1931, put a similar distribution system into place and soon became the runner‐up in personal lines to State
Farm. Capitalism had worked its magic, and these low‐cost operations looked unstoppable.”
- BRK 2004 Letter

“Insurance is a very tough field, but we should do just fine.

It's a tough field. The average company will do poorly. We think we have some very special companies. And we really
do think over time that we'll acquire and utilize float at a cost that's very, very attractive.”

“…you can make way more money in money mgmt than insurance business. There are few businesses as good as money
management. Average returns in insurance property and casualty have been pretty pathetic. Once you have enough
money you stop accepting compensation and just manage money ‐‐ it is more manly. At least 95% of the insurance
businesses in the world are worse than ours.”


“Let me emphasize again that cost‐free float is not a result to be expected for the P/C industry as a whole: In most years,
premiums have been inadequate to cover claims plus expenses. Consequently, the industry’s overall return on tangible
equity has for many decades fallen far short of that achieved by the S&P 500.”
- BRK 2009 Letter

“Let me emphasize again that cost‐free float is not an outcome to be expected for the P/C industry as a whole: In most
years, industry premiums have been inadequate to cover claims plus expenses. Consequently, the industry’s overall
return on tangible equity has for many decades fallen far short of the average return realized by American industry, a
sorry performance almost certain to continue. Berkshire’s outstanding economics exist only because we have some
terrific managers running some unusual businesses.”
- BRK 2010 Letter

“P&C insurance is a tough game. There are temptations to be stupid like there are in banking.”


Life Insurance

“We have no particular bias against the life insurance business; in fact, we’re in it through General Re. The problem with
it is that it’s not terribly profitable, and you wind up basically managing equities for other people [so there is a sum
certain at death]. We don’t want to wear two hats, just one for Berkshire Hathaway. We want to put our best equity
ideas into Berkshire Hathaway and it wouldn’t be fair to other investor/policy holders out of the picture.”



Money Management

“…you can make way more money in money mgmt than insurance business. There are few businesses as good as money
management. Average returns in insurance property and casualty have been pretty pathetic. Once you have enough
money you stop accepting compensation and just manage money ‐‐ it is more manly. At least 95% of the insurance
businesses in the world are worse than ours.”



Portfolio Management

“Management’s objective is to achieve a return on capital over the long term which averages somewhat higher than that
of American industry generally – while utilizing sound accounting and debt policies.”
- BRK 1973 Letter

“You will notice that our major equity holdings are relatively few. We select such investments on a long‐term basis,
weighing the same factors as would be involved in the purchase of 100% of an operating business: (1) favorable long‐
term economic characteristics; (2) competent and honest management; (3) purchase price attractive when measured
against a yardstick of value to a private owner; and (4) an industry with which we are familiar and whose long‐term
business characteristics we feel competent to judge. It is difficult to find investments meeting such a test, and that is one
reason for our concentration of holdings. We simply can’t find one hundred different securities that conform to our
investment requirements. However, we feel quite comfortable concentrating our holdings in the much smaller number
that we do identify as attractive.”
- BRK 1976 Letter

“Both our operating and investment experience cause us to conclude that “turnarounds” seldom turn, and that the
same energies and talent are much better employed in a good business purchased at a fair price than in a poor business
purchased at a bargain price. Although a mistake, the Waumbec acquisition has not been a disaster. Certain portions of
the operation are proving to be valuable additions to our decorator line (our strongest franchise) at New Bedford, and
it’s possible that we may be able to run profitably on a considerably reduced scale at Manchester. However, our original
rationale did not prove out.”
- BRK 1979 Letter

“One of the ironies of the stock market is the emphasis on activity. Brokers, using terms such as “marketability” and
“liquidity”, sing the praises of companies with high share
turnover (those who cannot fill your pocket will confidently fill your ear). But investors should understand that what is
good for the croupier is not good for the customer. A hyperactive stock market is the pickpocket of enterprise.

For example, consider a typical company earning, say, 12% on equity. Assume a very high turnover rate in its shares of
100% per year. If a purchase and sale of the stock each extract commissions of 1% (the rate may be much higher on
low‐priced stocks) and if the stock trades at book value, the owners of our hypothetical company will pay, in aggregate,
2% of the company’s net worth annually for the privilege of transferring ownership.
This activity does nothing for the earnings of the business, and means that 1/6 of them are lost to the owners through
the “frictional” cost of transfer. (And this calculation does not count option trading, which would increase frictional costs
still further.)

All that makes for a rather expensive game of musical chairs. Can you imagine the agonized cry that would arise if a
governmental unit were to impose a new 16 2/3% tax on earnings of corporations or investors? By market activity,
investors can impose upon themselves the equivalent of such a tax.”
- BRK 1983 Letter



“As indicated in Schedule I accompanying Wesco's financial statements, common stock investments, both those in the
savings and loan subsidiary and those held temporarily elsewhere pending sale to fund business extension, tend to be
concentrated in very few companies. Through this concentration practice better understanding is sought with respect to
the few decisions made.”
- WSC 1983 Letter

“The speed at which a business's success is recognized, furthermore, is not that important as long as the company's
intrinsic value is increasing at a satisfactory rate. In fact, delayed recognition can be an advantage: It may give us the
chance to buy more of a good thing at a bargain price.

Sometimes, of course, the market may judge a business to be more valuable than the underlying facts would indicate it
is. In such a case, we will sell our holdings. Sometimes, also, we will sell a security that is fairly valued or even
undervalued because we require funds for a still more undervalued investment or one we believe we understand better.

We are quite content to hold any security indefinitely, so long as the prospective return on equity capital of the
underlying business is satisfactory, management is competent and honest, and the market does not overvalue the
business.”
- BRK 1987 Letter

“In each case we try to buy into businesses with favorable long‐term economics. Our goal is to find an outstanding
business at a sensible price, not a mediocre business at a bargain price.”
- BRK 1987 Letter

“Because of the way the tax law works, the Rip Van Winkle style of investing that we favor ‐ if successful ‐ has an
important mathematical edge over a more frenzied approach. Let's look at an extreme comparison.

Imagine that Berkshire had only $1, which we put in a security that doubled by yearend and was then sold. Imagine
further that we used the after‐tax proceeds to repeat this process in each of the next 19 years, scoring a double each
time. At the end of the 20 years, the 34% capital gains tax that we would have paid on the profits from each sale would
have delivered about $13,000 to the government and we would be left with about $25,250. Not bad. If, however, we
made a single fantastic investment that itself doubled 20 times during the 20 years, our dollar would grow to
$1,048,576. Were we then to cash out, we would pay a 34% tax of roughly $356,500 and be left with about $692,000.

The sole reason for this staggering difference in results would be the timing of tax payments. Interestingly, the
government would gain from Scenario 2 in exactly the same 27:1 ratio as we ‐ taking in taxes of $356,500 vs. $13,000 ‐
though, admittedly, it would have to wait for its money.”
- BRK 1989 Letter

“Mistakes of the First Twenty‐five Years (A Condensed Version)

To quote Robert Benchley, "Having a dog teaches a boy fidelity, perseverance, and to turn around three times before
lying down." Such are the shortcomings of experience. Nevertheless, it's a good idea to review past mistakes before
committing new ones. So let's take a quick look at the last 25 years.


o My first mistake, of course, was in buying control of Berkshire. Though I knew its business ‐ textile manufacturing ‐
to be unpromising, I was enticed to buy because the price looked cheap. Stock purchases of that kind had proved
reasonably rewarding in my early years, though by the time Berkshire came along in 1965 I was becoming aware that the
strategy was not ideal.

If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives
you a chance to unload at a decent profit, even though the long‐term performance of the business may be terrible. I call
this the "cigar butt" approach to investing. A cigar butt found on the street that has only one puff left in it may not offer
much of a smoke, but the "bargain purchase" will make that puff all profit.

Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original "bargain" price
probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than
another surfaces ‐ never is there just one cockroach in the kitchen.

Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if
you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can
realize a high return. But the investment will disappoint if the business is sold for $10 million in ten years and in the
interim has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful business, the
enemy of the mediocre.

You might think this principle is obvious, but I had to learn it the hard way ‐ in fact, I had to learn it several times over.
Shortly after purchasing Berkshire, I acquired a Baltimore department store, Hochschild Kohn, buying through a
company called Diversified Retailing that later merged with Berkshire. I bought at a substantial discount from book
value, the people were first‐class, and the deal included some extras ‐ unrecorded real estate values and a significant
LIFO inventory cushion. How could I miss? So‐o‐o ‐ three years later I was lucky to sell the business for about what I had
paid. After ending our corporate marriage to Hochschild Kohn, I had memories like those of the husband in the country
song, "My Wife Ran Away With My Best Friend and I Still Miss Him a Lot."

I could give you other personal examples of "bargain‐purchase" folly but I'm sure you get the picture: It's far better to
buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a
slow learner. But now, when buying companies or common stocks, we look for first‐class businesses accompanied by
first‐class managements.”
- BRK 1989 Letter

“Some of my worst mistakes were not publicly visible. These were stock and business purchases whose virtues I
understood and yet didn't make. It's no sin to miss a great opportunity outside one's area of competence. But I have
passed on a couple of really
big purchases that were served up to me on a platter and that I was fully capable of understanding. For Berkshire's
shareholders, myself included, the cost of this thumb‐sucking has been huge.”
- BRK 1989 Letter

“Wesco continues to try more to profit from always remembering the obvious than from grasping the esoteric. It is
remarkable how much long‐term advantage people like us have gotten by trying to be consistently not stupid, instead of
trying to be very intelligent. There must be some wisdom in the folk saying: ‘It's the strong swimmers who drown’. Our


approach, while it has worked fairly well on average in the past and will probably work fairly well over the long‐term
future, is bound to encounter periods of dullness and disadvantage as it limits action.
- WSC 1989 Letter

“Marketable Securities

Below we list our common stock holdings having a value of over $100 million. A small portion of these investments
belongs to subsidiaries of which Berkshire owns less than 100%.

12/31/90 Shares Company Cost Market
‐‐ ‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐
(000s omitted)

3,000,000 Capital Cities/ABC, Inc. .......... $ 517,500 $1,377,375
46,700,000 The Coca‐Cola Co. ................ 1,023,920 2,171,550
2,400,000 Federal Home Loan Mortgage Corp. .. 71,729 117,000
6,850,000 GEICO Corp. ....................... 45,713 1,110,556
1,727,765 The Washington Post Company ....... 9,731 342,097
5,000,000 Wells Fargo & Company ............. 289,431 289,375

Lethargy bordering on sloth remains the cornerstone of our investment style: This year we neither bought nor sold a
share of five of our six major holdings. The exception was Wells Fargo, a superbly‐managed, high‐return banking
operation in which we increased our ownership to just under 10%, the most we can own without the approval of the
Federal Reserve Board. About one‐sixth of our position was bought in 1989, the rest in 1990.”
- BRK 1990 Letter

“As indicated in Schedule I accompanying Wesco's financial statements, investments, both those in the savings and loan
and insurance subsidiaries and those held temporarily elsewhere pending sale to fund business extension, tend to be
concentrated in very few places. Through this practice of concentration of investments, we seek to better understand
the few decisions we make.(*)

(*) It is interesting to compare Wesco's approach (deliberate non‐diversification of investments in an attempt to be
more skillful per transaction) with an approach promoted for years by Michael Milken to help sell junk bonds. The
Milken approach, supported by theories of many finance professors, argued that (1) market prices were efficient in a
world where investors get paid extra for enduring volatility (wide swings in outcomes); (2) therefore, the prices at which
new issues of junk bonds came to market were fair in a probabilistic sense (meaning that the high promised interest
rates covered increased statistical expectancy of loss) and also provided some premium return to cover volatility
exposure; and (3) therefore, if a savings and loan association (or other institution) arranged diversification, say, by
buying, without much examination, a large part of each new Milken issue of junk bonds, the association would work
itself into the sure to‐get‐better‐than‐average‐results position of a gambling house proprietor with a "house" edge. This
type of theorizing has now wreaked havoc at institutions, governed by true‐believers, which backed their conclusions by
buying Milken's "bonds." Contrary to the theorizing, widely diversified purchases of such "bonds" have in most cases
produced dismal results. We can all understand why Milken behaved as he did and believed what he had to believe in
order to maintain an endurable self‐image. But how can we explain why anyone else believed that Milken was pad [sic]
5% commissions to put "bond" buyers in the position of the house in Las Vegas? We suggest this cause: many of the
foolish buyers, and their advisers, were trained by finance professors who pushed beloved models (efficient market


theory and modern portfolio theory) way too far, while they ignored other models that would have warned of danger.
This is a common type of "expert" error, as we have earlier indicated.”
- WSC 1990 Letter

“The goal of each investor should be to create a portfolio (in effect, a "company") that will deliver him or her the highest
possible look‐through earnings a decade or so from now.”
- BRK 1991 Letter

“Our stay‐put behavior reflects our view that the stock market serves as a relocation center at which money is moved
from the active to the patient.”
- BRK 1991 Letter

“We continually search for large businesses with understandable, enduring and mouth‐watering economics that are run
by able and shareholder‐oriented managements. This focus doesn't guarantee results: We both have to buy at a sensible
price and get business performance from our companies that validates our assessment. But this investment approach ‐
searching for the superstars ‐ offers us our only chance for real success. Charlie and I are simply not smart enough,
considering the large sums we work with, to get great results by adroitly buying and selling portions of far‐from‐great
businesses. Nor do we think many others can achieve long‐term investment success by flitting from flower to flower.
Indeed, we believe that according the name "investors" to institutions that trade actively is like calling someone who
repeatedly engages in one‐night stands a romantic.

If my universe of business possibilities was limited, say, to private companies in Omaha, I would, first, try to assess the
long‐term economic characteristics of each business; second, assess the quality of the people in charge of running it;
and, third, try to buy into a few of the best operations at a sensible price. I certainly would not wish to own an equal part
of every business in town. Why, then, should Berkshire take a different tack when dealing with the larger universe of
public companies? And since finding great businesses and outstanding managers is so difficult, why should we discard
proven products? (I was tempted to say "the real thing.") Our motto is: "If at first you do succeed, quit trying."
- BRK 1991 Letter

“ In my early days as a manager I, too, dated a few toads. They were cheap dates ‐ I've never been much of a sport ‐
but my results matched those of acquirers who courted higher‐priced toads. I kissed and they croaked.

After several failures of this type, I finally remembered some useful advice I once got from a golf pro (who, like all pros
who have had anything to do with my game, wishes to remain anonymous). Said the pro: "Practice doesn't make
perfect; practice makes permanent." And thereafter I revised my strategy and tried to buy good businesses at fair prices
rather than fair businesses at good prices.”
- BRK 1992 Letter

“Our equity‐investing strategy remains little changed from what it was fifteen years ago, when we said in the 1977
annual report: ‘We select our marketable equity securities in much the way we would evaluate a business for
acquisition in its entirety. We want the business to be one (a) that we can understand; (b) with favorable long‐term
prospects; (c) operated by honest and competent people; and (d) available at a very attractive price.’ We have seen


cause to make only one change in this creed: Because of both market conditions and our size, we now substitute ‘an
attractive price’ for ‘a very attractive price’."
- BRK 1992 Letter

“Considering the similarity of this year's [equities owned] list and the last, you may decide your management is
hopelessly comatose. But we continue to think that it is usually foolish to part with an interest in a business that is both
understandable and durably wonderful. Business interests of that kind are simply too hard to replace. An investor
should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he
owned all of that business.”
- BRK 1993 Letter

“Charlie and I decided long ago that in an investment lifetime it's just too hard to make hundreds of smart decisions.”
- BRK 1993 Letter

“In our opinion, the real risk that an investor must assess is whether his aggregate after‐tax receipts from an investment
(including those he receives on sale) will, over his prospective holding period, give him at least as much purchasing
power as he had to begin with, plus a modest rate of interest on that initial stake. Though this risk cannot be calculated
with engineering precision, it can in some cases be judged with a degree of accuracy that is useful. The primary factors
bearing upon this evaluation are:

1. The certainty with which the long‐term economic characteristics of the business can be evaluated;

2. The certainty with which management can be evaluated, both as to its ability to realize the full potential of the
business and to wisely employ its cash flows;

3. The certainty with which management can be counted on to channel the rewards from the business to the
shareholders rather than to itself;

4. The purchase price of the business;

5. The levels of taxation and inflation that will be experienced and that will determine the degree by which an
investor's purchasing‐power return is reduced from his gross return.

These factors will probably strike many analysts as unbearably fuzzy, since they cannot be extracted from a data base of
any kind. But the difficulty of precisely quantifying these matters does not negate their importance nor is it insuperable.
Just as Justice Stewart found it impossible to formulate a test for obscenity but nevertheless asserted, "I know it when I
see it," so also can investors ‐ in an inexact but useful way ‐ "see" the risks inherent in certain investments without
reference to complex equations or price histories.

Is it really so difficult to conclude that Coca‐Cola and Gillette possess far less business risk over the long term than, say,
any computer company or retailer? Worldwide, Coke sells about 44% of all soft drinks, and Gillette has more than a 60%
share (in value) of the blade market. Leaving aside chewing gum, in which Wrigley is dominant, I know of no other
significant businesses in which the leading company has long enjoyed such global power.



Moreover, both Coke and Gillette have actually increased their worldwide shares of market in recent years. The might
of their brand names, the attributes of their products, and the strength of their distribution systems give them an
enormous competitive advantage, setting up a protective moat around their economic castles. The average company, in
contrast, does battle daily without any such means of protection. As Peter Lynch says, stocks of companies selling
commodity‐like products should come with a warning label: "Competition may prove hazardous to human wealth."

The competitive strengths of a Coke or Gillette are obvious to even the casual observer of business. Yet the beta of their
stocks is similar to that of a great many run‐of‐the‐mill companies who possess little or no competitive advantage.
Should we conclude from this similarity that the competitive strength of Coke and Gillette gains them nothing when
business risk is being measured?

Or should we conclude that the risk in owning a piece of a company ‐ its stock ‐ is somehow divorced from the long‐term
risk inherent in its business operations? We believe neither conclusion makes sense and that equating beta with
investment risk also makes no
sense.

The theoretician bred on beta has no mechanism for differentiating the risk inherent in, say, a single‐product toy
company selling pet rocks or hula hoops from that of another toy company whose sole product is Monopoly or Barbie.
But it's quite possible for ordinary investors to make such distinctions if they have a reasonable understanding of
consumer behavior and the factors that create long‐term competitive strength or weakness. Obviously, every investor
will make mistakes. But by confining himself to a relatively few, easy‐to‐understand cases, a reasonably intelligent,
informed and diligent person can judge investment risks with a useful degree of accuracy.

In many industries, of course, Charlie and I can't determine whether we are dealing with a "pet rock" or a "Barbie." We
couldn't solve this problem, moreover, even if we were to spend years intensely studying those industries. Sometimes
our own intellectual shortcomings would stand in the way of understanding, and in other cases the nature of the
industry would be the roadblock. For example, a business that must deal with fast‐moving technology is not going to
lend itself to reliable evaluations of its long‐term economics. Did we foresee thirty years ago what would transpire in
the television‐manufacturing or computer industries? Of course not. (Nor did most of the investors and corporate
managers who enthusiastically entered those industries.) Why, then, should Charlie and I now think we can predict the
future of other rapidly‐evolving businesses? We'll stick instead with the easy cases. Why search for a needle buried in a
haystack when one is sitting in plain sight?”
- BRK 1993 Letter

“It's far better to own a significant portion of the Hope diamond than 100% of a rhinestone, and the companies just
mentioned easily qualify as rare gems. Best of all, we aren't limited to simply a few of this breed, but instead possess a
growing collection.”
- BRK 1994 Letter

“Our investments continue to be few in number and simple in concept: The truly big investment idea can usually be
explained in a short paragraph. We like a business with enduring competitive advantages that is run by able and owner‐
oriented people. When these attributes exist, and when we can make purchases at sensible prices, it is hard to go
wrong (a challenge we periodically manage to overcome).”
- BRK 1994 Letter



“Investors should remember that their scorecard is not computed using Olympic‐diving methods: Degree‐of‐difficulty
doesn't count. If you are right about a business whose value is largely dependent on a single key factor that is both easy
to understand and enduring, the payoff is the same as if you had correctly analyzed an investment alternative
characterized by many constantly shifting and complex variables.”
- BRK 1994 Letter

“Accordingly, we wrote our USAir investment down to $89.5 million, 25 cents on the dollar at yearend 1994. This
valuation reflects both a possibility that our preferred will have its value fully or largely restored and an opposite
possibility that the stock will eventually become worthless. Whatever the outcome, we will heed a prime rule of
investing: You don't have to make it back the way that you lost it.”
- BRK 1994 Letter

“The bad timing of Wesco in entering the electrical equipment field when it did was entirely the result of misjudgment
by the writer, caused by a strong, near‐lifelong preference for predicting relative consequences from business and
human quality while not attempting to predict business cycles.”
- WSC 1994 Letter

“Charlie Munger, Berkshire's Vice Chairman and my partner, and I want to build a collection of companies ‐ both wholly‐
and partly‐owned ‐ that have excellent economic characteristics and that are run by outstanding managers.”
- BRK 1995 Letter

“You may think this odd, but I have kept copies of every tax return I filed, starting with the return for 1944. Checking
back, I find that I purchased GEICO shares on four occasions during 1951, the last purchase being made on September
26. This pattern of persistence suggests to me that my tendency toward self‐intoxication was developed early. I
probably came back on that September day from unsuccessfully trying to sell some prospect and decided ‐ despite my
already having more than 50% of my net worth in GEICO ‐ to load up further. In any event, I accumulated 350 shares of
GEICO during the year, at a cost of $10,282. At yearend, this holding was worth $13,125, more than 65% of my net
worth.

You can see why GEICO was my first business love. Furthermore, just to complete this stroll down memory lane, I
should add that I earned most of the funds I used to buy GEICO shares by delivering The Washington Post, the chief
product of a company that much later made it possible for Berkshire to turn $10 million into $500 million.

Alas, I sold my entire GEICO position in 1952 for $15,259, primarily to switch into Western Insurance Securities. This act
of infidelity can partially be excused by the fact that Western was selling for slightly more than one times its current
earnings, a p/e ratio that for some reason caught my eye. But in the next 20 years, the GEICO stock I sold grew in value
to about $1.3 million, which taught me a lesson about the inadvisability of selling a stake in an identifiably‐wonderful
company.”
- BRK 1995 Letter

“One more bit of history: I first became interested in Disney in 1966, when its market valuation was less than $90
million, even though the company had earned around $21 million pre‐tax in 1965 and was sitting with more cash than


debt. At Disneyland, the $17 million Pirates of the Caribbean ride would soon open. Imagine my excitement ‐ a
company selling at only five times rides!

Duly impressed, Buffett Partnership Ltd. bought a significant amount of Disney stock at a split‐adjusted price of 31› per
share. That decision may appear brilliant, given that the stock now sells for $66. But your Chairman was up to the task
of nullifying it: In 1967 I sold out at 48› per share.”
- BRK 1995 Letter

“For us, at least, our experience in shifting from savings and loan operation to ownership of Freddie Mac shares tends to
confirm a long‐held notion that being prepared, on a few occasions in a lifetime, to act promptly in scale in doing some
simple thing will often be enough to make the financial results of that lifetime quite satisfactory.”
- WSC 1995 Letter

“Inactivity strikes us as intelligent behavior. Neither we nor most business managers would dream of feverishly trading
highly‐profitable subsidiaries because a small move in the Federal Reserve's discount rate was predicted or because
some Wall Street pundit had reversed his views on the market. Why, then, should we behave differently with our
minority positions in wonderful businesses? The art of investing in public companies successfully is little different from
the art of successfully acquiring subsidiaries. In each case you simply want to acquire, at a sensible price, a business with
excellent economics and able, honest management. Thereafter, you need only monitor whether these qualities are
being preserved.

When carried out capably, an investment strategy of that type will often result in its practitioner owning a few securities
that will come to represent a very large portion of his portfolio. This investor would get a similar result if he followed a
policy of purchasing an interest in, say, 20% of the future earnings of a number of outstanding college basketball stars.
A handful of these would go on to achieve NBA stardom, and the investor's take from them would soon dominate his
royalty stream. To suggest that this investor should sell off portions of his most successful investments simply because
they have come to dominate his portfolio is akin to suggesting that the Bulls trade Michael Jordan because he has
become so important to the team.”
- BRK 1996 Letter

“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily‐understandable
business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time,
you will find only a few companies that meet these standards ‐ so when you see one that qualifies, you should buy a
meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren't willing to
own a stock for ten years, don't even think about owning it for ten minutes. Put together a portfolio of companies
whose aggregate earnings march upward over the years, and so also will the portfolio's market value.”
- BRK 1996 Letter

“Our experience in shifting frorn savings and loan operation to ownership of Freddie Mac shares tends to confirm a long‐
held notion that being prepared, on a few occasions in a lifetime, to act promptly in scale in doing some simple and
logical thing will often dramatically improve the financial results of that lifetime. A few major opportunities, clearly
recognizable as such, will usually come to one who continuously searches and waits, with a curious mind, loving
diagnosis involving multiple variables. And then all that is required is a willingness to bet heavily when the odds are
extremely favorable, using resources available as a result of prudence and patience in the past.”


- WSC 1996 Letter

“How to Minimize Investment Returns

It’s been an easy matter for Berkshire and other owners of American equities to prosper over the years. Between
December 31, 1899 and December 31, 1999, to give a really long‐term example, the Dow rose from 66 to 11,497. (Guess
what annual growth rate is required to produce this result; the surprising answer is at the end of this section.) This huge
rise came about for a simple reason: Over the century American businesses did extraordinarily well and investors rode
the wave of their prosperity. Businesses continue to do well. But now shareholders, through a series of self‐inflicted
wounds, are in a major way cutting the returns they will realize from their investments.

The explanation of how this is happening begins with a fundamental truth: With unimportant exceptions, such as
bankruptcies in which some of a company’s losses are borne by creditors, the most that owners in aggregate can earn
between now and Judgment Day is what their businesses in aggregate earn. True, by buying and selling that is clever or
lucky, investor A may take more than his share of the pie at the expense of investor B. And, yes, all investors feel richer
when stocks soar. But an owner can exit only by having someone take his place. If one investor sells high, another must
buy high. For owners as a whole, there is simply no magic – no shower of money from outer space – that will enable
them to extract wealth from their companies beyond that created by the companies themselves.

Indeed, owners must earn less than their businesses earn because of “frictional” costs. And that’s my point: These costs
are now being incurred in amounts that will cause shareholders to earn far less than they historically have.

To understand how this toll has ballooned, imagine for a moment that all American corporations are, and always will be,
owned by a single family. We’ll call them the Gotrocks. After paying taxes on dividends, this family – generation after
generation – becomes richer by the aggregate amount earned by its companies. Today that amount is about $700 billion
annually. Naturally, the family spends some of these dollars. But the portion it saves steadily compounds for its benefit.
In the Gotrocks household everyone grows wealthier at the same pace, and all is harmonious.

But let’s now assume that a few fast‐talking Helpers approach the family and persuade each of its members to try to
outsmart his relatives by buying certain of their holdings and selling them certain others. The Helpers – for a fee, of
course – obligingly agree to handle these transactions. The Gotrocks still own all of corporate America; the trades just
rearrange who owns what. So the family’s annual gain in wealth diminishes, equaling the earnings of American business
minus commissions paid. The more that family members trade, the smaller their share of the pie and the larger the slice
received by the Helpers. This fact is not lost upon these broker‐Helpers: Activity is their friend and, in a wide variety of
ways, they urge it on.

After a while, most of the family members realize that they are not doing so well at this new “beat‐my‐brother” game.
Enter another set of Helpers. These newcomers explain to each member of the Gotrocks clan that by himself he’ll never
outsmart the rest of the family. The suggested cure: “Hire a manager – yes, us – and get the job done professionally.”
These manager‐Helpers continue to use the broker‐Helpers to execute trades; the managers may even increase their
activity so as to permit the brokers to prosper still more. Overall, a bigger slice of the pie now goes to the two classes of
Helpers.

The family’s disappointment grows. Each of its members is now employing professionals. Yet overall, the group’s
finances have taken a turn for the worse. The solution? More help, of course.

It arrives in the form of financial planners and institutional consultants, who weigh in to advise the Gotrocks on selecting
manager‐Helpers. The befuddled family welcomes this assistance. By now its members know they can pick neither the


right stocks nor the right stock‐pickers. Why, one might ask, should they expect success in picking the right consultant?
But this question does not occur to the Gotrocks, and the consultant‐Helpers certainly don’t suggest it to them.

The Gotrocks, now supporting three classes of expensive Helpers, find that their results get worse, and they sink into
despair. But just as hope seems lost, a fourth group – we’ll call them the hyper‐Helpers – appears. These friendly folk
explain to the Gotrocks that their unsatisfactory results are occurring because the existing Helpers – brokers, managers,
consultants – are not sufficiently motivated and are simply going through the motions. “What,” the new Helpers ask,
“can you expect from such a bunch of zombies?”

The new arrivals offer a breathtakingly simple solution: Pay more money. Brimming with selfconfidence, the hyper‐
Helpers assert that huge contingent payments – in addition to stiff fixed fees – are what each family member must fork
over in order to really outmaneuver his relatives.

The more observant members of the family see that some of the hyper‐Helpers are really just manager‐Helpers wearing
new uniforms, bearing sewn‐on sexy names like HEDGE FUND or PRIVATE EQUITY. The new Helpers, however, assure
the Gotrocks that this change of clothing is all‐important, bestowing on its wearers magical powers similar to those
acquired by mild‐mannered Clark Kent when he changed into his Superman costume. Calmed by this explanation, the
family decides to pay up.

And that’s where we are today: A record portion of the earnings that would go in their entirety to owners – if they all
just stayed in their rocking chairs – is now going to a swelling army of Helpers. Particularly expensive is the recent
pandemic of profit arrangements under which Helpers receive large portions of the winnings when they are smart or
lucky, and leave family members with all of the losses – and large fixed fees to boot – when the Helpers are dumb or
unlucky (or occasionally crooked).

A sufficient number of arrangements like this – heads, the Helper takes much of the winnings; tails, the Gotrocks lose
and pay dearly for the privilege of doing so – may make it more accurate to call the family the Hadrocks. Today, in fact,
the family’s frictional costs of all sorts may well amount to 20% of the earnings of American business.

In other words, the burden of paying Helpers may cause American equity investors, overall, to earn only 80% or so of
what they would earn if they just sat still and listened to no one.

Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t
extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the
stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to
discover ‐ the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.”
- BRK 2005 Letter

“We're trying to buy things that we'll want to own forever.

Shareholder: I think I understand how you decide when to buy stocks. But what criteria do you use to decide when it's
time to sell 'em?
Buffett: The best thing to do is to buy a stock that you don't ever want to sell. And that's what we're trying to do when
we buy a stock and when we buy a business. That's what we did when we bought all of GEICO, all of See's Candy and all
of the Buffalo News. We're not buying any of those things to resell 'em. We're trying to buy a business that we'll be
happy with if we own it for the rest of our lives. And we expect to do exactly that with those.
- 1998 BRK Meeting


“The ideal purchase ‐ buying more of what you like best.

Buffett: The same principle applies in the case of marketable securities. Only you get some extra options: For example,
you can add to a position.... For example, if we own 2% of a business by way of a marketable security and we like it at a
given price, we can increase our interest to 4% or 5%. So that's one advantage.

Incidentally, the ideal purchase is something you like already when it's selling at a price that makes you want to go out
and buy more. And we probably should have done more of that in the past....
That's one of the beauties of marketable securities. When you're in a wonderful business, you do get a chance
periodically to double up on it or something of that sort. Were the stock market to sell a lot cheaper than it is now, we'd
probably buy more of the businesses we already own. They'd certainly be the first ones we'd think about buying because
they're the ones we like best.”
- 1998 BRK Meeting

“When we sell, it doesn't mean we're negative ‐ at all....

Buffett: But we sometimes need the money for another sector ‐ like we did last year. And when we do, we can get the
money we need by trimming some of our holdings of marketable securities. But that doesn't mean we're negative about
those businesses ‐ not at all. In fact, we believe that they're wonderful businesses. Otherwise, we wouldn't own 'em.
However, we might sell some or all of our stock in Company A if we need money for other things. I sold the GEICO
stock that I bought in 1951, for example, a year or so later. And prior to its 1976 problems, those shares went on to be
worth 100 or more times what I paid. But at the time, I didn't have the money I needed to do something else. So we may
sell ... [for that reason].

The ideal time to sell....

Buffett: And we may sell if we believe that valuations between different markets are out of whack. Again, we've
occasionally done a little trimming ‐ like we did last year....
But that could well be a mistake. The real thing to do with a great business is to hang on for dear life. Charlie?
Munger: Yes. But for the sales that do happen, the ideal time [to sell] is when you've found something that you like
immensely better. Isn't it perfectly obvious that that's the ideal time to sell?

“ Buffett: Everything we've ever sold has gone up subsequently, but some of 'em have gone up more painfully than
others. Certainly, the Disney sale in the '60s was a huge mistake. Forget about whether I should have continued holding
it. I should have been buying it. That's happened many times.

“ Buffett: We think that anything we sell should go up subsequently ‐ because we own good businesses. And when we
sell 'em, it's because we need money to buy something else. But we still think they're good businesses. And we think
good businesses are going to be worth more over time.
So everything I sold in the past virtually ‐ that I can think of ‐ has gone on to sell for a lot more money. And I would
expect that to continue to be the case.
That's not a source of distress. But I must say that selling the Disney was a mistake. Actually, the ad agencies have
done very well since we sold 'em, too. Now maybe some of that money went into Coca‐Cola or something else. So I
don't worry about that.


I would worry, frankly, if I'd sold a bunch of things right at the top ‐ because that would indicate, in effect, that I was
practising a "greater fool" approach to investing. And I don't think it can be practised successfully over time.
I think the most successful investors, if they sell at all, will be selling things that end up going a lot higher ‐ because it
means they've been buying into good businesses as they've gone along. Charlie?”
‐ 1998 BRK Meeting

“We would sell if we needed the money for something else, but that hasn’t been a problem in the past 10‐15 years.
Earlier in my career, I had more ideas than money, but now it’s the reverse.

Now we typically sell when we reevaluate the economic characteristics of a business; when we had one view of the long‐
term competitive advantage, but are modifying it. That’s not to say it’s become a bad business – just that the
competitive advantages are not as strong as we initially thought.

“I’ve seen nothing to improve on Graham and Fisher. Just think about stocks as a business and then evaluate that
business. This requires insulating yourself from popular opinion.”

“Buying in stock declines

Over many decades, our usual practice is that if [the stock of] something we like goes down, we buy more and more.
Sometimes something happens, you realize you’re wrong, and you get out. But if you develop correct confidence in your
judgement, buy more and take advantage of stock prices.”

“Focus Investing

Buffett: You don’t have to be right on everything or 20%, 10%, or 5% of businesses. You only have to be right one or two
times a year. I used to handicap horses. You can come up with a very profitable decision on a single company. If
someone asked me to handicap the 500 companies in the S&P 500, I wouldn’t do a very good job. You only have to be
right a few times in your lifetime, as long as you don’t make any big mistakes.

Munger: What’s funny is that most big investment organizations don’t think like this.
They hire lots of people, evaluate Merck vs. Pfizer and every stock in the S&P 500, and think they can beat the market.
You can’t do it. Very few people have adopted our approach.

Buffett: Ted Williams, in his book The Science of Hitting, talked about how he carved up the strike zone into different
zones and only swung at pitches that were in his sweet spot.
Investing is the same way.”
- 2003 BRK Meeting

“Weathering Financial Cataclysms

Buffett: Absent leverage or just going crazy on valuation, the financial cataclysms won’t do you in. And if you have any
more money, you buy.


Munger: I want to make an apology. Last night, referring to some of our modern business tycoons – specifically Armand
Hammer – I said that when they’re talking, they’re lying, and when they’re quiet, they’re stealing. This wasn’t my
witticism; it was used [long ago] to describe the robber barons.”
- 2004 BRK Meeting

“Charlie and I put money in things we understand and think we’ll know what it’ll look like in 5, 10 or 20 years. Bill being
on the board doesn’t change this. I’ll listen to any idea of his and, in fact, our investment ideas overlap quite a bit. I still
wish I’d bought Microsoft when I’d first met him.”

“When I operated a partnership, I got hit in 1973 and 1974, which was the worst collapse since the 1930s. So I got hit
with a once‐in‐50‐years‐type event.”

“I don’t think any fully engaged young man wouldn’t have gotten into the pain that I did in 73‐74. If you weren’t
aggressive enough and buying on the way down and having some agony at the bottom, then you weren’t living a proper
investment life. I wouldn’t quarrel with anyone who was more cautious and less aggressive than I was. But what got me
into the agony was buying things for far less than what I was sure I could liquidate them for in due course. I don’t think it
was wrong, but it was agony.”

“It’s going to be difficult for people to have high real returns from deferring consumption. The reason my generation did
so well was kind of a fluke, and won’t necessarily continue. There will be lots of chicanery in future. Many claim alpha –
but really they are just taking earthquake risk. At end of year, when there is no earthquake, they take the money. This is
a dishonorable way to invest. It is always easier to get felicity by reducing expectations instead of seeking extreme
results.”

“At Berkshire, we have high opportunity costs…

You have to make your decisions in life based on opportunity cost. You are located in a certain place, you have a
certain amount of opportunities, and you find opportunity A that’s better than opportunity B, which is the best
alternative you know of. You therefore do A instead of B. Somebody else may have a better bet. But opportunity A may
be the best you have, given where you’re located and what you know.”

“And yet, in investment management, practically nobody operates that way. We operate that way – I’m talking about
Buffett and Munger. And we’re not alone in the world. But a huge majority of people have some other crazy construct in
their heads. And instead of waiting for a near cinch and loading up, they apparently ascribe to the theory that if they
work a little harder or hire more business school students, they’ll come to know everything about everything all the
time. To me, that’s totally insane.

How many insights do you need? Well, I’d argue that you don’t need many in a lifetime. If you look at Berkshire
Hathaway and all of its accumulated billions, the top ten insights account for most of it. Well, I’d argue that you don’t


need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top ten insights
account for most of it. And that’s with a very brilliant man – Warren’s a lot more able than I am and very discipline –
devoting his lifetime to it. I don’t mean to say that he’s only had ten insights. I’m just saying that most of the money
came from ten insights.

So you can get very remarkable investment results if you think more like a winning pari‐mutuel player. Just think of it as
a heavy odds against game full of bullshit and craziness with an occasional mispriced something or other. And you’re
probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. Its’
just that simple.

When Warren lectures at business schools, he says, ‘I could improve your ultimate financial welfare by giving you a
ticker with only twenty slots in it so that you had twenty punches – representing all the investments that you got to
make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.’

He says, ‘Under those rules, you’d really think carefully about what you did, and you’d be forced to lad up on what you’d
really thought about. So you’d do so much better.’

Again, this concept that seems perfectly obvious to me. And to Warren, it seems perfectly obvious. But this one of the
very few businesses classes in the United States where anybody will be saying so. It just isn’t the conventional wisdom.

To me, it’s obvious that the winner has to bet very selectively. It’s been obvious to me since very early in life. I don’t
know why it’s not obvious to very many other people.”
4/14/1994

“We’ve really made the money out of high‐quality businesses. (…) And most of the other people who’ve made a lot of
money have done so in high‐quality businesses.”

“Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the
business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much
different than a six percent return – even if you originally buy it at a huge discount. Conversely, if a business earns
eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking prices, you’ll end up with
one hell of a result.”
4/14/1994

“And ideally – and we’ve done a lot of this – you get into a great business which also has a great manager because
management matters. For example, it’s made a hell of a difference at General Electric that jack Welch came in instead of
the guy who took over Westinghouse – one hell of a difference. So management matters, too.

And some of it is predictable. I don not think it takes a genius to understand that Jack Welch was a more insightful
person and a better manager than his peers in other companies. Nor do I think it took tremendous genius to understand
that Disney had basic momentums in place that are very powerful and that Eisner and Wells were very unusual
managers.

So you do get an occasionally opportunity to get into a wonderful business that’s being run by a wonderful manager.
And, of course, that’s hog heaven day. If you don’t load up when you get those opportunities, it’s a big mistake.”


4/14/1994

“Once you are in the businesses of evaluating businesses and you decide that you are going to bring the effort and
intensity and time involved to get that job done, then I think diversification is a terrible mistake to any degree. I got
asked that question the other day at SunTrust. If you really know businesses, you probably shouldn’t own more than six
of them.

If you can identify six wonderful businesses, that is all the diversification you need. And you will make a lot of money.
And I can guarantee that going into a seventh one instead of putting more money into your first one is gotta be a
terrible mistake. Very few people have gotten rich on their seventh best idea. But a lot of people have gotten rich with
their best idea.”

“If we can do one intelligent thing a year we are ecstatic. You can negotiate us down to one every two or three years
without working very hard. That’s all you need. You need very few good ideas in your lifetime. You have to be willing to
have the discipline to say, ‘I’m not going to do something I don’t understand.’ Why should I do something I don’t
understand? That’s why I find it an advantage to be in Omaha instead of New York. I worked in New York for a few
years, and people were coming up to me on the corner and whispering in my ear all the time. I was getting excited all
the time. I was a wonderful customer for the brokers.”

“We do not try and buy more and more of everything. I call that the Noah’s Ark approach to investing – have two of
everything. We’ve got a very selective ark, and we only want a couple of specimens on there. It makes it more difficult,
but you don’t need very many good ideas. If we get one good idea a year, that would be terrific (…)You do not have to
keep hitting home runs all the time. That’s one of the nice things about this business. If you make one decision on
something like that, it takes care of a lot.”

“I don’t try to pick turns in any kind of an industry in terms of buying stocks. I just like to buy them when I think they’re
cheap relative to their long‐term earning power and I don’t happen to have that conviction about home builders now,
but it very well may be the case. It’s just I don’t have the conviction.”

“This is the cornerstone of our investment philosophy: Never count on making a good sale. Have the purchase price be
so attractive that even a mediocre sale gives good results.”

“Why in the world does this [underperformance] happen to very intelligent managements working with (1) bright
energetic staff people, (2) virtually unlimited resources, (3) the most extensive business contacts, and (4) literally
centuries of aggregate investment experience.”



“My opinion is that the first job of any investment management organization is to analyze its own techniques and results
before pronouncing judgment on the managerial abilities and performance of major corporate entities of the United
States.

In the great majority of cases the lack of performance exceeding or even matching an unmanaged index in no way
reflects lack of either intellectual capacity or integrity. I think it is much more the product of:
(1) group decisions – my perhaps jaundiced view is that it is close to impossible for outstanding investment management
to come from a group of any size with all parties really participating in decisions;
(2) a desire to conform to the policies and (to an extent) the portfolios of other large well‐regarded organizations;
(3) an institutional framework whereby average is “safe” and the personal rewards for independent action are in no way
commensurate with the general risk attached to such action;
(4) and adherence to certain diversification practices which are irrational; and finally and importantly
(5) inertia.”

“It is of enormous dollars‐and‐cents importance to evaluate objectively the accomplishments of the fellow who is
actually handling your money – even if it’s you.”

“More investment sins are probably committed by otherwise quite intelligent people because of “tax considerations”
than from any other cause. One of life’s errors are caused by forgetting what one is really trying to do. This is certainly
the case when an emotionally supercharged element like taxes enters the picture.”

“It is extremely improbable that 20 stocks selected from, say, 3000 choices are going to prove to be the optimum
portfolio both now and a year from now at the entirely different prices (both for the selections and the alternatives)
prevailing at that later date. If our objective is to produce the maximum after‐tax compound rate, we simply have to
own the most attractive securities obtainable at current prices. And, with 3,000 rather rapidly shifting variables, this
must mean change (hopefully “tax‐generating” change).

It is obvious that the performance of a stock last year or last month is no reason, per se, to either own it or to not own it
now. It is obvious that an inability to “get even” in a security that has declined is of no importance. It is obvious that the
inner warm glow that results from having held a winner last year is of no importance in making a decision as to whether
it belongs in an optimum portfolio this year.”

“There is one thing of which I can assure you. If good performance of the fund is even a minor objective, any portfolio
encompassing one hundred stocks (whether the manager is handling one thousand dollars or one billion dollars) is not
being operated logically. The addition of the one hundredth stock simply can’t reduce the potential variance in portfolio
performance sufficiently to compensate for the negative effect its inclusion has on the overall portfolio expectation.

Anyone owning such numbers of securities after presumably studying their investment merit (and I don’t care how
prestigious their labels) is following what I call the Noah School of Investing – two of everything. Such investors should


be piloting arks. While Noah may have been acting in accord with certain time‐tested biological principles, the investors
have left the track regarding mathematical principles.”

“We don’t buy and sell stocks based upon what other people think the stock market is going to do (I never have an
opinion) but rather upon what we think the company is going to do. The course of the stock market will determine, to a
great degree, when we will be right, but the accuracy of our analysis of the company will largely determine whether we
will be right. In other words, we tend to concentrate on what should happen, not when it should happen.”
- Buffett Partnership Letter, July 12, 1966

“If we make a mistake, we sell. It’s the wonderful business you hold forever. When in doubt, keep holding. We have an
attitude that when we buy that we are playing for keeps. The time we sell is when it’s not clear the company will make
money in the future. We like to ride for a LT. But if the competitive advantage disappears, if management loses our faith,
or if we find something more attractive and we don’t have any other money, then like last September, we’ll sell
something.”
- – WEB, 2009 BRK Shareholders meeting.

“I should emphasize that we do not measure the progress of our investments by what their market prices do during any
given year. Rather, we evaluate their performance by the two methods we apply to the businesses we own. The first test
is improvement in earnings, with our making due allowance for industry conditions. The second test, more subjective, is
whether their “moats” – a metaphor for the superiorities they possess that make life difficult for their competitors –
have widened during the year. All of the “big four” scored positively on that test.”
- – WEB, 2007 BRK shareholder letter.

“Our experience tends to confirm a long‐held notion that being prepared, on a few occasions in a lifetime, to act
promptly in scale, and doing some simple and logical thing, will often dramatically improve the financial results of that
lifetime.
A few major opportunities, clearly recognizable as such, will usually come to one who continuously searches and waits,
with a curious mind that loves diagnoses involving multiple variables.
And then all that is required is a willingness to bet heavily when the odds are extremely favorable, using resources
available as a result of prudence and patience in the past.”

- – Charlie Munger, Poor Charlie's Almanac Expanded Second Edition.

“the best businesses by far for owners continue to be those that have high returns on capital and that require little
incremental investment to grow.”
- BRK 2009 Letter

“Big opportunities come infrequently. When it’s raining gold, reach for a bucket, not a thimble.”
- BRK 2009 Letter

“We’ve put a lot of money to work during the chaos of the last two years. It’s been an ideal period for investors: A
climate of fear is their best friend. Those who invest only when commentators are upbeat end up paying a heavy price
for meaningless reassurance. In the end, what counts in investing is what you pay for a business – through the purchase
of a small piece of it in the stock market – and what that business earns in the succeeding decade or two.”
- BRK 2009 Letter


“If things change or we made a mistake, we sell. It’s the wonderful business you hold forever.”

“But we like to ride for a long time. But if the competitive advantage disappears, if management loses our faith, or if we
find something more attractive and we don’t have any other money, then like last September, we’ll sell something. Like
JNJ, I didn’t like our liquidity levels. I figured
I could always buy JNJ back at a later date.”

“We don’t have an opinion about stock prices. We don’t pick bottoms. Pricing is our game, and that’s not so difficult,
whereas picking bottoms is practically impossible.”

“If you have a great consumer product that requires very little capital to grow and support that growth – and you do
more volume as inflation grows – that is a wonderful asset to protect against inflation. The ultimate example of that is
your own earning ability. People who have made investments in themselves – outstanding teachers and doctors – see
their wages increase with inflation. They also don’t have to make an additional investment in themselves. People should
think about a long term real estate asset like a farm where additional capital is not require to finance inflationary
growth.”

“Munger: One great thing about cyclical business is that people often don’t like them. They don’t worry about lumpy
earnings. They like being in a position in which no one else was bidding for a brick plant in Alabama with no customers.

Buffett: See’s Candy loses money 8 months of the year. But, they understand the seasonal patterns and know that
Christmas will come – they have 2000 years on their side. But if you only look at 1 month or 1 quarter of See’s business,
you would wonder what Buffett was doing. However, looking at seasonal companies is like looking at cyclical companies.
You just need to have a longer time frame. It doesn’t matter if the returns come in a lumpy manner if they come
consistently for 20 years.”
- 2011 BRK Meeting


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