FOOL ON THE HILL
Highlights From Berkshire's Meeting

Berkshire Hathaway's annual meeting is a great place to go for investing wit and wisdom from Warren Buffett and Charlie Munger. Whitney Tilson was there this year, and in this column he shares some of the duo's choice comments on Berkshire, the impact of 9/11, keys to investment success, and more.

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By Whitney Tilson
May 8, 2002

I recently returned from Berkshire Hathaway's (NYSE: BRK.A) annual meeting in Omaha, and -- as I am every year -- was impressed with both the extraordinary intelligence, rationality, and capital allocation abilities of Warren Buffett and Charlie Munger (Berkshire's chairman and vice chairman, respectively) as well as the fabulous collection of businesses they've assembled over the past 30-plus years.

In this column, I will try to distill 17 pages of notes taken over five hours down to the most important things I heard (my notes can be seen in their entirety at my website; I also recommend reading the notes of fellow Fool, Selena Maranjian). I've added a little commentary, but will generally let Buffett and Munger speak for themselves.

As always, Buffett did most of the talking, so all quotes are his unless otherwise noted. Recording devices are not allowed in the meeting, so in many cases I am paraphrasing because I couldn't write quickly enough.

Update on Berkshire Hathaway's insurance operations
In an unusual step, prior to taking shareholder questions, Buffett presented a few slides showing the performance of Berkshire's insurance operations in the first quarter.  In his comments, he said:

"Float last year cost us 13%... There's been a change in the market, however. Barring some really negative catastrophe, we're doing pretty well. In Q1, our float increased by $1.834 billion to $37.342 billion with a net underwriting profit... Our goal is to gain more and more float at minimal or no cost. The cost of float over the next few years should be satisfactory."

While these comments may not sound especially bullish, keep in mind that Buffett is the ultimate underpromise, overdeliver CEO. A friend of mine -- also a veteran of many Berkshire meetings -- commented to me that he'd never heard Buffett more enthusiastic about Berkshire's insurance operations, and I agree.

Buffett also noted that "There was a cultural drift at Gen Re, largely due to the environment. It took a shock to get it back. Now, it's stronger than ever."

Impact of 9/11
"It made everyone realize that humans haven't progressed in how they behave, but have progressed in terms of their ability to hurt someone they hate.  9/11 brought that home.  It used to be that if you hated someone, you could only throw a rock at them."

"There are millions of people who hate us, but most can't do anything about it. But a few can, and there's incredibly more ability for a deranged person to do harm to us today."

Investing expectations
"We think people whose expectations were set from 1982 - 1999 will be disappointed [with future investment returns]. But there's nothing wrong with earning 6% annually on your money, in a world of low inflation."

Munger: "One of the smartest things a person can do is dampen investment expectations, especially with Berkshire."

Keys to investment success
"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."

Munger: "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."

Circle of competence
"If you have doubts whether something is in your circle of competence, it isn't. It's better to be well within the circle than tip-toeing along the edge."

"It's not terrible to have a small circle of competence. I think mine is pretty small."

Munger: "If you have competence, you know the edge. It wouldn't be a competence if you didn't know where the boundaries lie. It's a question that almost answers itself."

Valuation
"I don't think price-to-earnings, price-to-book, or price-to-sales ratios tell you very much. People want a formula, but it's not that easy. To value something, you simply have to take its free cash flows from now until kingdom come and then discount them back to the present using an appropriate discount rate. All cash is equal. You just need to evaluate a business's economic characteristics."

When to sell?
"It's not our natural inclination to sell... 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." 

(For more on this topic, see my columns, To Sell or Not to Sell and Never Too Late to Sell.)

Shorting stocks
"Charlie and I have agreed on around 100 stocks over the years that we thought were shorts or promotions. Had we acted on them, we might have lost all of our money, even though we were right just about every time."

"I had a harrowing experience shorting a stock in 1954. I wouldn't have been wrong over 10 years, but I was very wrong  after 10 weeks, which was the relevant period. My net worth was evaporating."

"Shorting is just tough. You must bet small. You can't short the whole company. It takes just one to kill you. As it rises, it consumes more and more money."

(See my column, Good Times to Short Stocks?)

Stock options
Munger: "If you look at the impact of stock options, you'll see a lot of terrible behavior... The theory that options have no cost has contributed to a lot of excesses, which is bad for the country because corporate compensation is perceived as unfair."

Buffett: "Well-fed CEOs are descending on Washington to persuade your Congressmen not to require expensing of options because they'd get less. It's sort of shameful."

"All of the opposition to options comes from people who would get fewer of them. If there was a rule saying the CEO's salary didn't count as an expense [and there was a proposal to rescind this rule], you can bet they'd be in there fighting to keep the status quo."

Munger: "A stock option is both an expense AND dilution. To argue anything else is insane."

(See my columns, The Stock Option Travesty, Stock Options' Perverse Incentives, and  Rebutting Stock Option Defenders.)

Funniest comments
Every year, Munger can be counted on to come up with some good zingers -- last year, it was his critique of the California legislature (my column on last year's meeting has the context) -- and he didn't disappoint this time.

During a discussion on why Berkshire Hathaway was running off its derivative book that it acquired as part of Gen Re, he said, "To say accounting for derivatives in America is a sewer is an insult to sewage."

He also said "I'd rather be playing piano in a whorehouse" than agree with the arguments (free registration required) defending stock options made in The New York Times by John Doerr of venture capital titan Kleiner Perkins.

Finally, in commenting stock options in general, he said, "The only thing that's consistent is that the whole thing is disgusting."

I also got a kick out of Buffett's quip that his proposed new advertising slogan for recently acquired Fruit of the Loom is "We cover the asses of the masses."

Conclusion
Buffett and Munger are, without a doubt, two of the greatest investors and capital allocators of all time, so investors would be well-served to study their thinking carefully. If you would like more from the annual meeting, read my complete notes or Selena's here on Fool.com. In addition, I suggest reading Buffett's annual letters, which are posted on Berkshire Hathaway's website.

Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. He owned shares of Berkshire Hathaway at the time of publication. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com. To read his previous columns for The Motley Fool and other writings, visit http://www.tilsonfunds.com/.