Rick Casterline made his annual trek to Omaha for the Berkshire Hathaway (NYSE:BRKa) (NYSE:BRKb) annual meeting, and he took some really great notes. We'll be releasing these serially over the next few days, and we hope you find them as enlightening as we do.
Part 1 covered the annual opening film and preamble comments from Warren Buffett regarding Berkshire's newest purchase, Israeli cutting-tool manufacturer Iscar. Today, we get to see Buffett and Charlie Munger taking questions from the crowd.
Q&A SESSION . UNTIL NOON, THEN A 45-MINUTE BREAK
Question: I read Running on Empty by Pete Peterson. We have an interest in a country taking care of its old people, but should there be a limit to entitlements? Do you and Munger disagree on this issue?
Warren Buffett: We should take care of those too young and too old to produce. This country has an output of almost $40,000 per person. We are lucky to be wired to get enormously wealthy. Some are not so lucky -- in a market system, they are barely able to support themselves while they are working. Our country can EASILY handle the entitlement of Social Security. It is true that if we maintain the present age bracket, we will have one person producing in [his or her] younger years for every two people in their older years, but we produce more as we go along. . It is a bigger slice of the pie, but we have a huge pie, and a growing pie.
Charlie Munger: I think the world of Pete Peterson, but I don't come to the same conclusions. It is child's play to provide by diverting to people who are older; it is crazy to freeze the share going to the old. It is one of the most successful programs in the history of the country. I wish my own party would wise up a bit.
Editor's note: Last year, Munger said the Republicans are "out of their cotton-picking minds."
WB: This is what happens when you ask old people about taking care of old people! Lots of hypocrisy.
Question: How would you design a compensation system in cyclical industry that can swing from boom to bust?
WB: That's a terrific question, because if you're running a copper factory at $3.50 per pound, you can coin money even if you are the village idiot. But when it is $0.80 or $0.90 per pound, you can have poor results. We design compensation systems at Berkshire. You are wise to ask how you design for this, because so often people come in with standardized systems. If we owned a copper mining company, we would evaluate more by cost of production, something that would not fluctuate a lot in a business like that. We would probably tie it to what we thought was under the control of managers. In a cyclical business, if oil is $70 per barrel, I don't think management has anything to do with it. In fact, [oil execs] recently denied before Congress that they had anything to do with it. I would pay people very well who could get oil at a lower cost.
CM: It is easy to have fair compensation systems, but about half of companies have grossly unfair systems in which the top people get paid too much.
WB: We have 68 operating companies; I'm probably responsible for the compensation of about 40 managers, because of overlap. I can't think of anyone we have lost over a 40-year period because of views on compensation. We've never had a compensation consultant at Berkshire. We don't spend a lot of time on it; it is not rocket science. It is made more confusing than it needs to be, because people want to get paid a lot more than they're worth. The system won't change, because it is worth it for people to have their hand on the switch.
CM: We were the biggest shareholder at Salomon, Warren was on the board. Warren demonstrated softly, I thought, toward a fairer system and was outvoted.
WB: Envy is the biggest reason. You can have someone with a $2 million bonus and they're fine, until someone else gets $2.1 million, and then they're sick for next year.
Charlie has always said that of the seven deadly sins, envy is the silliest, because if you have it, you don't feel better. You feel worse when [you're envious]. I've had some good times with gluttony . we won't get into lust.
Question: In the shareholders' letter, you end with a note about management in the future. How do you train your successor? How would you measure if [that person has] lived up to your expectations?
WB: Good question. I think . part of the reason [for that letter] is to convey what Berkshire is all about. This meeting is intended to give a personality and character to Berkshire. Everything we do is consistent with what our culture is, and that is training in itself. When you're in the home as a child, you are learning every day from these big people around you. There are plenty of people who don't like our culture, and they don't join us. We had one recently, and nothing will come of it. His brain processes information differently from mine. It would be bad to have a mismatch. I don't think any formal training is necessary. If I die tonight, there are three obvious candidates. They won't have any problem stepping into the culture, because it's theirs, too.
CM: If Warren has kept the faith until he is 75 years old, do you really think he'll blow the faith now? What could be more important? You all have something more important to do than worry that the candle is going to go out at Berkshire just because some people die. At Berkshire, we aren't training execs; we find them. And they aren't hard to find. If you stand in front of the Himalayas, you don't need to be a genius to know they're high mountains.
Question: Why are there premiums over net asset value? Are they rational?
WB: History will show all, or [at least] most, closed-end funds go to discount. If I had the interest in buying emerging markets through someone else's management in an open fund, you'd have to convince me strongly that the closed-end fund is better. Charlie and I have witnessed closed-end funds selling at 30%-40% below net asset value.
Question: There is a small but growing trend to move from plurality voting for directors to majority, long the standard in Great Britain. What are the upside and downside of majority voting?
CM: I don't think it will have any effect at all in ethics in the courtroom.
WB: What you want to know is to what extent they think like owners. Low pay is not the criteria. Boards should exercise independent judgment. The only cure to better corporate governance, in my view, is if shareholders zero in on the topics I just mentioned. It takes the big shareholders. It won't get done by any coalition of small shareholders.
Question: I heard you don't understand technology and rely on Bill [Gates] for that. I'm curious to learn what you've learned about other tech companies like IBM (NYSE:IBM), Intel (NASDAQ:INTC), and so on.
WB: Charlie and I have circles of competence that extend to evaluating a number of businesses, but [there are] some very few can evaluate. You get into situations where the future is so likely to be different from the present, maybe some have good insights into it, but we sure don't. Iscar will be a bigger company five years from now, maybe a much bigger company. When you think how much telecom has changed over the past 20 years, it's crazy. Charlie says we have three boxes at the company: in, out, and too hard. If you go to the Olympics . and we run 100 meters really well, we don't have to throw the shot put. Tom Watson [founder of IBM] said, "I'm no genius, but I'm smart in spots, and I stay around those spots." You mentioned Intel. I was there at the birth of Intel because I was at Grinnell. I knew Bob Noyce, and Grinnell invested $300,000 into it at inception. But I wouldn't have the faintest idea how to value Intel then, and I don't now.
CM: One of the foreign correspondents last year said in effect, "You guys don't seem smart enough to do so much better than everyone else as you're doing."
WB: Was he referring to me or you?
CM: And we said, "We know the edge of our competency better than most people do." I always say: It's not a competency if we don't know the edge of it.
Question: Consider three hypothetical investments; A share in median family income, which has been stagnant for 30 years, a share of all corporate income in the U.S. -- and corporate income has been taking an ever larger slice of GDP -- and finally, a share in all capital assets in the U.S. Which would you take, if any?
WB: I think I'd rather buy Iscar. Corporate profits have been high for several years as a percentage of GDP; they are close to their highs, except for a few years after World War II. Incidentally, corporate income taxes are not that high relative to income, so there's a disconnect there. Median income we haven't considered -- we're not shooting for that. It is certainly true that in the past five to 10 years, the disparity in income has widened significantly and tax breaks for the wealthy have been extraordinary. I pointed out in the past that most of the members of Forbes 400, myself included, pay a lower percentage of their income, counting Social Security, than the receptionist that works in their office. That was not true 30 years ago, and it shouldn't happen in a rich society, but it is something that has happened. I just computed my taxes. In 2004, my rate was below 15 or 16 people in the office, and I'm not taking advantage of any tax shelters, and in 2005 my rate was even lower. I think it's crazy, and I think the American people don't understand it very well. I don't think those of lower incomes have shared in the prosperity in a way proportional to the way it should be.
CM: I think the main figure that matters to all of us, including people in the media, is: How does GDP per capita grow? And those figures have been very good. There is a huge flux both up and down, so it isn't like we're all static in status. What's important is that pie grows. That being said, I don't disagree that Warren's right about too many tax cuts for the wealthy, but I don't think it's as important.
Question: What is your opinion on the economics of ethanol as a fuel additive, and as a potential investment? Should I be looking at that industry?
WB: Charlie and I don't know enough to answer that latter part. We've been approached many times, but we're trying to figure out the economics of an ethanol plant. It will depend on many factors, such as government policy and a lot of other variables we're not good at predicting. It's also a very hot area for investors right now, and our general experience is that we don't participate in things that are hot and easy to raise money for. I have a son who is head of the Ethanol Board in Nebraska. When he starts making more money than me, I'll reconsider. There's no question that usage will grow, but generally speaking, agricultural processing firms have not earned high ROICs. Look at Cargill, ADM (NYSE:ADM). It has not been a great business. Ethanol could prove to be an exception, but I'm not sure how you gain a significant competitive advantage with any particular ethanol plant.
CM: My attitude is even more hostile than Warren's. I have just enough knowledge of thermodynamics left in me to suspect that it takes more fossil fuel energy than you can get out of ethanol, and that's a very stupid way to solve an energy problem.
WB: I have friends who like ethanol and friends who don't like ethanol, and I want my position to be perfectly clear: I am for my friends. [Laughter]
There's much more to come in the days to follow. Be looking for Part 3 of the Berkshire meeting next week on Fool.com.
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Fool contributor Rick Casterline doesn't own shares of Berkshire Hathaway or of any other company mentioned. The Motley Fool has a disclosure policy.
