QUESTION: Regarding whether the size of float changes.

BUFFETT: If you have $37 billion of float, are you more constrained? As long as you have a lot of outside earning power, we'll be okay. We'll probably be operating with so much capital, so much liquidity... that we can deploy where we see the most opportunity with little risk.

MUNGER: Our constraint comes from lack of enthusiasm about stock opportunities.

QUESTION: Regarding gold.

BUFFETT: I grew up in a household where gold was often discussed. I don't think the price of gold has anything to do with how businesses are doing. It might reflect how businesses are doing, but it doesn't factor at all in my thinking. We don't use it as any kind of yardstick.

Interest rates, however, are important.

BUFFETT: I'm not smarter than the bond market. When it swings, do I swing with it? Yes. I spent years correlating stock prices with everything in the world. The problem is when you do find a correlation. The bottom line is that a business is worth what it will produce over its lifetime, discounted.

With a farm, you estimate yields and prices. With apartment rentals you estimate [things, too]. You can estimate what you think others will pay for something tomorrow -- that's speculation. Society gets nothing from that, but some gain at the expense of others. You saw that in the recent [Internet] bubble -- as a wealth transfer system, it was great.

I bought some REITs [real estate investment trusts] because I thought they were attractive based on what I thought they'd produce.

MUNGER: What makes common stock prices hard to predict is that a general liquid market occasionally produces a Ponzi scheme -- with people jumping in because others have. It can last for years. Trying to predict that is difficult -- and why it's dangerous to short stocks even when they're overvalued. You don't know how much more overvalued they can get.

BUFFETT: Charlie and I have identified about 100 [short-worthy] stocks over time -- we'd have [lost money shorting] them, but we've been right about just about all of them. It's recognizable -- to see when things are [out of whack], but you don't know how it will play out, how high or low it will go and when.

QUESTION: Regarding the expensing of stock options.

BUFFETT: If lots of stock options are issued, there would be no dilution... the argument is that it's better than paying employees with cash. I don't have a problem with options per se, but I have trouble with them not being counted as expenses. I think the opposition comes from people who think they'll get fewer options if they're expensed. Those folks would even like cash to not count as an expense.

Look at Dell Computer(Nasdaq: DELL). They were, like others, arguing that we don't know how to value options [so we therefore can't expense them], but were at the same time dealing in puts and other options -- and were obviously able to value those.

MUNGER: The stock option is both an expense and an illusion [I think he said "dilution"].

If I had to take [venture capitalist] John Doerr's public position [against expensing options], I'd rather make a living playing piano in a whorehouse. [More on Doerr's and Buffett's positions.]

QUESTION: Regarding Japan.

MUNGER: What's interesting about Japan is that a major modern Keynesian economy could have negative returns over 13 years without a major depression, while interest rates have dropped. I think we shouldn't think what's going on there and in Argentina can't happen here.

BUFFETT: Post-bubble periods produce fallout that not everyone will be terribly good at predicting.

QUESTION: Regarding hedge funds.

BUFFETT: Many think of A. W. Jones, who was a Fortune writer and in 1949 developed a hedge fund, [as the father of hedge funds]. [His outfit] didn't stick with their plans over time. They were not market neutral. Even the Federal Reserve credited A. W. Jones with being the first hedge fund, but Ben Graham set up a fund in the 1920s with attributes of modern hedge funds -- complete with paired holdings. Ben didn't find [the approach] all that effective, and wrote about it. Quite often, the pairing worked well, but in the less frequent times when it didn't work, the results [were disastrous].

You can't short a lot of something. You can't short a whole company. It takes just one short to kill you.

MUNGER: Creative accounting is an absolute curse to society. Double-entry accounting was a great invention, invented by a monk [ Luca Pacioli] -- anything that undoes the monk's work in order to defraud [is bad]. Enron took in a lot of nice people whom you wouldn't expect. Some good may come from Enron, via reforms.

BUFFETT: There's more money from owning the trademark, in Coke, in See's. It's not in the bottling. I'd rather own the trademark than the bottling business -- although both are good businesses -- the bottler because it has the right to profit from the trademark.

QUESTION: Regarding advice for "youngsters," asked by a youngster in college.

BUFFETT: If you have doubts if something is in your circle of competence, it's not. You can understand Wal-Mart, Coca-Cola, Costco(Nasdaq: COST), GM(NYSE: GM) (though you may not be able to value GM). It's better to stay well within your circle of competence, than wandering around its edges. You can have a small circle of competence and do well -- that's okay. My own is small.

MUNGER: If you have competence, you know where the edges are. Otherwise you don't have the competence.

QUESTION: Regarding population control and Living Within Limits, a book recommended earlier by Munger, and speculating that population growth is likely to be a major focus of the Buffett Foundation.

BUFFETT: Many projections have been made about population growth, many of which have been proven wrong. The carrying capacity of the earth is greater than we originally thought, but it's not infinite.

The dangers of overshooting the capacity, which we can' effectively estimate, is great. Imagine a spaceship. If it could take up to 300 people on a trip, you'd not take 300, due to the chance of error. What if the trip takes longer than expected, etc. You'd probably take 250 or so people. Our ship is Earth.

MUNGER: It's a complicated, controversial subject, where people learn slowly. The chances of a world inhabited by 15 billion people being better than five billion, we don't and can't know.

QUESTION: Regarding realistic expectations.

BUFFETT: I think we'll [Berkshire] do well, but not 15% per year. We'll have good opportunities and a return we won't be ashamed of, but nothing like in the past.

There's nothing wrong with earning 6% to 7% on your money.

MUNGER: One of the smartest things a person can do is dampen expectations in relation to past results. I'm just up here to demonstrate that you have maybe 10 more years out of Warren and I'm doing my best at that.

QUESTION: Regarding Lloyd's of London and the insurance industry and whether Buffett is isolated in any way.

BUFFETT: It's a worldwide market. You'll see things everyplace in the world -- if you have a good reputation. Like investing, you can invest internationally from anywhere. There are lots of choices out there. It al depends on what you say yes or no to.

We don't think the London market is better (or worse) than the U.S. market. It all depends on people taking risks they understand that are properly priced.

QUESTION: Regarding tips on planning for retirement, for the questioner's students.

BUFFETT: I haven't even thought about it! Tell them that if they're like I was when I was 16, I was thinking of mainly two things and Martin's [a former questioner] aunt wasn't going out with me, so it was cars.

Think of any car -- a genie offers you any car in the world. The catch is that it's the only car you'll ever get. What do you do? You read the manual 10 times, you change the oil twice as often as you need to, you take fastidious care, so that it remains the car of your dreams forever.

You get only one mind and body -- the same ones you'll have at 40, 60, etc. You need to take care of them and maximize their potential. It will be too late to take care of your body and mind (and car!) later on. You can maintain them, but it's hard or impossible to undo big mistakes or negligence later on. You don't want to end up with a wreck on your hands.

Your main asset is yourself. Treat yourself as a valuable asset. [I often explain to students that I'd be willing to pay today for a percentage of the future earnings of good students. They're valuable assets already, worth something.]

QUESTION: Regarding the sustainability of competitive advantages and how intelligent investors factor in legal risks and expenses.

MUNGER: I think it's fair to [write off] certain businesses that just have too much risk, and to avoid them.

Someone invented a better policeman's helmet. We wanted it for the police, but we didn't want to make it [due to liability].

BUFFETT: When involved with Pinkerton c. 1980, Berkshire would have been crazy to go into business putting guards at airports, we'd maybe have been liable for billions -- since we have the money. For us to be in a business like that would be madness, when a small guy in a basement who's judgment-proof can do it.

That reasoning has now expanded to apply to more businesses.

QUESTION: Regarding their views on real estate investing.

BUFFETT: If I was proposing a real estate investment, Charlie would say no, no, no or a while and I'd judge how [strongly he feels]. Under most conditions, it's hard to find real estate that's mispriced. We all know what a Class A office building in Chicago represents. Occasionally there could be big opportunities -- it might be because of a lot of chaos in financing.

MUNGER: We don't have any competitive advantage over others in the field... and tack on our tax liabilities... so by its nature, real estate tends to be a poor investment for people with our C-corporation tax structure. We spend very little time thinking about real estate and when we have gotten into it, it's usually been with so-so results.

QUESTION: Regarding valuing stock options.

BUFFETT: I could figure out what I'd pay for an option on a private company, a farm, an apartment building... every option has value. If my house is valued at X, I wouldn't accept an option of 2X for 10 years.

Take the private company Mars Inc.  In lieu of taking cash, I'd take an option on them. Black-Scholes [the option valuation formula] might be the best thing to use in some circumstances, but not always.

We've bought and sold options at Berkshire. We would probably pay something for just about any option.

Imagine two farms, both selling for the same price -- $100,000. But one farmer wants to sell an option to you, where he buys back 2% of the farm's earnings each year, for $2,000. So after 10 years, he's got 20% of the upside and you have all the downside risk.

MUNGER: Black-Scholes is used everywhere because it results in the largest possible value. It's a mad hatter's tea party. The only thing that's consistent is that the whole thing is disgusting.

QUESTION: Regarding Enron fallout.

BUFFETT: I think that Enron is bound to have some positive fallout -- in how people behave. It was a plus for our economy. [Looking at the big picture], I'm not negative on the American economic system -- we're [half the world's value] with 4% of the people. Sure, some people are behaving poorly, but they'd do so in any system.

So many people are spending other people's money -- disproportionately to who's producing real value. The tax system should be what distributes wealth. It doesn't make any sense to compensate me the way I've been compensated. [I wouldn't have gotten so rich] if I'd been born in Bangladesh. Imagine two people with equal gifts. If I and an equal had to bid to be born in the United States vs. Bangladesh with a percentage of our future income, I'd have bid pretty high.

So many people like investment bankers are paid insanely high relative to what they do.

MUNGER: The culture on Wall Street has deteriorated. Whatever can be sold (in investment banking) will be sold. There used to be two classes of investment bankers -- the [more honorable] ones and those who would securitize anything. The lines dividing them have blurred these days.

Certain kinds of clients get certain kinds of service -- some shouldn't even get in the door, but they do.

QUESTION: Regarding Dexter Shoe, which has been put under H. H. Brown.

BUFFETT: We lost a lot of money on Dexter, due to a mistake I made - maybe several mistakes. The textile industry has mostly gone abroad. It [fell apart] in the U.S., and similar things are happening in furniture manufacturing.

Our shoe business will be good -- making money, good management at Justin and H. H. Brown... We'll do well -- not extraordinarily -- but we can't do so domestically.

MUNGER: That shows that no matter how much you try to remain in your circle of competence, you still make mistakes. I can assure you it won't be our last mistake.

BUFFETT: [Regretting the closing of shoe manufacturing plants in the U.S.] When you think of people who've invested a lifetime learning a trade that for no reason of their own is gone... [you realize that] we haven't borne the brunt of this -- they have.

We're the lucky ones in this situation. We have a charge-off, these people -- some 60 years old, only speaking Portuguese -- have much bigger problems.

QUESTION: Regarding why look-through earnings were not included in this year's annual report.

BUFFETT: Look-through earnings didn't seem that important.

MUNGER: We don't want to be difficult to audit. We try to keep things simple. See's goes to cash every year like a little farm stand. An idiot could audit See's without getting in trouble. Many of our businesses are like See's.

BUFFETT: No doubt that auditors have gotten too compliant in agreeing with management -- now they'll likely go back to serving shareholders more.

Andersen certainly employed many. It would have been a shame if Salomon caused 8,000 people to lose jobs due to the bad acts of one person. Charlie -- how do you feel about those 40,000 Andersen employees who had nothing to do with shredding and so on?

MUNGER: Andersen had no system of control. Capitalism should just accept the failure of businesses and lost jobs. You feel bad, but capitalism without it is like religion without hell.

BUFFETT: What about if you and I screwed up -- what about all our employees?

MUNGER: It wouldn't happen with us. You have to be careful -- and careful in who you accept as a client and the business you take on.

QUESTION: Regarding what they look for when hiring someone.

BUFFETT: That's too easy a question for me, so... Charlie?

MUNGER: A fair answer is that I'm incapable of answering.

BUFFETT: It's like asking how to pick a wife. I can't give you a formula, but I'm sure you'll pick right. [I can't say 80% sense of humor, 12% looks, etc.]

I had that problem at Salomon. I had to pick one person to run the place -- after spending a little time with various people, you just know -- or you get a sense. I only had three hours. I think in the end you'd have picked the same person I did.

MUNGER: If one person is good at A but bad at Z, and another person is good at Z and bad at A, which is more important -- A or Z? [I'm not sure I got this down correctly.]

QUESTION: Regarding why See's isn't in the Mall of America in Minnesota and why it's not in Costco [where Munger sits on the board].

MUNGER: That's up to Jack Huggins, not us, due to our decentralization. We haven't done too well out of the West.

BUFFETT: No one else is making and selling chocolates in their own stores. We can do it in the West. It's very irritating to us that it doesn't work as well elsewhere. We have opened kiosks at holiday time nationwide...

MUNGER: Costco makes its own decisions. I won't get into it.

BUFFETT: I'll get into it. We don't want our stuff discounted. God bless Costco. They'll discount everything. Costco and See's are wonderful businesses, but never the twain shall meet.

QUESTION: Regarding B shares and why they don't get to designate charitable contributions and why they're set up as they are.

BUFFETT: Our B shares were issued in response to some people selling [sub-shares] of A to people who wouldn't realize that others were making money off them. [So the B shares were issued to thwart this practice.] When we issued them, we made them 1/30th the value of A shares. We said the stock was differentiated in two ways -- by voting rights and designated charitable contributions. (Because it would have been a logistical nightmare. This year, A shares got to give away $18 each; B shares would have been 60 cents each.

QUESTION: Regarding silver and the leasing of silver.

BUFFETT: In the end, the price of silver depends on how much of it is around. Leasing doesn't make any difference.

QUESTION: Regarding the recent story of some Kirby vacuum salespeople using aggressive tactics to take advantage of the elderly.

BUFFETT: [Years ago?] we put into place a policy that anyone over the age of 65 who was unhappy with their purchase could get a refund within a year.

It wasn't mentioned at all [in the story] that the guy who was interviewed -- his mother did get the refund. It wasn't a great moment in ABC journalism.

Next: Notes From the Press Conference>>

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