Berkshire Hathaway Annual Meeting Q&A - Buffett & Munger on Float, Businesses & Compensation

Buffett on why they abandoned 'cigar butt' investing: buying pathetic companies cheap looking for 'one good free puff.' He had a 'portfolio full of soggy cigar butts.' Problem: if a business earns 5-6% on equity, 'time is the enemy' - you won't do well even buying it cheap. Contrast with great businesses earning 20-25% on equity where 'time is your friend.' Munger: 'It's not that much fun to buy a business where you really hope this sucker liquidates before it goes broke.' Buffett admits Berkshire itself was a mistake - 'a company that in the previous 10 years had earned less than nothing... selling well below working capital so it was a cigar butt.' They could have done everything from a neutral base instead of negative.

Buffett explains why Berkshire's $7 billion float has greater value than equal equity: it comes at NEGATIVE cost (they make underwriting profit). If offered to eliminate the $7 billion 'liability' and boost equity by $7 billion tax-free, Berkshire would refuse. The key isn't today's float/cost but what it will be in 10-15 years. Munger: 'If the float keeps growing, that is a wonderful thing indeed.' The insurance business is 'way less likely to get really clobbered than most' and 'safer on the downside with better upside.' Losing $1 billion in California quake isn't 'getting really clobbered' - that's part of the game.

Buffett's savage critique: he doesn't mind paying a lot for PERFORMANCE (like in athletics/entertainment), but in business 'the people who are the 200 hitters' who 'would not attract a crowd as an entertainer' have worked out a system where 'many of them take huge sums and I think that's obscene.' The system feeds on itself - every CEO looks at other proxies and says 'if Joe Smith is worth X, I have to be worth more.' Consultants ratchet up rewards. 'You wouldn't be hiring anybody below average so how can you pay me below average?' The people with their hands on the switch are the beneficiaries. Munger: 'The original Vanderbilt didn't take any salary at all. He thought it was beneath him as a significant shareholder.' Charlie: 'Prostitution would be a step up for' compensation consultants. Buffett: 'Put him down as undecided.'

Munger reports Vanderbilt 'didn't take any salary at all - he thought it was beneath him as a significant shareholder to take a salary. That ideal died with him.' Buffett: 'Charlie and I our directors are paid $900 a year but I tell them on an hourly basis they're making a fortune because we don't work that hard.' The oversight: 'What Charlie and I did not think through when we established $900/year is that they set OUR salaries too. We have not followed the standard procedure which is to load it on the directors and the directors shall load it on you.' Buffett's civilization concern: 'At the very top, corporate salaries in America are too high and that is not a good thing for a civilization when the leaders are regarded as not dealing fairly with the institutions.'

Munger's business quality test: 'The difference between a good business and a bad business is the good business just throws up one easy decision after another, whereas the bad business gives you horrible choices where the decision is hard to make.' System for identifying good vs. bad: 'See which one is throwing the management bloopers time after time - easy decisions.' It's not hard to decide to open new See's stores in successful California shopping centers - 'it's a blooper.' But plenty of businesses throw 'just awful' decisions at you. See's: they'd love to spend $10-500 million for past returns but 'there aren't good ways to do it - capital doesn't produce the profits.' FlightSafety: capital produces profits (more simulators = more training). Coca-Cola: when new markets emerge (China, East Germany, Soviet Union), you don't make ROI calculations - 'as far as I'm concerned it's a waste of time because you're going to do it anyway.'

Buffett on traditional due diligence: 'We are not big fans of that.' When boards commission expensive due diligence reports, they're really 'just to go through with the deal they want to go through with anyway, and all the professionals know that.' Berkshire has made countless deals where 'traditional due diligence has had a thing to do with' exactly zero. Their surprises have been 'on the favorable side' - the people they deal with 'usually told us the bad things first and good things after we made the deal.' Example: Eugene Abegg at Illinois National Bank & Trust in 1969 - deal made in 'a couple of hours.' After, every lunch Gene would point out buildings they owned not on the books, foundations with unreported money, even uncut currency bills still sitting around. 'Gene was not a guy to show all his cards.' Focus on dealing with the right people.