2003 Berkshire Hathaway Annual Shareholder Meeting

Warren Buffett opens the 2003 annual meeting, acknowledges Andy Hayward for the cartoons, and announces the acquisition of McLane Company from Walmart. The $1.5 billion deal for the grocery and food distribution business was negotiated in just one to two hours after meeting with Walmart representatives. Buffett explains that the acquisition makes sense for both parties - Walmart can focus on their core retail business while McLane gains access to customers who previously avoided them due to competitive concerns with Walmart.

Buffett addresses questions about Executive Jet (NetJets), acknowledging the business is currently unprofitable but expressing confidence in the long-term model. He believes that perhaps 10 times the current number of customers will eventually fly with NetJets, and that having the best service, safety record, and security will make them dominant in the fractional aircraft ownership field. However, he does not expect profitability in the current year.

Discussion of Berkshire's $42.5 billion insurance float and whether it can be counted as pseudo-equity when calculating intrinsic value. Buffett explains that if the float is cost-free or better, it has significant value. He expresses skepticism about 10% annual growth given Berkshire's already substantial market share, but notes the entire American property casualty industry float might only be in the low hundreds of billions.

Buffett delivers a strong critique of executive compensation practices at American corporations. He describes the fundamental imbalance where CEOs have enormous personal interest in their compensation while compensation committee members are dealing with 'play money' that isn't meaningfully theirs. He criticizes compensation consultants who never suggest reducing CEO pay or removing poor performers, and argues that compensation is the acid test of corporate reform.

Buffett revisits his famous 1977 Fortune article 'How Inflation Swindles the Equity Investor,' discussing how low inflation is a definite plus for equity owners compared to the high inflation environment of the late 1970s. He explains that real returns will be higher in a low inflation environment if businesses are purchased at similar prices. The discussion covers how inflation affects the real value of corporate earnings and investor returns.

Buffett provides a critical analysis of insurance companies taking on credit risk through derivatives. He expresses concern that many participants in the credit guarantee business don't really know what they're doing, noting the ease with which insurance companies can accept money for writing guarantees without fully understanding the risks. He questions why financial guarantee insurers with 141 leverage and correlated risks maintain AAA ratings.

Buffett explains Berkshire's philosophy on stock repurchases, stating their preference is to buy businesses rather than buy back stock. However, if Berkshire stock were significantly undervalued and the likelihood of using the money to buy businesses was low, they would consider repurchasing shares. He emphasizes they would only buy back stock at a clear discount from intrinsic value and after giving shareholders all relevant information.

Discussion of MidAmerican Energy's role in Berkshire's portfolio and future growth prospects. Buffett expresses confidence that MidAmerican, already a big part of Berkshire, will become much bigger. He discusses the potential repeal of the Public Utility Holding Company Act (PUHCA) from 1935, which would make acquisitions easier. He mentions that Berkshire's ability to act quickly may have saved a couple of utility companies from bankruptcy.

Buffett contrasts entrepreneurs who love their businesses with financial buyers looking to flip investments. He explains Berkshire's preference for passionate entrepreneurs who treat their businesses like Buffett treats Berkshire - they won't let anything bad happen and may even tell him to stay out if he might interfere. He avoids investment banker deals from people looking to resell businesses they bought a few years earlier, viewing those as 'pieces of meat' rather than beloved enterprises.

Buffett explains how Berkshire's acquisition opportunities have evolved over nearly 40 years. He describes it as a snowball effect - successful acquisitions where sellers are happy lead to more referrals and opportunities. He notes that 20-30 years ago they didn't hear from anyone, but now they get a reasonable percentage of the calls they should get in the US. Outside the US, Berkshire is not yet on the radar screen for acquisition opportunities.

Buffett addresses concerns about Value Capital, a Berkshire investment where Mark Byrne manages money using leverage and derivatives in fixed income strategies. He explains that while the leverage is higher than Berkshire typically uses, it's reasonable for that business. Berkshire has no guarantees of Value Capital's obligations and treats it as an investment, not a business unit, though accounting rules may require consolidation.

Buffett contrasts two types of businesses earning 12% on capital: one that generates excess cash that can be removed and redeployed, and another (like used construction equipment) where profits just sit in inventory. He emphasizes Berkshire's preference for businesses that generate cash that can be moved around and deployed elsewhere, acknowledging that even great businesses like Gillette's razor business can't absorb unlimited capital at high returns.

Discussion of Social Security as a forced investment for low-income workers and the regressive nature of the tax when combined with income taxes. Buffett notes he pays about the same percentage of his income to the federal government as his secretary does, because while he pays higher income tax rates, she pays more in Social Security taxes due to the wage cap. The conversation touches on dividend tax proposals and their fairness implications.

Discussion of the safety of securities held at brokerage firms and the potential for domino effects in the financial system. Buffett expresses comfort with owning securities in cash accounts at large exchange firms but cautions about margin accounts where securities can be rehypothecated. He compares it to historical domino effects in banking and notes that interrelated financial institutions always carry some systemic risk.

Buffett explains Berkshire's approach to discount rates in valuation, stating they use the same discount rate across all securities because if you really know the cash flows, that should suffice. He discusses having minimum threshold returns below which they're unwilling to commit money, regardless of current interest rate levels. A shareholder challenges this with modern finance theory about co-variance and timing of cash flows, leading to a discussion of practical versus theoretical approaches to valuation.