Value Investing

We won't sell a business just because it's underperforming.

The competition right now is tough, so our efforts to buy businesses are likely to be futile. But there are 1-2 deals we might get done…

Berkshire doesn't do much conventional asset allocation. We just search for good opportunities and don't want to put up artificial barriers.

Our test has been whether, if we retain a dollar, will it be worth more than a dollar in present value.

I'm also careful not to communicate anything to the contrary via body language.

Insurance companies in particular can report pretty much any numbers that they want. With $44 billion of reserves, it would be easy to adjust the reserves to show whatever profit was desired.

Munger: What we don't like in modern capitalism is the expectations game. It's not the kissing cousin of evil; it's the blood brother.

Munger: What we don't like in modern capitalism is the expectations game. It's not the kissing cousin of evil; it's the blood brother. Buffett: People who predict precisely are either kidding themselves or others. We've seen people get their egos involved. And everyone in the organization knows what the CEO has promised in public. It's setting up a system that sets up financial or psychological pressure for people to do things they probably don't want to do. It's a terrible mistake.

I think about this a lot - it's my job to think about the absolute worst-case scenario. No matter what happens, we'll be OK. But everything that can happen will happen.

GEICO is a great, great business model, run by a superb person and businessman

This is a good life lesson: getting the right people into your system is the most important thing you can do.

The Chinese government owns 90% and we own 1.3%, so if we vote with them, together we control the business. (Laughter)

Use Bill Gates to Invest in Tech Stocks? Charlie and I put money in things we understand and think we'll know what it'll look like in 5, 10 or 20 years. Bill being on the board doesn't change this. I'll listen to any idea of his and, in fact, our investment ideas overlap quite a bit. I still wish I'd bought Microsoft when I'd first met him. (Laughter)

Comments on Financial Companies Financial companies are more difficult to analyze than other companies. They can report whatever earnings they want - it's an easy game to play. For banks, earnings depend on loans and the reserves set aside. It's easy to change and manipulate the reserves.

Comments on Financial Companies Financial companies are more difficult to analyze than other companies. They can report whatever earnings they want - it's an easy game to play. For banks, earnings depend on loans and the reserves set aside. It's easy to change and manipulate the reserves. With a company like WD-40 or a brick company, the financials are easy to analyze. But with financial [companies] it's tough, especially when you throw in derivatives.

I'm concerned about our political leadership, but as Peter Lynch once said, "Invest in businesses any idiot could run because someday one will." (Laughter) We've had all sorts of bad Presidents, but have still done well. Our real GDP per capital rose seven-fold in the last century, which is remarkable. Sure, the big consumer debt load and trade deficit could cause some financial market distress - there are great investment opportunities in dislocations - but the country will survive. Eventually the country will do fine, but there's a significant possibility of a chaotic situation.

I knew a guy who had $5 million and owned his house free and clear. But he wanted to make a bit more money to support his spending, so at the peak of the internet bubble he was selling puts on internet stocks. He lost all of his money and his house and now works in a restaurant. It's not a smart thing for the country to legalize gambling [in the stock market] and make it very accessible. Buffett: Is there anyone we've forgotten to offend? We don't want to miss anyone. (Laughter)

Buffett: We're like an incredibly rich family. We sit on the porch of our huge farm - so big that we can't even see the end of it - and each year, we consume 6% more than the farm produces. To pay for this, each year we sell or mortgage a little bit of the farm that we can't see, so we don't even notice. We're very, very rich and the rest of the world is happy to buy from us or lend to us, so each year they take a piece of our valuable assets - and they work very hard. But we will have to service this. If it goes on for a long time, our children will pay. We're sending $2 billion per day [overseas right now].

Invest in Yourself It's hard for individual investors to successfully pick stocks or time the market. The best investment you can make is in your own abilities. Anything you can do to develop your own abilities or business is likely to be more productive than investing in foreign currencies. If you own your own business in America [and you run it well, you'll do OK].

Avoiding Mental Mistakes The first step is to recognize the traps. Charlie, in Poor Charlie's Almanack, talks about various traps, so read that book. Our personalities are such that we're probably less prone to falling into these traps, but it still happens - just less than before. Munger: You don't have to have perfect wisdom to get very rich - just a bit better than average over a long period of time. -15- Buffett: It reminds me of the story about the two guys being chased by the bear and one guy says to the other, "I don't have to outrun the bear. I just have to outrun you!" (Laughter)

Poor Charlie's Almanack Munger: Peter Kaufman did it. He came up with the idea and Warren got excited about it. It's a ridiculous name [the title]. (Laughter) If you assimilate everything that's in that simple book, you'll be far ahead in the game. Buffett: It's a sensational book. You'll learn a whole lot about life - and making money.

Learning to be a Good Investor When I was seven years old, I first took an interest in stocks. My dad was in the business, so I'd go with him to the office and I saw interesting things. [When I was a little older,] I went to the library and read every book on markets and investing. When I was 11, I bought my first stock - three shares. I was following charts. When I was 19, I read The Intelligent Investor and it changed my whole framework. My advice is to read a lot. There are no secrets in the business that only the priesthood knows. It's all right there. It requires qualities of temperament way more than qualities of intellect. Once you have a 125 IQ, much more doesn't matter. Look for opportunities that fit your framework. Try to learn every day, but you can't act every day. It's important to enjoy the game, just as it is to enjoy bridge or baseball [if you're going to play those games seriously].

We like buying businesses with some untapped pricing power. For example, when we bought See's for $25 million, I asked myself, "If we raised prices by 10 cents per pound, would sales fall off a cliff?" The answer was obviously no. You can determine the strength of a business over time by the amount of agony they go through in raising prices.

You can learn a lot about the durable economics of a business by watching price behavior. The beer industry is able to raise prices, but it's getting tougher.

Market Views Regardless of the market, I will keep buying businesses. We like low prices. We're not good at forecasting markets. Charlie and I spend no time thinking about where the market's going. We do know when we're getting good value [when we're buying a stock or business]. There are always going to be some good and bad things happening. I've seen more people lose more money by getting focused too much on one factor. We've never not bought something due to macroeconomic concerns.

The Best Business The best businesses can maintain their earnings without continued reinvestment, whereas in the worst you have to keep pouring money into a money-losing business. The best business is being the best surgeon in town. You don't have to do any reinvestment - the investment was the education. The surgeon will retain his earnings power, regardless of inflation.

More on the Housing Bubble (and Why Foreigners Invest in the U.S.) The financing terms have become easier and easier as prices have risen, which is contrary to normal [and prudent] practices. But the financing process has become so disintermediated that the mortgage buyer doesn't care. The easier financing has led to a boom in prices. The Nebraska farm bubble was fueled by banks that historically had been conservative but went crazy. They said that a farm was an asset-appreciation investment, not an income investment - in other words, they were playing the greater fool game.

Buffett: I have less than 1% of my net worth outside Berkshire and when the Nasdaq hit its high, I had nearly all of it in REITs, which were selling at a discount to their liquidation values. REITs are quite attractive now, especially compared with 5-6 years ago when they were very unpopular. It's better to pay attention to something being scorned than championed. Munger: And REIT accounting is phony. Buffett: Other than that, we love REITs. (Laughter)

[GM CEO] Rick Waggoner and [Ford Chairman] Bill Ford have both been handed, by past managers, extremely difficult hands to play. They're not the consequences of their own doing, but they have inherited a legacy cost structure, with contracts put in place decades ago, that make it very difficult for them to be competitive in today's world.

Munger: Warren just gave a very optimistic prognosis in my view. Just because the full consequences haven't yet hit, doesn't mean there isn't a huge problem. It's as if someone jumped out of a window on the 42nd floor. As you go by the 20th floor, you're still OK, but that doesn't mean you don't have a real problem. (Laughter)

Munger: We just throw some decisions into the "too hard" file and go onto others. Buffett: We get paid not for jumping over 7-foot bars but for finding 1-foot bars that we can step over.

#2不要管别人怎么说，也不论有多少人反对，反正只要是自己喜欢的，就去追寻，这样就会成功。

　一旦我清楚知道自己在做什么时，是不会有风险的。当然市场有可能在我决定投资、也投入金钱后继续修正，这时候我会回过头来检视，我究竟有没有彻底了解、做足功课，如果没有，那么风险是来自于我没有做好研究。倘若我有确实做好功课，那么面对市场超跌的状况，我会投入更多金钱。所以风险高不高的症结在于有没有做功课，而不是集中投资就是高风险。

In it, we tell you everything I'd want to know if our positions were reversed. If I had 100% of my net worth in the stock and had been on a desert island for a year, it has everything I'd want to know. We don't leave anything out. You could drown people in information that doesn't make much difference. We explain it in the way we think about it. It's the report I would make to Charlie or he'd make to me if one of us were running the business and the other were inactive.

How to Value Berkshire I'd think about what's there, what are they trying to do, what's it worth if they don't succeed in deploying additional capital, and what it's worth if they do. What are the resources available to keep adding to the collection of businesses? I think you'll find the information [in the annual report] that you need to evaluate Berkshire. Don't take it out to 4 decimal places. If Charlie and I had to write down a number, it would be different but in the same ballpark. What Berkshire will be worth 10 years from now will depend on earnings, the quality of those earnings and the liquid assets we have. We keep working on it, but we're so big. There's no way in the world we can replicate the past, but hopefully we do a reasonable job.

Munger: Quickly get rid of the no-brainer decisions. Just go through the cash and investments, which are easy to value. The insurance operation is very interesting and look at the way the cash is deployed.

While we don't like having excess cash, we like doing dumb deals even less because we're stuck with them forever. You're right that we should be uncomfortable that we have this cash, but [the alternative of doing bad deals is far worse].

The calls we want to get are from people who care about their business, who for tax or family-ownership reasons want to sell to us. They're looking to change the ownership structure, not the operating personality and culture of the company they care deeply about.

Munger: The interesting thing about it to me is the mindset. With all these "helpers" running around, they talk about doing deals. We talk about welcoming partners. The guy doing deals, he wants to do a deal and then unwind it in the near future. It's totally opposite for us. We like to build lasting relationships. I think our system will work better in the long term than flipping deals. I think there are so many of them [helpers] that they'll get in each other's way. I don't think they'll make enough money to meet their expectations, by flipping, flipping, flipping. Buffett: By charging fees, fees, fees. [Laughter] Munger: Warren talked to guy at an investment bank and asked how they made their money. He said, "Off the top, off the bottom, off both sides and in the middle."

They invariably try to sell it quickly to a strategic buyer, which is another way of saying someone who pays too much. Anytime someone calls me and says we'd be a logical strategic buyer, I hang up the phone faster than Charlie would.

We're a one-of-a-kind place for certain owners. They have a problem to solve and only we can offer a good home [for their business]. - he made a niche for himself.

In our shareholder letter and in this meeting, [we try to make clear what our culture is]. We want managers to join us who believe in what we do and make a lifetime commitment to join us. Once they join us, we want to act consistently and be consistent. They see that it works. There are plenty of people who don't believe in our culture and they don't join us. It would be bad to have a mismatch. The nice thing about it is that our culture is so well defined that there are rarely mismatches.

We don't train executives, we find them. If a mountain stands up like Everest, you don't have to be a genius to figure out that it's a high mountain.

Our shareholders are long-term and loyal owners. We have the most honest-to-god attitude of ownership of any public company. People buy it to own it.

The motivation for buying back stock used to be just because companies thought their shares were cheap. Thirty or forty years ago, it was very fertile to invest in companies that were buying back their stock. The most extreme case was Teledyne - we made some money investing there. But that's being swamped today by companies doing it because it's in fashion or to prop up the stock. The SEC has rules to prevent propping up the stock on a daily basis [but companies still try to do it]. We wouldn't do it for those reasons.

I thought we'd have economies of scale, but if anything we've had diseconomies of scale. I could give you reasons, but Rich Santulli knows the business and is addressing it. He works 16 hours a day. There is no one I have greater confidence in to fix this business. High fuel costs are a pass-through but affect the business. I think it'll be profitable before long, but I've been wrong so far.

Buffett: We are best at evaluating businesses where we can come to a judgment that they will look a lot like they do now in five years. The businesses will change, but the fundamentals won't. Iscar will be better - maybe a lot bigger - in five years, but the fundamentals will be the same.

Charlie says we have three boxes: In, Out and Too Hard. You don't have to do everything well. At the Olympics, if you run the 100 meters well, you don't have to do the shot put.

Tom Watson [the founder of IBM] said, "I'm no genius. I'm smart in spots and I stay around those spots."

Munger: A foreign correspondent, after talking to me for a while, once said: "You don't seem smart enough to be so good at what you're doing. Do you have an explanation?" [Laughter] Buffett: Was he referring to me or you? [Laughter] Munger: I said, "We know the edge of our competency better than most." That's a very worthwhile thing. It's not a competency if you don't know the edge of it.

You didn't have to have a high IQ or a lot of investment smarts to buy junk bonds in 2002, or certain other things after Long-Term Capital Management blew up. You just had to have the courage of your convictions and the willingness to act when everyone else was terrified and paralyzed. The lesson of following logic rather than emotion is obvious, but some people can follow it and some can't.

How Buffett Would Manage $1 Million Today We formed our first partnership 50 years and two days ago, on May 4, 1956, with $105,000. If we were starting again, Charlie would say we shouldn't be doing this, but if we were, we'd be investing in securities around the world. Charlie would say we couldn't find 20, but we don't need 20 - we only need a few that can pay off very big. We'd also be buying [stocks in] smaller companies. If we were planning to buy [entire] businesses, we'd have a tough time. We'd have no reputation and only $1 million. Charlie started out in real-estate development because with only a little capital, brain power and energy, you could magnify the returns in real estate unlike in other sectors. I'd just do it one foot in front of the other over time. But the basic principles wouldn't be different. If I'd been running a little partnership three years ago, I'd have started out 100% in Korea. Munger: You should find something to invest in and then compare everything else against that. That's your opportunity cost. That's what you learn in freshman economics, even if it hasn't made it into modern portfolio theory. That's why modern portfolio theory is so asinine.

Charlie started out in real-estate development because with only a little capital, brain power and energy, you could magnify the returns in real estate unlike in other sectors.

I'd just do it one foot in front of the other over time.

Buffett: Ben Graham said you're neither right nor wrong if you're investing with the crowd - you're right if your facts and reasoning are right. Once you have the facts, you have to think about what they mean. You don't take a survey.

You should focus on what's important and knowable. There are many things that are important but now knowable, like [whether there will be] a nuclear attack tomorrow. You can't focus on those.

As Ben Graham said in chapter 8 of The Intelligent Investor: The market is there to serve you, not instruct you. If it does something silly, it gives you a chance to do something. It just sets prices. If it doesn't give you an opportunity, go play bridge and come back the next day. And the nice thing is that the prices will be different.

At that time, there was [an unprecedented] 30 basis point spread between on- versus off-the-run 30-year Treasuries. All you have to do [in such situations] is make sure you can play out your hand under all circumstances. If you can and you have the right facts - and you let the market serve rather than instruct you - you can't miss.

Munger: It would be one of the most irritating experiences in the world to do a lot of work to uncover a fraud and then watch it go from X to 3X and watch the crooks happily partying with your money while you're meeting margin calls. Why would you want to go within hailing distance of that?

Buffett: I don't think there's a bubble in agricultural commodities like wheat, corn and soybeans. But in metals and oil there's been a terrific [price] move. It's like most trends: At the beginning, it's driven by fundamentals, then speculation takes over. With copper there was a little shortage and then people got worried [and then the price skyrocketed]. As the old saying goes, "What the wise man does in the beginning, fools do in the end." With any asset class that has a big move, first the fundamentals attract speculation, then the speculation becomes dominant. Once a price history develops and people hear that their neighbor made a lot of money on something, envy sets in and that impulse takes over. We're seeing that in commodities - and housing as well. Orgies tend to be wildest toward the end. But you never know when it will end.

It's like Cinderella at the ball. At the start of the party, the punch is flowing and everything's going well, but you know that at midnight everything's going to turn back to pumpkins and mice. But you look around and say, 'one more dance,' and so does everyone else. Everyone thinks they'll get out right at midnight. This is what's happening with copper today, Internet stocks in 1999 and uranium stocks in the 1950s. The party does get to be more fun - and besides, there are no clocks on the wall. And then suddenly the clock strikes 12, and everything turns back to pumpkins and mice.

Munger: We didn't get where we are by owning non-interest-bearing commodities. It's a good habit to trumpet your failures and be quiet about your successes. Buffett: Well, we have a lot of to trumpet then! [Laughter]

I read five newspapers every day. Charlie does too.

But we have a method of coping: we just put it in the "too hard" basket. If something is too hard, we move on to something that's not too hard. What could be more simple?

Investing Based on Big Trends Buffett: We don't play big trends like demographic trends. They just don't mean that much. There's too much money to be made year to year than worry about trends that take ten years to play out. I can't think of one investment we've ever made based on a macro or demographic trend. Munger: Not only that, but we've missed the biggest commodity boom in history - and we'll continue to miss things like this! Buffett: But we'll search for new ways to fail! [Laughter] -

Charlie and I do not know enough about the [ethanol production] business to evaluate it. We've been approached many times and they're quite popular, but trying to figure out the economics of an ethanol plant will depend on 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.

Ethanol could prove to be an exception, but I'm not sure how you gain a significant competitive advantage with any particular ethanol plant.

Munger: My attitude is even more hostile than Warren's. I know just enough about thermodynamics to understand that if it takes too much fossil-fuel energy to create ethanol, that's a very stupid way to solve an energy problem. [

He trusted you, Warren, and I think that mattered.

If you buy a house for $300,000 and take a $270,000 mortgage, you're going to stay there and continue to make your mortgage payments, even if the market value of the house falls (unless something bad happens to you like losing your job). But if you have investors and speculators holding the properties - effectively day traders in the condo market - that kind a speculation can produce a market that can move in a big way. First the buying and selling stops and then the market reopens.

Buffett: In the boardroom, it's partly a business situation and partly a social situation. The key is: Do they think like owners and, even if they do, do they understand enough about business that their decisions are any good? We've been on many boards and I've never seen any difference in behavior based on the nature of the votes that got them there. But I think you'd be blown away by the difference in savviness and whether people think like owners.

But you can't pay 2 and 20 [2% annual management fee and 20% of the profits, standard for private-equity and hedge funds

The whole concept of the house advantage is an interesting one in modern money management. The terms of the managers of the private partnerships look a lot like the take of the croupier at Monte Carlo, only greater. Buffett: Is there anyone we've forgotten to offend? [Laughter]

Buffett: That's a terrific question. If you run a copper company and it's at $3.50/lb., you could be the village idiot and coin money. But if it's at 80-90 cents/lb., which is what it's been for most of my life, there can be tough times. If we owned a copper-mining company in its entirely, we'd base compensation on costs of production, which management has control over, rather than things based on market prices, which they don't control. Costs won't fluctuate a lot. Compensation should tie to what is under the control of management. Try to understand what management can have impact on.

If oil is $70 per barrel, I don't think management has anything to do with it - in fact, they denied they did in front of Congress. I'd measure the cost of finding new reserves over time - the ability to discover and extract oil at low unit costs. Some firms are much better at this than others.

It's not rocket science. But a complicated, confusing system works to the advantage of people who have their hand on the switch.

Incidentally, the SEC wants more transparency in pay, which is a good idea, but it can become a shopping list. One CEO sees the other getting his haircuts paid for and he wants it too…

Munger: I think much of [how bankruptcy is handled] is pretty horrible. It's a situation where courts themselves have gone into the business of bidding to attract bankruptcy proceedings. They've found that if they develop a process in which they over-pay people (lawyers, etc.), they can attract the most cases. It's so upsetting to watch that I don't follow it as much as I should. I'm an old man and I don't like to have an upset stomach.

It is certainly true that in the last 5 to 10 years, the disparity in income has widened significantly and the tax breaks for the wealthy have been extraordinary. I've said in the past that most of the members of the Forbes 400, myself included, pay a lower percentage of their income in taxes than their receptionist. This wasn't true decades ago and it's wrong in a rich society. In 2004, my tax rate was the lowest of the 15 people in my office - and I'm not taking advantage of any tax shelters - and it's even lower in 2005. That's crazy. I don't think the American people understand that, and if they did, they wouldn't be very happy about it. I don't think the average American has participated in the growing wealth of the country over the past 10 years.

Philanthropy Buffett: You have to pick the things that are important to you. For many people, it's their church or their school or schools generally. To some extent, you should give to whatever gives you the most satisfaction. I like to think of things that are important but don't have natural funding constituencies, but for most people there's nothing wrong with giving to things that give them satisfaction. You don't have to be as objective about that as you are when picking securities. I'd go where my gut told me.

Our country can easily handle the Social Security issue. It astounds me that a government running a $300-400 billion deficit now is worried about a $100 billion deficit decades from now. We produce more every year as we go along. There's always a debate over how to split the pie, but it's a huge and growing pie so we can take care of older people.

What you see is what you'll continue to get.

"In the video, Davidson said he immediately knew Buffett was something special - he knew all about GEICO and asked exactly the right questions."

"We had the most benign hurricane season imaginable last year. When hurricanes occur, we'll pay out a lot of money. We hope over time to more or less break even on our underwriting. When you see last year's profit, look at it as an offset to future losses."

I have never seen anything as automated as that Iscar operation. I think they view it as a disgrace if any human hand has to do anything."

What has caused this extreme record to go on for such a long time? I would argue that it started with a young man reading everything when he was 10 years old, becoming a learning machine. He started this long run early. Had he not been learning all this time, our record would be a mere shadow of what it is. And he's actually improved since he passed the age at which most other people retire. Most people don't even try this - it takes practice. So it's been a long run, with extraordinarily concentrated power by a man who is a ferocious learner. Our system ought to be more copied than it is. The system of passing power from one old codger to another is not necessarily the right system at all.

Many people are very smart, but are not wired to think about things that haven't happened before.

We're not looking for someone to teach - we're looking for someone who knows how to do it.

Anything times zero is zero and I don't care how good the record is in every other year if one year there's a zero. We're looking for someone who is wired in such a way as to see risks that haven't occurred and be cognizant of risks that have occurred. Charlie and I have seen guys go broke or close to it because 99 of 100 of their decisions were good, but the 100th did them in.

Munger: It reminds me of the young guy who went up to Mozart and said, "I'd like to write symphonies." When Mozart said, "You're too young," the young man replied, "But you were young when you started." Mozart pointed out, "Yes, but I wasn't asking anyone else for advice on how to do it."

We don't buy businesses with much thought of world trends, but we do think about businesses subject to foreign competition, with high labor content and a product that can be shipped in. I bought into an airline [US Air] with high seat-mile costs of 12 cents. It was protected, but that was before Southwest showed up with 8-cent costs.

We learned about foreign labor competition in our shoe business. It reminds me of Will Rogers, who said he didn't think man should have to learn easy lessons in such a hard fashion. You should be able to learn not to pee on an electrified fence without actually trying it.

It's not as easy as it looks to buy these big positions. When we were buying Coca-Cola, we bought every share we could - we bought 30-40% of the volume, yet it still took us a long time to accumulate our position. However, we like it better when we have these problems now than when we didn't earlier. Buffett: We usually feel we can buy 20% of the daily volume and not move the market too much. That means if we want to buy $5 billion, we have to wait for $25 billion to trade and not a lot of stocks trade that much.

I don't think the railroad industry will be a lot more exciting, but the competitive position of the railroads has improved somewhat since 20 years ago. There's been progress on labor issues and an improved competitive position vis-à-vis truckers. Higher oil prices hurt railroads, but hurt truckers more by a factor of four. What was a terrible business 30 years ago, operating under heavy regulation, has become decent and could be better over time. But it will never be a fabulous business - it's too capital intensive.

I'm not sure who we sold our silver too, but whoever bought it was a lot smarter than I was. I bought it too early and sold it too early, but other than that it was a perfect investment. [Laughter] Charlie had nothing to do with it - it was all me.

We would not necessarily view metals investing as protection against inflation. The best protection is your own earnings power, whether the currency is in seashells or paper money. A first-class surgeon or teacher will do alright in terms of commanding the earning power of other people. The second best protection is owning a wonderful business, not metals or raw materials or minerals. The truth is, if you own Coca-Cola or Snickers bars or anything that people are going to want to give a portion of their current income to keep getting, and it has low capital-investment requirements, that's the best investment you can possibly have in an inflationary world.

We normally don't want to do deals with partners. If we like a deal, we want to do it all. We have a lot of money, so we don't need a money partner. As for a knowledge partner, we don't want to do a deal where we're relying on someone else.

As for what could trigger this and when, who knows? Who had any idea that shooting an archduke would start Word War I?

Munger: The accounting being enormously deficient contributes to the risk. If you get paid enormous bonuses based on profits that don't exist, you'll keep going. What makes it difficult [to stop] is that most of the accounting profession doesn't realize how stupidly it's behaving. One person told me the accounting is better because positions are marked to market and said, "Don't you want real-time information?" I replied that if you can mark to market to report any level of profits you want, you'll get terrible human behavior. The person replied, "You just don't understand accounting."

Buffett: When we went to close out Gen Re's derivatives book, we took a $400 million loss on a portfolio that was "marked to market" by the prior management and auditors - and I'm not criticizing our auditor. Any auditor would have said the same. I wish I could have sold to the auditors instead!

Take a dry cleaning business that owes $15. Their books show a $15 accounts payable and the other company shows an offsetting $15 accounts receivable. But there are only four big auditing firms, so in many cases, if they're auditing my side, the same firm may be valuing or attesting to the value of what's on the books of the person on the other side. I will guarantee you that if you add up the marks on both sides, they don't add up to zero. We have 60 or more derivative contracts, and I'll bet the other side isn't valuing them like we are. I have no reason to mark the value up - we don't get paid for that. If I value it at $1 million on our side, the other side should be marking it at minus $1 million, but I guarantee the numbers are widely different. Auditors should check both sides of derivative trades and the "marks" should sum to about zero. They don't. Munger: As sure as God made little green apples, this will cause a lot of trouble. This will go on and on, but eventually will cause a big dénouement.

Buffett: If you take the percentage of bonds and stocks held by people who could change their minds tomorrow based on what the Fed does, etc., it's gone up a lot. I call it an electronic herd, who change what they do every day or minute. The turnover of stocks has gone from 40% to over 100%, and the turnover of bonds has gone up dramatically as well. There's nothing evil about it, but it's a different game and there are consequences. If you're trying to beat the other fellow on a day-to-day basis and you're watching the news or the other fellow, and you think he's going to push the sell button, you'll try to push it quicker. When Charlie and I were at Salomon, they talked about 5- or 6-sigma events, but that doesn't mean anything when you're talking about real markets and human behavior. Look at what happened in 1998 and in 2002. You'll see it when people try to beat the markets day by day.

Munger: When people talk about sigmas in terms of disaster probabilities in markets, they're crazy. They think probabilities in markets are Gaussian distributions, because it's easy to compute and teach, but if you think Gaussian distributions apply to markets, then you must believe in the tooth fairy. It reminds me of when I asked a doctor at a medical school why he was still teaching an outdated procedure and he replied, "It's easier to teach."

History doesn't repeat itself, but it rhymes. We'll have something that rhymes.

It's in the national interest to give loans to the deserving poor. But the moment you give loans to the undeserving poor or the stretched rich, you run into trouble. I don't see how people did it and still shaved in the morning, because looking back at them was a face that was evil and stupid.

It's in the national interest to give loans to the deserving poor. But the moment you give loans to the undeserving poor or the stretched rich, you run into trouble. I don't see how people did it and still shaved in the morning, because looking back at them was a face that was evil and stupid.

It will be at least a couple of years before real estate recovers. In some areas of the country, the [housing] inventory overhang is huge. The people who were counting on flipping the homes are going to get flipped, but in a different way.

We think the most logical fund is like the one we manage at Berkshire, where we can do anything, but are not compelled to do anything. We would not limit ourselves to one area of the market - we buy stocks, futures, bonds, currencies, entire businesses, etc. We think it's a mistake to shrink the universe of opportunities. There's no form that produces good investment results, be it hedge funds, private equity funds or mutual funds. What makes the difference is whether the people running them know their strengths and weaknesses and play when it is to their advantage and do nothing when it is not.

Compensation is not rocket science. We have very simple systems to compensate our people. We don't make it complicated. We don't pay them for things that are happening that they have nothing to do with.

If oil goes from $30 to $60, there's no reason to pay [an oil company executive] for that. If they have low finding costs, which they can control, I'd pay them like crazy for that. That is the job you hire them for. To hand them huge checks for something they have no control over is crazy, and it's equally crazy to penalize them if oil prices go down. If oil prices went down and my CEO had low finding costs, we'd pay him like crazy.

It reminds me of the joke about why the woman told the census taker that the man of the house was in jail for embezzlement. Because she didn't want to admit that her dad was a comp consultant.

For a long time, most directors were sort of like potted plants. Management had its agenda and didn't want input on major matters and Charlie and I can testify that we've had very little success in influencing big issues. If someone's spent 20-30 years rising to become CEO, they don't want a board telling them what to do. It's changed a little bit today in terms of process.

When a significant deal comes along, it's a chance for the board to weigh in and discuss the economics of what's going on. But the CEO doesn't bring a deal unless he wants it done and so he stacks the deck.

Buffett: In most stock deals, the CEO thinks about what he's getting, but not what he's giving. You have to make sure you think about this. I can't ever think of a discussion [when I was on a board] of weighing what you're giving away vs. what you're getting in a stock deal. If more value is being given away, then don't do it! When I gave away 2% of Berkshire to buy Dexter shoes, it was one of the dumbest things ever. Not 2% of Berkshire then, but 2% of Berkshire today! Munger: Fortunately, you've made some good decisions. Buffett: Or half of you wouldn't be here. It gets swept under the rug.

We owned a bank that went to acquire a smaller bank. The CEO of the smaller bank held out for a high price and various terms and conditions and, because he was taking stock, had one last condition for the acquiring bank: "Promise never to do a deal this dumb in the future."

It's a real owners board. Every board member had a significant percentage of his net worth in the company and every decision was made for business reasons.

But every now and then, things really get out of whack. But the gradations in between are too tough. If you own great businesses, you should just hold on most of the time, maybe sell if the valuations get extremely high and buy more if they get really cheap like in the early 1970s.

The shorts generally have a tougher time of it in this world. More people are bullish on stocks. It's a tough way to make a living. It's very easy to spot a phony stock or a heavily promoted stock, but it's hard to say when it will turn. If it's trading at five times its intrinsic value, there's no reason it can't trade at ten times.

"We own one currency position right now that will surprise you - we'll tell you about it next year." I wonder what that is. Hope I remember it next year to find it out.

We favor businesses where we really think we know the answer. If we think the business's competitive position is shaky, we won't try to compensate with price. We want to buy a great business, defined as having a high return on capital for a long period of time, where we think management will treat us right. We like to buy at 40 cents on the dollar, but will pay a lot closer to $1 on the dollar for a great business.

Munger: Margin of safety means getting more value than you're paying. There are many ways to get value. It's high school algebra; if you can't do this, then don't invest.

Buffett: Let's say you decide you want to buy a farm and you make calculations that you can make $70/acre as the owner. How much will you pay [per acre for that farm]? Do you assume agriculture will get better so you can increase yields? Do you assume prices will go up? You might decide you wanted a 7% return, so you'd pay $1,000/acre. If it's for sale at $800, you buy, but if it's at $1,200, you don't. Buffett: If you're going to buy a farm, you'd say, "I bought it to earn $X growing soybeans." It wouldn't be based on what you saw on TV or what a friend said. It's the same with stocks. Take out a yellow pad and say, "If I'm going to buy GM at $30, it has 600 million shares, so I'm paying $18 billion," and answer the question, why? If you can't answer that, you're not subjecting it to business tests.

We have to understand the competitive position and dynamics of the business and look out into the future. With some businesses, you can't. The math of investing was set out by Aesop in 600 BC: a bird in the hand is worth two in the bush. We ask ourselves how certain we are about birds in the bush. Are there really two? Might there be more? We simply choose which bushes we want to buy from in the future.

Munger: We have no system for estimating the correct value of all businesses. We put almost all in the "too hard" pile and sift through a few easy ones. Buffett: We know how to recognize and step over one-foot bars and recognize and avoid seven-foot bars.

I think you should read everything you can. In my case, by the age of 10, I'd read every book in the Omaha public library about investing, some twice. You need to fill your mind with various competing thoughts and decide which make sense. Then you have to jump in the water - take a small amount of money and do it yourself. Investing on paper is like reading a romance novel vs. doing something else. [Laughter] You'll soon find out whether you like it. The earlier you start, the better.

I remain big on reading everything in sight. And when you get the opportunity to meet someone like Lorimer Davidson, as I did, jump at it. I probably learned more in that four hours than in almost any course in college or business school.

Buffett: Charlie and I have made money in a lot of different ways, some of which we didn't anticipate 30-40 years ago. You can't have a defined roadmap, but you can have a reservoir of thinking, looking at markets in different places, different securities, etc. The key is that we knew what we didn't know. We just kept looking. We knew during the Long Term Capital Management crisis that there would be a lot of opportunities, so we just had to read and think eight to ten hours a day. We needed a reservoir of experience. We won't spot every one, though - we've missed all kinds of things.

But you need something in the way you're programmed so you don't lose a lot of money. Our best ideas haven't done better than others' best ideas, but we've lost less. We've never gone two steps forward and then one step back - maybe just a fraction of a step back.

Munger: And of course the place to look when you're young is the inefficient markets. You shouldn't be trying to guess if one drug company is going to have a better pipeline than another.

Munger: And of course the place to look when you're young is the inefficient markets. You shouldn't be trying to guess if one drug company is going to have a better pipeline than another.

Munger: And of course the place to look when you're young is the inefficient markets. You shouldn't be trying to guess if one drug company is going to have a better pipeline than another.

But you need something in the way you're programmed so you don't lose a lot of money. Our best ideas haven't done better than others' best ideas, but we've lost less. We've never gone tw

But you need something in the way you're programmed so you don't lose a lot of money. Our best ideas haven't done better than others' best ideas, but we've lost less. We've never gone two steps forward and then one step back - maybe just a fraction of a step back.

course the place to look when you're young is the inefficient markets.

If I were working with a very small sum - you all should hope this doesn't happen - I'd be doing almost entirely different things than I do. Your universe expands - there are thousands of times as many options if you're investing $10,000 rather than $100 billion, other than buying entire businesses. You can earn very high returns with very small amounts of money. Everyone can't do it, but if you know what you're doing, you can do it. We cannot earn phenomenal returns putting $3, $4 or $5 billion in a stock. It won't work - it's not even close.

Munger: Two things matter: if the quality of the business is good enough, it can carry bad management. The reverse isn't true, though. It's very rare for a great manager to take over a bad business, say the textile business, and make it great. You shouldn't look for Warrens.

I get letters all the time from people who have been taken advantage of in financial transactions. It's sad. A lot isn't fraud - just the frictional costs and the baloney. Charlie and I have had very good luck buying businesses and putting our trust in people - it's been overwhelmingly good, but we filter out a lot of people. People give themselves away and maybe it's an advantage being around awhile and seeing how people give themselves away by what they talk about and what's important and not important to them.

Buffett: When they make certain kinds of comments, what they laugh about, if they say "it's so easy." It's not so easy. We rule out people 90% of the time. Maybe we're wrong sometimes, but what's important is the ones we let in.

I couldn't have told you which of the three would be the best, but the one thing I was sure of was that they were going to be sensational stewards of money and do what was right for clients rather then try to make 2x in commissions in a given year. Anytime someone who takes what I think is an unfair fee structure because they can get it, I rule them out.

Munger: The concept of a hurdle rate makes nothing but sense, but a lot of people using this make terrible errors. I don't think there's any substitute for thinking about a whole lot of investment options and thinking about the returns from each. The trouble isn't that we don't have one [a hurdle rate] - we sort of do - but it interferes with logical comparison. If I know I have something that yields 8% for sure, and something else came along at 7%, I'd reject it instantly. It's like the mail-order-bride firm offering a bride who has AIDS - I don't need to waste a moment considering it. Everything is a function of opportunity cost.

Buffett: I've been on 19 boards and seen a zillion presentations projecting a certain IRR [internal rate of return]. If the boards had burned them all, they'd have been better off. The IRR is based on what the CEO wants. The numbers are made up. Munger: I have a young friend who sells private partnership interests to investors, and it's hard to get returns in that field. I asked him, "What returns do you tell them you can get?" He said "20%." I said, "How did you come up with that number?" He said, "If I told them anything lower, they wouldn't give me the money." Buffett: There's no one in the world who can earn 20% on big money. It's amazing how gullible pension funds and other investors are. They want it so badly that they'll believe even total nonsense.

Volatility does not measure risk. The problem is that the people who have written about and taught volatility do not understand risk. Beta is nice and mathematical, but it's wrong. Past volatility does not determine risk. Take farmland here in Nebraska: the price of land went from $2,000 to $600 per acre. The beta of farms went way up, so according to standard economic theory, I was taking more risk buying at $600. Most people would know that's nonsense because farms aren't traded. But stocks are traded and jiggle around and so people who study markets translate past volatility into all kinds of measures of risk. The whole concept of volatility is useful for people whose career is teaching, but useless to us. Risk comes from the nature of certain kinds of businesses by the simple economics of the business, and from not knowing what you're doing. If you understand the economics and you know the people, then you're not taking much risk.

Munger: We'd argue that what's taught is at least 50% twaddle, but these people have high IQs. We recognized early on that very smart people do very dumb things, and we wanted to know why and who, so we could avoid them.

Buffett: We are willing to lose $6 billion in one catastrophe, but our insurance business over time is not very risky. If you own a roulette wheel, you sometimes have to pay 35-to-1, but that's okay. We would love to own a lot of roulette wheels.

Choosing your heroes is very important. Associate well,

I want to give the claim checks to someone who can follow generally what I would do myself if I were to do it myself.

What are the best ways for a 10-year-old to earn money? That was a subject I gave a lot of thought to when I was 10. You're probably a little young to deliver papers. I got half my capital from that - I liked it because I could do it by myself. You can do it when you're 12 or 13. I tried 20 different businesses by the time I got out of high school. The best was a pinball-machine business, but I wouldn't recommend it now.

I saw a study that correlated business success with a range of variables like grades, parents, whether one attended business school - and they found it correlated best with the age at which you first started in business. You see this in athletics and music as well.

Look for what people don't want to do for themselves. Ask around, see what other kids have done.

Munger: When I was young, I read The Richest Man in Babylon, which said to under-spend your income and invest the difference. Lo and behold, I did this and it worked. I got the idea to add a mental compound interest too, so I decided I would sell myself the best hour of the day to improving my own mind, and the world could buy the rest of the time. It sounds selfish, but it worked.

I was worried about Charlie's hearing so I asked a doctor about it. He said to test Charlie's hearing by standing across the room and saying something. So I stood at the opposite side of the room and said, "I think we ought to buy GM at $30." I got no reaction so I moved halfway across the room and said it again. Still no answer, so I went very close to him and said it and Charlie replied, "For the third time, yes!"

Munger: It's too tough. We can't solve that one. We try to look for easy problems. We don't try tough things. Sometimes life hands you a very tough -30- problem you have to wrestle with - not financial problems for us, but personal ones.

I think the idea of running vehicles on corn is one of the dumbest ideas I've ever seen. Governments, under pressure, do crazy things, but this is among the craziest. Raise the cost of food so you can run these autos around? You use up just about as much hydrocarbons making ethanol as it produces, and its cost doesn't even factor in the permanent loss of topsoil. I love Nebraska to the core, but this was not my home state's finest moment.

Buffett: I believe the odds are good that global warming is serious. There's enough evidence that it would be foolish to say there's a 99% chance it isn't a problem. In this case, you have to build the ark before the rains come. If you have to make a mistake, err on the side of the planet. Build a margin of safety to take care of the only planet we have.

I think Planned Parenthood is a terrific organization. I really think it's too bad that for millennia women, not only in the U.S. but over the world, have involuntarily had forced upon them the bearing of babies, generally by governments run by men.

I think Planned Parenthood is a terrific organization. I really think it's too bad that for millennia women, not only in the U.S. but over the world, have involuntarily had forced upon them the bearing of babies, generally by governments run by men. [Applause] I think it's an important issue that doesn't have a natural funding constituency - it's not like putting your name on a hospital. I think if we'd had a Supreme Court with nine women on it from the beginning, I don't think a question like yours would even be asked. I think it's wonderful that women can make reproductive choices. I hope you'll respect my opinion as I do yours. [More applause]

I think Planned Parenthood is a terrific organization. I really think it's too bad that for millennia women, not only in the U.S. but over the world, have involuntarily had forced upon them the bearing of babies, generally by governments run by men. [Applause] I think it's an important issue that doesn't have a natural funding constituency - it's not like putting your name on a hospital. I think if we'd had a Supreme Court with nine women on it from the beginning, I don't think a question like yours would even be asked. I think it's wonderful that women can make reproductive choices. I hope you'll respect my opinion as I do yours. [More applause]