Berkshire Hathaway Annual Meeting May 6, 2006

Summary of Proceedings of the

Berkshire Hathaway Annual Meeting – May 6, 2006

SummaryPrepared by David I. Kass, Ph.D.

Adjunct Professor of Finance

RobertH.SmithSchool of Business

University of Maryland

Warren Buffett (WB) announced that 24,000 were present for this meeting. He reported on Berkshire Hathaway’s (BH) first quarter 2006 earnings and said that both Geico and General Reinsurance had a good first quarter (through March 31). However, “hurricanes do not occur during the first quarter”.

WB also informed the meeting that BH had just purchased an 80% share of the privately held Israeli metal cutting tool company Iscar Metalworking Companies (IMC) for $4 billion. He will be visiting Israel in September in search of additional companies to buy.

Aone hour humorous film was shown with a cast that included Warren Buffett (Chairman), Charlie Munger (Vice Chairman), Jimmy Buffett, Jamie Lee Curtis, the entire cast of Desperate Housewives, Arnold Schwarzenegger, Ellen DeGeneres, Bill Gates, Donald Graham (The Washington Post), Jack Byrne (former CEO of GEICO), Donald Keough (former neighbor and former President of Coca-Cola), and cartoon characters of Dick Cheney (on a hunting trip), Oprah Winfrey, and Donald Trump.

Warren Buffett (WB) and Charlie Munger (CM) then proceeded to answer 45 questions from shareholders on the following topics over the next 5 hours (with a 45 minute break for lunch) in the following order:

(1) Social Security

WB: The U.S. will be able to solve the Social Security funding problem.

(2) Corporate Executive Compensation

WB: There is a problem with envy vs. greed. CEO’s want to earn more than their counterparts at other companies. If someone receives a $2 million bonus he feels good. But if his neighbor receives $2.1 million, he will feel bad.

(3) Culture at BH

WB: The culture at BH is discussed in its Annual Report. This culture will be maintained after WB is no longer Chairman.

(4) Emerging Market Closed End Funds

WB: The current market premiums over net asset values of these funds are irrational.

(5) Plurality vs. Majority Voting for Boards of Directors

WB: This has no effect. However, large shareholders could have an impact.

(6) Investing in Technology Companies

WB: Technology companies are not within WB’s “circle of competence”. Some businesses are hard to predict. WB cannot predict how Intel will be doing 5 years from now.

CM: “We know the edge of our competency”.

(7) Personal Incomes, Taxes, Corporate Profits, and the Economy

WB: Corporations pay low tax rates. The rich pay taxes that are a lower percentage of their incomes than do lower income people. WB pays taxes that are a lower percentage of his income than do the much lower income people in his office. The U.S., however, is experiencing a good rate of growth in GDP per capita.

(8) Economic Future of Ethanol

WB: The agricultural processing industry does not earn a high rate of return on capital. Ethanol does not have a bright future. The production of ethanol consumes more energy from fossil fuel than the resulting energy that ethanol produces.

(9) Commodity Bubble (Copper)

WB: “What the wise man does in the beginning, the fool does in the end”. People become envious of their neighbors who are making a lot of money and want to do the same. This leads to speculative participation (e.g., tulip bulbs). In addition to current speculation in the metals markets, there is also speculation in housing. The price of silver was about $1 per ounce in the 1960’s and ran up to $50 per ounce around 1980. If the fundamentals are attractive then one can make money. However, after speculation takes hold, “at midnight everything turns into pumpkins and mice” and “there are no clocks on the wall”.

(10) Investing in South America

WB: It is unlikely that BH would invest a lot of money into small South American countries. He did invest $400 million in China a few years ago in PetroChina which is now worth $2 billion. WB would want a good price to compensate for the additional risks of investing in other countries.

(11) Demand for the Manufacturing of Housing (BH owns ClaytonHomes)

WB: Manufactured homes represent a low percentage (15%) of new homes and sell for $45 per square foot which is a good value.

CM: ClaytonHomes is expecting good growth.

WB: There has been a lot of dumb lending in residential housing in recent years.

(12) Investing in Russia

WB: BH had a bad experience investing in Russia in the 1980’s. After one of its projects located oil, the Russian government seized the property. He mentioned the recent experience of Yukos.

CM: “If you find oil, they will steal it”. The Russian government has a negative attitude to outside capital.

(13) Residential Real Estate in California

WB: There is a slowdown in real estate everywhere and a bubble in the high end as well as in investment (speculation) properties rather than in properties for use. There is now the equivalent of day trading for condos. In Dade/Broward counties in Florida, there are 30,000 listings for condos, but only 2,000 are selling. When there is a bubble, there will be discontinuities in prices. Significant downward adjustments in prices are expected. By contrast, real estate prices in Omahaare reasonable.

(14) BH Has $37 Billion in Cash

WB: It would be normal for BH to hold $10 billion in cash to cover insurance claims. But BH is sitting on $37 billion in cash as of the end of March. $4 billion has just been invested in Iscar. WB now has one $15 billion idea, but it is unlikely to work out. “We don’t do dumb deals either”.

(15) Coca-Cola (BH Owns 8% of Coca-Cola)

WB: In 1997-98 Coca-Cola (KO) was selling for $80/share (now in the low $40’s) and was selling for 50 times earnings per share. BH has a large profit in KO since purchasing it in 1988. Its market share is increasing and it earns an excellent rate of return on capital. It is experiencing a 4% -5% rate of growth along with a 2% rate of growth in the population. BH will still own KO 10 years from now.

(16) Insurance

WB: Automobile insurance accounts for 40% of all insurance sold. (BH owns Geico.) Prices along the GulfCoast are increasing for reinsurance. (BH owns General Reinsurance.) BH is number one in the industry with respect to “mega-catastrophe” insurance. The insurance industry has sustained big losses over the last two years, although the last 100 years (on average) have been okay. Modeling does not result in accurate forecasts of the future. (WB referred to chaos theory and nonlinear relationships.) But BH likes this business. Hurricane Katrina cost the industry $60 billion. BH can pay (its share of claims ), but other insurers cannot.

(17) NetJets (BH-owned business that sells fractional interests in corporate jets)

WB: There are diseconomies of scale in this business and it is capital intensive. But it is a good business and WB expects it to make money before long. Rich Santulli (NetJets CEO) is fixing it.

(18) Silver

WB: BH no longer has a position in silver. There are no earnings to be derived from holding commodities (non-interest bearing).

(19) Investing in Regions with Natural Resources

WB: BH failed to benefit (from commodities) in the recent largest commodity boom in history.

(20) Risk of Nuclear Terrorism

WB: There is a major risk of state-sponsored terrorism. There are evil people in this world. Preventing this from happening is the world’s top priority. (Even the U.S. used nuclear weapons twice in 1945.)

CM: The probability is zero that nuclear weapons will not be used over the next 50 years.

(21) Share Repurchases

WB: BH has recently purchased shares in Wal-Mart and Anheuser-Busch, but none of its own shares. WB wants “a greater margin” before buying BH shares. BH has 400,000 shareholders.

(22) Investment Professionals and Advice For Young People/Shareholders/Investors and BusinessSchools

CM: (To young people): “Reduce your expectations”.

WB: Professionals (investment advisors, etc.) neutralize each other. Investment professionals do not produce value added. This is a $40 billion/year industry. But individuals can do just as well by spending 10 minutes a year by themselves. (CM: ‘Not necessarily”.) It is a false idea that price equates to value. “Business Schools are a great business”. Many falsely believe that a business school that charges $50,000 per year is better than one that charges $10,000 per year. Hedge funds charge 2% per year of funds invested plus 20% of profits in good years. In bad years they fold, only to re-start later. But there are a few exceptions (good funds). The big question is how does one identify them?

(23) Illegal Immigrants

WB: Illegal immigration is “a problem that should be addressed and addressed promptly”. “I don’t believe in shipping 11 million people away. I think we ought to enforce rules in the future. I don’t think it (legalizing immigrants) would make a dramatic difference. You may end up paying a little more for meat in the end.”

(24) Finance and BusinessSchools

WB: This year students from 40 business schools will be visiting Omaha to meet with WB. They will be doubling up, since WB can only handle 20 meetings per year. “There is a more reasonable approach to the teaching of finance at the University of Kansas (a student from this university asked this question), ColumbiaUniversity, and Stanford”. “Twenty years ago the flat earth approach was the orthodoxy”. “Modern portfolio theory and efficient markets would not do you any good, and might get you into trouble.” Graduates of business schools are setting their expectations too high. They are comparing themselves with their age cohorts at Goldman Sachs.

(25) CEO Under WB

WB: There is no need for a CEO under WB. The culture of BH will stay the same under WB’s successor. Wal-Mart continued its tradition after Sam Walton died in 1991.

(26) Charitable Contributions

WB: BH will be allocating its charitable contributions where large sums will have an impact.

(27) Electric Utilities

WB: Electric utilities need to be efficient and manage costs.

(28) Newspapers vs. The Internet

WB: Each person has only two eyes and 24 hours per day. There is much information that is available for free (Internet). The economics of newspapers is deteriorating. (Although these companies are still profitable and their rate of return on assets is good.) More competition is not good for information and entertainment businesses. This is also true for television and cable vs. telecom.

(29) Value of the Dollar (Currency)

WB: The currency (U.S. Dollar) picture is not good. The current account deficit is double what it was 4 years ago. This will lead to higher inflation and a devaluation of the dollar (so it will be cheaper to pay our debts). There will be “a rush to the door” (from the dollar) in the end. WB prefers to invest in foreign companies rather than just foreign currencies. (WB also referred to “portfolio insurance” of the1980’s that incorporated mechanistic procedures which led to a one day price decline of 22% in the Dow Jones Industrial Average on October 19, 1987.)

(30) Consumer Price Index (CPI)

WB: The CPI understates inflation for many people. Bill Gross (PIMCO) has written that the CPI is not a good measure of inflation. The core inflation rate excludes food and energy and includes imputed rental costs. It does not reflect new housing costs. “Buying a new house and driving” would result in a higher CPI.

CM: “Costco has no inflation”. (CM is on the Board of Directors of Costco.)

(31) Recent Acquisitions

WB: The acquisition of Russell Corporation (athletic and sporting goods) is in the process of being completed. BH has recently acquired Pacific Corp. (electric utility), an insurance subsidiary of General Electric, and Applied Underwriters. BH will not participate in auctions.

CM: BH welcomes partners rather than just doing deals.

(32) Recent Financial Crises

WB mentioned Long Term Capital Management (1998). In 1991, Salomon Brothers (SB) came very close to bankruptcy (within 30 minutes on a Sunday afternoon). Treasury Secretary Nicholas Brady saved SB because he trusted WB. It is not known what would have happened the next day if SB had entered bankruptcy.

(33) Newspaper Stocks

WB: Present prices do not compensate for the deteriorating economics in the newspaper industry. What multiple is appropriate when earnings per share are declining by 5% per year (vs. growing at 5% per year)? The decline in this industry is accelerating. Older people who read newspapers are dying. Younger people do not read newspapers.

(34) General Investment Advice

WB: Do something when everyone else is petrified. In 1974 stocks were being ignored and were extremely undervalued. (WB was buying stocks in 1974.) In 2002 junk bonds were being ignored and were undervalued. (WB was buying junk bonds in 2002.) Three years ago Korea, with 50 million people, had a stock market being valued at only 3 times earnings.

CM: “When we were young we had way less competition than you (younger people) do now. There weren’t very many smart people in the investment management field. Now we’ve got armies of brilliant young people…and we’ve got a vast amount of talent in the investment management business, and there’s a lot of competition.”

(35) Investment Ideas

WB: One generally has only a few good investment ideas. There is an opportunity cost of applying modern portfolio theory and not pursuing these ideas.

(36) Jeremy Siegel’s Latest Book

CM: Jeremy Siegel’s projections are the equivalent of “comparing apples with elephants.” CM then referred to Jeremy Siegel as being “demented”.

(37) On Being Right

WB: You are right if your facts are right. Focus on what is knowable and important.

(38) Intrinsic Value of BH

WB: The intrinsic value of BH is a function of earnings per share, quality of earnings, rate of growth, and liquid assets.

CM: The intrinsic value of BH depends on operating earnings.

(39) The U.S. Health Care Delivery System

WB: BH has not examined this issue and has no insights.

(40) Chapter 11 Bankruptcy

WB: BH purchased Fruit of Loom when it was in Chapter 11 bankruptcy proceedings and it is now profitable. It has also successfully invested in junk bonds including the bonds of Sytel. The courts play an important role in bankruptcy proceedings.

(41) The Pharmaceutical Business of Procter & Gamble

WB: Although Procter & Gamble (PG) is now one of BH’s largest stock holdings as a result of its acquisition of Gillette (large holding of BH), WB does not know anything about PG’s pharmaceutical business.

(42) Private Equity

WB: BH is not interested in buying a company from a private equity firm that had bought the company a few years before. Private equity firms “borrow more than they are worth”.

(43) Investing in Europe

WB: In Europe there is both high unemployment and job security. It is less attractive to invest there.

(44) Gambling

WB: Those who gamble create risk. WB then referred to living in a house on the Florida coast.

(45) Naked Short Sellers

WB: Naked short sellers have to buy back the underlying securities later. Being a short seller is “an emotional and tough way to earn a living”. If someone buys a stock at 20, the worst that can happen is that it goes to 0. However, if you short a stock at 20, your potential loss is unlimited.

David I. Kass, Ph.D.

Adjunct Professor of Finance

RobertH.SmithSchool of Business

4412 Van Munching Hall

University of Maryland

College Park, Maryland20742-1815