Berkshire Hathaway

TerraPower, the Bellevue-based nuclear reactor company Gates co-founded and chairs, began with a traveling-wave reactor design and a 2015 agreement with China National Nuclear Corporation to build a 600-megawatt prototype at Xiapu in Fujian province, with commercial plants planned for the late 2020s; the project was abandoned in January 2019 when the Trump administration restricted the necessary technology transfers. The company then won a October 2020 Department of Energy award, between $400 million and $4 billion over five to seven years, under the Advanced Reactor Demonstration Program for its sodium-cooled Natrium design. In June 2021 TerraPower and PacifiCorp, a Berkshire Hathaway Energy subsidiary, announced plans for a joint reactor, and on November 16, 2021, Kemmerer, Wyoming, was selected from four coal-reliant candidate towns. The 345-megawatt project, estimated at four billion dollars with the department covering half and Gates contributing a billion, broke ground in June 2024 and received its construction permit in March 2026, the first ever granted for a non-light-water reactor.

In June 2006, Warren Buffett pledged roughly ten million Berkshire Hathaway Class B shares, then valued at $3,071 each before a later fifty-to-one split, to be delivered over multiple years, with the first 500,000-share tranche worth about $1.5 billion. The gift came with three conditions: Bill or Melinda Gates must remain alive and active in the foundation's administration, the foundation must continue to qualify as a charity, and each year it must give away the previous year's Berkshire contribution plus an additional five percent of net assets, effectively converting the donation into a matching grant that doubled giving rather than swelling the endowment. The foundation received five percent of the earmarked shares in 2006 and declining installments each July thereafter, with Buffett adding another two billion dollars of stock in 2018. His cumulative giving to the foundation reached roughly $48 billion before the partnership ended in 2026.

The foundation was designed to die. In October 2006 it was split into a trust that manages the endowment and an operating foundation that makes grants, with the announcement that all resources would be spent within fifty years of Bill's and Melinda's deaths, a deadline later tightened to twenty years in contrast to the perpetual life of most large foundations. In May 2025, Gates went further, announcing that the foundation would cease operations on December 31, 2045. The spend-down logic is administrative as much as philosophical: a fixed horizon lowers administrative costs over the institution's life and prevents the drift into token grantmaking that consumes perpetual endowments. Buffett's own stipulation that proceeds from shares he still owns at death be deployed within ten years of his estate's settlement reinforced the same conviction that philanthropic capital should be spent, not preserved.

In June 2006 Gates announced he would transition out of his day-to-day Microsoft role to concentrate on philanthropy, splitting his responsibilities between Ray Ozzie, who took over management, and Craig Mundie, who took long-term product strategy; the two-year handover was completed on June 27, 2008. He stepped down as chairman in February 2014, handing the board chair to John W. Thompson and becoming a technology adviser to the newly appointed chief executive Satya Nadella, a position he has retained. In March 2020 Microsoft announced Gates would leave his board seats at both Microsoft and Berkshire Hathaway to devote himself to climate change, global health and development, and education. The Wall Street Journal later reported that his departure came before the board concluded an external law firm's probe, begun in late 2019, into an alleged inappropriate relationship with a Microsoft employee, leaving his four-decade operating role at the company fully behind.

; Thom Lachman, the Chairman and CEO of Duracell, a Berkshire Hathaway company; and Jean-Baptiste Wautier, the former Chairman of the Investment Committee and CIO of BC Partners, a large European private equity firm. JB also serves as a director of PSH. Our long-term objective is to transform HHH into a modern-day Berkshire Hathaway: a diversified holding company built upon a foundation of high-quality, durable growth companies that can compound their intrinsic values at high rates over the long term. In December, HHH took an important step forward in executing its new strategy by entering into a definitive agreement to acquire Vantage Group Holdings, Ltd. (“Vantage”), a specialty insurance and reinsurance company, for $2.1 billion. We believe Vantage is an ideal platform to begin HHH’s transformation. It is well diversified across specialty lines of insurance, has an excellent and experienced management team, and benefits from established regulatory licenses, strong credit ratings, and a growing presence in the market. In light of its short operating history – Vantage was launched in 2020 – it has limited risk associated with long-dated legacy insurance exposures. The Vantage acquisition is expected to close in the second quarter of 2026, subject to regulatory approvals. The transaction will be funded with approximately $1.2 billion of cash from HHH’s balance sheet, together with up to $1.0 billion of preferred equity from PSH (the “HHH Preferred”).

The HHH Preferred is structured to provide bridge equity to HHH while offering PSH a return similar to a direct investment in Vantage plus a small premium in the likely event it is repurchased by HHH over the next several years. If HHH does not fully repurchase the HHH Preferred from PSH, it converts into common stock in Vantage at the initial acquisition price, and PSH has registration rights which can facilitate a public listing of the company. As part of our services arrangement with HHH, Pershing Square will manage the assets of Vantage for no incremental cost. We intend for Vantage to invest 100% of its insurance float in short-term U.S. Treasurys, and over time, its surplus capital in common stocks, similarly to how Berkshire Hathaway has managed its insurance subsidiaries’ assets. We expect that our approach to managing Vantage’s assets will allow it to earn a substantially higher return on equity than a typical insurer, which should enable it to compound its book value at a high rate over time. If we are successful in achieving our expectations for Vantage, it will materially accelerate HHH’s growth profile, diversify the sources of its revenues and earnings, reduce its cost of capital, and accelerate HHH’s long-term growth in intrinsic value and share price. The Current Economic and Market Backdrop We believe that 2026 could be a very strong economic year. There are a number of geopolitical, economic, and political factors and forces that contribute to our view.

The foundation's origin story, as Gates tells it, begins with his parents and a newspaper article. The core belief that every life has equal value came from lessons his mother and father taught early, and as Microsoft wealth grew in the late 1990s, he and Melinda began looking for ways to give back, starting with expanding technology access in American public libraries. Then he read an article reporting that millions of children in poor countries were dying annually of diseases that rich nations had long since learned to prevent, and he sent it to his father with a note asking whether they could do something about it. That moment redirected his life. He began meeting scientists, health workers, and community leaders to learn where philanthropy could matter, and the foundation born in 2000 co-founded Gavi with a $750 million pledge and helped create the Global Fund, with Warren Buffett's extraordinary 2006 pledge of more than $30 billion enabling bigger, longer bets.

Active vs Passive Fund Share of US Equity Fund Assets Source: Research Affiliates, Data as at 31st Dec 2024 The financial services industry sometimes does not aid understanding with the labels it employs. Index funds and index ETFs are often labelled ‘passives’ in contrast with ‘active’ funds, like Fundsmith Stewardship Fund, which have a fund manager making investment decisions. The ‘passives’ mostly track the index they invest in by holding the stocks in proportion to their market value. Far from being passive in any normally accepted sense of the word, this makes them a momentum strategy. A momentum investment strategy is one in which the investor buys stocks which are performing strongly. If you redeem money from an active fund like Fundsmith and invest it in an S&P 500 Index tracker fund your new fund will buy the index stocks in proportion to their market value. Currently about 7% of it will go into Nvidia which we do not own. About 35% will go into the Magnificent Seven of which we own only three stocks — Alphabet, Meta and Microsoft. This gives added momentum to those stocks we do not own which are a major part of the index. John Bogle, the pioneer of index investing who founded Vanguard, the index fund manager, was asked at the 2017 Berkshire Hathaway annual meeting if there was a level of assets in index funds which would distort markets and he agreed that there was, although he had no method of determining that level. We may already have reached it.markets

Buffett opened the 2023 annual meeting against the backdrop of a first quarter that had produced operating earnings of approximately $8.1 billion and a reported cash position of approximately $130 billion, an all-time record. Buffett and Munger told shareholders that the Company had bought an additional approximately $12 billion of equity holdings during the quarter, including the disclosure of stakes in Capital One Financial and additional positions in the existing financial services and energy portfolios. Buffett walked shareholders through the broader context of the March 2023 regional banking crisis, including the failure of Silicon Valley Bank and Signature Bank and the deposit migration to the money-centre banks. He argued that the regulatory response of guaranteeing all deposits at the failed institutions had been necessary to prevent a broader contagion but that the underlying incentive structure that had created the vulnerability, including the unrealised losses on the held-to-maturity bond portfolios of the regional banks, remained unresolved. Buffett also acknowledged the partial sale of additional BYD H-shares during the quarter, framing it as continued position-size discipline. On the Q&A, shareholders pressed on whether the size of the cash position implied that the opportunity set in the equity market was narrow. Buffett responded that the cash was a by-product of the willingness to wait for attractive opportunities rather than a deliberate accumulation, and that the recent deployment pace demonstrated the willingness to act when the market presented. Munger added that the discipline of waiting for fat pitches had been the central advantage of the Berkshire structure for decades and that the willingness to carry large cash positions through extended periods of low deployment had been the price of the long-term outperformance. Buffett also defended the increased concentration of the portfolio in Apple, arguing that the underlying franchise met the test of a wonderful company at a fair price and that the position size reflected that assessment. The meeting closed with Buffett and Munger reiterating the long-term framework of compounding intrinsic value per share, anchored on the insurance float, the wholly-owned operating businesses, the concentrated long-term equity portfolio and the discipline of carrying large cash reserves through extended periods of low deployment, and with Munger delivering what would prove to be his final set of public remarks at a Berkshire annual meeting before his death in November 2023.

Buffett opened the 2022 annual meeting against the backdrop of a first quarter in which Berkshire had deployed approximately $51 billion of cash into the equity market, including the disclosure of a 14.6 percent stake in Occidental Petroleum and the material build-out of the Chevron position to approximately $26 billion. Buffett and Munger told shareholders that the energy sector deployments reflected the underlying unit economics of the Permian unconventional resource base and the discipline of the Chevron capital allocation framework, and that the Occidental stake reflected the structural value of the underlying Permian resource base plus the optionality on the preferred shares acquired in 2019. Buffett walked shareholders through the partial reduction in the BYD position, indicating that Berkshire had sold approximately 5 million BYD H-shares during August at approximately HK$277 per share, while continuing to hold the bulk of the 225 million shares acquired in 2008. He framed the partial reduction as the natural outcome of position-size discipline after a position that had grown from the original $232 million cost basis to a market value in the multiple billions of dollars, while continuing to express admiration for the BYD management and the long-term trajectory of the Chinese EV industry. Munger, who had championed the original BYD investment, declined to add detail beyond defending the underlying franchise. On the Q&A, shareholders pressed on whether the energy sector deployments represented a fundamental shift in Berkshire's sectoral concentration. Buffett responded that the deployments reflected the underlying unit economics and the capital allocation discipline of the specific companies rather than a thematic bet on the energy sector, and that the long-term equity portfolio continued to be anchored on the consumer brand and the financial services franchises that had defined it for decades. Munger added that the energy sector was one of the few sectors where the underlying business economics and the capital allocation discipline of the specific companies were both attractive at the prevailing prices. The meeting closed with Buffett and Munger reiterating the long-term framework of compounding intrinsic value per share, anchored on the insurance float, the wholly-owned operating businesses, the concentrated long-term equity portfolio and the willingness to deploy large amounts of capital rapidly when the market presented attractive opportunities.

At the 2022 Berkshire annual meeting - Munger's last before his death in November 2023 - he was characteristically blunt about what he refused to touch. He told the audience that he tried to avoid things that were evil, stupid, and made him look bad relative to someone else. The formulation compressed Munger's lifelong filter into a single line: a thing did not have to be all three to be avoided; any one of the three was sufficient. The investor who internalized the rule would refuse most of the propositions the market pressed on him. He sharpened the point with reference to crypto. Munger had been a public critic of cryptocurrency for years, and at the 2022 meeting he did not soften. He told the audience that he regarded crypto as a disgusting development and that those who promoted it were, in his view, either deluded or self-interested. He did not pretend that the asset class might be a legitimate innovation in payments or a hedge against monetary debasement; he treated it as a speculation that exploited the same incentive biases and psychology of crowds that had produced every previous speculative mania, and he refused to participate in any form. The avoidance principle, in Munger's telling, was not the absence of strategy. It was the strategy. The things he refused to touch - crypto, complex derivatives, structured products, financial engineering generally - defined the perimeter inside which he was willing to operate. The perimeter was deliberately narrow. The great investment decisions inside the perimeter - See's, Coca-Cola, BYD, Costco, the Japanese trading houses - had produced returns that an investor following the broader market could not have matched. The avoidance of the evil and the stupid was, paradoxically, what made the great investments possible.

Munger used the 2022 platform to restate his view of derivatives, the asset class he and Buffett had been warning about publicly since the 2003 meeting. He told the audience that the world had become more complex, more leveraged, and more interconnected since the original warning, and that the derivatives web had grown rather than shrunk in the intervening two decades. The systemic fragility had, in his view, become worse, not better. He did not predict a specific crisis; he predicted the pattern - that the next serious credit event would, as in 2008, propagate through the derivatives counterparty web faster than the regulators could contain it. The prescription was unchanged: stay simple, stay liquid, stay out of contracts whose payoff depended on a counterparty's solvency in a crisis. He told the room that Berkshire itself held a large cash position precisely because Buffett and Munger believed that the optionality of being able to act in a crisis was worth more than the small incremental return they would have earned by deploying that cash in calm markets. The cash was not a waste; it was insurance on the franchise. He closed with a callback to the avoidance principle. The investor who stayed out of the derivatives web, out of the crypto speculation, and out of the structured products would, in the next crisis, be one of the few people with both the capital and the courage to act. That was the actual content of risk management, in Munger's view - not the elaborate value-at-risk models that the banks ran, but the simple discipline of refusing to own assets whose behavior in a crisis could not be underwritten. The simple discipline, repeated over decades, was what produced the long-run record.

Buffett opened the 2020 annual meeting in an empty Omaha arena, with Charlie Munger absent in person and the meeting conducted by video link against the backdrop of the COVID-driven market collapse of March 2020. Buffett told shareholders that Berkshire had deployed approximately $5 billion into the public equity market during the March collapse, had sold off approximately $4 billion of equity holdings to fund the deployment and had taken a $9.8 billion writedown on the Kraft Heinz investment reflecting the structural pressure on the packaged-food franchise. Buffett walked shareholders through the broader context, acknowledging that the COVID-driven collapse in airline demand had led Berkshire to sell the entirety of its airline equity positions - the holdings in Delta, United, American and Southwest - during April. He framed the airline sale as a recognition that the underlying business model had been changed by the pandemic in ways that were not yet visible, and that the disciplined response was to exit rather than to attempt to time a recovery that he had no edge in forecasting. On the Q&A, shareholders pressed on whether Berkshire should be deploying more aggressively into the post-COVID collapse. Buffett responded that Berkshire had not seen opportunities at the scale and the terms available in 2008, that the Federal Reserve's rapid intervention had effectively crowded out the natural buyers of crisis capital and that the Company would continue to carry a very large cash position until attractive opportunities emerged. He also defended the decision to sell the airline positions, arguing that the underlying industry economics had been structurally weak for the entire history of commercial aviation and that the pandemic had crystallised the structural disadvantage. The meeting closed with Buffett reiterating the long-term framework of compounding intrinsic value per share, anchored on the insurance float, the wholly-owned operating businesses and the discipline of carrying large cash reserves through bull markets to deploy through panics, and signalling that the succession planning for the CEO role was being executed against the long-stated plan with Greg Abel as the designated successor.

Buffett wrote that Berkshire's resilience during the pandemic came from the diversity of its non-insurance operating businesses, each of which had its own demand cycle but whose aggregate cash flow was durable across most scenarios. He argued that the lesson of the period was the value of owning businesses whose balance sheets and cash flows could absorb shocks without requiring external capital, and that Berkshire's conservative capital structure was itself a competitive advantage in a crisis.

On resilience and the value of a conservative balance sheet.

At the 2019 Berkshire annual meeting, Munger was asked about share repurchases. The question probed the precision of Buffett's buyback threshold and whether Berkshire would be more liberal in repurchasing its own stock. Munger's answer was deliberately imprecise. He told the audience that he was a little more liberal in repurchasing shares than Buffett, and that the question of un-precision in railroading was a related problem - at some point, in a complicated operation, you accepted that you were operating with judgment rather than measurement. The point Munger was making was that capital allocation at Berkshire scale was not a marks-to-the-penny exercise. Repurchasing shares below intrinsic value was a clear duty when the price was clearly below the estimate; the difficulty was that intrinsic value itself was an estimate, not a quote. He told the room that pretending to more precision than the business actually allowed was itself a form of misjudgment. The honest framing was that Buffett and Munger had a range for intrinsic value, and they repurchased aggressively when the market price fell well below the low end of that range. The corollary was a critique of the modern buyback fashion. Munger noted that, historically, companies had refused to buy back their stock when it was a very good idea and were buying it back aggressively when the stock was so high that doing so was frequently a bad idea. He welcomed the audience to adult life - this is the way it is. The observation was that corporate buyback behavior was pro-cyclical, driven by the same incentive biases that drove every other form of capital allocation. The disciplined operator did the opposite: he bought back stock when the price was low and refrained when the price was high, regardless of what the Street was telling him about the optics.

At the 2019 Daily Journal meeting, Munger offered his most compact summary of why Berkshire and the Daily Journal had outperformed. The answer, he said, was pretty simple. They tried to do less. They had never had the illusion they could just hire a bunch of bright young people and have them know more than anybody about canned soup and aerospace and utilities. They had never thought they could get really useful information on all subjects the way Jim Cramer pretends to have it. They had always realized that if they worked very hard, they could find a few things where they were right, and the few things were enough. He tied the point to expectations. If you had asked Warren Buffett for his single best idea in a given year, Munger said, and you had just followed it, you would have found that it worked beautifully. Buffett would not have tried to give you a whole heap of names - he would have given you one or two stocks, because he had more limited ambitions than the typical mutual fund manager. The discipline was not to know a lot, but to know a few things very well and to act on them only when the conviction was high. Munger closed the thought with the kicker: that is a very different way to approach the process than the way mutual funds approach it. The fund industry's job, structurally, is to be in everything so that no benchmark-relative argument can ever be made against it. Munger's job was to be in very few things so that the few things he was in were the ones where he had an edge. The two philosophies produce very different long-run returns.

Munger used the 2019 platform to reflect on BYD, more than a decade after Berkshire's original 2008 investment. The position had been the source of considerable public attention, and Munger had been the principal advocate inside Berkshire for the bet on the Chinese EV maker. He told the audience that the bet had worked out, that BYD had become a serious business, and that the early conviction about the founder and the technology had been validated by the company's subsequent execution. The reflection was characteristically Munger in two respects. First, he refused to take credit for foresight. The investment had worked because the founder had executed; the bet had been a bet on a person and a culture, and the person and the culture had delivered. Munger's framing was that he had identified a small number of things that mattered - the founder's character, the technology trajectory, the Chinese government's commitment to electrified transport - and had refused to be talked out of the bet by the surface-level concerns about Chinese governance and disclosure that had scared other foreign investors away. Second, Munger connected the BYD reflection to the broader thesis on international investing. He told the room that Berkshire had made a serious amount of money in China over the years - PetroChina before BYD - because the great companies in China had traded at lower multiples than comparable great companies in the United States. The pattern was not luck; it was the consequence of doing the work and being willing to underwrite a foreign franchise when other investors were standing on the sideline. The lesson for the audience was that the international opportunity set was real and recurring, and that the patient, disciplined investor who did the work would be paid for doing it.

Munger closed the 2019 meeting with a series of operating lessons drawn from Berkshire's history. He pointed to the founding businesses of Berkshire Hathaway - a doomed department store, a doomed New England textile company, and a doomed trading stamp company - and said that out of that mix came Berkshire. They had handled those losing hands pretty well and they had bought into them very cheaply. But, Munger said, of course the success came from changing their ways and getting into better businesses. The lesson was that scrambling out of mistakes without letting them cost too much is a real and underappreciated part of long-run compounding. He sharpened the point. It isn't that we were so good at doing things that were difficult, he said. We were good at avoiding things that were difficult, and finding things that were easy. The inversion of the popular image of Berkshire - which celebrates Buffett and Munger as patient geniuses who solve the hardest problems - was deliberate. Munger was telling the room that the actual edge was in saying no to the hard stuff and saying yes only when the proposition was simple, durable, and within reach. He connected the lesson to expectations and to China. His advice to a seeker of compound interest that works ideally was to reduce expectations, because he thought returns were going to be tougher for a while, and that having realistic expectations made you less crazy. On China, he repeated his 2017 line: the great companies in China were cheaper than the great companies in the United States. And he closed with the too-hard pile again - there was a pile on his desk, he said, that solved most of his problems. Every once in a while an easy decision came along and he made it. That was the system.

But there are other matters that must concern those of us in the mutual fund industry. First and foremost among them is the question of costs. In the BHB studies, advisory fees and administrative and custody costs were not taken into account. Indeed, given the nature of the studies (focusing primarily on quarterly variations rather than cumulative annualized returns) and the nature of institutional pension plans (fairly moderate variations in advisory fees, probably ranging from 0.40% to 0.80%), costs would likely have had zero impact on the conclusions. Costs in the mutual fund industry are a different matter. They are generally much higher than for pension funds, and they vary widely. Equity fund expense ratios average 1.5% annually, ranging from 0.2% to 2.2% or more. Balanced funds carry average expenses of 1.0%, and range from 0.3% to 1.9%. These wide variations in costs among mutual funds don’t affect the variations in their quarterly returns, but they have a great impact on differences in long-term returns. In the mutual fund industry, a mountain of data confront us that strongly affirm that the cost of investing goes hand in hand with asset allocation as the key determinant of long-term returns. In short, costs matter. I’ve been saying that for years, and it was with some delight that I read these words from Warren Buffett in the Berkshire Hathaway Annual Report for 1996: “Seriously, costs matter.

The Gotrocks Family Even before you think about index funds, however, think about the eerie nature of our financial system. Using my version of a parable from Warren Buffett’s letter in the Berkshire Hathaway 2005 Annual Report (it’s in the Little Book), here’s how investing actually works: Once upon a Time . . . a wealthy family named the Gotrocks, grown over the generations to include thousands of brothers, sisters, aunts, uncles, and cousins, owned 100 percent of every stock in the United States. Each year, they reaped the rewards of investing: all the earnings growth that those thousands of corporations generated and all the dividends that they distributed. Each family member grew wealthier at the same pace, and all was harmonious. Their investment had compounded over the decades, creating enormous wealth, because the Gotrocks family was playing a winner’s game. But after a while, a few fast-talking Helpers arrive on the scene, and they persuade some “smart” Gotrocks cousins that they can earn a larger share than the other “dumb” relatives. These Helpers convince the cousins to sell their shares in overvalued companies to other family members and to buy shares of undervalued companies from them in return. The Helpers handle the transactions, and as brokers, they receive commissions for their services. The ownership is thus rearranged among the family members. To their surprise, however, the family’s share of the generous pie that U.S.

everything but the value of nothing,” he could have as easily been talking about the typical fund manager. The Mutual Fund Barrel Clearly, if we are to return to a system of owners capitalism, the active participation of institutional investors is essential and the mutual fund industry must be involved. That will not be easy, for the deeply-flawed mutual fund governance barrel makes the corporate governance barrel seem pristine. Think about it: Fund independent directors in actuality have only two important responsibilities: Obtaining the best possible investment manager and negotiating with that manager for the lowest possible fee. Yet their record has been absolutely pathetic. They follow a zombie-like process that makes a mockery of stewardship. Able but greedy managers have overreached and tried to dip too deeply into the shareholders’ pockets, and directors haven’t slapped their hands. They have failed as well in negotiating management fees. “Independent” directors, over more than six decades, have failed miserably. Fee reductions mean nothing to “independent” directors, while meaning everything to managers. So guess who wins? I would not have the temerity to use such highly charged language. Those words were actually written by Warren Buffett in his recent Berkshire Hathaway annual report. Mr. Buffett is, of course, right. And I dare to add, “as usual.” Of course the managers win. For the chairman of the fund is almost invariably the head of the management company.

benefits at the expense of those they trade with. [But] over time, the aggregate gains made by Berkshire shareholders must of necessity match the business gains of the company.” How often investors lose sight of that eternal principle! Yet the record is clear. History, if only we would take the trouble to look at it, reveals the remarkable, if essential, linkage between the cumulative long-term returns earned by business—the annual dividend yield plus the annual rate of earnings growth—and the cumulative returns earned by the U.S. stock market. Think about that certainty for a moment. Can you see that it is simple common sense? Need proof? Just look at the record of stock returns over the past 100 years. The average annual total return on stocks was 9.6 percent, virtually identical to the investment return of 9.5 percent—4.5 percent from dividend yield and 5 percent from earnings growth. That tiny difference of 0.1 percent per year, arose from what I call speculative return. Depending on how one looks at it, merely statistical noise, or perhaps it reflects a generally upward long-term trend in stock valuations, a willingness of investors to pay higher prices for each dollar of earnings at the end of the century than at the beginning. Compounding these returns over the century produced accumulations that are truly staggering. Each dollar initially invested in 1900 at an investment return of 9.5 percent grew by the close of 2005 to $15,062.

This proportion of your return from the companies’ reinvestment activities is even more extreme when you invest in a good company with a high return on retained capital than in an average company. All of this was much more succinctly encapsulated by Warren Buffett when he said: ‘It's far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.’ He made the transition from being a traditional value investor based upon studying under Benjamin Graham (author of “The Intelligent Investor” and “Security Analysis”) into a quality investor looking for companies which could compound in value based upon the teachings of Philip Fisher (author of Common Stocks and Uncommon Profits) and the influence of Charlie Munger. Here’s how Buffett explained this change in his 1989 letter to Berkshire Hathaway shareholders: ‘The original 'bargain' price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces — never is there just one cockroach in the kitchen. [Plus], any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return.investment

Lastly, there are some commentators who say that one way to address this is to have a portion of your portfolio invested in both strategies — some in quality growth and some in value. I think the assertion that there is no harm in this diversification approach has been disproved rather comprehensively by Warren Buffett, but what does he know? Perhaps we should look at the value investment versus quality and growth strategy debate this way: would you rather side with a) a large section of the UK financial press and rent-a-quote investment advisers; or b) Warren Buffett, Charlie Munger (Berkshire Hathaway), Bill Gates (Microsoft), the Bettencourt family (L’Oréal), the Brown family (Brown-Forman), the Walton family (Walmart) and Bernard Arnault (LVMH)? The latter all seem to have become extraordinarily rich by concentrating their investment in a single high quality business and not trading regardless of valuation. So much for it not doing any harm to diversify across strategies. It seems impossible to comment upon developments in equity investing in the UK in 2019 without mentioning the word Woodford. The demise of Woodford Investment Management following the ‘gating’ of its main LF Woodford Equity Income Fund was undoubtedly the main news in the industry last year.

At the 2018 Daily Journal meeting, Munger returned to the theme of opportunity cost. The point he made to the audience was that Berkshire's discipline about saying no was not a virtue of caution but a virtue of focus. If they had one thing they could do more of, he said, they were not interested in anything that was not better than that. The rule simplified life a great deal. Anything that did not clearly exceed the next-best use of the marginal dollar was, in Munger's framing, a no - and the no was the active investment decision, not the absence of one. He tied the point to activity itself. It is amazing, Munger told the room, how intelligent it is to spend some time just sitting. A lot of people are just way too active. The observation was directed at the modern investor's bias toward doing something - anything - in response to market moves, news, or peer behavior. Munger's prescription was the opposite. The intelligent posture was to think, read, and wait, and to act only when the proposition in front of you was unambiguously better than the next-best alternative. He closed with the too-hard pile callback. Most of the propositions that came across his desk went onto the too-hard pile and stayed there. He did not feel guilty about that. The pile was the working part of his investment process. Every once in a while an easy decision came along, and he made it. That, Munger said, was his system. The audience was meant to take it as an actual system, not as false modesty - the discipline of refusing to invest in things you do not understand is, in Munger's view, the single most underrated competitive advantage an individual investor can have.

I would like to end by addressing the question of what will happen next in equity markets, which may surprise you given that I always respond to questions about this by saying I haven’t got a clue, and neither has anyone else. Imagine a fund manager approached you with an offer for you to invest in a portfolio of high quality companies. You may quite like the strategy but you are worried about whether or not this is a good time to invest in the stock market. Take a look at the chart below which shows the world’s largest index by market capitalisation, the S&P 500, and which includes more quality companies than any other index. Source: Bloomberg The chart looks like a roller coaster that has just passed the peak of the ride. Surely you would be stupid if you invested now no matter how good the strategy is. Better to wait until the market has had a proper fall. You may notice that there are no dates on this chart of the S&P 500. That’s because I wanted you to assume I was referring to the current market and our own fund, Fundsmith. In fact, the chart above shows the 37 years up to 1965 — the year in which Warren Buffett took control of Berkshire Hathaway. If you had made the decision to time the market and hold back from investing then you would probably have missed out on the 20.9% compound growth in the market value per share of Berkshire since 1965 as a result.

‘Ah but that’s not how market timing works’, I can foresee someone saying. ‘Just because I didn’t buy into it in June 1965 doesn’t mean that I wouldn’t have bought into Berkshire later after the market had fallen.’ Seems fair except that the market didn’t fall in the remainder of 1965. In fact, the S&P 500 went up by a further 13% in the second half of 1965. What would you have done then? Panicked and bought Berkshire or held off? If you had the nerve to do the latter, you might have felt vindicated in 1966 when the S&P 500 fell by 22% at one point. There are several problems with this though. Berkshire Hathaway is not the S&P 500. Its shares rose 49.5% in 1965 and only fell by 3.4% in 1966. So, your hesitancy would not have paid off. Moreover, by 1967 the market had recovered to a new peak. Are you really smart enough to not only a) predict a market fall but also; b) figure out how this translates into individual stock movements; c) get your timing sufficiently correct that you do not either forgo gains which far outweigh any losses you protect against or suffer some of the downturn; d) have sufficient mental agility and nerve to start buying when your prediction of a market fall has become reality; and e) get the timing roughly right on that side of the trade so that you don’t end up catching the proverbial falling knife or missing some or all of the recovery? If so, I doubt you will be reading this letter on your private island. But above all, I doubt you exist.

To be fair, there have been plenty of big falls in both the market and Berkshire Hathaway’s stock in the intervening 50 odd years since 1965. Berkshire’s shares fell by over 50% in 1973–75 and 2008–09, and by nearly 50% in 1998–2000, plus a mere 37% in 1987. The point about this is not simply that getting the timing of markets right is impossible it is also that in even attempting to do so you might have missed out on investing in Warren Buffett’s Berkshire Hathaway, the results of which far outweigh any market timing gains. So where are we now?date:

Munger told the 2017 audience that the Daily Journal and Berkshire Hathaway had succeeded, more than anything else, by refusing to attempt to know too much. He kept a too-hard pile on his desk, he said, and most of the problems that crossed his path got shifted onto it. Every once in a while an easy decision came along, and he made it. That, he said, was his entire system. The room laughed, but Munger meant it as a serious investment philosophy. He tied the too-hard pile to the discipline of patience. A normal human life does not have very many great decisions in it. He told the audience that if they actually counted the meaningful decisions made in the history of the Daily Journal Corporation or the history of Berkshire Hathaway, the number per year was not very high. The game was being there all the time, recognizing the rare opportunity when it came, and recognizing that normal human life does not contain very many such moments. He contrasted this with what he called the racetrack tout - the people who sell securities and act as though they have an endless supply of wonderful opportunities. Those people, Munger said, are not even respectable. They pretend to know a lot of stuff they do not know, and pretend to furnish opportunities they are not furnishing. His advice to the audience was to avoid them - unless, he added with characteristic dryness, you happen to be running a stock brokerage firm, in which case you need them. The honest investor's job was to recognize the rarity and to refuse to manufacture the frequent.

There is also the fact that the alternative of investing in cyclicals, financials and so- called ‘value’ stocks involves investing in companies, which over time do not create shareholder value by generating returns on capital above their cost of capital and growing by deploying more capital at such favourable returns. We seek to invest in companies which accomplish this. Quoting Warren Buffett, the ‘Sage of Omaha’ and arguably the best investor over the past fifty or so years has in my view become somewhat passé. It is frequently done by acolytes or imitators many of whom seem to have done only the most cursory study of what he actually does, if anything at all. So instead I am going to quote his business partner and Berkshire Hathaway’s Vice Chairman, Charlie Munger: ‘Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return— even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result’ (emphasis added). I have no idea why Mr. Munger chose those particular rates of return but what I do know is that he is not voicing an opinion. What he is describing is a mathematical certainty.

Today 30 of the 50 largest fund managers are held by banks and financial conglomerates, 10 more with significant public ownership—in all, 40 of the 50 largest fund managers. The SEC’s concern was prescient. For decades, trafficking in management company ownership has characterized much of the fund industry. Management companies are bought and sold in the marketplace. Fund directors seemingly sign up with the new management company (which bought the firm from the previous management company), but rarely extract any material benefit for the fund shareholders whom they are duty bound to represent. In the 2003 Berkshire Hathaway Annual Report, Warren Buffett used far tougher words than mine: Year after year, at literally thousands of funds, directors had routinely rehired the incumbent management company, however pathetic its performance had been. Just as routinely, the directors had mindlessly approved fees that in many cases far exceeded those that could have been negotiated. Then, when a management company was sold— invariably at a huge price relative to tangible assets—the directors experienced a “counter-revelation” and immediately signed on with the new manager and accepted its fee schedule.old

Unilever / Kraft Heinz On 17th February, the story broke that Unilever had received a bid approach from Kraft Heinz, the listed food products company controlled by 3G, the Brazilian entrepreneurs who also control AB InBev, the world’s largest brewer, and Burger King, together with Warren Buffett’s Berkshire Hathaway. On 22nd February, Unilever put out two releases by way of immediate response. The first was entitled, ‘Unilever guidance update’ which said that Unilever ‘now expects core operating margin improvement for 2017 to be at the upper end of its 40–80bps guidance’. The second release said, ‘Unilever is conducting a comprehensive review of options available to accelerate delivery of value for the benefit of our shareholders. The events of the last week have highlighted the need to capture more quickly the value we see in Unilever. We expect the review to be completed by early April, after which we will communicate further.’ On 6th April, Unilever announced the results of this review.

The company said it was: • ‘Accelerating its ‘Connected 4 Growth’ programme and targeting a 20% underlying operating margin, before restructuring, by 2020’ • Combining the foods and refreshment units into one unit, ‘unlocking future growth and faster margin progression’ • Establishing a net debt/EBITDA target of 2x • Launching a €5bn share buyback program • Raising the dividend by 12%—about double the recent rate of increase This approach clearly falls foul of our scepticism when management produces rabbits from a hat when an activist or takeover comes into view. We think we should already have seen the rabbits or at least been told about their existence. To hopefully be clear, we are not fans of Kraft Heinz. We have never owned any shares in Kraft Heinz or its constituent parts. Although 3G has managed to operate the business with efficiency as they have AB InBev, to produce great cost savings leading to operating profit margins of 23% in 2016 and strong gains for owners, well certainly for 3G and Berkshire Hathaway, we have never found a business which can cut its way to growth. Although the Kraft Heinz management are certainly handicapped in this regard by the nature of the company’s brands, which are mostly not in growing areas of the market, the sort of people and approaches you need to grow businesses tend not to flourish in cultures in which the emphasis is on cost cutting.

-4- waiting. That doesn’t mean you sit around waiting for the next depression. You can’t do that. But a fair amount of patience is required . . . Patience followed by pretty aggressive conduct. Imagine sitting there having all this money rolling in from the foreclosure boom and in like one day [being fully invested]. Now that was luck [but] it wasn’t luck that we had the money on hand when other people didn’t and were willing to deploy it when other people [didn’t]. Questioner: Historically, Berkshire was built around its insurance operations to provide a low-cost source of capital. What other business models did you try/consider but ultimately did not pursue? Charlie Munger: Well, we were always opportunistic. We wanted to buy the best thing that was conveniently available that we could understand. In the early days we thought we had a special advantage as investors in marketable securities. So we tended to look carefully at float businesses. Nowadays, of course, we have enormous float but not [of] much usefulness. Such is the nature of life. We made so much money out of those float businesses it was obscene in the early days. It is not a tragedy that now our float businesses don’t get much advantage above the . . . . Berkshire’s cash, which is large, is not getting much of a return. In Europe the rates are negative. In Japan the rates are negative. Questioner: What do you think about the attractiveness of the average software business?

Charlie Munger: The software-based businesses: some of ‘em have become some of the most profitable businesses on earth. Other software companies are shrinking and failing. So it’s like the rest of capitalism. It has its good spots and its bad spots. As I said, the ones we’re pursuing I think will be sticky if we succeed in it. Questioner: Journal Technologies is growing slower than some of the competitors are paying high multiples for acquisitions, would you ever consider selling Journal Technologies? Charlie Munger: Well nobody’s offered us a high multiple, and so we haven’t had the problem and/or the opportunity. It’s a peculiar part of the software business involving a lot of agony now for a payoff way later. You can’t judge it as a normal business, or as a normal rollup of profitable companies. It’s venture capital; it just happens to be located in a [newspaper] company. It’s venture capital that if it works can gradually evolve into a pretty huge business. But of course, everybody’s trying to evolve into a pretty huge business, and only a few will succeed. We’re not like a normal software business. And those little companies – you shouldn’t call -- those are not acquisitions like Berkshire Hathaway makes acquisitions. Those are not established companies that we’re sure to succeed and [are] relatively foolproof.

And last month he sold 10,000 electric cars in China, which is more than Tesla sold. Of course, nobody’s hardly ever heard of BYD. It’s an interesting company. Berkshire doesn’t do this venture capital stuff. [I] hope the Daily Journal works out half as well as BYD worked out. BYD is in a position, on purpose, to benefit from this electrification trend in the world. It’s very helpful to them that the people are dying on the streets of Beijing because they can’t breathe the air. They have to go to electric cars. Grab all these subsidies, and so forth, and be way ahead in terms of [the] efficient manufacturing of electric cars sold. And electric fork lifts in this country: do you really want a forklift spewing out carbon monoxide in the middle of your warehouse? So electric forklifts are a very big idea. They’re very well-located. That’s a very interesting venture capital investment. That was an accident, sort of, that Berkshire departed from its standard methods and did that one. And it was an accident that Daily Journal is doing its version of venture capital. I only wish our prospects were as good as BYD’s. And by the way, they might be… Questioner: My question: as an investor, what do you use to value a business or a company…How do you use the discount rate to calculate intrinsic value? Charlie Munger: Obviously, it’s relevant what the return you get on your bonds is, that affects the value of other assets in the general climate.

But I do think that the constant search for wisdom and the constant search for the right temperamental reaction to opportunity, I think that’ll never be obsolete. And you can apply that to your personal life too. Of course, most of you are not going to get five opportunities to marry some wonderful person. Most of you aren’t going to get one. You’re just going to have to make to with an ordinary result. The nature of ordinary results is that they’re ordinary. Questioner: You mentioned earlier about Wells Fargo. Other banks were failing, even Washington Mutual. Why was Wells Fargo [a good investment] at that time when other banks were failing? Charlie Munger: That’s a good question. I’ll take you back one time before. When Berkshire bought into Wells Fargo, the world was coming unglued in a banking panic. Again, real estate funding had been a sore subject. And Wells Fargo had been huge in the real estate market. This is back when Berkshire first bought into Wells Fargo. The answer was that we knew that the lending officers at Wells Fargo were not normal bank lending officers. They had come up a lot of them from the Garment District, they had a cynical view of human life, they were appropriately careful, and when they needed to intervene strongly they did so, because they’d learned that was the right way to run a garment . . . business. And they were just better.

-13- be all right because free markets are all right. A lot of those people are in my party, by the way. Questioner: The automobile industry right now is appreciably different today than it was ten years ago. Does it make sense to have General Motors in a Berkshire portfolio? Charlie Munger: General Motors is in the Berkshire portfolio because one of our young men likes it, and Warren lets the young men do as they please. Warren when he was a young man didn’t want any old men telling him what to do. He gives them that kind of freedom. I haven’t got the faintest idea why this young man likes General Motors. It is true that it’s statistically cheap. But of course – and it may be impacted by the Federal Government in the end, so it may be a very good investment. But the auto industry is about as brutally competitive an industry now as I have ever seen. Everybody knows how to make good cars. Everybody. They rely on the same suppliers, and the cars last a long time with very little service. This has all the earmarks of a very commoditized, difficult, super-competitive market. So I don’t think the auto industry is going to be a terribly easy place to [invest]. And it may actually shrink one of these days. In other words, the culture everybody has . . . cars could actually shrink. So I think the auto industry is not [the place to be]. If I were investing in the auto industry, I’d want some place that’s really a hell of a lot better competitor than the others.

He has to eat the same food, watch the same television, leave the money to something . . . Is he the main problem we have? He’s not really using the wealth very much. And most of these guys are not that interested in politics. People who like to talk about the [wealthy’s] terrible influence on politics. If you’re rich you realize how little influence the rich really have. You see a lot of people lay out a lot of money, who are rich, and get practically nowhere. So I think these people who are raging about inequality, like Warren and Sanders, are wrong; but I think the people who say the undeserved wealth deserves some attention, I think they’re right. And I think a huge source of the undeserved wealth is coming from finance. Questioner: You mentioned Wells Fargo and its culture, [as] the reason why you [got involved] back in the 80s. [You also own] Bank of America, and its culture is a little different. And I’m curious [about] the decision of buying Bank of America. Charlie Munger: The Bank of America was bought the way we used to buy securities . . . It was selling for less than a quarter, way less [than it was worth]. Questioner: I’m pretty excited about the prospects on self-driving cars in the next ten to twenty years. It seems like the technology is moving very quickly. But as a Berkshire shareholder I’m worried about the implications for the entire auto insurance industry if accidents, hopefully, become a thing of the past.

-18- Questioner: Would you address the future of the beverage business [and Berkshire’s investment in Coca-Cola]? Charlie Munger: Well that’s an easy one. For many decades, the basic product, full-sugared Coke, grew every year. It was like an inevitable march of time. In recent years, full-sugared Coke is declining. Fortunately, the Coca-Cola Company has a vast distribution business infrastructure and a lot of other products, so while Coca-Cola as an individual product is declining some, instead of going up the way it always did before, the rest of the businesses are on average rising. So I think Coke is a pretty strong company and will be a respectable investment, but it’s not like it used to be when it was like shooting fish in a barrel. [End of recorded material]

Buffett argued that owning a whole business and owning a piece of one through the stock market are economically the same act, and that Berkshire's mix of wholly-owned subsidiaries and marketable securities was a single portfolio chosen by the same standard. He wrote that the only differences were tax and control, and that the mistake many investors make is to treat 'investing' and 'acquiring' as different disciplines.

On the unity of investing in whole businesses and in marketable securities.

Buffett argued that share repurchases are value-accretive only when two conditions are met: the business is available below intrinsic value, and the company has cash it cannot deploy more valuably elsewhere. He wrote that a buyback above intrinsic value transfers value from continuing shareholders to selling shareholders, and that managements who buy back stock simply to support the price, or to hit earnings-per-share targets, are destroying owner wealth regardless of how the action is framed.

On the intrinsic-value test for buybacks.

Buffett decomposed Berkshire's intrinsic value into three components: the value of its non-insurance businesses, the value of its insurance operations (including investable float), and the value of its marketable securities. He argued that this decomposition was more informative than book value, which understated the value of businesses whose economic goodwill had grown well above its recorded amount.

On the three-part intrinsic value framework.

Buffett opened the 2009 annual meeting against the backdrop of the recently completed crisis-era preferred equity investments in Goldman Sachs, General Electric, Wrigley and Harley-Davidson, totalling approximately $14.5 billion of crisis-deployed capital. Buffett and Munger told shareholders that the transactions had been structured to provide Berkshire with attractive current yield on the preferred and the warrants to acquire common equity at the strike prices, and that the underlying counterparty companies were positioned to weather the cycle given the durability of their underlying franchises. Buffett walked shareholders through the Berkshire capital deployment discipline during the crisis, framing the transactions as the natural outcome of carrying the largest cash position in Berkshire's history into the downturn. He flagged that the cash had been deliberately preserved for exactly the environment in which it had been deployed, that the warrants were the optionality on the long-term recovery of the underlying franchises and that Berkshire had been able to negotiate terms that no other counterparty could have negotiated because of the size of the cash deployment, the speed of execution and the perceived long-term stewardship that Berkshire provided to the counterparty companies. On the Q&A, shareholders pressed on whether the credit crisis implied that Berkshire's own insurance subsidiaries, especially the derivative structures Berkshire had entered into, were exposed to collateral calls. Buffett responded that the equity-indexed put and the credit default swap portfolios were long-dated and that the mark-to-market losses were not realisation events, that Berkshire's balance sheet had been stress-tested through significantly worse environments than the 2008 panic and that the Company would not be a forced seller of any position. Munger added that the most important lesson of the crisis was the rarity of being able to deploy large amounts of capital at attractive terms and that Berkshire had been preparing for exactly that environment for two decades. The meeting closed with Buffett and Munger reiterating the long-term framework of compounding intrinsic value per share, anchored on the insurance float, the wholly-owned operating businesses, the concentrated long-term equity portfolio and the willingness to carry large cash reserves through bull markets to deploy through panics.

Buffett wrote that the test for a large acquisition was whether it would increase Berkshire's per-share intrinsic value, and that the test had to be applied against the alternative of buying back Berkshire's own shares or returning capital to owners. He argued that the discipline of comparing every use of capital against the intrinsic-value-per-share benchmark was the chief defense against the temptation to do deals for their own sake.

On the per-share intrinsic-value test for acquisitions.

principal property-casualty affiliates (“Swiss Re”). Under this agreement, which was enthu- siastically approved by Wesco’s Board of Directors, Wes-FIC assumed 2% of essentially all Swiss Re property-casualty risks incepting over the five-year period which began on January 1, 2008, on the same terms as NICO’s agreement with Swiss Re. Wes-FIC’s share of written and earned premiums under the contract were $294.1 million and $276.7 million for 2009 and $265.2 million and $183.2 million for 2008, representing very significant increases in Wes- FIC’s reinsurance activities. It is important to keep in mind that premiums assumed under the contract in each of the next three years could vary significantly depending on market conditions and opportunities. For several years, through yearend 2007, Wes-FIC’s principal reinsurance activity con- sisted only of its participation in several pools managed by a subsidiary of General Rein- surance Corporation (“Gen Re”), another insurance subsidiary of Berkshire Hathaway. The arrangement became effective in 2001 and has covered domestic hull, liability and workers’ compensation exposures relating to the aviation industry. For the past three years, Wes-FIC has reinsured 16.67% of the hull and liability pools and 5% of the workers’ compensation pool. Since mid-2009 Wes-FIC has also been reinsuring 25% of an international hull and liability pool.

Another subsidiary of Gen Re provides a portion of the upper-level reinsurance protection to these aviation risk pools on terms that could result in the Berkshire subsidiary having a different interest from that of Wes-FIC under certain conditions, e.g., in settling a large loss. Premium volume under these pools has approximated $35 million annually. It is the nature of even the finest property-casualty insurance businesses that in keeping their accounts they must estimate and deduct all future costs and losses from premiums already earned. Uncertainties inherent in this undertaking make financial statements more mere “best honest guesses” than is typically the case with accounts of non-insurance-writing corporations. And the reinsurance portion of the property-casualty insurance business, because it contains one or more extra links in the loss-reporting chain, usually creates more accounting uncertainty than the non-reinsurance portion. Wesco shareholders should remain aware of the inherent imperfections of Wes-FIC’s financial reporting, based as it is on forecasts of outcomes over many future years. Wes-FIC’s underwriting results have typically fluctuated from year to year, but have been satisfactory. When stated as a percentage, the sum of insurance losses, loss adjustment expenses and underwriting expenses, divided by premiums, gives the combined ratio. Wes- FIC’s combined ratios from reinsurance activities were 94.9% for 2009, 101.0% for 2008 and 93.

We believe that none of the banks whose deposits are currently insured are facing significant risk of failure. This decrease in exposure to loss, of course, has caused a sharp decline in Kansas Bankers’ insurance volume, inasmuch as premiums from guarantee bonds not only approx- imated half of Kansas Bankers’ written premiums for 2008, but also represented the entirety of the business it had conducted in almost half of the states in which it was licensed to write insurance in 2008. The insurance business is highly competitive, with lengthy periods during which competitors offer coverages at prices we do not consider adequate. Kansas Bankers is now licensed to sell insurance in 29 states, down from 39 states one year earlier, with plans soon to withdraw from 4 more. We expect that Kansas Bankers will ultimately expand its premium volume, at prices deemed satisfactory. When Wesco purchased Kansas Bankers, it had been ceding almost half of its premium volume to reinsurers. In 2009 it reinsured only about 1%. And, because it has also restruc- tured the layers of losses reinsured, it is now better protected from the downside risk of large losses. Effective in 2006, insurance subsidiaries of Berkshire Hathaway became KBS’s sole reinsurers. Previously, an unaffiliated reinsurer was also involved. The increased volume of business retained comes, of course, with increased irregularity in the income stream. Kansas Bankers’ combined ratios were 140.2% for 2009, 111.6% for 2008 and 55.

Shortly after its acquisition by Wesco, CORT started up a nation-wide apartment locator service, originally intended mainly to supplement CORT’s furniture rental business by providing apartment locator and ancillary services to relocating individuals. Paul Arnold, long CORT’s able CEO, and his management team, have devoted much effort in recent years, expanding CORT’s rental relocation services, and redirecting them toward the needs of businesses and government agencies who require a skilled and able partner to provide comprehensive and seamless relocation services for the temporary relocation of employees worldwide. These efforts had not yet gained traction when recession hit. CORT is now focusing its efforts more on cost containment than on expansion of services. Under Wesco’s ownership, CORT has continuously undertaken to improve its compet- itive position. With several websites, principally, www.cort.com and www.apartment- search.com, professionals in more than 80 domestic metropolitan markets, affiliates servicing more than 50 countries, almost twenty-one thousand apartment communities referring their tenants to CORT, many ancillary services, and its entrée to the business community as a Berkshire Hathaway company, CORT is better positioned than previously to benefit from an economic turnaround if it occurs in due course. Near term, we expect more of the difficult business conditions of the recent past, but we do not expect another operating loss at CORT in 2010.

Consolidated Balance Sheet and Related Discussion Wesco has unusual balance sheet strength, concentrated in security holdings of its insurance subsidiaries. These holdings, in turn, are concentrated in a few securities. Details can be found in Note 2 to the accompanying financial statements. Wesco carries its investments at fair value. As a result, unrealized appreciation or depreciation, after income tax effect, is included as a component of shareholders’ equity and net worth per share. Affected substantially by changes in market value of securities owned, Wesco’s yearend net worth per share has varied only slightly during recent tumultuous years. Figures are as follows: 2006 $337 2007 356 2008 334 2009 358 These results are not impressive. Moreover, if net worth per share had been computed at its low point in the recent stock market panic, stability implied by the foregoing figures would have been considerably lessened. We repeat our standard warning. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway.

Moreover, the quality disparity in book value’s intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway. The Board of Directors recently increased Wesco’s regular dividend from 391 ⁄2 cents per share to 41 cents per share, payable March 4, 2010, to shareholders of record as of the close of business on February 4, 2010. Shareholders can thank Director Elizabeth Peters for the recommendation that Wesco increase its next and future dividends to ensure that share- holders are paid in even pennies. This annual report contains Form 10-K, a report filed with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries, as well as audited financial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Shareholders can access much Wesco information, including printed annual reports, earnings releases, SEC filings, and the websites of Wesco’s subsidiaries and parent, Berkshire Hathaway, from Wesco’s website: www.wescofinancial.com. Charles T.2010

In the 2008 Berkshire shareholder letter, written in the depths of the global financial crisis, Buffett and Munger disclosed Berkshire's $230 million investment for roughly 9.6% of BYD, the Chinese battery and electric-vehicle maker. The investment had been Munger's champion play inside Berkshire. He had argued that BYD's founder, Wang Chuanfu, was one of the most capable operating executives he had ever met, and that the combination of low-cost Chinese manufacturing, advanced battery chemistry, and an early-mover position in electrified transport would compound for decades. The investment thesis was deliberately simple. BYD was, in Munger's view, a real company making real products at low cost, with a genuine engineering edge in batteries and a market - China - that was being underwritten by a state committed to electrification. The price was modest relative to the long-run earnings power. The risks were real - Chinese corporate governance, foreign-currency exposure, execution risk on the technology roadmap - but Munger's view was that the market had over-discounted those risks and that the underlying franchise was available at a price that did not require any heroic assumption to justify. The retrospective implication, captured in the 2008 letter's plain disclosure of the position, was that Munger had identified a small number of things that mattered - founder quality, technology trajectory, market underwriting, valuation - and had refused to be talked out of the bet by the surface-level concerns that scared other foreign investors away. The position would, over the next fifteen years, multiply many times in value. By the time Munger discussed BYD at the 2023 DJCO meeting, the company was making more than $2 billion after taxes in its Chinese auto business alone. The bet on the founder and the technology had been one of the most profitable investments Berkshire ever made on Munger's recommendation.

parent. The arrangement became effective in 2001 and has covered hull, liability and workers’ compensation exposures relating to the aviation industry, as follows: for 2006, to the extent of 121 ⁄2% of the hull and liability pools and 5% of the workers’ compensation pool; and, since 2007, 16.67% of the hull and liability pools and 5% of the workers’ compensation pool. The Berkshire subsidiary provides a portion of the upper-level rein- surance protection to these aviation risk pools on terms that could result in the Berkshire subsidiary having a different interest from that of Wes-FIC under certain conditions, e.g., in settling a large loss. At the beginning of 2008, Wes-FIC entered into a retrocession agreement with National Indemnity Company (“NICO”), another Berkshire Hathaway insurance subsid- iary, for the assumption of 10% of NICO’s 20% quota-share reinsurance of Swiss Rein- surance Company and its principal property-casualty affiliates (“Swiss Re”). Under this agreement, which was enthusiastically approved by Wesco’s Board of Directors, Wes-FIC has assumed 2% of essentially all Swiss Re property-casualty risks incepting over the five- year period which began on January 1, 2008, on the same terms as NICO’s agreement with Swiss Re. Wes-FIC’s share of written and earned premiums under the contract for 2008 were $265.2 million and $183.2 million, representing a very significant increase in Wes- FIC’s reinsurance activities to date.

4 billion, insuring 796 institutions at February 15, 2009, the first date that non-renewals and non-voluntary cancellations became effective. It is believed that few of the institutions Kansas Bankers insures are facing significant risk of failure. Because of aggregate limits as well as the purchase of reinsurance, the after-tax risk to Wesco from the failure of any single bank insured by Kansas Bankers is limited to a maximum of $7.6 million. Thus, we believe that Wesco’s shareholders’ equity is not significantly at risk as Kansas Bankers rapidly exits this line of insurance. This decrease in exposure to loss, of course, will cause a sharp decline in Kansas Bankers’ insurance volume, inasmuch as premiums from guarantee bonds not only approximated half of Kansas Bankers’ written premiums for 2008, but also represented the entirety of the business it has recently conducted in 16 of the 39 states in which it is licensed to write insurance. When Wesco purchased Kansas Bankers, it had been ceding almost half of its premium volume to reinsurers. In 2008 it reinsured only about 14%. And, because it has also restructured the layers of losses reinsured, it is now better protected from the downside risk of large losses. Effective in 2006, insurance subsidiaries of Berkshire Hathaway became KBS’s sole reinsurers. Previously, an unaffiliated reinsurer was also involved. The increased volume of business retained comes, of course, with increased irregularity in the income stream.

com, professionals in more than 80 domestic metropolitan markets, affiliates servicing more than 50 countries, almost twenty thousand apartment communities refer- ring their tenants to CORT, many ancillary services, and its entrée to the business com- munity as a Berkshire Hathaway company, CORT is better positioned than previously to benefit from an economic turnaround, certain to occur in due course. Near term, we expect more of the difficult business conditions of the recent past. More details with respect to CORT are contained throughout this annual report, to which your careful attention is directed. Precision Steel Warehouse, Inc. (“Precision Steel”) The businesses of Wesco’s Precision Steel subsidiary, headquartered in the outskirts of Chicago at Franklin Park, Illinois, operated at after-tax profits of $0.8 million in 2008 and $0.9 million in 2007. These figures reflect after-tax LIFO inventory accounting adjustments decreasing after-tax income by $0.7 million for 2008 and $1.0 million for 2007. Precision Steel’s operating results for 2008 also reflect the benefit of $0.in

The worldwide economy is currently suffering the effects of a deepening recession, perhaps the worst economic disaster since the Great Depression. We will not attempt to prognosticate the effects that Wesco will suffer or when the economy will recover, but we are certain that in due course, Wesco will prosper. In the mean time, Wesco’s operations will bear their share of economic woes. We will continue to practice Ben Franklin’s advice, that “a penny saved is a penny earned,” as we trim expenses, albeit in higher denomi- nations, to better endure the weakening economic conditions that surely lie ahead. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good- but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway.the

quality disparity in book value’s intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for investment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. The Board of Directors recently increased Wesco’s regular dividend from 381 ⁄2 cents per share to 391 ⁄2 cents per share, payable March 5, 2009, to shareholders of record as of the close of business on February 5, 2009. This annual report contains Form 10-K, a report filed with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries as well as audited financial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Shareholders can access much Wesco information, including printed annual reports, earnings releases, SEC filings, and the websites of Wesco’s subsidiaries and parent, Berkshire Hathaway, from Wesco’s website: www.wescofinancial.com. Charles T. Munger Chairman of the Board and President February 25, 2009

Speaking to USC Law graduates in May 2007, Munger argued that wisdom acquisition is a moral duty, not merely a career strategy. He had come to that conviction early, he said, and had lived by it ever since. The corollary, in his telling, was uncompromising: you are hooked for lifetime learning, and without it you will not get very far. What you already know is barely the down payment; what you learn after you leave the hall determines the trajectory. He grounded the claim in the Berkshire record. The skill set that got Berkshire through one decade would not have sufficed for the next, he said. Without Warren Buffett functioning as a continuous learning machine, the documented long-run investment record would have been absolutely impossible. He then generalized the lesson: at lower walks of life he constantly sees people rise who are not the smartest and sometimes not even the most diligent, but who are learning machines. They go to bed every night a little wiser than when they got up. With a long run ahead of you, he said, that habit does the heavy lifting. He closed the thought with Alfred North Whitehead's observation that civilization advanced only when man invented the method of invention. Munger flipped the same logic onto the individual: if civilization can only progress when it invents the method of invention, you can only progress when you learn the method of learning. Coming to law school already equipped with the method of learning, he said, was the luckiest break of his long life and the one that paid off most reliably.

In the 2007 Berkshire shareholder letter, Buffett - crediting Munger throughout - used the See's Candies acquisition as the textbook case for what a brand franchise actually does to a business. Berkshire had bought See's in 1972 for $25 million, against an asset value of about $8 million and pre-tax earnings of about $4 million. The price looked full to the traditional cigar-butt investor, and Buffett had initially hesitated. Munger had pushed him to pay it, arguing that the franchise was worth the premium because the brand could raise prices year after year without losing volume. The retrospective made the math visible. See's had generated pre-tax earnings cumulatively in the many hundreds of millions of dollars in the years since purchase, on the original $25 million base. The asset base had grown only modestly. The incremental capital required to grow the business had been tiny relative to the cash thrown off. The whole return had come from the brand's pricing power, not from reinvestment. That, Munger and Buffett were saying, is what a real moat looks like - the cash grows faster than the asset base because customers keep paying up for the name. Munger's investment lesson, distilled in the 2007 letter, was that See's taught Berkshire to look past the cigar-butt habit and toward the great franchise. The intangibles - brand, distribution, customer loyalty, pricing power - were not a speculative add-on to intrinsic value. They were the source of it. The companies that grew cash faster than assets were the companies that compounded intrinsic value per share, and the only way to find them was to look at the qualitative strengths that traditional accounting did not capture. See's was the school. Every later Berkshire acquisition - Coca-Cola, Gillette, GEICO in full - was a graduate of that school.

No investment gains or losses were realized in 2006. The discussion below will concen- trate on insurance underwriting, not on the results from investments. Wes-FIC engages in the reinsurance business. For the past several years, its reinsur- ance activity has consisted of the participation in several risk pools managed by an insurance subsidiary of Berkshire Hathaway, our 80%-owning parent. The arrangement became effective in 2001 and most recently covered hull, liability and workers’ compen- sation exposures relating to the aviation industry, as follows: for 2006, to the extent of ⁄2% of the hull and liability pools and 5% of the workers’ compensation pool; for 2007, 16.67% of the hull and liability pools and 5% of the workers’ compensation pool. The participation rates remain unchanged for 2008. The Berkshire subsidiary provides a portion of the upper-level reinsurance protection to these aviation risk pools on terms that could result in the Berkshire subsidiary having a different interest from that of Wes-FIC under certain conditions, e.g., in settling a large loss.

Wesco’s Board of Directors has recently and enthusiastically approved Wes-FIC’s most significant reinsurance contract to date: its participation, since January 1, 2008, in an agreement with National Indemnity Company (“NICO”), another Berkshire Hathaway insurance subsidiary, for the assumption of 10% of NICO’s quota-share reinsurance of Swiss Reinsurance Company and its property-casualty affiliates (“Swiss Re”). Under this retrocession agreement, Wes-FIC will effectively assume 2% of all of Swiss Re’s property- casualty risks incepting over the next five years on the same terms as NICO’s agreement with Swiss Re. If recent years’ volumes were to continue over the next five years, the annual written premiums assumed by Wes-FIC under this retrocession agreement would be in the $300 million range; however, actual premiums assumed over the five-year period could vary significantly depending on market conditions and opportunities. It is the nature of even the finest casualty insurance businesses that in keeping their accounts they must estimate and deduct all future costs and losses from premiums already earned. Uncertainties inherent in this undertaking make financial statements more mere “best honest guesses” than is typically the case with accounts of non-insurance-writing corporations.

satisfactory acquisition, reflecting the sound management of President Don Towle and his team. Kansas Bankers was chartered in 1909 to underwrite deposit insurance for Kansas banks. Its offices are in Topeka, Kansas. Over the years its service has continued to adapt to the changing needs of the banking industry. Today its customer base, consisting mostly of small- and medium-sized community banks, is spread throughout 38 mainly midwestern states. In addition to bank deposit guaranty bonds which insure deposits in excess of FDIC coverage, KBS offers directors and officers indemnity policies, bank employment practices policies, bank insurance agents professional errors and omissions indemnity policies and Internet banking catastrophe theft insurance. When Wesco purchased KBS, it had been ceding almost half of its premium volume to reinsurers. Now it reinsures only about 15%. Effective in 2006, insurance subsidiaries of Berkshire Hathaway became KBS’s sole reinsurers. Previously, an unaffiliated reinsurer was also involved. The increased volume of business retained comes, of course, with increased irregularity in the income stream. KBS’s combined ratios were 55.1% for 2007 and 73.8% for 2006. We continue to expect volatile but favorable long-term results from KBS. CORT Business Services Corporation (“CORT”) In February 2000, Wesco purchased CORT Business Services Corporation (“CORT”) for $386 million in cash.

marketing toward the needs of businesses and governmental agencies who require a skilled and able partner to provide comprehensive and seamless relocation services for the temporary relocation of employees, worldwide. With several websites, principally www.cort.com, www.relocationcentral.com and www.apartmentsearch.com, profession- als in more than 80 domestic metropolitan markets, affiliates in more than 50 countries, almost twenty thousand apartment communities referring their tenants to CORT, many ancillary services, and its entrée to the business community as a Berkshire Hathaway company, CORT’s rental relocation operations may now be moving in the right direction. In January 2008, CORT expanded its operations to the United Kingdom through the purchase of Roomservice Group, a small regional provider of furniture rental and relo- cation services. CORT’s operations are subject to economic cycles. We are pleased with CORT’s progress in the past few years; however, we believe that it will likely suffer its share of the downturn as we enter a period of economic contraction. CORT is now a stronger company than it was when acquired by Wesco, helped by several “tuck-in” acquisitions, and poised towards long-term growth despite periodic bumps to be encountered along the way. More details with respect to CORT are contained throughout this annual report, to which your careful attention is directed. Precision Steel Warehouse, Inc.

deferred income taxes of $322 million, subtracted in determining its net worth. This interest-free “loan” from the government is at this moment working for Wesco shareholders and amounted to about $45 per Wesco share at yearend 2007. However, some day, parts of the interest-free “loan” may be removed as securities are sold. Therefore, Wesco’s shareholders have no perpetual advantage creating value for them of $45 per Wesco share. Instead, the present value of Wesco’s shareholders’ advantage must logically be much lower than $45 per Wesco share. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good- but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value’s intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for investment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. Last year we reported that Wesco had held more than $1 billion of cash equivalents and fixed-maturity investments since early in 2003.

In the latter part of 2007 Wesco invested $802 million, net, in marketable equity securities. Of its $3.1 billion of assets at December 31, 2007, $565 million is invested in cash equivalents and fixed-maturity investments. Unless significant additional amounts can be attractively reinvested in acquisitions, equity securities or other long-term instruments of the type that helped cause the long-term growth of Wesco’s shareholders’ equity, future returns on shareholders’ equity will probably be less than those of the past. Due to the current size of Wesco and its parent, Berkshire Hathaway, Wesco’s opportunities for growing shareholders’ equity are unlikely to be as attractive as in the past. The Board of Directors recently increased Wesco’s regular dividend from 371 ⁄2 cents per share to 381 ⁄2 cents per share, payable March 6, 2008, to shareholders of record as of the close of business on February 7, 2008. This annual report contains Form 10-K, a report filed with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries as well as audited financial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Shareholders can access much Wesco information, including printed annual reports, earnings releases, SEC filings, and the websites of Wesco’s subsidiaries and parent, Berkshire Hathaway, from Wesco’s website: www.wescofinancial.com. Charles T.2008

1. A Parable The first of the two relentless rules of humble arithmetic I’ll mention is a simple one: Gross return in the financial markets, minus the costs of financial intermediation, equals the net return that we investors share. To understand that is how our financial system really works. Consider my version of this parable told by Warren Buffett, chairman of Berkshire Hathaway Inc., in the firm’s 2005 annual report. It clarifies the foolishness and counterproductivity of our vast and complex financial market system. Here goes: Once upon a time . . . a wealthy family named the Gotrocks, grown over the generations to include thousand of brothers, sisters, aunts, uncles, and cousins, owned 100 percent of every stock in the United States. Each year, they reaped the rewards of investing: all the earnings growth that those thousands of corporations generated and all the dividends that they distributed. Each family member grew wealthier at the same pace, and all was harmonious. Their investment had compounded over the decades, creating enormous wealth, because the Gotrocks family was playing a winner’s game. But after a while, a few fast-talking Helpers arrive on the scene, and they persuade some “smart” Gotrocks cousins that they can earn a larger share than the other relatives. These Helpers convince the cousins to sell some of their shares in the companies to other family members, and to buy some shares of others from them in return.

With these profound, indeed, earth-shaking changes, our financial markets have become far more volatile and unpredictable than the underlying businesses that they ultimately represent, which collectively account for their aggregate market capitalization. Put another way, investors are more volatile than investments. Economic reality governs the returns earned by our businesses, but emotions and perceptions—the swings of hope, greed, and fear among the participants in our financial system—govern the returns earned in our markets. Emotional factors sometimes magnify, sometimes minimize, this central core of economic reality, and financial crises can arise at any time, but in the long-term it is reality that triumphs over illusion. Warren Buffett states the issue with his usual clarity. His firm, Berkshire Hathaway, is publicly held, and he regularly hammers home to his shareholders the message that he prefers its shares to trade at or around its intrinsic value—neither materially higher nor lower. He explains: “Intrinsic value is the discounted value of the cash that can be taken out of the business during its remaining life . . . When the stock temporarily over-performs or under-performs the business, a limited number of shareholders—either sellers or buyers—receive out-sized benefits at the expense of those they trade with. [But] over time, the aggregate gains made by Berkshire shareholders must of necessity match the business gains of the company.

$1 $10 $100 $1,000 $10,000 $100,000 1909 1919 1929 1939 1949 1959 1969 1979 1989 1999 Investment Return 9.5 % (earnings growth plus yield) Annual Growth Rate Investment Return Growth of $1 from 1900 1. accretion of dividend yields and earnings growth—resembles a gently upward-slopping line with, at least during the past 75 years, precious few significant aberrations. (Chart 1) Speculation is just the opposite. It represents the short-term—not long-term—holding of financial instruments—not business—focused (usually) on the belief that their prices—as distinct from their intrinsic values—will rise; indeed, the expectation that the prices of the stocks that are selected will rise more than other stocks, as the expectations of other investors come to match one’s own. The line that we draw representing the path of stock prices over the same period is significantly more jagged and spasmodic than the line showing investment returns. (Chart 2) In the short run, speculative returns are only tenuously linked with investment returns. But in the long-run, both returns must be—and will be—identical. Don’t take my word for it. Listen to Warren Buffett: “the most that owners in the aggregate can earn between now and Judgment Day is what their business in the aggregate earns.” Illustrating the point with Berkshire Hathaway, the publicly-owned

operating income excludes investment gains of $216.6 million, net of income taxes, realized in 2005. No investment gains or losses were realized in 2006. The discussion below will concentrate on insurance underwriting, not on the results from investments. Wes-FIC engages in the reinsurance business. For the past several years, its reinsurance activity has consisted of the participation in several risk pools managed by an insurance subsidiary of Berkshire Hathaway, our 80%-owning parent. The arrangement became eÅective in 2001 and most recently covered hull, liability and workers' compensation exposures relating to the aviation industry, as follows: for 2005, to the extent of 10% in the hull and liability pools and 5% of a workers' compensation pool; for 2006, 121 /2% of the hull and liability pools and 5% of the workers' compensation pool. For 2007, participation in the hull and liability pools has increased to 16.67%. The Berkshire subsidiary provides a portion of the upper-level reinsurance protection to these aviation risk pools on terms that could result in the Berkshire subsidiary having a diÅerent interest from that of Wes-FIC under certain conditions, e.g., in settling a large loss. Wes-FIC's underwriting results have Öuctuated from year to year, but have been satisfactory. When stated as a percentage, the sum of insurance losses, loss adjustment expenses and underwriting expenses, divided by premiums, gives the combined ratio.

on an “at cost” basis for the benefit of its owners rather than its managers—was my attempt to walk the walk that I had talked the talk about nearly a quarter-century earlier. Today, I assure you that my youthful idealism remains intact. Indeed, it is shamelessly reflected not only in Vanguard but in my Battle book, an expression of my concern about our American society today, my conviction that our system of capital formation is essential to our economic growth and world leadership, and my acknowledgement that much has gone wrong in our financial system. 2. A Parable So what’s gone wrong? Let’s begin with a parable that describes how the system really works. It’s my version of a story told by Warren Buffett, chairman of Berkshire Hathaway Inc., in the firm’s 2005 annual report, and it clarifies the foolishness and counterproductivity of our vast and complex financial market system. Here goes: Once upon a time . . . a wealthy family named the Gotrocks, grown over the generations to include thousand of brothers, sisters, aunts, uncles, and cousins, owned 100 percent of every stock in the United States. Each year, they reaped the rewards of investing: all the earnings growth that those thousands of corporations generated and all the dividends that they distributed. Each family member grew wealthier at the same pace, and all was harmonious. Their investment had compounded over the decades, creating enormous wealth, because the Gotrocks family was playing a winner’s game.

The combined ratios of Wes-FIC have been much better than average for insurers. Wes-FIC's combined ratios were 94.0% for 2006 and 75.9% for 2005. We try to create some underwriting gain as results are averaged out over many years. We expect this to become increasingly diÇcult. Kansas Bankers was purchased by Wes-FIC in 1996 for approximately $80 million in cash. Its tangible net worth now exceeds its acquisition price, and it has been a very satisfactory acquisition, reÖecting the sound management of President Don Towle and his team. Kansas Bankers was chartered in 1909 to underwrite deposit insurance for Kansas banks. Its oÇces are in Topeka, Kansas. Over the years its service has continued to adapt to the changing needs of the banking industry. Today its customer base, consisting mostly of small- and medium-sized community banks, is spread throughout 30 mainly midwestern states. In addition to bank deposit guaranty bonds which insure deposits in excess of FDIC coverage, KBS oÅers directors and oÇcers indemnity policies, bank employment practices policies, bank insurance agents professional errors and omissions indemnity policies and Internet banking catastrophe theft insurance. When Wesco purchased KBS, it had been ceding almost half of its premium volume to reinsurers. Now it reinsures only about 14%. EÅective in 2006, insurance subsidiaries of Berkshire Hathaway became KBS's sole reinsurers. Previously, an unaÇliated reinsurer was also involved.

investment company he has run for more than 40 years, Buffett says, “When the stock temporarily over- performs or under-performs the business, a limited number of shareholders—either sellers or buyers— receive out-sized benefits at the expense of those they trade with. [But] over time, the aggregate gains made by Berkshire shareholders must of necessity match the business gains of the company.” Put another way, as Benjamin Graham, legendary author of The Intelligent Investor and Warren Buffett’s great mentor, pointed out, “in the short run the stock market is a voting machine . . . (but) in the long run it is a weighing machine.” But we must take Buffett’s obvious truism—and Mr. Graham’s—one step further. For while “the gains made by shareholders must of necessity match the business gains of the company,” the aggregate gains or losses by the sellers and buyers—even though they are trading back and forth with one another in what is pretty much a closed circle—do not balance out evenly. Investors capture Berkshire’s return; speculators do not. Why? As these traders trade with one another, they incur transaction costs—largely brokerage fees, bid-ask spreads, and excess taxes, and also, in today’s agency society (we have come a long way from an old ownership society) most of us pay, directly or indirectly, our mutual fund and pension fund agents additional fees for doing our trading for us.

I have written much on the subject of accounting, and take the liberty of attaching excerpts from my books Don’t Count On It! (Wiley, 2011) and The Battle for the Soul of Capitalism (Yale University Press, 2005), as well as my Seymour Jones Distinguished Lecture at NYU where I served as Henry Kaufman Visiting Professor in 2002. Among the subjects I take on are: ∑ Operating and pro forma earnings ∑ The role of public accountants as gatekeepers ∑ Earnings management ∑ Pension accounting and return assumptions ∑ Financial reporting improvements ∑ Fundamental accounting principles ∑ Option accounting 1 In his 1996 letter to shareholders, Warren Buffett said “when the price of Berkshire-Hathaway stock temporarily over-performs or under-performs the business, a limited number of shareholders—either sellers or buyers—receive out-sized benefits at the expense of those they trade with. [But] over time, the aggregate gains made by Berkshire shareholders must of necessity match the business gains of the company.”

publicly-owned investment company he has run for 40 years, Buffett says, “When the stock temporarily over-performs or under-performs the business, a limited number of shareholders— either sellers or buyers—receive out-sized benefits at the expense of those they trade with. But over time, the aggregate gains made by Berkshire shareholders must of necessity match the business gains of the company. How often investors lose sight of that eternal principle! Yet the record is clear. History, if only we would take the trouble to look at it, reveals the remarkable, if essential, linkage between the cumulative long-term returns earned by business—the annual dividend yield plus the annual rate of earnings growth—and the cumulative returns earned by the U.S. stock market. Think about that certainty for a moment. Can you see that it is simple common sense? Need proof? Just look at the record since the twentieth century began. The average annual total return on stocks was 9.6 percent, virtually identical to the investment return of 9.5 percent—4.5 percent from dividend yield and 5 percent from earnings growth. That tiny difference of 0.1 percent per year arose from what I call speculative return, depending on how one looks at it. Perhaps it is merely statistical noise, or perhaps it reflects a generally upward long-term trend in stock valuations, a willingness of investors to pay higher prices for each dollar of earnings at the end of the period than at the beginning.

com, professionals in more than 80 domestic metropolitan markets, aÇliates in more than 50 countries, almost twenty thousand apartment communities referring their tenants to CORT, many ancillary services, and its entr πee to the business community as a Berkshire Hathaway company, CORTline now seems to be moving in the right direction. We are pleased with the progress CORT made in the past two years. We are cautiously optimistic that, in future years, we will be able to look back to the recent past and consider it merely a cyclical aberration in CORT's growth. We note, however, that the number of furniture leases outstanding has been slightly declining in each of the past two years.

This interest-free ""loan'' from the government is at this moment working for Wesco shareholders and amounted to about $42 per Wesco share at yearend 2006. However, some day, parts of the interest-free ""loan'' may be removed as securities are sold. Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $42 per Wesco share. Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $42 per Wesco share. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally- good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for investment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. Wesco's consolidated balance sheet reÖects total assets of $3.0 billion as of yearend 2006. Of that amount, more than $1 billion has been invested in cash equivalents and Ñxed-maturity investments since early in 2003.

Unless those funds can be attractively reinvested in acquisitions, equity securities or other long-term instruments of the type that helped cause the long-term growth of Wesco's shareholders' equity, future returns on shareholders' equity will probably be less than those of the past. Due to the current size of Wesco and its parent, Berkshire Hathaway, Wesco's opportunities for growing shareholders' equity are unlikely to be as attractive as in the past.

Wesco's shares were listed for many years on both the American Stock Exchange and, since 1963, on a regional exchange previously known as the PaciÑc Stock Exchange. Following the recent merger of various regional exchanges into the NYSE, the PaciÑc Exchange became the NYSE Arca exchange. We had happily paid a minimal annual listing fee of $1,000 for the privilege of having our shares listed on the PaciÑc Exchange. When notiÑed last December that NYSE Arca had decided to increase Wesco's annual listing fee to $30,000, Wesco voted with its feet. Its shares are now listed only on the American Exchange. The Board of Directors recently increased Wesco's regular dividend from /2 cents per share to 371 /2 cents per share, payable March 8, 2007, to shareholders of record as of the close of business on February 1, 2007. This annual report contains Form 10-K, a report Ñled with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries as well as audited Ñnancial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Shareholders can access much Wesco information, including printed annual reports, earnings releases, SEC Ñlings, and the websites of Wesco's subsidiaries and parent, Berkshire Hathaway, from Wesco's website: www.wescoÑnancial.com. Charles T. Munger Chairman of the Board and President February 27, 2007

As shown above, operating income includes signiÑcant net investment income, representing dividends and interest earned from marketable securities. However, operating income excludes investment gains of $216.6 million, net of income taxes, realized in 2005. No investment gains or losses were realized in 2004. The discussion below will concentrate on insurance underwriting, not on the results from investments. Wes-FIC engages in the reinsurance business, occasionally insuring against loss from rare but horrendous ""super-catastrophes.'' In much reinsurance sold by us, other Berkshire subsidiaries have sold several times as much reinsurance to the same customers on the same terms. In certain instances but not always, such subsidiaries have taken from us a 3%-of-premiums ceding commission on premium volume passed through them to Wes-FIC. Excepting this ceding commission, Wes-FIC has had virtually no insurance-acquisition or insurance administration costs. In some cases, other Berkshire subsidiaries act as reinsurers at higher levels than the level at which Wes-FIC is reinsuring; terms of the reinsurance are considered to be fair or advanta- geous to Wes-FIC.

For the past several years Wes-FIC's reinsurance activity has consisted of the participation in two arrangements described below, the second of which was termi- nated in the fourth quarter of 2004: (1) Participation, since 2001, in several risk pools managed by an insurance subsidiary of Berkshire Hathaway, our 80%-owning parent, recently covering hull, liability and workers' compensation exposures relating to the aviation industry as follows: for 2004, to the extent of 10% in the hull and liability pools; for 2005, 10% of the hull and liability pools and 5% of the workers' compensation pool. For 2006, participation in the hull and liability pools has increased to 121 /2 %. The Berkshire subsidiary provides a portion of the upper-level reinsurance protection to these aviation risk pools on terms that could result in the Berkshire subsidiary having a diÅerent interest from that of Wes-FIC under certain conditions, e.g., in settling a large loss. (2) A multi-year contract entered into in 2000 through another Berkshire insur- ance subsidiary, as intermediary without proÑt, covering certain multi-line property and casualty risks of a large, unaÇliated insurer. This contract was commuted in the fourth quarter of 2004, at which time Wes-FIC paid the ceding company $43.1 million, cash, representing all unearned premiums, reduced by unamortized costs and expenses. After the commutation, Wes- FIC's obligation to indemnify any further insurance losses under the contract ceased.

the government is at this moment working for Wesco shareholders and amounted to about $36 per Wesco share at yearend 2005. However, some day, parts of the interest-free ""loan'' may be removed as securities are sold. Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $36 per Wesco share. Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $36 per Wesco share. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally- good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for investment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. Wesco's consolidated balance sheet reÖects total assets of $2.7 billion as of yearend 2005. Of that amount, more than $1 billion has been invested in cash equivalents and Ñxed-maturity investments since early in 2003.

Unless those funds can be attractively reinvested in acquisitions, equity securities or other long-term instru- ments of the type that have been responsible for the long-term growth of Wesco's shareholders' equity, future returns on shareholders' equity will probably be less than those of the past. Due to the current size of Wesco and its parent, Berkshire Hathaway, Wesco's opportunities for growing shareholders' equity are unlikely to be as attractive as in the past. The Board of Directors recently increased Wesco's regular dividend from 351 /2 cents per share to 361 /2 cents per share, payable March 2, 2006, to shareholders of record as of the close of business on February 1, 2006. This annual report contains Form 10-K, a report Ñled with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidi- aries as well as audited Ñnancial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Shareholders can access much Wesco information, including printed annual reports, earnings releases, SEC Ñlings, and the websites of Wesco's subsidiaries and parent, Berkshire Hathaway, from Wesco's website: www.wescoÑnancial.com. Charles T.2006

have taken from us a 3%-of-premiums ceding commission on premium volume passed through them to Wes-FIC. Excepting this ceding commission, Wes-FIC has had virtually no insurance-acquisition or insurance administration costs. In some cases, other Berkshire subsidiaries act as reinsurers at higher levels than the level at which Wes-FIC is reinsuring; terms of the reinsurance are considered by Wes-FIC to be fair or advantageous to Wes-FIC. For the past several years Wes-FIC's reinsurance activity has consisted of the participation in two arrangements: (1) Participation in four risk pools managed by an insurance subsidiary of Berkshire Hathaway, our 80%-owning parent, covering hull, liability, work- ers' compensation and satellite exposures relating to the aviation industry as follows: with respect to 2001, to the extent of 3% for each pool, with satellite exposures eÅective June 1; for 2002, 13% of the hull and liability pools, increasing to 15.5% in August, and 3% of the workers' compensa- tion pool (satellite exposures were not renewed in June); and, for 2003 and 2004, 10% of the hull and liability pools only. The Berkshire subsidiary provides a portion of the upper-level reinsurance protection to these aviation risk pools, and therefore to Wes-FIC, on terms that could result in the Berkshire subsidiary having a diÅerent interest from that of Wes-FIC under certain conditions, e.g., in settling a large loss.

(2) A multi-year contract entered into in 2000 through another Berkshire insurance subsidiary, as intermediary without proÑt, covering certain multi-line property and casualty risks of a large, unaÇliated insurer. This contract was commuted (terminated) in the fourth quarter of 2004, at which time Wes-FIC paid the ceding company $43.1 million, cash, repre- senting all unearned premiums, reduced by unamortized costs and ex- penses. After the commutation, Wes-FIC's obligation to indemnify any further insurance losses under the contract ceased. Under that contract, there was a net reduction in written premiums of $2.3 million for 2004, compared with written premiums of $30.4 million for 2003; earned premiums were $6.4 million for 2004 and $42.0 million for 2003. Underwriting results of Wes-FIC in both 2004 and 2003 were weirdly favorable, causing the underwriting gains of $14.6 million for 2004 and $15.7 million for 2003. Such weirdly favorable results are not to be expected over the long term. It should be recalled that Wes-FIC reported an underwriting loss of $8.1 million as recently as 2001. However, we do try to create some underwriting gain as results are averaged out over many years. Kansas Bankers was purchased by Wes-FIC in 1996 for approximately $80 mil- lion in cash. Its tangible net worth now exceeds its acquisition price, and it has been a very satisfactory acquisition, reÖecting the sound management of President Don Towle and his team.

Of course, so long as Wesco does not liquidate, and does not sell any appreciated securities, it has, in effect, an interest-free ""loan'' from the government equal to its deferred income taxes on the unrealized gains, subtracted in determining its net worth. This interest-free ""loan'' from the government is at this moment working for Wesco shareholders and amounted to about $32 per Wesco share at yearend 2004. However, some day, parts of the interest-free ""loan'' may be removed as securities are sold. Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $32 per Wesco share. Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $32 per Wesco share. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for invest- ment of Wesco versus Berkshire Hathaway stock at present stock-market quotations.

Shareholders should note that the recently announced sale of The Gillette Company to The Procter and Gamble Company, subject to shareholder approval later in 2005, is expected to result in Wesco's recognition of an investment gain of about $190 million, after income taxes. No income taxes will be paid in cash, and all of Wesco's Gillette shares will be converted into Procter and Gamble shares. Although we will be pleased to become owners of shares of Procter and Gamble, we do not regard this ""mere accounting'' gain as signiÑcant to Wesco shareholders. The Board of Directors recently increased Wesco's regular dividend from 341 /2 cents per share to 351 /2 cents per share, payable March 2, 2005, to shareholders of record as of the close of business on February 2, 2005. This annual report contains Form 10-K, a report Ñled with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries as well as audited Ñnancial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Shareholders can access much Wesco information, including printed annual reports, earnings releases, SEC Ñlings, and the websites of Wesco's subsidiaries and parent, Berkshire Hathaway, from Wesco's website: www.wescoÑnancial.com. We regret the pending retirement of Wesco's President, Bob Bird, who is not standing for reelection.

At the 2003 Berkshire annual meeting, Buffett and Munger issued what Buffett later called a wake-up call on derivatives. The ballooning and thoughtless use of risky derivatives contracts had, in their joint view, become a systemic danger. Munger's phrasing was characteristically blunt: he told the audience that the derivatives market had become a gathering place for weapons of financial mass destruction. The phrase was deliberately inflammatory, and Munger meant it to be. The argument was structural. Derivatives, in Munger's framing, did not just transfer risk - they magnified it, because the counterparty web was opaque and the mark-to-market process was unreliable. A financial system in which large institutions owed each other enormous notional sums, recorded at model prices rather than transactable prices, was a system in which the failure of one node could cascade unpredictably through the rest. The 1998 LTCM collapse had already shown the pattern; Munger and Buffett were telling the room that the pattern would recur at larger scale. The prescription was avoidance. Berkshire itself used derivatives sparingly and only when it could price them honestly - the equity put writtings of later years were a deliberate exception, undertaken only when the premiums and the structural terms were clearly attractive. For most institutions, Munger's view was that the right answer was to stay out of the contracts entirely, to refuse the short-term earnings boost they offered, and to accept that the apparent opportunity was a fee-generation mirage that would, in some future crisis, become a loss-generation machine.

At the 2003 Wesco annual meeting - held in the same week as the now-famous Berkshire derivatives warning - Munger reflected on what made Berkshire's structure durable. He told the audience that the Berkshire conglomerate model worked because it had almost no corporate bureaucracy. There was practically nobody at headquarters. The people running the operating businesses were sensible people who were left alone to run them. The absence of bureaucracy was, in Munger's view, a huge advantage - not a management fad but a structural property of the conglomerate that compounded year after year. He paired the structural observation with a warning. Bureaucracy, Munger said, breeds failure and stupidity. How could it be otherwise? The point was that bureaucratic organizations systematically destroyed the judgment of the people inside them, because the bureaucratic structure rewarded process over outcome, compliance over insight, and risk-avoidance over capital allocation. A company that allowed a bureaucracy to grow was, in Munger's framing, slowly converting its smartest operators into the kind of people who could not make a real decision even when one was needed. The takeaway for the room was that capital allocation discipline and organizational discipline were the same problem. Berkshire's edge was not just that Buffett and Munger had good judgment; it was that the structure they had built protected the judgment of the operators below them from being bureaucratized away. The same lesson, Munger implied, applied to the smaller Wesco conglomerate - KBS, Wes-FIC, Precision Steel - and to any organization that wanted to compound intrinsic value over decades. Keep the headquarters empty, keep the operators in charge, and refuse to grow the corporate center in the name of oversight.

Munger extended the derivatives critique into a broader indictment of modern financial engineering. The same incentives that produced the gallbladder surgeon - the man who had convinced himself that removing the organ was the right answer because the procedure paid him - produced the derivatives desk that built the structured product because the structured product paid the desk. The customer's interest and the seller's interest were aligned only at the surface; at the level of incentives, they were routinely in conflict. Munger told the audience to be deeply suspicious of any investment product created by professionals and aggressively merchandised. He tied the point to credit cycles. The derivatives web had grown during the easy-money years because the contracts looked profitable when credit was loose and counterparty risk was underpriced. When credit tightened, those same contracts would re-price violently and the unwinding would itself become a credit event. The derivatives problem and the credit-cycle problem were therefore not separate pathologies; they were two faces of the same pathology. Munger's prescription was to stay liquid, stay simple, and stay out of contracts whose payoffs depended on a counterparty's solvency in a crisis. He closed with a historical note. The Defense Department had, after enough experience with cost-plus-percentage-of-cost contracts, made it a felony for the federal government to write one. Munger took that as proof of concept: when a contract structure was so incentive-misaligned that even the government eventually criminalized it, the private sector's continued use of the same logic - in cost-plus mutual fund fees, in derivatives desks, in private equity carry - was not innovation but recidivism. The investor who recognized the pattern had a structural edge.

The 2003 Wesco meeting is also notable as the public precursor to Munger's Psychology of Human Misjudgment speech. Tilson's notes flagged that Munger was, in the meeting, already working through the material that he would shortly deliver at Harvard as the 24 standard causes of human misjudgment. The Wesco audience heard the same psychological framework that the Harvard audience would hear, applied to insurance underwriting, banking, and corporate governance rather than to the general investor. Munger's argument, in both venues, was that the standard survey course in psychology had failed to give investors the tools they needed because the course had badly underweighted incentive-caused bias. He told the Wesco audience that if they read the standard thousand-page psychology text they would find, somewhere in the back, one sentence on incentive bias - and yet incentive bias was, in his experience, the single most powerful driver of bad decisions in business and investing. The prescription was to learn the real list of cognitive biases - the ones Munger had compiled from his own experience - and to apply them as rigorously to one's own decisions as to other people's. He closed with the lollapalooza warning. The really catastrophic failures of judgment, Munger said, came not from any single bias operating alone but from several biases reinforcing each other in the same direction. Incentive bias plus consistency bias plus social proof plus authority bias, all pointing the same way, could produce a decision that no individual bias could have produced on its own. The lollapalooza effect was the reason that crowds of intelligent people could collectively do very stupid things. The defense was the latticework of mental models - to recognize the lollapalooza pattern in real time and refuse to participate in it, even when the social pressure to participate was intense.

However, the interested reader could glean much of that by reading the following: 1. In the Appendix of Charlie Munger’s biography (entitled “Damn Right!”), is an essay by Munger on the thesis behind Berkshire’s investment in Coca Cola. Buffett and Munger almost never provide such a descriptive of the analytics behind their various brilliant investment decisions, so this writeup is a rare treat. It is a wonderful window into how Munger’s remarkable latticework mind works. 2. I’ve written three articles in the past that encapsulate most of the thesis of the talk. They are: Buffett Succeeds at Nothing (The Motley Fool, Oct.2003

Wes-FIC engages in the reinsurance business, occasionally insuring against loss from rare but horrendous ""super-catastrophes.'' In much reinsurance sold by us, other Berkshire subsidiaries sold several times as much reinsurance to the same customers on the same terms. In certain instances but not always, such subsidiaries have taken from us a 3%-of-premiums ceding commission on premium volume passed through them to Wes-FIC. Excepting this ceding commission, Wes-FIC has had virtually no insurance-acquisition or insurance administration costs. In some cases, other Berkshire subsidiaries act as reinsurers at higher levels than the level at which Wes-FIC is reinsuring; terms of the reinsurance are considered by Wes-FIC to be fair or advantageous to Wes-FIC. Underwriting results of Wes-FIC in 2003 were weirdly favorable, causing the underwriting gain of $15.7 million. Such weirdly favorable results are not to be expected over the long term. It should be recalled that Wes-FIC reported an underwriting loss of $8.1 million as recently as 2001. However, we do try to create some underwriting gain as results are averaged out over many years. Kansas Bankers was purchased by Wes-FIC in 1996 for approximately $80 mil- lion in cash. Its tangible net worth now exceeds its acquisition price, and it has been a very satisfactory acquisition, reÖecting the sound management of President Don Towle and his team. Kansas Bankers was chartered in 1909 to underwrite deposit insurance for Kansas banks.

California Summer Reading The time I get to read books is inversely proportional to the level of the Dow Jones index. When we have times like 2003 when markets are very overvalued, I find myself with more time for general reading and if we were to witness markets like 1974 again, then general reading would go out the window. I’m periodically questioned on the contents of my bookshelf on the website and specifically where I would suggest getting started. It’s a difficult question to answer as it depends on one’s aptitudes and interests. However, I decided that I’d periodically discuss a few books read recently and in the not too distant past to help folks decide for themselves if they are likely to enjoy certain books over others. The best book on Warren Buffett (in my opinion) is The Making of an American Capitalist by Roger Lowenstein. It’s a good book to get started on Buffett. Following Lowenstein’s book, I’d recommend reading Buffett’s Letters to Shareholders from 1977 to 2002. You can also get a hard copy of the letters (3 bound books) by sending proof of shareholding or a check for $35 to Berkshire Hathaway, Inc. 3555 Farnam Street, Suite 1440, Omaha, NE 68131.5

Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $32 per Wesco share. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for invest- ment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. To progress from this point at a satisfactory rate, Wesco plainly needs more favorable investment opportunities, recognizable as such by its management, prefer- ably in whole companies, but, alternatively, in marketable securities to be purchased by Wesco's insurance subsidiaries. Our views regarding the general prospects for investment in common stocks are unchanged one year after Warren BuÅett wrote the following, in his 2002 annual report to shareholders of our parent company: ""We continue to do little in equities.

Wesco now has a website: www.wescoÑnancial.com. Shareholders can there access much Wesco information, including printed annual reports, earnings releases, SEC Ñlings, and the websites of Wesco's subsidiaries and parent, Berkshire Hathaway. This annual report contains Form 10-K, a report Ñled with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries as well as audited Ñnancial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Charles T.2004

As you are aware, the funds are allowed to employ leverage. PIFI can leverage upto 30% and the other funds can go upto 50%. When Buffett ran his partnerships in the 1950s and 60s, he almost always had more ideas than money and the funds were nearly fully leveraged (50%) during most of the period. Buffett’s use of leverage was focused on workout and special situation investments. Today Buffett’s vehicle for leverage is insurance float – which is simply brilliant since that float is subdivided into a myriad of risk classes being covered that are very very unlikely to have any sort of aggregation ever. As an example, after 9/11, some of Berkshire’s Insurance units saw big claims, but its GEICO auto insurance unit with about 15% of the float was untouched by the events of 9/11. Many partners and potential partners have voiced concerns about the use of leverage in the funds to me from time to time. I have always been very careful with leverage – only using it for special situations. However, after a great deal of reflection, I have come to the conclusion that there are really no limits to the short-term irrationality of markets. I don’t believe 1929 represents the extreme to which markets can go. If fact, until 1987 common wisdom was that big market drops were a thing of the past. So while we are probably protected against a 50 or 100 year flood, I don’t think we’re protected against a 1000 year flood.

If the market were to drop 50+% in a course of 2 to 3 days and if it happened while we were fully leveraged, we’d have a problem. We’d be forced to sell positions at the exact opposite time that we’d like to sell. As an example, the Nasdaq has seen over 75% of its capitalization disappear over the last 2 years. There is nothing that prevents such drops from occurring over a matter of days versus a matter of years. While I don’t believe we will ever see the type of drops I’m alluding to, I would not want to bet on it – especially with your hard-earned money. If we are totally unleveraged and the market dropped 50%, there is no real problem. We can just wait out the storm and eventually the underlying businesses will get priced around their intrinsic value. Indeed, if we ever saw such big drops with no change in portfolio fundamentals, I’d be asking partners to add funds and we’d go shopping selectively. I started thinking hard about the leverage issue last year when Charlie Munger made the following comment at the 2001 Berkshire Hathaway meeting alluding to the “Monopoly” board game when speaking on the subject of use of leverage. “I don’t want to go back to Go! I’ve been a Go once and have no desire to see it again.” t I thought a lot about the appropriate percentage of leverage (while still being able to withstand a 1000 year flood) and concluded that it should be zero.

We engage in other reinsurance business, including large and small quota share arrangements similar and dissimilar to our previous reinsurance contract with Fire- man's Fund Group, and, from time to time, in super-cat reinsurance, described in detail in previous annual reports, which Wesco shareholders should re-read each year. Following is a summary of Wes-FIC's current reinsurance activity: ‚ A three-year arrangement entered into in 2000 through an insurance subsidi- ary of Berkshire Hathaway, our 80%-owning parent, as intermediary without ceding commission, for participation to the extent of 3.3% in certain property and casualty exposure ceded by a large, unaÇliated insurer. The terms of this arrangement are identical to those accepted by that Berkshire subsidiary except as to the amount of the participation. ‚ Participation in four risk pools managed by a Berkshire insurance subsidiary (also acting as intermediary without ceding commission) covering hull, liability, workers' compensation and satellite exposures relating to the aviation industry as follows: with respect to 2001, to the extent of 3% for each pool; for 2002, 13% of the hull and liability pools, 3% of the workers' compensation pool and, eÅective mid-year, 15.5% of the satellite pool; and, for 2003, 10% of the hull and liability pools only. The Berkshire subsidiary provides a portion of the reinsurance protection to these aviation risk pools, and therefore to Wes-FIC.

In much reinsurance sold by us, other Berkshire subsidiaries sold several times as much reinsurance to the same customers on the same terms. In certain instances but not always, such subsidiaries have taken from us a 3%-of-premiums ceding commis- sion on premium volume passed through them to Wes-FIC. Excepting this ceding commission, Wes-FIC has had virtually no insurance-acquisition or insurance admin- istration costs. KBS, purchased by Wes-FIC in 1996 for approximately $80 million in cash, contributed $7.4 million to the after-tax operating earnings of the insurance busi- nesses in 2002 and $9.3 million in 2001. The 2001 Ñgure is before goodwill amortization of $.8 million; there was no goodwill amortization for 2002. Prior to 2002 goodwill was amortized mainly on a straight-line basis over 40 years. As explained above, as of the beginning of 2002, Wesco discontinued amortization of goodwill and became subject to other changes in goodwill accounting, as required by the Financial Accounting Standards Board. The results of KBS have been com- bined with those of Wes-FIC, and are included in the table on page 1 in the category of ""insurance businesses.'' KBS was chartered in 1909 to underwrite deposit insurance for Kansas banks. Its oÇces are in Topeka, Kansas. Over the years its service has continued to adapt to the changing needs of the banking industry.

in excess of FDIC coverage, KBS oÅers directors and oÇcers indemnity policies, bank employment practices policies, bank annuity and mutual funds indemnity policies, and bank insurance agents professional errors and omissions indemnity policies. Also, KBS has recently begun oÅering Internet banking catastrophe theft insurance. Beginning in 2003, KBS revised the allocation of its reinsurance between a Berkshire insurance subsidiary and a non-aÇliate: Under the previous program, the Berkshire subsidiary and the non-aÇliate each reinsured 50% of the per-occurrence risks of $3 million in excess of $2 million, and the non-aÇliate also reinsured 70% of the per-occurrence risks up to $10 million above $5 million, all for approximately 5% of KBS's premiums. Beginning in 2003, the Berkshire subsidiary has replaced the non-aÇliate on the second layer, and total reinsurance costs are expected to aggregate 10%-12% of premiums. Reinsurance costs have risen greatly throughout the insurance industry, and the revised arrangement is considered fair by all in- volved, all factors considered. (Indeed, we believe that our combined insurance arrangements through Berkshire constitute a net advantage to Wes-FIC that would not be available from Berkshire in the absence of its 80% ownership of Wesco, and such combined insurance arrangements have worked out well so far, even after taking into account our September 11 loss in 2001.) KBS increased the volume of business retained eÅective in 1998.

Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of real estate assets with a net book value of about $5.8 million, consisting mainly of the nine-story commercial oÇce building in downtown Pasadena, where Wesco is headquartered. MS Property Company's results of operations, immaterial versus Wesco's present size, are included in the breakdown of earnings on page 1 within ""other operating earnings.'' Other Operating Earnings Other operating earnings, net of interest paid and general corporate expenses, amounted to $.6 million in both 2002 and 2001. Sources were (1) rents ($3.3 mil- lion gross in 2002) from Wesco's Pasadena oÇce property (leased almost entirely to outsiders, including Citibank as the ground Öoor tenant), and (2) interest and dividends from cash equivalents and marketable securities held outside the insur- ance subsidiaries, less (3) general corporate expenses plus minor expenses involving tag-end real estate. Corporate Governance Two of our long-standing directors, Jim Gamble and Dave Robinson, are not standing for reelection. At practically no pay, they have been wise and honorable protectors of Wesco shareholders for many decades going back to a time before Berkshire Hathaway had any interest in Wesco.

working for Wesco shareholders and amounted to about $28 per Wesco share at yearend 2002. However, some day, parts of the interest-free ""loan'' may be removed as securities are sold. Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $28 per Wesco share. Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $28 per Wesco share. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for invest- ment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. To progress from this point at a satisfactory rate, Wesco plainly needs more favorable investment opportunities, recognizable as such by its management, prefer- ably in whole companies, but, alternatively, in marketable securities to be purchased by Wesco's insurance subsidiaries.

from them in the 1950s and 60s Buffett Partnerships. Buffett continues to invest in workouts for his own account as well as Berkshire Hathaway. Another terms for workouts would be Arbitrage or simply “Special Situations” Buffett does two types of investing. One is buying great companies at compelling valuations and holding them for a long time (Coca Cola, American Express etc.) The other is workout investing. He has made a lot of money in his career for these workouts. Workouts typically offer modest returns, but virtually no risk. Let me give you some examples: Company A is publicly traded and its stock is at $30/share. Company A announces that it has reached an agreement to be sold to Company B in an all-cash transaction for $35/share. They announce that the both the boards have approved the transaction and recommended that shareholders approve it as well. A month later, the shareholders have approved the merger and the deal is expected to close in 30-45 days. Company A’s stock is trading in a range of $34-$34.50/share. The NASDAQ drops 10% a month before the merger and the stock drops to $33.50/share. If one bought the stock at $33.50 and got $35 a month later, it’s a 53.73% annualized rate of return with virtually no risk! This is known as “Merger Arbitrage”. Usually spreads on announced cash mergers are slim, but occasionally these spreads widen. They are sometimes quite wide if the companies are small cap as liquidity issues keep big players out.

expenses, beneÑting after-tax operating earnings in 2001 and 2000 by $.8 million each. We engage in other reinsurance business, including large and small quota share arrangements similar and dissimilar to our previous reinsurance contract with Fire- man's Fund Group, and, from time to time, in super-cat reinsurance, described in detail in previous annual reports, which Wesco shareholders should re-read each year. In almost all recent reinsurance sold by us, other subsidiaries of our 80%-owning parent, Berkshire Hathaway, sold several times as much reinsurance to the same customers on the same terms. In certain instances, such subsidiaries have taken from us a 3%-of-premiums ceding commission on premium volume passed through them to Wes-FIC. Excepting this ceding commission, Wes-FIC has had virtually no insurance-acquisition or insurance administration costs with regard to those policies. KBS, purchased by Wes-FIC in 1996 for approximately $80 million in cash, contributed $9.3 million to the after-tax operating earnings of the insurance busi- nesses in 2001 and $7.0 million in 2000. These Ñgures are before goodwill amortiza- tion under accounting convention of $.8 million each year. The results of KBS have been combined with those of Wes-FIC, and are included in the table on page 1 in the category of ""insurance businesses.'' KBS was chartered in 1909 to underwrite deposit insurance for Kansas banks. Its oÇces are in Topeka, Kansas.

Over the years its service has continued to adapt to the changing needs of the banking industry. Today its customer base, consisting mostly of small and medium-sized community banks, is spread throughout 27 mainly midwestern states. In addition to bank deposit guaranty bonds which insure deposits in excess of FDIC coverage, KBS also oÅers directors and oÇcers indemnity policies, bank employment practices policies, bank annuity and mutual funds indemnity policies and bank insurance agents professional errors and omissions indemnity policies. KBS increased the volume of business retained eÅective in 1998. It had previously ceded almost half of its premium volume to reinsurers. Now it reinsures only about 5% under arrangements whereby other Berkshire subsidiaries take 50% and unrelated reinsurers take the other 50%. As we indicated last year, the increased volume of business retained comes, of course, with increased irregularity in the income stream. The combined ratio of an insurance company represents the percentage that its underwriting losses and expenses bear to its premium revenues. KBS's combined ratio has been much better than average for insurers, at 55.1% for 2001 and 73.9% for 2000, and we continue to expect volatile but favorable long-term eÅects from increased insurance retained. KBS is ably run by Donald Towle, President, assisted by 15 dedicated oÇcers and employees.

Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for invest- ment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. To progress from this point at a satisfactory rate, Wesco plainly needs more favorable investment opportunities, recognizable as such by its management, prefer- ably in whole companies like CORT, but, alternatively, in marketable securities to be purchased by Wesco's insurance subsidiaries. The thing that should interest Wesco shareholders most with respect to 2001 is that we found no new common stocks for our insurance companies to buy. We are not excited by general prospects for common stocks. The Board of Directors recently increased Wesco's regular dividend from 311 /2 cents per share to 321 /2 cents per share, payable March 6, 2002, to shareholders of record as of the close of business on February 6, 2002.

We also have a diversity of backgrounds represented ranging from a trader on the Chicago Board of Options Exchange, a Court Reporter in Minnesota, an Attorney, a Silicon Valley venture capitalist, an operator of an aircraft parts mail-order house, retirees in Florida and Vermont, IT consultants, several entrepreneurs, CEO/COOs of companies, folks in the printing business, software business, a commercial real- estate developer, an ethnic food wholesaler etc. Several partners are also Berkshire Hathaway shareholders. I was surprised to learn that some sold Class A Berkshire shares to invest in The Pabrai Investment Fund. I’m not sure of everyone’s age, but have virtually every age group from 20-something to 70-something represented. We now have 22 Limited Partners between the two funds – up from 8 when we started 15 months ago. I’m already looking forward to next year’s annual meeting. We’ll need a bigger room!

However, it will take a long time before all claims are settled, and, meanwhile, Wes-FIC is being helped over many years by proceeds from investing ""Öoat'' and by favorable loss develop- ment, which has enabled it to reduce the liability for losses and loss-related expenses, beneÑting after-tax operating earnings by $.8 million in 2000 and $1.7 mil- lion in 1999. Wes-FIC engages in other reinsurance business, including large and small quota share arrangements similar and dissimilar to our previous reinsurance contract with Fireman's Fund Group, and, from time to time, in super-cat reinsurance, described in great detail in our pre-1999 annual reports, which Wesco shareholders should re- read each year. Although Wes-FIC was not active in super-cat reinsurance business in 2000, its operating earnings beneÑted by $.9 million, after taxes, in 1999. On super-cat reinsurance accepted by Wes-FIC to date (March 5, 2001) there has been no loss whatsoever that we know of, but some ""no-claims'' contingent commissions have been paid to original cessors of business (i.e., cessors not including Berkshire Hathaway). The balance of Wes-FIC's after-tax underwriting proÑt or loss not described above, amounted to underwriting loss of $1.2 million for 2000 and underwriting proÑt of $.2 million for 1999. In all recent reinsurance sold by us, other subsidiaries of our 80%-owning parent, Berkshire Hathaway, sold several times as much reinsurance to the same customers on the same terms.3%-

Today its customer base, consisting mostly of small and medium-sized community banks, is spread throughout 25 mainly midwestern states. In addition to bank deposit guaranty bonds which insure deposits in excess of FDIC coverage, KBS also oÅers directors and oÇcers indemnity policies, bank employment practices policies, bank annuity and mutual funds indemnity policies and bank insurance agents professional errors and omissions indemnity policies. KBS increased the volume of business retained eÅective in 1998. It had previously ceded almost half of its premium volume to reinsurers; and, it now reinsures only about 5% under arrangements whereby other Berkshire subsidiaries take 50% and unrelated reinsurers take the other 50%. As we indicated last year, the increased volume of business retained comes, of course, with increased irregularity in the income stream. KBS's combined ratio remained much better than average for insurers, at 73.9% for 2000 and 59.4% for 1999, versus 37.2% for 1997, and we continue to expect volatile but favorable long-term eÅects from increased insurance retained. KBS is run by Donald Towle, President, assisted by 15 dedicated oÇcers and employees.

Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $36 per Wesco share. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway.an

equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for invest- ment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. To progress from this point at a satisfactory rate, Wesco plainly needs more favorable investment opportunities, recognizable as such by its management, prefer- ably in whole companies like CORT, but, alternatively, in marketable securities to be purchased by Wesco's insurance subsidiaries. The Board of Directors recently increased Wesco's regular dividend from 30¥ cents per share to 31¥ cents per share, payable March 7, 2001, to shareholders of record as of the close of business on February 7, 2001. This annual report contains Form 10-K, a report Ñled with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries as well as audited Ñnancial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Charles T. Munger Chairman of the Board March 5, 2001

The Kansas Bankers Surety Company (""KBS''), owned by Wes-FIC since 1996. KBS is discussed in the section, ""The Kansas Bankers Surety Company,'' below. At the end of 1999 Wes-FIC retained about $21 million in invested assets, oÅset by claims reserves, from its former reinsurance arrangement with Fireman's Fund Group. This arrangement was terminated August 31, 1989. However, it will take a long time before all claims are settled, and, meanwhile, Wes-FIC is being helped over many years by proceeds from investing ""Öoat.'' In addition, Wes-FIC has been engaged for several years in super-cat reinsur- ance, described in great detail in our pre-1999 annual reports, which Wesco shareholders should re-read each year. Wes-FIC also engages in other reinsurance business, including large and small quota share arrangements similar and dissimilar to our previous reinsurance contract with Fireman's Fund Group. In all recent reinsurance sold by us, other subsidiaries of our 80%-owning parent, Berkshire Hathaway, sold four times as much reinsurance to the same customers on the same terms, except that such subsidiaries usually take from us a 3%-of-premiums ceding commission on premium volume passed through them to Wes-FIC. Excepting this ceding commission, Wes-FIC has virtually no insurance-acquisition or insurance administration costs.

Early in the current year (2000) Wes-FIC made an intracompany loan that funds a large majority of the purchase price of CORT Business Services Corporation, discussed below. Wes-FIC remains a very strong insurance company, with very low costs, and, one way or another, in the future as in the past, we expect to continue to Ñnd and seize at least a few sensible insurance opportunities. On super-cat reinsurance accepted by Wes-FIC to date (March 3, 2000) there has been no loss whatsoever that we know of, but some ""no-claims'' contingent commissions have been paid to original cessors of business (i.e., cessors not including Berkshire Hathaway). Super-cat underwriting proÑt of $1.4 million a year, before taxes, beneÑted earnings in 1999 and 1998. The balance of pre-tax underwrit- ing proÑt amounted to $3.0 million for 1999 and $1.9 million for 1998. These Ñgures came mostly from favorable revision of loss reserves on the old Fireman's Fund contract. Wesco shareholders should continue to realize that recent marvelous underwrit- ing results are sure to be followed, sometime, by one or more horrible underwriting losses from super-cat or other insurance written by Wes-FIC.

Part of KBS's continuing insurance volume is now ceded through reinsurance to other Berkshire subsidiaries under reinsurance arrangements whereunder such other Berkshire subsidiaries take 50% and unrelated reinsurers take the other 50%. KBS is run by Donald Towle, President, assisted by 15 dedicated oÇcers and employees. CORT Business Services Corporation (""CORT'') In February 2000, Wesco purchased 100% of CORT Business Services Corpora- tion (""CORT'') for $384 million in cash. In addition, CORT retains about $45 million of previously existing debt. CORT is a very long established company that is the country's leader in rentals of furniture that lessees have no intention of buying. In the trade, people call CORT's activity ""rent-to-rent'' to distinguish it from ""lease-to-purchase'' businesses that are, in essence, installment sellers of furniture. However, just as Hertz, as a rent-to-rent auto lessor in short-term arrangements, must be skilled in selling used cars, CORT must be and is skilled in selling used furniture. In 1999, CORT had total revenues of $354 million. Of this, $295 million was furniture rental revenue and $59 million was furniture sales revenue. CORT's pre-tax earnings in 1999 were $46 million.

value as guessed in a similar calculation at the end of 1998. And, Ñnally, this reasonable-to-this-writer, $286-per-share Ñgure for intrinsic per share value of Wesco stock should be compared with the $245 per share price at which Wesco stock was selling on December 31, 1999. This comparison indicates that Wesco stock was then selling about 14% below intrinsic value. Wesco's investment portfolio suÅered more than its commensurate share of decline in market value in 1999. Last year, we said ""as Wesco's unrealized apprecia- tion has continued to grow in frothy markets for securities, it should be remembered that it is subject to market Öuctuation, possibly dramatic on the downside, with no guaranty as to its ultimate full realization .'' The stock of several of our largest investees lagged the market in 1999 by a large margin. It's no sure thing that the value of our marketable securities will quickly recover. Unrealized after-tax apprecia- tion represented 69% of Wesco's shareholders' equity at 1999 yearend, versus 76% and 73% one and two years earlier. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway.

Moreover, the quality disparity in book value's intrinsic merits has, in recent years, been widening in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for invest- ment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. The Board of Directors recently increased Wesco's regular dividend from 29¥ cents per share to 30¥ cents per share, payable March 8, 2000, to shareholders of record as of the close of business on February 9, 2000. This annual report contains Form 10-K, a report Ñled with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries as well as audited Ñnancial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Charles T.2000

Warren Buffett opened the 1998 Berkshire Hathaway annual meeting against the backdrop of the recently announced acquisition of General Reinsurance in a $22 billion all-stock transaction, the largest in Berkshire's history. Buffett and Vice Chairman Charlie Munger told shareholders that the acquisition would double Berkshire's float, that the integration would be executed without disrupting General Re's underwriting culture and that the company's long-standing aversion to issuing shares for acquisitions had been set aside in this case because the strategic value of the global reinsurance franchise and the additional float justified the share dilution. Buffett walked shareholders through the long-term economics of the insurance float, framing it as borrow-and-invest capacity that, when underwritten at a combined ratio below 100, effectively paid Berkshire to invest the float in the equity portfolio. He flagged that the General Re acquisition would lift Berkshire's float above $15 billion, that the additional investment capacity would be deployed gradually into the long-term equity portfolio and that Berkshire would not be a forced seller of any of the General Re investment portfolio even where the holdings overlapped with Berkshire's existing positions. On the Q&A, shareholders pressed on whether the General Re acquisition marked a shift toward large acquisitions and away from the equity portfolio that had defined Berkshire's prior decades. Buffett responded that the General Re acquisition was an opportunistic transaction that met the test of being acquired at a fair price, that the equity portfolio would continue to compound alongside the wholly-owned operating businesses and that the Berkshire structure allowed the company to allocate capital across both modes depending on what the market presented. Munger added that the General Re transaction reflected the deep structural advantage of being able to be the natural long-term home for a major reinsurance franchise, where the seller's motivation was not price maximisation but certainty of long-term stewardship. The meeting closed with Buffett and Munger reiterating the long-term framework of compounding intrinsic value per share at a rate above the S&P 500 average, anchored on the insurance float, the wholly-owned operating businesses and the concentrated long-term equity portfolio.

Wesco-Financial Insurance Company (""Wes-FIC'') Wes-FIC's normal net income for 1998 was $34,654,000, versus $33,507,000 for 1997. The Ñgures include $4,987,000 in 1998 and $6,044,000 in 1997 contributed by The Kansas Bankers Surety Company (""KBS''), owned by Wes-FIC since 1996. KBS is discussed in the section, ""The Kansas Bankers Surety Company,'' below. At the end of 1998 Wes-FIC retained about $24 million in invested assets, oÅset by claims reserves, from its former reinsurance arrangement with Fireman's Fund Group. This arrangement was terminated August 31, 1989. However, it will take a long time before all claims are settled, and, meanwhile, Wes-FIC is being helped over many years by proceeds from investing ""Öoat.'' We previously informed shareholders that Wes-FIC had entered into the busi- ness of super-cat reinsurance through retrocessions from the Insurance Group of Berkshire Hathaway, Wesco's ultimate parent. Wes-FIC's entry into the super-cat reinsurance business early in 1994 followed the large augmentation of its claims- paying capacity caused by its merger with Mutual Savings, the former savings and loan subsidiary of Wesco. In 1994, in recognition of Wes-FIC's sound Ñnancial condition, Standard and Poor's Corporation assigned to Wes-FIC the highest possible claims-paying-ability rating: AAA. The super-cat reinsurance business, in which Wes-FIC is engaged, continues to be a very logical business for Wes-FIC.

Wes-FIC has a large net worth in relation to annual premiums being earned. And this is exactly the condition rationally required for any insurance company planning to be a ""stand alone'' reinsurer covering super- catastrophe risks it can't safely pass on to others sure to remain solvent if a large super-catastrophe comes. Such a ""stand alone'' reinsurer must be a kind of Fort Knox, prepared occasionally, without calling on any other reinsurers for help, to pay out in a single year many times more than premiums coming in, as it covers losses from some super catastrophe worse than Hurricane Andrew. In short, it needs a balance sheet a lot like Wes-FIC's. In connection with the retrocessions of super-cat reinsurance to Wes-FIC from the Berkshire Hathaway Insurance Group, the nature of the situation as it has evolved is such that Berkshire Hathaway, owning 100% of its Insurance Group and only 80% of Wesco and Wes-FIC, does not, for some philanthropic reason, ordinarily retrocede to Wes-FIC any reinsurance business that Berkshire Hathaway considers desirable and that is available only in amounts below what Berkshire Hathaway wants for itself on the terms oÅered. Instead, retrocessions occur only occasionally, under limited conditions and with some compensation to Berkshire Hathaway.

Such retrocessions ordinarily happen only when (1) Berkshire Hathaway, for some reason (usually a policy of overall risk limitation), desires lower amounts of business than are available on the terms oÅered and (2) Wes-FIC has adequate capacity to bear the risk assumed and (3) Wes-FIC pays a fair ceding commission designed to cover part of the cost of getting and managing insurance business.

Generally, Berkshire Hathaway, in dealing with partly owned subsidiaries, tries to lean over a little backward in an attempt to observe what Justice Cardozo called ""the punctilio of an honor the most sensitive,'' but it cannot be expected to make large and plain giveaways of Berkshire Hathaway assets or business to a partially owned subsidiary like Wes-FIC. Given Berkshire Hathaway's unwillingness to make plain giveaways to Wes-FIC and reductions in opportunities in the super-cat reinsurance market in recent years, prospects are often poor for Wes-FIC's acquisition of retroceded super-cat reinsurance. Moreover, Wesco shareholders should continue to realize that super-cat rein- surance is not for the faint of heart. A huge variation in annual results, with some very unpleasant future years for Wes-FIC, is inevitable. But it is precisely what must, in the nature of things, be associated with these bad possibilities, with their huge and embarrassing adverse consequences in occa- sional years, that makes Wes-FIC like its way of being in the super-cat business. Buyers (particularly wise buyers) of super-cat reinsurance often want to deal with Berkshire Hathaway subsidiaries (possessing as they do the highest possible credit ratings and a reliable corporate personality) instead of other reinsurers less cautious, straightforward and well endowed.

And many competing sellers of super-cat reinsur- ance are looking for a liberal ""intermediary's'' proÑt, hard to get because they must Ñnd a ""layoÅ'' reinsurer both (1) so smart that it is sure to stay strong enough to pay possible losses yet (2) so casual about costs that it is not much bothered by a liberal proÑt earned by some intermediary entity not willing to retain any major risk. Thus the forces in place can rationally be expected to cause acceptable long-term results for well-Ñnanced, disciplined decision makers, despite horrible losses in some years and other years of restricted opportunity to write business. And, again, we wish to repeat that we expect only acceptable long-term results. We see no possibility for bonanza. It should also be noted that Wes-FIC, in the arrangements with the Insurance Group of Berkshire Hathaway, receives a special business-acquisition advantage from using Berkshire Hathaway's general reputation. Under all the circumstances, the 3% ceding commission now being paid seems more than fair to Wes-FIC. Certainly and obviously, Berkshire Hathaway would not oÅer terms so good to any other entity outside the Berkshire Hathaway aÇliated group. Finally, we repeat an important disclosure about Wes-FIC's super-cat-reinsur- ance-acquisition mechanics. It is impractical to have people in California make complex accept-or-reject decisions for Wes-FIC when retrocessions of reinsurance are oÅered by the Berkshire Hathaway Insurance Group.

Hathaway subsidiaries. Each retrocession is to be accepted forthwith in writing in Nebraska by agents of Wes-FIC who are at the same time salaried employees of wholly owned subsidiaries of Berkshire Hathaway. Moreover, each retrocession will be made at a 3%-of-premiums ceding commission. Finally, two conditions must be satisÑed: (1) Wes-FIC must get 20% or less of the risk (before taking into account eÅects from the ceding commission) and (2) wholly owned Berkshire Hathaway subsidiaries must retain at least 80% of the identical risk (again, without taking into account eÅects from the ceding commission). We will not ordinarily describe individual super-cat reinsurance contracts in full detail to Wesco shareholders. That would be contrary to our competitive interest. Instead, we will try to summarize reasonably any items of very large importance. Will more reinsurance be later available to Wes-FIC through Berkshire Hathaway subsidiaries on the basis and using the automatic procedure we have above described? Well, we have often proved poor prognosticators. We can only say that we hope so and that more reinsurance should come, albeit irregularly and with long intermissions. No new contracts became available to Wes-FIC in 1998. As of 1998 yearend, the one remaining super-cat contract, plus one other contract, not a super-cat contract, represented Wes-FIC's active reinsurance business.

We continue to examine other possible insurance-writing opportunities, and also insurance company acquisitions, like and unlike the purchase of KBS. Wes-FIC is now a very strong insurance company, with very low costs, and, one way or another, in the future as in the past, we expect to continue to Ñnd and seize at least a few sensible insurance opportunities. On super-cat reinsurance accepted by Wes-FIC to date (March 8, 1999) there has been no loss whatsoever that we know of, but some ""no-claims'' contingent commissions have been paid to original cessors of business (i.e., cessors not including Berkshire Hathaway). Super-cat underwriting proÑt of $1.4 million, before taxes, beneÑted 1998 earnings, versus $2.3 million in 1997. The balance of pre-tax underwriting proÑt amounted to $1.9 million for 1998 and $2.8 million for 1997. These Ñgures came mostly from favorable revision of loss reserves on the old Fireman's Fund contract. The Kansas Bankers Surety Company (""KBS'') KBS, purchased by Wes-FIC in 1996 for approximately $80 million in cash, contributed $4,987,000 to the normal net operating income of the insurance businesses in 1998 and $6,044,000 in 1997, after reductions for goodwill amortiza- tion under consolidated accounting convention of $782,000 each year. The results of KBS have been combined with those of Wes-FIC, and are included in the foregoing table in the category, "" 'normal' net operating income of Wes-FIC and KBS insurance businesses.''

changing needs of the banking industry. Today its customer base, consisting mostly of small and medium-sized community banks, is spread throughout 25 mainly midwestern states. In addition to bank deposit guaranty bonds which insure deposits in excess of FDIC coverage, KBS also oÅers directors and oÇcers indemnity policies, bank employment practices policies, bank annuity and mutual funds indemnity policies and bank insurance agents professional errors and omissions indemnity policies. The principal change in KBS's operations in 1998 was a large reduction in insurance premiums ceded to reinsurers, eÅective January 1, 1998. The increased volume of business retained (94% in 1998 versus 58% in 1997) accompanied reduced underwriting income during 1998. However, KBS's combined ratio re- mained much better than average for insurers, at 62.2% for 1998, versus 37.2% for 1997 and 29.3% for 1996, and we expect volatile but favorable long-term eÅects from increased insurance retained. Part of KBS's continuing insurance volume is now ceded through reinsurance to other Berkshire subsidiaries under reinsurance arrange- ments whereunder such other Berkshire subsidiaries take 50% and unrelated reinsur- ers take the other 50%. KBS is run by Donald Towle, President, assisted by 15 dedicated oÇcers and employees.

Convertible Preferred Stockholdings At the end of 1998, Wesco and its subsidiaries owned $20,000,000, at original cost, in convertible preferred stock which by merger of Travelers and Citicorp late in 1998 became convertible preferred stock of Citigroup. The Travelers preferred stock, itself, was received in 1997 (see the preceding section) in exchange for the Wesco group's remaining shares of Salomon preferred stock, which originally cost $20,000,000, and whose cost was adjusted upwards to $45,000,000 as of the date of the exchange. The issue requires redemption at par value of $20,000,000 on October 31, 1999, if not converted to 892,105 shares of common stock before that date. The investment is carried on Wesco's consolidated balance sheet at fair value of $44,000,000 as of December 31, 1998, the approximate market value of the common shares at that date, with the $1,000,000 diÅerence between its adjusted cost and market value deducted from shareholders' equity, net of income tax eÅect, without aÅecting reported net income, according to accounting convention. The convertible preferred stock was obtained at the same time Wesco's parent corpora- tion, Berkshire Hathaway, obtained additional amounts of the same stock at the same price per share. Through yearend 1997, Wesco's consolidated Ñnancial statements reÖected an investment in 9.25% convertible preferred stock of US Airways Group, Inc.

Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier.continues

plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, been widening in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for invest- ment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. We are not now pessimists, on a long-term basis, about business expansion. Despite present super-ebullient markets for entire businesses, making it hard for Wesco to Ñnd attractive opportunities, we do not believe that such opportunities will never come. On January 13, 1999 Wesco increased its regular dividend from 28¥ cents per share to 29¥ cents per share, payable March 10, 1999, to shareholders of record as of the close of business on February 10, 1999. This annual report contains Form 10-K, a report Ñled with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries as well as audited Ñnancial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Charles T. Munger Chairman of the Board March 8, 1999

At the 1997 Berkshire annual meeting, Buffett and Munger were asked to explain how they decided whether to buy a business. The afternoon session produced one of the clearest distillations of the joint filter the two men applied. The first cut was whether they could genuinely understand the business - not the stock, not the industry narrative, but the unit economics, the moat, and the trajectory of intrinsic value over a decade. If that test was failed, they moved on without remorse. Munger's contribution to the answer was characteristically about the negative space. The discipline was less about saying yes to the right business and more about saying no to the wrong ones, fast. He told the audience that they did not have a list of businesses they wanted to be in; they had a list of businesses they refused to be in. The screening-by-exclusion was the actual operating system. Most deals, in most years, did not pass the first screen. The second cut was management. They had to be people Buffett and Munger would trust to run the business correctly without supervision - not people they would have to monitor, but people they could empower and leave alone. Munger's standard for managers was character first, judgment second, energy third. He told the room that you could not fix a character problem with compensation, and you could not fix a judgment problem with effort. The filter was severe, which was the whole point of having a filter at all.

Munger used the 1997 platform to restate what he considered Berkshire's single most underappreciated advantage: the willingness to do less. He had tried, he said, never to operate under the illusion that he could hire a bunch of bright young people and have them know more than anybody about every industry under the sun. The honest framing was that with very hard work he and Buffett could find a few things where they were right, and the few things were enough. That was a reasonable expectation. Anything more ambitious than that, Munger suggested, was self-flattery. He contrasted Berkshire's approach with the institutional investor's approach. The fund manager was paid to be in the market, paid to have a view, paid to look active. Berkshire was paid by no one to be active. It could sit. It could go years without a serious move, then move aggressively when the rare opportunity arrived. The structural asymmetry - Berkshire had no benchmark to defend, no client to appease, no quarterly questionnaire to answer - was, in Munger's view, the single most underrated edge in long-term investing. He connected the do-less philosophy to position sizing. When the rare opportunity did arrive, the discipline was to size it correctly. A great idea deserves serious capital. Munger told the room that the temptation, when the world is calm, was to spread bets in the name of safety; the temptation, when the world is in crisis, was to small-size the great opportunity in the name of risk management. Both temptations were to be resisted. The whole trick was recognizing the rare fat pitch and then swinging hard.

The Kansas Bankers Surety Company (""KBS'') following its purchase by Wes-FIC early in the third quarter of 1996. The purchase of KBS is discussed in the section, ""The Kansas Bankers Surety Company,'' below. At the end of 1997 Wes-FIC retained about $27.5 million in invested assets, oÅset by claims reserves, from its former reinsurance arrangement with Fireman's Fund Group. This arrangement was terminated August 31, 1989. However, it will take a long time before all claims are settled, and, meanwhile, Wes-FIC is being helped over many years by proceeds from investing ""Öoat.'' We previously informed shareholders that Wes-FIC had entered into the busi- ness of super-cat reinsurance through retrocessions from the Insurance Group of Berkshire Hathaway, Wesco's ultimate parent. Wes-FIC's entry into the super-cat reinsurance business early in 1994 followed the large augmentation of its claims- paying capacity caused by its merger with Mutual Savings, the former savings and loan subsidiary of Wesco. In 1994, in recognition of Wes-FIC's sound Ñnancial condition, Standard and Poor's Corporation assigned to Wes-FIC the highest possible claims-paying-ability rating: AAA. The super-cat reinsurance business, in which Wes-FIC is engaged, continues to be a very logical business for Wes-FIC. Wes-FIC has a large net worth in relation to annual premiums being earned.

And this is exactly the condition rationally required for any insurance company planning to be a ""stand alone'' reinsurer covering super- catastrophe risks it can't safely pass on to others sure to remain solvent if a large super-catastrophe comes. Such a ""stand alone'' reinsurer must be a kind of Fort Knox, prepared occasionally, without calling on any other reinsurers for help, to pay out in a single year many times more than premiums coming in, as it covers losses from some super catastrophe worse than Hurricane Andrew. In short, it needs a balance sheet a lot like Wes-FIC's. In connection with the retrocessions of super-cat reinsurance to Wes-FIC from the Berkshire Hathaway Insurance Group, the nature of the situation as it has evolved is such that Berkshire Hathaway, owning 100% of its Insurance Group and only 80% of Wesco and Wes-FIC, does not, for some philanthropic reason, ordinarily retrocede to Wes-FIC any reinsurance business that Berkshire Hathaway considers desirable and that is available only in amounts below what Berkshire Hathaway wants for itself on the terms oÅered. Instead, retrocessions occur only occasionally, under limited conditions and with some compensation to Berkshire Hathaway.

Such retrocessions ordinarily happen only when (1) Berkshire Hathaway, for some reason (usually a policy of overall risk limitation), desires lower amounts of business than are available on the terms oÅered and (2) Wes-FIC has adequate capacity to bear the risk assumed and (3) Wes-FIC pays a fair ceding commission designed to cover part of the cost of getting and managing insurance business.make

large and plain giveaways of Berkshire Hathaway assets or business to a partially owned subsidiary like Wes-FIC. Given Berkshire Hathaway's unwillingness to make plain giveaways to Wes-FIC and reductions in opportunities in the super-cat reinsurance market in recent years, prospects are often poor for Wes-FIC's acquisition of retroceded super-cat reinsurance. Moreover, Wesco shareholders should continue to realize that super-cat rein- surance is not for the faint of heart. A huge variation in annual results, with some very unpleasant future years for Wes-FIC, is inevitable. But it is precisely what must, in the nature of things, be associated with these bad possibilities, with their huge and embarrassing adverse consequences in occasional years, that makes Wes-FIC like its way of being in the super-cat business. Buyers (particularly wise buyers) of super-cat reinsurance often want to deal with Berkshire Hathaway subsidiaries (possessing as they do the highest possible credit ratings and a reliable corporate personality) instead of other reinsurers less cautious, straightforward and well endowed.

And many competing sellers of super-cat reinsurance are looking for a liberal ""intermediary's'' proÑt, hard to get because they must Ñnd a ""layoÅ'' reinsurer both (1) so smart that it is sure to stay strong enough to pay possible losses yet (2) so casual about costs that it is not much bothered by a liberal proÑt earned by some intermediary entity not willing to retain any major risk. Thus the forces in place can rationally be expected to cause acceptable long-term results for well-Ñnanced, disciplined decision makers, despite horrible losses in some years and other years of restricted opportunity to write business. And, again, we wish to repeat that we expect only acceptable long-term results. We see no possibility for bonanza. It should also be noted that Wes-FIC, in the arrangements with the Insurance Group of Berkshire Hathaway, receives a special business-acquisition advantage from using Berkshire Hathaway's general reputation. Under all the circumstances, the 3% ceding commission now being paid seems more than fair to Wes-FIC. Certainly and obviously, Berkshire Hathaway would not oÅer terms so good to any other entity outside the Berkshire Hathaway aÇliated group. Finally, we repeat an important disclosure about Wes-FIC's super-cat-reinsur- ance-acquisition mechanics. It is impractical to have people in California make complex accept-or-reject decisions for Wes-FIC when retrocessions of reinsurance are oÅered by the Berkshire Hathaway Insurance Group.

But, happily, the Berkshire Hathaway Insurance Group executives making original business-acquisition deci- sions are greatly admired and trusted by the writer and will be ""eating their own cooking.'' Under such circumstances, Wesco's and Wes-FIC's boards of directors, on the writer's recommendation, have simply approved automatic retrocessions of reinsurance to Wes-FIC as oÅered by one or more wholly owned Berkshire Hathaway subsidiaries. Each retrocession is to be accepted forthwith in writing in Nebraska by agents of Wes-FIC who are at the same time salaried employees of wholly owned subsidiaries of Berkshire Hathaway. Moreover, each retrocession will be made at a 3%-of-premiums ceding commission.be

satisÑed: (1) Wes-FIC must get 20% or less of the risk (before taking into account eÅects from the ceding commission) and (2) wholly owned Berkshire Hathaway subsidiaries must retain at least 80% of the identical risk (again, without taking into account eÅects from the ceding commission). We will not ordinarily describe individual super-cat reinsurance contracts in full detail to Wesco shareholders. That would be contrary to our competitive interest. Instead, we will try to summarize reasonably any items of very large importance. Will more reinsurance be later available to Wes-FIC through Berkshire Hathaway subsidiaries on the basis and using the automatic procedure we have above described? Well, we have often proved poor prognosticators. We can only say that we hope so and that more reinsurance should come, albeit irregularly and with long intermissions. No new contracts became available to Wes-FIC in 1997, although one super-cat contract of three-years' duration, written in 1996, became eÅective in January 1997, and another expired during the year. As of 1997 yearend, the one remaining super-cat contract, plus one other contract, not a super-cat contract, and renewed during the year, represented Wes-FIC's active reinsurance business. We continue to examine other possible insurance-writing opportunities, and also insurance company acquisitions, like and unlike the purchase of KBS.

Wes-FIC is now a very strong insurance company, with very low costs, and, one way or another, in the future as in the past, we expect to continue to Ñnd and seize at least a few sensible insurance opportunities. On super-cat reinsurance accepted by Wes-FIC to date (March 9, 1998) there has been no loss whatsoever that we know of, but some ""no-claims'' contingent commissions have been paid to original cessors of business (i.e., cessors not including Berkshire Hathaway). Super-cat underwriting proÑt of $2.3 million, before taxes, beneÑted 1997 earnings, versus $3.9 million in 1996. The balance of pre-tax underwriting proÑt, amounting to $2.8 million for 1997, came mostly from favorable revision of loss reserves on the old Fireman's Fund contract. Our accounting policy requires contract expiration before super-cat underwriting proÑt is recognized. Needless to say, we would not have similar reluctance to report losses before contract expirations. The Kansas Bankers Surety Company (""KBS'') KBS, purchased by Wes-FIC early in the third quarter of 1996 for approximately $80 million in cash, contributed $6,044,000 to the normal net operating income of the insurance businesses in 1997 and $2,288,000 in 1996, after reductions for goodwill amortization under consolidated accounting convention of $508,000, after taxes, in 1997 and $275,000 in 1996.

The investments are carried on Wesco's consolidated balance sheet at fair value, with any diÅerence between adjusted cost and market value included in sharehold- ers' equity, net of income tax eÅect, without aÅecting reported net income, accord- ing to accounting convention. Following is a summary of these investments in convertible preferred stocks at yearend 1997: Conversion Price 12/31/97 at Which Par Market Price Yearend Preferred Par Value Value May Be of Common Carrying Dividend of Exchanged for Stock on Value of Security Rate Holding Common Stock 12/31/97 Holding Travelers Group Inc. ÏÏÏ 9.00% $40 Million $22.42 $53.875 $ 96 Million US Airways Group, Inc. 9.25% 12 Million 38.74 62.50 19.2 Million These convertible preferred stocks were obtained at the same time Wesco's parent corporation, Berkshire Hathaway, obtained additional amounts of the same stocks at the same price per share. The preferred stock of Travelers was obtained in exchange for the remaining shares of preferred stock of Salomon Inc which Wesco and its subsidiaries had acquired in 1987. On October 31, 1995, in accordance with the terms of its convertible preferred stock, Salomon redeemed $20 million par value of its preferred shares owned by Wesco at cost plus accrued dividends.

Thus, if the value of the advantage from the interest-free tax-deferral ""loan'' present was $25 per Wesco share at yearend 1997, and after-tax liquidating value was then about $248 per share (Ñgures that seem rational to the writer), Wesco's intrinsic value per share would become about $273 per share at yearend 1997, up 39% from intrinsic value as guessed in a similar calculation at the end of 1996. And, Ñnally, this reasonable-to-this-writer, $273-per-share Ñgure for intrinsic per share value of Wesco stock should be compared with the $300 per share price at which Wesco stock was selling on December 31, 1997. This comparison indicates that Wesco stock was then selling about 10% above intrinsic value. As Wesco's unrealized appreciation has continued to grow in frothy markets for securities, it should be remembered that it is subject to market Öuctuation, possibly dramatic on the downside, with no guaranty as to its ultimate full realization. Unrealized after-tax appreciation represents 73% of Wesco's shareholders' equity at 1997 yearend), versus 70% and 63% one and two years earlier. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier.

Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, been widening in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for invest- ment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. We are not now pessimists, on a long-term basis, about business expansion. Despite present super-ebullient markets for entire businesses, making it hard for Wesco to Ñnd attractive opportunities, we do not believe that such opportunities will never come. On January 28, 1998 Wesco increased its regular dividend from 27¥ cents per share to 28¥ cents per share, payable March 11, 1998, to shareholders of record as of the close of business on February 11, 1998. This annual report contains Form 10-K, a report Ñled with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries as well as audited Ñnancial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Charles T.1998

Buffett wrote that he could not promise that Berkshire's managers would never make mistakes, but that he could promise that the firm would never knowingly tolerate conduct intended to mislead regulators, customers, or the public. He argued that an institution's culture is set by what its leadership tolerates, and that the single most reliable predictor of future conduct is the conduct leadership has already excused.

On the standard for institutional culture.

Buffett published his first detailed account of his own mistakes. He distinguished errors of commission — buying a business that turned out badly — from errors of omission, the opportunities he saw and failed to act on. He argued that omission errors are invisible in the financial statements but are often the largest in dollar terms, and that the remedy is to act decisively when conviction is genuine.

On mistakes of omission vs commission.

Buffett argued that a business that must continuously reinvest to stay competitive — a textile mill, an airline — reports earnings that are economically fictional for the owner, because the cash never reaches the owner; it is consumed by the business itself. The test is whether a dollar of retained earnings eventually produces more than a dollar of market value. If not, the business is destroying capital regardless of what its income statement says.

Connecting owner earnings to the retained-earnings test.

Buffett explained that the textile business had been a chronic disappointment despite capable management. The problem was structural: the industry's economics — commodity output, intense competition, heavy reinvestment merely to stay even — overwhelmed the efforts of honest operators. He closed the operation rather than continue pouring capital into a business that could not earn an adequate return, framing it as a lesson that a bad business is not redeemed by good people.

On closing the original Berkshire textile mills; the founding mistake of the Berkshire name.

To the Shareholders of Berkshire Hathaway Inc.: Operating earnings improved to $41.9 million in 1980 from $36.0 million in 1979, but return on beginning equity capital (with securities valued at cost) fell to 17.8% from 18.6%. We believe the latter yardstick to be the most appropriate measure of single-year managerial economic performance. Informed use of that yardstick, however, requires an understanding of many factors, including accounting policies, historical carrying values of assets, financial leverage, and industry conditions.

Generally accepted accounting principles require (subject to exceptions, naturally, as with our former bank subsidiary) full consolidation of sales, expenses, taxes, and earnings of business holdings more than 50% owned. Blue Chip Stamps, 60% owned by Berkshire Hathaway Inc., falls into this category. Therefore, all Blue Chip income and expense items are included in full in Berkshire's Consolidated Statement of Earnings, with the 40% ownership interest of others in Blue Chip's net earnings reflected in the Statement as a deduction for 'minority interest'.

Full inclusion of underlying earnings from another class of holdings, companies owned 20% to 50% (usually called 'investees'), also normally occurs. Earnings from such companies - for example, Wesco Financial, controlled by Berkshire but only 48% owned - are included via a one-line entry in the owner's Statement of Earnings. Unlike the over-50% category, all items of revenue and expense are omitted; just the proportional share of net income is included. Thus, if Corporation A owns one-third of Corporation B, one-third of B's earnings, whether or not distributed by B, will end up in A's earnings. There are some modifications, both in this and the over-50% category, for intercorporate taxes and purchase price adjustments, the explanation of which we will save for a later day. (We know you can hardly wait.)

We impose this short - and over-simplified - course in accounting upon you because Berkshire's concentration of resources in the insurance field produces a corresponding concentration of its assets in companies in that third (less than 20% owned) category. Many of these companies pay out relatively small proportions of their earnings in dividends. This means that only a small proportion of their current earning power is recorded in our own current operating earnings. But, while our reported operating earnings reflect only the dividends received from such companies, our economic well-being is determined by their earnings, not their dividends.

Our holdings in this third category of companies have increased dramatically in recent years as our insurance business has prospered and as securities markets have presented particularly attractive opportunities in the common stock area. The large increase in such holdings, plus the growth of earnings experienced by those partially-owned companies, has produced an unusual result; the part of 'our' earnings that these companies retained last year (the part not paid to us in dividends) exceeded the total reported annual operating earnings of Berkshire Hathaway. Thus, conventional accounting only allows less than half of our earnings 'iceberg' to appear above the surface, in plain view. Within the corporate world such a result is quite rare; in our case it is likely to be recurring.

The value to Berkshire Hathaway of retained earnings is not determined by whether we own 100%, 50%, 20% or 1% of the businesses in which they reside. Rather, the value of those retained earnings is determined by the use to which they are put and the subsequent level of earnings produced by that usage. This is true whether we determine the usage, or whether managers we did not hire - but did elect to join - determine that usage. (It's the act that counts, not the actors.) And the value is in no way affected by the inclusion or non-inclusion of those retained earnings in our own reported operating earnings. If a tree grows in a forest partially owned by us, but we don't record the growth in our financial statements, we still own part of the tree.

In the sixteen years since present management assumed responsibility for Berkshire, book value per share with insurance-held equities valued at market has increased from $19.46 to $400.80, or 20.5% compounded annually. (You've done better: the value of the mineral content in the human body compounded at 22% annually during the past decade.) It is encouraging, moreover, to realize that our record was achieved despite many mistakes. The list is too painful and lengthy to detail here. But it clearly shows that a reasonably competitive corporate batting average can be achieved in spite of a lot of managerial strikeouts.

As we said last year, Berkshire has no corporate solution to the problem. (We'll say it again next year, too.) Inflation does not improve our return on equity. Indexing is the insulation that all seek against inflation. But the great bulk (although there are important exceptions) of corporate capital is not even partially indexed. Of course, earnings and dividends per share usually will rise if significant earnings are 'saved' by a corporation; i.e., reinvested instead of paid as dividends. But that would be true without inflation. A thrifty wage earner, likewise, could achieve regular annual increases in his total income without ever getting a pay increase - if he were willing to take only half of his paycheck in cash (his wage 'dividend') and consistently add the other half (his 'retained earnings') to a savings account. Neither this high- saving wage earner nor the stockholder in a high-saving corporation whose annual dividend rate increases while its rate of return on equity remains flat is truly indexed.

For capital to be truly indexed, return on equity must rise, i.e., business earnings consistently must increase in proportion to the increase in the price level without any need for the business to add to capital - including working capital - employed. (Increased earnings produced by increased investment don't count.) Only a few businesses come close to exhibiting this ability. And Berkshire Hathaway isn't one of them.

We, of course, have a corporate policy of reinvesting earnings for growth, diversity and strength, which has the incidental effect of minimizing the current imposition of explicit taxes on our owners. However, on a day-by-day basis, you will be subjected to the implicit inflation tax, and when you wish to transfer your investment in Berkshire into another form of investment, or into consumption, you also will face explicit taxes.

The table below shows the sources of Berkshire's reported earnings. Berkshire owns about 60% of Blue Chip Stamps, which in turn owns 80% of Wesco Financial Corporation. The table shows aggregate earnings of the various business entities, as well as Berkshire's share of those earnings. All of the significant capital gains and losses attributable to any of the business entities are aggregated in the realized securities gains figure at the bottom of the table, and are not included in operating earnings. Our calculation of operating earnings also excludes the gain from sale of Mutual's branch offices. In this respect it differs from the presentation in our audited financial statements that includes this item in the calculation of 'Earnings Before Realized Investment Gain'.

Blue Chip Stamps and Wesco are public companies with reporting requirements of their own. On pages 40 to 53 of this report we have reproduced the narrative reports of the principal executives of both companies, in which they describe 1980 operations. We recommend a careful reading, and suggest that you particularly note the superb job done by Louie Vincenti and Charlie Munger in repositioning Mutual Savings and Loan. A copy of the full annual report of either company will be mailed to any Berkshire shareholder upon request to Mr. Robert H. Bird for Blue Chip Stamps, 5801 South Eastern Avenue, Los Angeles, California 90040, or to Mrs. Bette Deckard for Wesco Financial Corporation, 315 East Colorado Boulevard, Pasadena, California 91109.

As indicated earlier, undistributed earnings in companies we do not control are now fully as important as the reported operating earnings detailed in the preceding table. The distributed portion, of course, finds its way into the table primarily through the net investment income section of Insurance Group earnings. We show below Berkshire's proportional holdings in those non-controlled businesses for which only distributed earnings (dividends) are included in our own earnings.

(a) All owned by Berkshire or its insurance subsidiaries. (b) Blue Chip and/or Wesco own shares of these companies. All numbers represent Berkshire's net interest in the larger gross holdings of the group. From this table, you can see that our sources of underlying earning power are distributed far differently among industries than would superficially seem the case. For example, our insurance subsidiaries own approximately 3% of Kaiser Aluminum, and 1 1/4% of Alcoa. Our share of the 1980 earnings of those companies amounts to about $13 million. (If translated dollar for dollar into a combination of eventual market value gain and dividends, this figure would have to be reduced by a significant, but not precisely determinable, amount of tax; perhaps 25% would be a fair assumption.) Thus, we have a much larger economic interest in the aluminum business than in practically any of the operating businesses we control and on which we report in more detail. If we maintain our holdings, our long-term performance will be more affected by the future economics of the aluminum industry than it will by direct operating decisions we make concerning most companies over which we exercise managerial control.

Of course, whether or not the undistributed earnings of GEICO are picked up annually in our operating earnings figure has nothing to do with their economic value to us, or to you as owners of Berkshire. The value of these retained earnings will be determined by the skill with which they are put to use by GEICO management. On this score, we simply couldn't feel better. GEICO represents the best of all investment worlds - the coupling of a very important and very hard to duplicate business advantage with an extraordinary management whose skills in operations are matched by skills in capital allocation.

As you can see, our holdings cost us $47 million, with about half of this amount invested in 1976 and most of the remainder invested in 1980. At the present dividend rate, our reported earnings from GEICO amount to a little over $3 million annually. But we estimate our share of its earning power is on the order of $20 million annually. Thus, undistributed earnings applicable to this holding alone may amount to 40% of total reported operating earnings of Berkshire.

Our Workers Compensation operation suffered a severe loss when Frank DeNardo died last year at 37. Frank instinctively thought like an underwriter. He was a superb technician and a fierce competitor; in short order he had straightened out major problems at the California Workers Compensation Division of National Indemnity. Dan Grossman, who originally brought Frank to us, stepped in immediately after Frank's death to continue that operation, which now utilizes Redwood Fire and Casualty, another Berkshire subsidiary, as the insuring vehicle.

Disposition of Illinois National Bank and Trust of Rockford On December 31, 1980 we completed the exchange of 41,086 shares of Rockford Bancorp Inc. (which owns 97.7% of Illinois National Bank) for a like number of shares of Berkshire Hathaway Inc. Our method of exchange allowed all Berkshire shareholders to maintain their proportional interest in the Bank (except for me; I was permitted 80% of my proportional share). They were thus guaranteed an ownership position identical to that they would have attained had we followed a more conventional spinoff approach. Twenty-four shareholders (of our approximate 1300) chose this proportional exchange option.

We also allowed overexchanges, and thirty-nine additional shareholders accepted this option, thereby increasing their ownership in the Bank and decreasing their proportional ownership in Berkshire. All got the full amount of Bancorp stock they requested, since the total shares desired by these thirty-nine holders was just slightly less than the number left available by the remaining 1200-plus holders of Berkshire who elected not to part with any Berkshire shares at all. As the exchanger of last resort, I took the small balance (3% of Bancorp's stock). These shares, added to shares I received from my basic exchange allotment (80% of normal), gave me a slightly reduced proportional interest in the Bank and a slightly enlarged proportional interest in Berkshire.

The managing underwriters, Donaldson, Lufkin & Jenrette Securities Corporation, represented by Bill Fisher, and Chiles, Heider & Company, Inc., represented by Charlie Heider, did an absolutely first-class job from start to finish of the financing. Unlike most businesses, Berkshire did not finance because of any specific immediate needs. Rather, we borrowed because we think that, over a period far shorter than the life of the loan, we will have many opportunities to put the money to good use. The most attractive opportunities may present themselves at a time when credit is extremely expensive - or even unavailable. At such a time we want to have plenty of financial firepower.

Businesses meeting our standards are not easy to find. (Each year we read of hundreds of corporate acquisitions; only a handful would have been of interest to us.) And logical expansion of our present operations is not easy to implement. But we'll continue to utilize both avenues in our attempts to further Berkshire's growth. Under all circumstances we plan to operate with plenty of liquidity, with debt that is moderate in size and properly structured, and with an abundance of capital strength. Our return on equity is penalized somewhat by this conservative approach, but it is the only one with which we feel comfortable.

To the Shareholders of Berkshire Hathaway Inc.: Again, we must lead off with a few words about accounting. Since our last annual report, the accounting profession has decided that equity securities owned by insurance companies must be carried on the balance sheet at market value. We previously have carried such equity securities at the lower of aggregate cost or aggregate market value. Because we have large unrealized gains in our insurance equity holdings, the result of this new policy is to increase substantially both the 1978 and 1979 yearend net worth, even after the appropriate liability is established for taxes on capital gains that would be payable should equities be sold at such market valuations.

As you know, Blue Chip Stamps, our 60% owned subsidiary, is fully consolidated in Berkshire Hathaway's financial statements. However, Blue Chip still is required to carry its equity investments at the lower of aggregate cost or aggregate market value, just as Berkshire Hathaway's insurance subsidiaries did prior to this year. Should the same equities be purchased at an identical price by an insurance subsidiary of Berkshire Hathaway and by Blue Chip Stamps, present accounting principles often would require that they end up carried on our consolidated balance sheet at two different values. (That should keep you on your toes.) Market values of Blue Chip Stamps' equity holdings are given in footnote 3 on page 18.

The book value per share of Berkshire Hathaway on September 30, 1964 (the fiscal yearend prior to the time that your present management assumed responsibility) was $19.46 per share. At yearend 1979, book value with equity holdings carried at market value was $335.85 per share. The gain in book value comes to 20.5% compounded annually. This figure, of course, is far higher than any average of our yearly operating earnings calculations, and reflects the importance of capital appreciation of insurance equity investments in determining the overall results for our shareholders. It probably also is fair to say that the quoted book value in 1964 somewhat overstated the intrinsic value of the enterprise, since the assets owned at that time on either a going concern basis or a liquidating value basis were not worth 100 cents on the dollar. (The liabilities were solid, however.)

If we should continue to achieve a 20% compounded gain - not an easy or certain result by any means - and this gain is translated into a corresponding increase in the market value of Berkshire Hathaway stock as it has been over the last fifteen years, your after-tax purchasing power gain is likely to be very close to zero at a 14% inflation rate. Most of the remaining six percentage points will go for income tax any time you wish to convert your twenty percentage points of nominal annual gain into cash.

One friendly but sharp-eyed commentator on Berkshire has pointed out that our book value at the end of 1964 would have bought about one-half ounce of gold and, fifteen years later, after we have plowed back all earnings along with much blood, sweat and tears, the book value produced will buy about the same half ounce. A similar comparison could be drawn with Middle Eastern oil. The rub has been that government has been exceptionally able in printing money and creating promises, but is unable to print gold or create oil.

We intend to continue to do as well as we can in managing the internal affairs of the business. But you should understand that external conditions affecting the stability of currency may very well be the most important factor in determining whether there are any real rewards from your investment in Berkshire Hathaway. We again present a table showing the sources of Berkshire's earnings. As explained last year, Berkshire owns about 60% of Blue Chip Stamps which, in turn, owns 80% of Wesco Financial Corporation. The table shows both aggregate earnings of the various business entities, as well as Berkshire's share. All of the significant capital gains or losses attributable to any of the business entities are aggregated in the realized securities gain figure at the bottom of the table, and are not included in operating earnings.

A copy of the full annual report of either company will be mailed to any shareholder of Berkshire upon request to Mr. Robert H. Bird for Blue Chip Stamps, 5801 South Eastern Avenue, Los Angeles, California 90040, or to Mrs. Bette Deckard for Wesco Financial Corporation, 315 East Colorado Boulevard, Pasadena, California 91109. The relative significance of these two areas has diminished somewhat over the years as our insurance business has grown dramatically in size and earnings. Ben Rosner, at Associated Retail Stores, continues to pull rabbits out of the hat - big rabbits from a small hat. Year after year, he produces very large earnings relative to capital employed - realized in cash and not in increased receivables and inventories as in many other retail businesses - in a segment of the market with little growth and unexciting demographics. Ben is now 76 and, like our other 'up-and-comers', Gene Abegg, 82, at Illinois National and Louis Vincenti, 74, at Wesco, regularly achieves more each year.

And, of course, there is the possibility that our present analysis is much too negative. The chances for very low rates of inflation are not nil. Inflation is man-made; perhaps it can be man-mastered. The threat which alarms us may also alarm legislators and other powerful groups, prompting some appropriate response. Furthermore, present interest rates incorporate much higher inflation projections than those of a year or two ago. Such rates may prove adequate or more than adequate to protect bond buyers. We even may miss large profits from a major rebound in bond prices. However, our unwillingness to fix a price now for a pound of See's candy or a yard of Berkshire cloth to be delivered in 2010 or 2020 makes us equally unwilling to buy bonds which set a price on money now for use in those years. Overall, we opt for Polonius (slightly restated): 'Neither a short-term borrower nor a long-term lender be.'

This will be the last year that we can report on the Illinois National Bank and Trust Company as a subsidiary of Berkshire Hathaway. Therefore, it is particularly pleasant to report that, under Gene Abegg's and Pete Jeffrey's management, the bank broke all previous records and earned approximately 2.3% on average assets last year, a level again over three times that achieved by the average major bank, and more than double that of banks regarded as outstanding. The record is simply extraordinary, and the shareholders of Berkshire Hathaway owe a standing ovation to Gene Abegg for the performance this year and every year since our purchase in 1969.

As you know, the Bank Holding Company Act of 1969 requires that we divest the bank by December 31, 1980. For some years we have expected to comply by effecting a spin-off during 1980. However, the Federal Reserve Board has taken the firm position that if the bank is spun off, no officer or director of Berkshire Hathaway can be an officer or director of the spun-off bank or bank holding company, even in a case such as ours in which one individual would own over 40% of both companies.

However, you should be aware that we do not expect to be able to fully, or even in very large part, replace the earning power represented by the bank from the proceeds of the sale of the bank. You simply can't buy high quality businesses at the sort of price/earnings multiple likely to prevail on our bank sale. During 1979, NASDAQ trading was initiated in the stock of Berkshire Hathaway This means that the stock now is quoted on the Over-the-Counter page of the Wall Street journal under 'Additional OTC Quotes'. Prior to such listing, the Wall Street journal and the Dow-Jones news ticker would not report our earnings, even though such earnings were one hundred or more times the level of some companies whose reports they regularly picked up.

Furthermore, perhaps 90% of our shares are owned by investors for whom Berkshire is their largest security holding, very often far and away the largest. Many of these owners are willing to spend a significant amount of time with the annual report, and we attempt to provide them with the same information we would find useful if the roles were reversed.

We feel that you, as owners, are entitled to the same sort of reporting by your manager as we feel is owed to us at Berkshire Hathaway by managers of our business units. Obviously, the degree of detail must be different, particularly where information would be useful to a business competitor or the like. But the general scope, balance, and level of candor should be similar. We don't expect a public relations document when our operating managers tell us what is going on, and we don't feel you should receive such a document.

We much prefer owners who like our service and menu and who return year after year. It would be hard to find a better group to sit in the Berkshire Hathaway shareholder 'seats' than those already occupying them. So we hope to continue to have a very low turnover among our owners, reflecting a constituency that understands our operation, approves of our policies, and shares our expectations. And we hope to deliver on those expectations.

This approach produces an occasional major mistake that might have been eliminated or minimized through closer operating controls. But it also eliminates large layers of costs and dramatically speeds decision-making. Because everyone has a great deal to do, a very great deal gets done. Most important of all, it enables us to attract and retain some extraordinarily talented individuals - people who simply can't be hired in the normal course of events - who find working for Berkshire to be almost identical to running their own show.

To the Shareholders of Berkshire Hathaway Inc.: First, a few words about accounting. The merger with Diversified Retailing Company, Inc. at yearend adds two new complications in the presentation of our financial results. After the merger, our ownership of Blue Chip Stamps increased to approximately 58% and, therefore, the accounts of that company must be fully consolidated in the Balance Sheet and Statement of Earnings presentation of Berkshire. In previous reports, our share of the net earnings only of Blue Chip had been included as a single item on Berkshire's Statement of Earnings, and there had been a similar one-line inclusion on our Balance Sheet of our share of their net assets.

This full consolidation of sales, expenses, receivables, inventories, debt, etc. produces an aggregation of figures from many diverse businesses - textiles, insurance, candy, newspapers, trading stamps - with dramatically different economic characteristics. In some of these your ownership is 100% but, in those businesses which are owned by Blue Chip but fully consolidated, your ownership as a Berkshire shareholder is only 58%. (Ownership by others of the balance of these businesses is accounted for by the large minority interest item on the liability side of the Balance Sheet.) Such a grouping of Balance Sheet and Earnings items - some wholly owned, some partly owned - tends to obscure economic reality more than illuminate it. In fact, it represents a form of presentation that we never prepare for internal use during the year and which is of no value to us in any management activities.

For that reason, throughout the report we provide much separate financial information and commentary on the various segments of the business to help you evaluate Berkshire's performance and prospects. Much of this segmented information is mandated by SEC disclosure rules and covered in 'Management's Discussion' on pages 29 to 34. And in this letter we try to present to you a view of our various operating entities from the same perspective that we view them managerially.

A second complication arising from the merger is that the 1977 figures shown in this report are different from the 1977 figures shown in the report we mailed to you last year. Accounting convention requires that when two entities such as Diversified and Berkshire are merged, all financial data subsequently must be presented as if the companies had been merged at the time they were formed rather than just recently. So the enclosed financial statements, in effect, pretend that in 1977 (and earlier years) the Diversified-Berkshire merger already had taken place, even though the actual merger date was December 30, 1978. This shifting base makes comparative commentary confusing and, from time to time in our narrative report, we will talk of figures and performance for Berkshire shareholders as historically reported to you rather than as restated after the Diversified merger.

With that preamble it can be stated that, with or without restated figures, 1978 was a good year. Operating earnings, exclusive of capital gains, at 19.4% of beginning shareholders' investment were within a fraction of our 1972 record. While we believe it is improper to include capital gains or losses in evaluating the performance of a single year, they are an important component of the longer term record. Because of such gains, Berkshire's long-term growth in equity per share has been greater than would be indicated by compounding the returns from operating earnings that we have reported annually.

For example, over the last three years - generally a bonanza period for the insurance industry, our largest profit producer - Berkshire's per share net worth virtually has doubled, thereby compounding at about 25% annually through a combination of good operating earnings and fairly substantial capital gains. Neither this 25% equity gain from all sources nor the 19.4% equity gain from operating earnings in 1978 is sustainable. The insurance cycle has turned downward in 1979, and it is almost certain that operating earnings measured by return on equity will fall this year. However, operating earnings measured in dollars are likely to increase on the much larger shareholders' equity now employed in the business.

To give you a better picture of just where Berkshire's earnings are produced, we show below a table which requires a little explanation. Berkshire owns close to 58% of Blue Chip which, in addition to 100% ownership of several businesses, owns 80% of Wesco Financial Corporation. Thus, Berkshire's equity in Wesco's earnings is about 46%. In aggregate, businesses that we control have about 7,000 full-time employees and generate revenues of over $500 million.

The table shows the overall earnings of each major operating category on a pre-tax basis (several of the businesses have low tax rates because of significant amounts of tax-exempt interest and dividend income), as well as the share of those earnings belonging to Berkshire both on a pre-tax and after-tax basis. Significant capital gains or losses attributable to any of the businesses are not shown in the operating earnings figure, but are aggregated on the 'Realized Securities Gain' line at the bottom of the table. Because of various accounting and tax intricacies, the figures in the table should not be treated as holy writ, but rather viewed as close approximations of the 1977 and 1978 earnings contributions of our constituent businesses.

Blue Chip and Wesco are public companies with reporting requirements of their own. Later in this report we are reproducing the narrative reports of the principal executives of both companies, describing their 1978 operations. Some of the figures they utilize will not match to the penny the ones we use in this report, again because of accounting and tax complexities. But their comments should be helpful to you in understanding the underlying economic characteristics of these important partly- owned businesses. A copy of the full annual report of either company will be mailed to any shareholder of Berkshire upon request to Mr. Robert H. Bird for Blue Chips Stamps, 5801 South Eastern Avenue, Los Angeles, California 90040, or to Mrs. Bette Deckard for Wesco Financial Corporation, 315 East Colorado Boulevard, Pasadena, California 91109.

The number one contributor to Berkshire's overall excellent results in 1978 was the segment of National Indemnity Company's insurance operation run by Phil Liesche. On about $90 million of earned premiums, an underwriting profit of approximately $11 million was realized, a truly extraordinary achievement even against the background of excellent industry conditions. Under Phil's leadership, with outstanding assistance by Roland Miller in Underwriting and Bill Lyons in Claims, this segment of National Indemnity (including National Fire and Marine Insurance Company, which operates as a running mate) had one of its best years in a long history of performances which, in aggregate, far outshine those of the industry. Present successes reflect credit not only upon present managers, but equally upon the business talents of Jack Ringwalt, founder of National Indemnity, whose operating philosophy remains etched upon the company.

We confess considerable optimism regarding our insurance equity investments. Of course, our enthusiasm for stocks is not unconditional. Under some circumstances, common stock investments by insurers make very little sense. We get excited enough to commit a big percentage of insurance company net worth to equities only when we find (1) businesses we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) priced very attractively. We usually can identify a small number of potential investments meeting requirements (1), (2) and (3), but (4) often prevents action. For example, in 1971 our total common stock position at Berkshire's insurance subsidiaries amounted to only $10.7 million at cost, and $11.7 million at market. There were equities of identifiably excellent companies available - but very few at interesting prices. (An irresistible footnote: in 1971, pension fund managers invested a record 122% of net funds available in equities - at full prices they couldn't buy enough of them. In 1974, after the bottom had fallen out, they committed a then record low of 21% to stocks.)

Earnings attributable to the shares of SAFECO owned by Berkshire at yearend amounted to $6.1 million during 1978, but only the dividends received (about 18% of earnings) are reflected in our operating earnings. We believe the balance, although not reportable, to be just as real in terms of eventual benefit to us as the amount distributed. In fact, SAFECO's retained earnings (or those of other well-run companies if they have opportunities to employ additional capital advantageously) may well eventually have a value to shareholders greater than 100 cents on the dollar.

We are required to divest our bank by December 31, 1980. The most likely approach is to spin it off to Berkshire shareholders some time in the second half of 1980. Upon merging with Diversified, we acquired 100% ownership of Associated Retail Stores, Inc., a chain of about 75 popular priced women's apparel stores. Associated was launched in Chicago on March 7, 1931 with one store, $3200, and two extraordinary partners, Ben Rosner and Leo Simon. After Mr. Simon's death, the business was offered to Diversified for cash in 1967. Ben was to continue running the business - and run it, he has.

To the Stockholders of Berkshire Hathaway Inc.: Operating earnings in 1977 of $21,904,000, or $22.54 per share, were moderately better than anticipated a year ago. Of these earnings, $1.43 per share resulted from substantial realized capital gains by Blue Chip Stamps which, to the extent of our proportional interest in that company, are included in our operating earnings figure. Capital gains or losses realized directly by Berkshire Hathaway Inc. or its insurance subsidiaries are not included in our calculation of operating earnings. While too much attention should not be paid to the figure for any single year, over the longer term the record regarding aggregate capital gains or losses obviously is of significance.

Our insurance operation continued to grow significantly in 1977. It was early in 1967 that we made our entry into this industry through the purchase of National Indemnity Company and National Fire and Marine Insurance Company (sister companies) for approximately $8.6 million. In that year their premium volume amounted to $22 million. In 1977 our aggregate insurance premium volume was $151 million. No additional shares of Berkshire Hathaway stock have been issued to achieve any of this growth.

A little digression illustrating this point may be interesting. Berkshire Fine Spinning Associates and Hathaway Manufacturing were merged in 1955 to form Berkshire Hathaway Inc. In 1948, on a pro forma combined basis, they had earnings after tax of almost $18 million and employed 10,000 people at a dozen large mills throughout New England. In the business world of that period they were an economic powerhouse. For example, in that same year earnings of IBM were $28 million (now $2.7 billion), Safeway Stores, $10 million, Minnesota Mining, $13 million, and Time, Inc., $9 million. But, in the decade following the 1955 merger aggregate sales of $595 million produced an aggregate loss for Berkshire Hathaway of $10 million. By 1964 the operation had been reduced to two mills and net worth had shrunk to $22 million, from $53 million at the time of the merger. So much for single year snapshots as adequate portrayals of a business.

We again increased our equity interest in Blue Chip Stamps, and owned approximately 36 1/2% at the end of 1977. Blue Chip had a fine year, earning approximately $12.9 million from operations and, in addition, had realized securities gains of $4.1 million. Both Wesco Financial Corp., an 80% owned subsidiary of Blue Chip Stamps, managed by Louis Vincenti, and See's Candies, a 99% owned subsidiary, managed by Chuck Huggins, made good progress in 1977. Since See's was purchased by Blue Chip Stamps at the beginning of 1972, pre-tax operating earnings have grown from $4.2 million to $12.6 million with little additional capital investment. See's achieved this record while operating in an industry experiencing practically no unit growth. Shareholders of Berkshire Hathaway Inc. may obtain the annual report of Blue Chip Stamps by requesting it from Mr. Robert H. Bird, Blue Chip Stamps, 5801 South Eastern Avenue, Los Angeles, California 90040.