Charlie Munger on Valuation

Asked at the 2023 DJCO meeting about Costco's economic moat in the long term, Munger gave the line that would become one of his most-quoted final verdicts on a business: as long as Costco kept the faith with its strong culture and extreme low mark-up policy, he didn't see any stopping it. The trouble with Costco, he said, was that it traded at forty times earnings. But except for that, he said, it was a perfect damn company. It had a marvelous future, a wonderful culture, and it had been run by wonderful people. He told the room he loved everything about Costco, that he was a total addict, and that he was never going to sell a share. The Munger formulation matters because it separated the business from the price. The business was perfect; the price was not cheap. He refused to pretend otherwise on either side. He did not say the multiple was justified by growth, and he did not say the business was a sell because of the multiple. He told the truth in two clauses: the moat is intact, the price is full. Investors who try to compress that truth into a single buy or sell call, Munger implied, are losing the actual information. The point about pricing discipline - buy wonderful businesses but don't pay any price for them - was Munger's version of Buffett's margin-of-safety principle, applied at the level of the multiple rather than the level of the asset value. He had lived by it. His own Costco position had compounded enormously and he still refused to sell; his own DJCO bank stocks he held for tax reasons even after they had multiplied many times. The discipline was never sell a great business at any price; the discipline was also never buy a great business at any price. The two had to be held together.

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.

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.

-6- investment decision making. If you happen to have a rich uncle who will sell you his business for 10 percent of what it’s worth, you don’t want to think about some other investment. If the opportunity cost is so great, considering everything else, you should forget about it. And most people don’t pay enough attention to opportunity cost. Bridge players know about opportunity cost. Poker players know about opportunity cost. But in an MBA faculty members and other important people, they hardly know their ass from a plate of hot squash. Questioner: When you try to arrive at a valuation number using the discount rate, does it mean that between the two rates–– Charlie Munger We don’t use numeric formulas that way. We take into account a whole lot of factors. It’s a multi-factor thing. And there are tradeoffs between factors. It’s just like a bridge hand. You have to think of a lot of different things at once. There’s never going to be a formula that will make you rich just by going through some horrible process. If that were true, every mathematical nerd who gets A’s in algebra would be rich. . . . So you have to be comfortable thinking about a lot of things at once, and correctly thinking about a lot of things at once. And we don’t have a formula that will help you. And all that stuff is relevant. Opportunity cost of course is crucial. And of course the risk-free rate is a . . . factor . . . Questioner: Do you use the same rate for different types of businesses?

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.

63 billion at yearend 2008, including an aggregate of $650 million, at cost, invested in the common stocks of Wells Fargo & Company and US Bancorp. The timing of our recent investments could not have been much worse. During 2008, several crises affecting the financial system and capital markets of the U.S. resulted in very large price declines in the general stock market, and in the banking sector, in particular, due significantly to the ongoing liquidity crisis as well as the deterioration of asset quality and earnings reported by the banking industry. Wesco carries its investments at fair value, with unrealized appreciation or depreci- ation, after income tax effect, included as a component of shareholders’ equity, and related deferred taxes included in income taxes payable, on its consolidated balance sheet. As indicated in the accompanying consolidated financial statements, Wesco’s net worth, as accountants compute it under their conventions, decreased to $2.38 billion ($334 per Wesco share) at yearend 2008 from $2.53 billion ($356 per Wesco share) one year earlier. The principal cause of the decrease was the after-tax decline in fair value of Wesco’s investments in marketable equity securities. As a result of further declines in fair values of these investments subsequent to yearend 2008, Wesco’s shareholders’ equity has further declined, by $303 million ($43 per share), through February 24, 2009.

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

For more information, if you want a very-high-end condominium, simply phone Bob Sahm (626-585-6700). 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 (Loss) Other operating earnings (loss), net of interest paid and general corporate expenses, amounted to ($0.1 million) in 2007, versus $0.2 million in 2006. The components of the $0.1 million of other operating loss in 2007 were (1) rents ($3.9 million gross in 2007) prin- cipally from Wesco’s Pasadena office property (leased almost entirely to outsiders, includ- ing Citibank as the ground floor tenant), and (2) interest and dividends from cash equivalents and marketable securities held outside the insurance subsidiaries, less (3) gen- eral corporate expenses plus minor expenses involving tag-end real estate. Consolidated Balance Sheet and Related Discussion Wesco carries its investments at fair value, with unrealized appreciation, after income tax effect, included as a separate component of shareholders’ equity, and related deferred taxes included in income taxes payable, on its consolidated balance sheet. As indicated in the accompanying financial statements, Wesco’s net worth, as accountants compute it under their conventions, increased to $2.53 billion ($356 per Wesco share) at yearend 2007 from $2.40 billion ($337 per Wesco share) at yearend 2006.

The main causes of the increase were net operating income after deduction of dividends paid to shareholders, and appreciation in fair value of investments. The foregoing $356-per-share book value approximates liquidation value assuming that all Wesco’s non-security assets would liquidate, after taxes, at book value.its

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 income taxes payable, on its consolidated balance sheet. Thus, the entire after-tax gain on the non-cash merger had been reÖected in the unrealized gain component of Wesco's shareholders' equity as of September 30, 2005. That amount was merely switched from unrealized gain to retained earnings, another component of shareholders' equity. This accounting entry had no economic eÅect on Wesco, and you should ignore it when you are evaluating Wesco's 2005 earnings. Consolidated Balance Sheet and Related Discussion As indicated in the accompanying Ñnancial statements, Wesco's net worth, as accountants compute it under their conventions, increased to $2.40 billion ($337 per Wesco share) at yearend 2006 from $2.23 billion ($313 per Wesco share) at yearend 2005. The main causes of the increase were appreciation in fair value of investments, and net operating income after deduction of dividends paid to shareholders. The foregoing $337-per-share book value approximates liquidation value assuming that all Wesco's non-security assets would liquidate, after taxes, at book value. Of course, so long as Wesco does not liquidate, and does not sell any appreciated securities, including the PG shares Wesco received in connection with PG's acquisition of Gillette in 2005, discussed above in the section, ""Realized Investment Gains,'' Wesco has, in eÅect, an interest-free ""loan'' from the government equal to its deferred income taxes, 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 $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.

Accounting standards promulgated by the Financial Accounting Standards Board require that the fair (market) value of shares received in such an exchange be recorded as the new cost basis as of the date of the exchange, with the difference between the new basis and the historical cost realized in the audited financial statements as an investment gain. For tax return purposes the exchange is recorded at the original cost of the securities exchanged; no gain is reported, and no taxes are yet due. Although the realized gain had a material impact on Wesco's reported earnings, it had no impact on Wesco's shareholders' equity. Wesco carries its investments at fair value, with unrealized appreciation, after income tax eÅect, included as a separate component of shareholders' equity, and related taxes included in income taxes payable, on its consolidated balance sheet. Thus, the entire after-tax gain on the non- cash merger had been reÖected in the unrealized gain component of Wesco's shareholders' equity as of September 30, 2005. That amount was merely switched from unrealized gain to retained earnings, another component of shareholders' equity. This accounting entry had no economic eÅect on Wesco, and you should ignore it when you are evaluating Wesco's 2005 earnings. Consolidated Balance Sheet and Related Discussion As indicated in the accompanying Ñnancial statements, Wesco's net worth, as accountants compute it under their conventions, increased to $2.

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.

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.

inclined to add to them. Though these enterprises have good prospects, we don't yet believe their shares are undervalued. ""In our view, the same conclusion Ñts stocks generally. Despite three years of falling prices, which have signiÑcantly improved the attractiveness of com- mon stocks, we still Ñnd very few that even mildly interest us. That dismal fact is testimony to the insanity of valuations reached during The Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge. ""The aversion to equities that ®we© exhibit today is far from congenital. We love owning common stocks Ì if they can be purchased at attractive prices. In ®my© 61 years of investing, 50 or so years have offered that kind of opportunity. There will be years like that again. Unless, however, we see a very high probability of at least 10% pre-tax returns (which translates to 61 /2-7% after corporate tax), we will sit on the sidelines. With short-term money returning less than 1% after-tax, sitting it out is no fun. But occasionally successful investing requires inactivity.'' In fact, the one thing that should interest Wesco shareholders most with respect to 2004 is that, as in 2003, 2002 and 2001, Wesco found no new common stocks for our insurance companies to buy.

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.

inclined to add to them. Though these enterprises have good prospects, we don't yet believe their shares are undervalued. ""In our view, the same conclusion Ñts stocks generally. Despite three years of falling prices, which have signiÑcantly improved the attractiveness of com- mon stocks, we still Ñnd very few that even mildly interest us. That dismal fact is testimony to the insanity of valuations reached during The Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge. ""The aversion to equities that ®we© exhibit today is far from congenital. We love owning common stocks Ì if they can be purchased at attractive prices. In ®my© 61 years of investing, 50 or so years have oÅered that kind of opportunity. There will be years like that again. Unless, however, we see a very high probability of at least 10% pre-tax returns (which translates to 6 1 /2-7% after corporate tax), we will sit on the sidelines. With short-term money returning less than 1% after-tax, sitting it out is no fun. But occasionally successful investing requires inactivity.'' In fact, the one thing that should interest Wesco shareholders most with respect to 2003 is that, as in 2002 and 2001, Wesco found no new common stocks for our insurance companies to buy. The Board of Directors recently increased Wesco's regular dividend from 331 /2 cents per share to 341 /2 cents per share, payable March 3, 2004, to shareholders of record as of the close of business on February 4, 2004.

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.

Our views regarding the general prospects for investment in common stocks are contained in the following excerpt from Warren BuÅett's recent letter to shareholders of our parent company: ""We continue to do little in equities. ®We© are increasingly comfortable with our holdings in ®our© major investees because most of them have in- creased their earnings while their valuations have decreased. But we are not inclined to add to them. Though these enterprises have good prospects, we don't yet believe their shares are undervalued. ""In our view, the same conclusion Ñts stocks generally. Despite three years of falling prices, which have signiÑcantly improved the attractiveness of com- mon stocks, we still Ñnd very few that even mildly interest us. That dismal fact is testimony to the insanity of valuations reached during The Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge. ""The aversion to equities that ®we© exhibit today is far from congenital. We love owning common stocks Ì if they can be purchased at attractive prices. In ®(Warren states:) my© 61 years of investing, 50 or so years have oÅered that kind of opportunity. There will be years like that again. Unless, however, we see a very high probability of at least 10% pre-tax returns (which translates to /2-7% after corporate tax), we will sit on the sidelines. With short-term money returning less than 1% after-tax, sitting it out is no fun.

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.

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

Of course, so long as Wesco does not liquidate, and does not sell any appreciated assets, it has, in eÅect, 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 $99 per Wesco share at yearend 1999. However, some day, perhaps soon, major parts of the interest-free ""loan'' must be paid as assets are sold. Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $99 per Wesco share. Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $99 per Wesco share. In the writer's judgment, the value of Wesco's advantage from its temporary, interest-free ""loan'' was probably about $20 per Wesco share at yearend 1999. After the value of the advantage inhering in the interest-free ""loan'' is estimated, a reasonable approximation can be made of Wesco's intrinsic value per share. This approximation is made by simply adding (1) the value of the advantage from the interest-free ""loan'' per Wesco share and (2) liquidating value per Wesco share. Others may think diÅerently, but the foregoing approach seems reasonable to the writer as a way of estimating intrinsic value per Wesco share.intrinsic

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.

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.

(where interesting potential now lies almost entirely in Wesco's equity in its oÇce property in Pasadena) containing only 125,000 net rentable square feet, and (2) unrealized appreciation in other assets (primarily Precision Steel) cannot be large enough, in relation to Wesco's overall size, to change very much the overall computation of after-tax liquidating value. Of course, so long as Wesco does not liquidate, and does not sell any appreciated assets, it has, in eÅect, 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 $127 per Wesco share at yearend 1998. However, some day, perhaps soon, major parts of the interest-free ""loan'' must be paid as assets are sold. Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $127 per Wesco share. Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $127 per Wesco share. In the writer's judgment, the value of Wesco's advantage from its temporary, interest-free ""loan'' was probably about $30 per Wesco share at yearend 1998. After the value of the advantage inhering in the interest-free ""loan'' is estimated, a reasonable approximation can be made of Wesco's intrinsic value per share.

This approximation is made by simply adding (1) the value of the advantage from the interest-free ""loan'' per Wesco share and (2) liquidating value per Wesco share. Others may think diÅerently, but the foregoing approach seems reasonable to the writer as a way of estimating intrinsic value per Wesco share. Thus, if the value of the advantage from the interest-free tax-deferral ""loan'' present was $30 per Wesco share at yearend 1998, and after-tax liquidating value was then about $312 per share (Ñgures that seem rational to the writer), Wesco's intrinsic value per share would become about $342 per share at yearend 1998, up 25% from intrinsic value as guessed in a similar calculation at the end of 1997. And, Ñnally, this reasonable-to-this-writer, $342-per-share Ñgure for intrinsic per share value of Wesco stock should be compared with the $354∂ per share price at which Wesco stock was selling on December 31, 1998. This comparison indicates that Wesco stock was then selling about 4% 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 76% of Wesco's shareholders' equity at 1998 yearend), versus 73% and 70% one and two years earlier.

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

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.

On October 31, 1996 and October 31, 1997, Wesco converted an aggregate of $40 mil- lion par value of its remaining preferred shares of Salomon to 1,052,628 shares of Salomon common stock, with Wesco continuing to hold par value of $40 million of Salomon preferred stock. On November 28, 1997, Wesco and its subsidiaries received $40 million par value of Travelers 9% preferred stock plus 1,784,204 shares of Travelers common stock, in exchange for the Salomon holdings, in connection with a merger of Salomon into Travelers. Fair value of the Travelers preferred and common shares, carried on Wesco's consolidated balance sheet in the categories ""securities with Ñxed maturities'' and ""marketable equity securities,'' were $96.0 million and $96.1 million, respectively, at yearend 1997, versus the adjusted costs of $90.0 and $90.8 million, respectively, at which they were carried. US Air has called its convertible preferred stock for redemption on March 15, 1998. On March 13, 1998, Wesco converted its shares, acquired for $12 million in 1989 and written down to an adjusted cost of $3 million in 1994, to 309,718 shares of US Air common. In previous years we noted that ""few, if any, investors have ever prospered mightily from investing in convertible preferred stocks of leading corporations.'' Our experience proves, yet again, what poor prognosticators we are.

In the writer's judgment, the value of Wesco's advantage from its temporary, interest-free ""loan'' was probably about $25 per Wesco share at yearend 1997. After the value of the advantage inhering in the interest-free ""loan'' is estimated, a reasonable approximation can be made of Wesco's intrinsic value per share. This approximation is made by simply adding (1) the value of the advantage from the interest-free ""loan'' per Wesco share and (2) liquidating value per Wesco share. Others may think diÅerently, but the foregoing approach seems reasonable to the writer as a way of estimating intrinsic value per Wesco share.

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