Berkshire Hathaway 1999 Annual Meeting Audience Question # 26

Should Berkshire be included in the S&P 500?

Warren Buffett:

OK, Zone 13.

Audience Member:

Good morning, Mr. Buffett and Mr. Munger. I’m Cary Flecker from Wellington, Florida. Thank you for stopping by the convention center before, Mr. Buffett. It’s nice to see you again.

Warren Buffett:

My pleasure.

Audience Member:

Recently, much has been made of the fact that Berkshire is the largest company to not be included in the S&P 500.

Do you gentleman have an opinion as… or what is your opinion… as to whether Berkshire should be included and why? Thank you.

Warren Buffett:

Yeah, that’s a question we’ve gotten asked quite often since the General Re deal was announced.

Berkshire, if you talk to the S&P people, I think they would say… I think they’ve even said it publicly, or at least a representative has… that we certainly qualify in every way that… except from what they might term the liquidity standpoint.

It’s probable that maybe it’s 6 percent, maybe 7 percent of the investment funds, the equity funds in the United States are indexed. And the number, or the amount, is going up somewhat as we go along. I saw an article to the contrary on that. But I think they had it wrong. The amount of index money is, in my view, rising month by month.

So, if you were to put Berkshire into the index tomorrow, in effect, you’d have a market order to buy 6 to 7 percent of the company, or roughly 100,000 shares a day.

That would not be good, you know, if the stock would obviously spike up dramatically as some stocks already have when they’ve been added. I mean, there’ve been some… I’ve looked at the list of all the companies that have been added and some have moved up substantially.

And we would have even… there’d be even more impact at Berkshire than the typical stock because our stock is fairly tightly held. Most people don’t want to sell it.

There are two solutions to that. Three solutions, one of them being not to put us in the index.

But we are the most… I think, probably the most significant in the United States that isn’t in the index, in terms of market value and a lot of other factors.

So, if you want to put Berkshire or a company like it in the index and not have some crazy market aberration, you could have one of two things happen. And this would be true, I think, more and more of other companies, as well, as they add them to the index and there’s more money against index.

One, you could have the company agree that at the time it was added to the index that simultaneously, the company, itself, would sell an amount of stock that was about equal to the index buying that would be generated.

In other words, if we were to offer 100,000 shares, roughly, of A stock at the same as being added to the index, that would neutralize the index buying.

The only problem with that is we don’t want to sell 100,000 shares or 10,000 shares or 100 shares of A stock at Berkshire unless we had some very good use for the money. It isn’t going to happen.

So we are not going to do something like that just because we want to be in an index.

The other possibility, and I believe this was used in Australia, when a very large mutual life company converted to stock. I think it was the largest company in Australia… AMP. And that would be to phase in the weighting of a stock like Berkshire.

And I think later on, I think they may have to do it for all stocks. But phase in the weighting, say, over a 12-month period. So that I was 1/12th weighted the first month, 1/12th weighted the second month and so on. That means, in effect, there would have to be a market order once a month for a half of 1 percent, roughly, of Berkshire.

Well, I don’t think that would be very particularly disruptive. And I think there’d be a… once you knew that phase in was coming, there would be some anticipation so that you would not get big spikes in the stock and dips, subsequently.

I think that would be a logical way, but Standard and Poor’s, to date, has not had to do that sort of thing. And they may have various reasons, and various good reasons for not wanting to do that.

Now, if indexation continues to grow as it has and you get a situation where 15 percent of the money becomes indexed, you know, I think they’re going to have to come up with some approach similar to one of these two that I’ve named, or it will simply get too disruptive to the market.

It would be interesting. I know America Online has behaved very well since it was introduced to the S&P some time back.

But I would think that it might get to be the case that, if you simply shorted the companies that got added to the S&P after the S&P effect had been felt, that that might… you might find that those stocks would tend to underperform, as that one artificial buy order, in effect, its impact wore off.

So, I think something is going to happen. I think indexation has far exceeded what anybody anticipated, including S&P or including me or Charlie. And I think there’s been a good reason for it to develop.

I think as it continues to develop it will have more and more impact on the market in ways that, probably, S&P is not that excited about, nor would the index funds be excited about.

So, there’s likely to come a solution to the liquidity problem that might be particularly acute at Berkshire, but that prevails throughout the market, that occurs when stocks are added.

And I would think if they adopt some solution, that certainly, if they adopt a solution of gradual weighting, that Berkshire would be a very logical candidate for the S&P.

It really makes no difference to us what is done along that line. We would not unhappy being in the S&P, as long as it didn’t have some huge market impact at the moment of putting it in.

On the other hand, you know, we love the owners we’ve got. And I don’t see how we could improve on this group much by having the index funds.

So, it… we’ll see what happens on it. It is not a big deal to us. And we want to be sure if we’re ever added, it isn’t too big a deal to the market.

Because I would not like… you know, the people who sold that day, might like it… but I would not like the stock to jump up, you know, $20,000 a share on one day because there’s some market order for 100,000 shares, and then gradually work its way back down to where it should’ve been in the first place.

No one benefits from that except the people who sell in the very short-term. And that is not the group that I primarily worry about.

Charlie?

Charlie Munger:

My guess is that Berkshire will eventually be in the S&P index. Somebody will figure out how to do that, sensibly. Maybe not soon. But someday.

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