A letter a day!

[aashka_trivedi]

A letter a day!

Letter #26 1972

1. General

1. For those tracking the insurance industry, it is important to track events like accident frequency, accident severity, and others factors in order to check the profitability of the industry as a whole for that particular year.

“Significant improvement was recorded in all of our major lines of business, but the most dramatic gains were in insurance underwriting profit. Due to an unusual convergence of favorable factors—diminishing auto accident frequency, moderating accident severity, and an absence of major catastrophes underwriting profit margins achieved a level far above averages of the past or expectations of the future.”

2. In one of the earlier letters, many investors asked Buffett about shutting down other operations except textiles in Berkshire Hathaway because of no profits, to which Buffett said that he had a long-term vision for this department. In this letter, he has stated

" Your present management assumed policy control of the company in May, 1965. Eight years later, our 1972 operating earnings of $11,116,256 represent a return manyfold higher than would have been produced had we continued to devote our resources entirely to the textile business. At the end of the 1964 fiscal year, shareholders’ equity totaled $22,138,753. Since that time, no additional equity capital has been introduced into the business, either through cash sale or through merger"

Benefits of diversification and conviction.
2) Insurance Underwriting

1. More entry of competition into the insurance segment will impact the volumes in short term.

"Substantial new competition was forecast in our annual report for last year and we experienced in 1972 the decline in premium volume that we stated such competition implied. Our belief is that industry underwriting profit margins will narrow substantially in 1973 or 1974 and, in time, this may produce an environment in which our historical growth can be resumed. Unfortunately, there is a lag between the deterioration of underwriting results and the tempering of competition. During this period we expect to continue to have negative volume comparisons in our traditional operation. Our seasoned management, headed by Jack Ringwalt and Phil Liesche, will continue to underwrite to produce a profit, although not at the level of 1972, and base our rates on long‐term expectations rather than short‐term hopes. Although this approach has meant dips in volume from time to time in the past, it has produced excellent long‐term
results."

2. Expense ratios in the new companies will always be high till the time they are in the development stage.

3. Banking operations

1. The Illinois Bank and Trust Co. of Rockford, maintained its position of industry leadership in profitability due to the following reasons:

“After‐tax earnings of 2.2% on average deposits in 1972 are the more remarkable when evaluated against such moderating factors as (1) a mix of 50% time deposits heavily weighted toward consumer savings instruments, all paying the maximum rates permitted by law; (2) an unvaryingly strong liquid position and avoidance of money‐market borrowings; (3) a loan policy that has produced a net charge‐off ratio in the last two years of about 5% of that of the average commercial bank.”

[aashka_trivedi]

A letter a day!

Letter #27 1973

Key learnings:

1. Textile Business

1.Textile business is considered semi-cyclical due to fluctuating prices of the raw materials. While analyzing any of the textile business, we can check if they follow a LIFO method for valuing inventory. This method ensures that current cost matches that current current revenue and no notional profits is visible in the P&L.

“Because of the extraordinary price rises in raw materials during 1973, which show signs of continuing in 1974, we have elected to adopt the “lifo” method of inventory pricing. This method more nearly matches current costs against current revenues, and minimizes inventory “profits” included in reported earnings. Further information on this change is included in the footnotes to our financial statements.”

2. Insurance Business

1. One of things I learned while reading Buffett’s letters is to look beyond numbers and to look at people running the business, and the products and services that ultimately fills the balance sheet. In each and every letter he clearly states by each of managers leading various business operations run by Berkshire Hathaway. So that investors are clear who is managing the business in which their money is invested.

“During 1973, Jack Ringwalt retired as President of National Indemnity Company after anm absolutely brilliant record since founding the business in 1940. He was succeeded by Phil Liesche who, fortunately for us, possesses the same underwriting and managerial philosophy that worked so well for Jack.”

One more example

“Our reinsurance operation had a somewhat similar year—good underwriting experience, but difficulty in maintaining previous volume levels. This operation, guided by the tireless and well‐ directed efforts of George Young, has been a major profit producer since its inception in 1969.”

3. Merger of Diversified retailing company into Berkshire Hathaway.
   When Buffett retired from managing public money, he announced he will keep updating investors about diversified retailing company and Berkshire Hathaway
   till the time he is invested. In this year he merged DRC with BH. A beginning of making of BH we see today!’

4. We all know about one of Berkshire Hathaway’s multi bagger see candy. It was a part of the company known as Blue chip and even Wesco financial corporation. Buffett was on
   in the Board of directors of this companies.

“Blue Chip’s trading stamp business has declined drastically over the past year or so, but it has important sources of earning power in its See’s Candy Shops subsidiary as well as Wesco Financial Corporation, a 54% owned subsidiary engaged in the savings and loan business. We expect Blue Chip Stamps to achieve satisfactory earnings in future years related to capital employed, although certainly at a much lower level than would have been achieved if the trading stamp business had been maintained at anything close to former levels. Your Chairman is on the Board of Directors of Blue Chip Stamps, as well as Wesco Financial Corporation, and is Chairman of the Board of See’s Candy Shops Incorporated. Operating management of all three entities is in the hands of first‐class, able, experienced executives.”

[aashka_trivedi]

A letter a day!

Letter #28 1974

Key learnings:

1.As already guided in the earlier letters, the performance of the insurance business has declined and is expected to decline even in the next year. Buffett’s course of action during this bad performance is to build financial strength and liquidity so that when the insurance rates are in favor they can aggressively pursue opportunities for growth in this area.

2.Textile operations: The textile business of BH is “curtain goods”. In periods of uncertainty, these goods tend to get a lower level of importance. As there is lesser demand, Buffett has chosen to operate on 1/3 of the capacity to reduce inventory.

“Our products are largely in the curtain goods area. During a period of consumer uncertainty, curtains may well be high on the list of deferrable purchases. Very low levels of housing starts also serve to dampen demand. In addition, retailers have been pressing to cut inventories generally, and we probably are feeling some effect from these efforts. These negative trends should reverse in due course, and we are attempting to minimize losses until that time comes.”

3.Insurance underwriting: This business has been experiencing losses due to 2 major factors: 1) competition and 2) inflation. The premium rates have remained unchanged to sustain in the competitive environment while the cost of repairing etc which is
covered by insurance has been increased due to inflation. This is very well explained in the letter, sharing its excerpt here:

"The costs of the product we deliver (auto repair, medical payments, compensation benefits, etc.) are increasing at a rate we estimate to be in the area of 1% per month. Of course, this increase doesn’t proceed in an even flow but, inexorably, inflation grinds very heavily at the repair services—to humans and to property—that we provide. However, rates virtually have been unchanged in the property and casualty field for the last few years. With costs moving forward rapidly and prices remaining unchanged, it was not hard to predict what would happen to profit margins.
Best’s, the authoritative voice of the insurance industry, estimates that in 1974 all auto
insurance premiums in the United States increased only about 2%. Such a growth in the pool of dollars available to pay insured losses and expenses was woefully inadequate. Obviously, medical costs applicable to people injured during the year, jury awards for pain and suffering, and body shop charges for repairing damaged cars increased at a dramatically greater rate during the year. Since premiums represent the sales dollar and the latter items represent the cost of goods sold, profit margins turned sharply negative."

4 When a new player enters a concentrated industry, it is extremely difficult to survive. Buffett in his last letter decided to expand the insurance business in Florida. However, due to the concentration in the industry players, they suffered huge losses and decided
to shut down the business.

“We can’t blame external insurance industry conditions for this mistake. In retrospect, it is apparent that our management simply did not have the underwriting information and the pricing knowledge necessary to be operating in the area. In Cook County, where Home and Auto’s volume traditionally has been concentrated, evidence also became quite clear during 1974 that rates were inadequate. Therefore, rates were increased during the middle of the year but competition did not follow; consequently, our volume has dropped significantly in this area as competitors take business from us at prices that we regard as totally unrealistic.”

[aashka_trivedi]

A letter a day!

Letter #29 1975

Key learnings:

1. Textile Operations:
   Textile as an industry was facing problems as stated by Buffett in the earlier letters. When the entire industry is depressed, it is the right time to acquire distressed companies which are already struggling. Buffett is known for this and he did the same this year.

On April 28, 1975, we acquired Waumbec Mills Incorporated and Waumbec Dyeing and
Finishing Co., Inc. is located in Manchester, New Hampshire. These companies have long sold woven goods into the drapery and apparel trade. Such drapery materials complement and extend the line already marketed through the Home Fabrics Division of Berkshire Hathaway. In the period prior to our acquisition, the company had run at a very substantial loss, with only about 55% of looms in operation and the finishing plant operating at about 50% of capacity. Losses continued on a reduced basis for a few months after acquisition."

2. Insurance investments
   Buffett has highlighted the criteria he uses to select a company for making investments of money received via the insurance business.

“Our equity investments are heavily concentrated in a few companies that are selected based on favorable economic characteristics, competent and honest management, and a purchase price attractive when measured against the yardstick of value to a private owner. With this approach, stock market fluctuations are of little importance to us—except as they may provide buying opportunities—but business performance is of major importance.”

3.Insurance Operations
At the time of bad cycles in the insurance business, only the companies with a strong liquidity position will survive. Other companies will have to sell their investments in order to sustain the cycle.

“We have continued to maintain a strong liquid position in our insurance companies. We consider such market fluctuation of minor importance as our liquidity and general financial strength make it highly improbable that bonds will have to be sold at times other than those of our choice.”

4. Diversification
   Buffett emphasizes the importance of diversification in investing and how Berkshire Hathaway’s portfolio is diversified across different industries and companies. He writes,

“In 1965, two New England textile mills were the company’s only sources of earning power and, before Ken Chace assumed responsibility for the operation, textile earnings had been erratic and, cumulatively, something less than zero subsequent to the merger of Berkshire Fine Spinning and Hathaway Manufacturing. Since 1964, net worth has been built to $92.9 million, or $94.92 per share. We have acquired total, or virtually total ownership of six businesses through negotiated purchases for cash (or cash and notes) from private owners, started four others, purchased a 31.5% interest in a large affiliate enterprise and reduced the number of outstanding shares of Berkshire Hathaway to 979,569. Overall, equity per share has compounded at an annual rate of slightly over 15%.”

[aashka_trivedi]

A letter a day!

Letter # 30 1976

Key learnings:

1. Textile division
   The business continues to face problems. Apart from the overall industrial factors, Buffett has also stated some misses on their part which resulted in poor performance. He writes:

“Our textile division was a significant disappointment during 1976. Earnings, measured either by return on sales or by return on capital employed, were inadequate. In part, this was due to industry conditions that did not measure up to expectations of a year ago. But equally important were our own shortcomings. Marketing efforts and mill capabilities were not properly matched in our new Waumbec operation. Unfavorable manufacturing cost variances were produced by improper evaluation of machinery and personnel capabilities.”

Further, he also clarifies that one may not expect a good return on investment from textile operations. However, it is a good business from an employment generation point of view.

“It should be recognized that the textile business does not offer the expectation of high returns on investment. Nevertheless, we maintain a commitment to this division—a very important source of employment in New Bedford and Manchester—and believe reasonable returns on average are possible.”

2. Insurance underwriting

The combined ratio is one of the yardsticks to measure the performance of the insurance business. A combined ratio of 100 is breakeven. Anything above that will indicate losses and anything below that is profitable.

As the insurance industry was facing headwinds due to inflation and competition, some relief is observed this year as competitors have finally reacted to the inadequacy of the past rates. As per Buffett, this is a temporary phase. He writes

"Thus present rates, which are adequate for today, will not be adequate tomorrow.
Our opinion is that before long, perhaps in 1978, the industry will fall behind on rates as
temporary prosperity produces unwise competition. If this happens, we must be prepared to meet the next wave of inadequate pricing by a significant reduction in volume"

3. He has concluded the expected performance of the business. This is very beautiful communication and a must-read if you are a fund manager who needs to communicate expected fund performance to the investors. Rather than stating an expected number of the fund performance, it is always to give an idea about the expected performance of the businesses you are holding, since that will ultimately translate to the fund performance.

"However, we consider the yearly business progress of the companies in which we own stocks to be very important. And here, we have been delighted by the 1976 business performance
achieved by most of our portfolio companies. If the business results continue excellent over a
period of years, we are certain eventually to achieve good financial results from our stock
holdings, regardless of wide year‐to‐year fluctuations in market values."

[aashka_trivedi]

letter a day!

Letter # 31 1977

Key learnings:

1. General
   We have often seen companies/fund managers who write record high earnings. Buffett writes on the same
   “Most companies define “record” earnings as a new high in earnings per share. Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding.”

He considers Return on Equity to be a better measurement than earnings per share.

“Except for special cases (for example, companies with unusual debt‐equity ratios or those with important assets carried at unrealistic balance sheet values), we believe a more appropriate measure of managerial economic performance to be return on equity capital.”

2. Textile operations

Textile operations have been underperforming since the last 2 years and the same has happened again this year. Many investors have started questioning to still continue with the textile business to which Buffett has replied

"Our reasons are several: (1) Our mills in both New Bedford and
Manchester are among the largest employers in each town, utilizing a labor force of high average age possessing relatively non‐transferable skills. Our workers and unions have exhibited unusual understanding and effort in cooperating with management to achieve a cost structure and product mix which might allow us to maintain a viable operation. (2)
management also has been energetic and straightforward in its approach to our textile
problems. In particular, Ken Chace’s efforts after the change in corporate control took place in 1965 generated capital from the textile division needed to finance the acquisition and expansion of our profitable insurance operation. (3) With hard work and some imagination regarding manufacturing and marketing configurations, it seems reasonable that at least modest profits in the textile division can be achieved in the future."

3. Insurance operations

Insurance operations have performed well this year in comparison to textiles. Buffett writes

“It is comforting to be in a business where some mistakes can be made and yet a quite satisfactory overall performance can be achieved. In a sense, this is the opposite case from our textile business where even very good management probably can average only modest results. One of the lessons your management has learned ‐ and, unfortunately, sometimes re‐learned ‐ is the importance of being in businesses where tailwinds prevail rather than headwinds.”

Underwriting margins are not increasing at the same pace as that of cost increases. Hence underwriting profits are still expected to shrink.
But unlike textile, Buffett feels that in the insurance business, these headwinds are temporary.

Buffett on insurance as business:

“Insurance companies offer standardized policies which can be copied by anyone. Their only products are promises. It is not difficult to be licensed, and rates are an open book. There are no important advantages from trademarks, patents, location, corporate longevity, raw material sources, etc., and very little consumer differentiation to produce insulation from competition. It is commonplace, in corporate annual reports, to stress the difference that people make. Sometimes this is true and sometimes it isn’t. But there is no question that the nature of the insurance business magnifies the effect which individual managers have on company performance.”

4. Buffett on purchasing small stakes in marketable securities

"We select our marketable equity securities in much the same way we would evaluate a
business for acquisition in its entirety. We want the business to be (1) one that we can
understand, (2) with favorable long‐term prospects, (3) operated by honest and
competent people, and (4) available at a very attractive price. We ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term. In fact, if their business experience continues to satisfy us, we welcome lower market prices of stocks we own as an opportunity to acquire even more of a good thing at a better price."

“Our experience has been that pro‐rata portions of truly outstanding businesses sometimes sell in the securities markets at very large discounts from the prices they would command in negotiated transactions involving entire companies. Consequently, bargains in business ownership, which simply are not available directly through corporate acquisition, can be obtained indirectly through stock ownership. When prices are appropriate, we are willing to take very large positions in selected companies, not with any intention of taking control and not foreseeing sell‐out or merger, but with the expectation that excellent business results by corporations will translate over the long term into correspondingly excellent market value and dividend results for owners, minority as well as majority. Such investments initially may have a negligible impact on our operating earnings.”

[aashka_trivedi]

A letter a day!

Letter #32 1978

Key Learnings:

1. Inclusion of capital gains in evaluating the performance:
   Capital gains are not the results of daily operations. Hence it may indicate a high EPS for that year.

“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.”

2.Textile Business

Buffett explains the situation in the textile business in a humorous way
“Obvious approaches to improved profit margins involve differentiation of product, lowered manufacturing costs through more efficient equipment or better utilization of people, redirection toward fabrics enjoying stronger market trends, etc. Our management is diligent in pursuing such objectives. The problem, of course, is that our competitors are just as diligently doing the same thing.”

He also adds

“The textile industry illustrates in textbook style how producers of relatively undifferentiated goods in capital-intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage. As long as excess productive capacity exists, prices tend to reflect direct operating costs rather than capital employed. Such a supply excess condition appears likely to prevail most of the time in the textile industry, and our expectations are for profits of relatively modest amounts in relation to capital.
We hope we don’t get into too many more businesses with such tough economic characteristics.”

If I summarize it there are 2 key takeaways from this to be careful with the business having 1) Undifferentiated goods 2) Capital-intensive business.

3. Insurance Business

National Indemnity Company was the biggest contributor to the earnings of Berkshire in 1978. Buffett says:

“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.

Jack Ringwalt retired from the company in 1973. He must have been a terrific manager that even after 5 years after his departure, Buffett is praising him for the success of National Indemnity.

Buffett is open to both ways of expanding the insurance business organic and inorganic.

He says “It is not easy to buy a good insurance business, but our experience has been that it is easier to buy one than to create one. However, we will continue to try both approaches, since the rewards for success in this field can be exceptional.”

4. We often buy a stock that according to us is cheaper in valuation and we expect the market to value it upwards. But many times cheap stocks become cheaper
   On this Buffett says:

“We are not concerned with whether the market quickly revalues upward securities that we believe are selling at bargain prices. In fact, we prefer just the opposite since, in most years, we expect to have funds available to be a net buyer of securities. And consistent attractive purchasing is likely to prove to be of more eventual benefit to us than any selling opportunities provided by a short-term run up in stock prices to levels at which we are unwilling to continue buying.”

5. Buffett on concentrated holdings:

“Our policy is to concentrate holdings. We try to avoid buying a little of this or that when we are only lukewarm about the business or its price. When we are convinced as to attractiveness, we believe in buying worthwhile amounts.”
“We simply can’t find one hundred different securities that conform to our investment requirements. However, we feel quite comfortable concentrating our holdings in the much smaller number that we do identify as attractive.”

The lesson to take away from here is not to stop diversification but to avoid over-diversification and invest only if the stock meets
all your required criteria.

6. Buffett on retained earnings of his indirect holdings:

"We are not at all unhappy when our wholly-owned businesses retain all of their earnings if they can utilize internally those funds at attractive rates. Why should we feel differently about the retention of earnings by companies in which we hold small equity interests, but where the record indicates even better prospects for the profitable employment of capital? (This proposition cuts the other way, of course, in industries with low capital requirements, or if management has a record of plowing capital into projects of low profitability; then earnings should be paid out or used to repurchase shares — often by far the most attractive option for capital utilization.)

Berkshire itself hasn’t declared dividends for a prolonged period of time but it has generated wealth for shareholders by
deploying capital in better opportunities.

7. Associated Retail became part of Berkshire in 1978. At the time of the merger Ben Rosner was managing it. About Ben, Buffet says:

“Associated’s business has not grown, and it consistently has faced adverse demographic and retailing trends. But Ben’s combination of merchandising, real estate, and cost-containment skills has produced an outstanding record of profitability, with returns on capital necessarily employed in the business often in the 20% after-tax area.”

Most of these managers are very old and yet they are actively involved in running their businesses. With Ben, Buffett tells what a great manager can do to a business even when things are difficult. Buffett once again uses the financial metric of returns on capital employed to measure management quality and ability.

[aashka_trivedi]

A letter a day!

Letter #33 1979

1. On disclosure of securities at cost and not market value

In this year, SEC mandated the disclosure of market securities at market value. Buffett adopted the disclosure of the same at the cost or market value whichever is lower. However, for the presentation to investors, he still chose to disclose it at the cost and has given a reason to do the same

" Measuring such results against shareholders’ equity with securities valued at market could significantly distort the operating performance percentage because of wide year-to-year
market value changes in the net worth figure that serves as the denominator. For example, a large decline in securities values could result in a very low “market value” net worth that, in
turn, could cause mediocre operating earnings to look unrealistically good. Alternatively, the more successful that equity investments have been, the larger the net worth base
becomes and the poorer the operating performance figure appears. Therefore, we will continue to report operating performance measured against beginning net worth, with securities valued at cost."

2. ROE VS ROCE
   A better way to evaluate the management quality is by analyzing the ROCE than ROE. Buffett writes

" On this basis, we had a reasonably good operating performance in 1979 - but not quite as good as that of 1978 - with operating earnings amounting to 18.6% of beginning net
worth. Earnings per share, of course, increased somewhat (about 20%) but we regard this as an improper figure upon which to focus. We had substantially more capital to work with in 1979 than in 1978, and our performance in utilizing that capital fell short of the earlier year, even though per-share earnings rose. “Earnings per share” will rise constantly on a dormant savings account or on a U.S. Savings Bond bearing a fixed rate of return
simply because “earnings” (the stated interest rate) are continuously plowed back and added to the capital base. Thus, even a “stopped clock” can look like a growth stock if the
dividend payout ratio is low.

“The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share. In our view, many businesses would be better understood by their shareholder owners, as well as the general public, if managements and financial analysts modified the primary emphasis they place upon earnings per share, and upon yearly changes in that figure.”

3. Buffett never guaranteed that the past performance will be repeated in the future as well.

" Before we drown in a sea of self-congratulation, a further - and crucial - observation must be made. A few years ago, a business whose per-share net worth compounded at 20%
annually would have guaranteed its owners a highly successful real investment return. Now such an outcome seems less certain. For the inflation rate, coupled with individual tax rates, will be the ultimate determinant as to whether our internal operating performance produces successful investment results - i.e., a reasonable gain in purchasing power from funds committed - for you as shareholders."

4. Turnarounds seldom turn.

" Both our operating and investment experience cause us to conclude that “turnarounds” seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price. Although a mistake, the Waumbec acquisition has not been a disaster. Certain portions of the operation are proving to be valuable additions to our decorator line (our strongest franchise) at New Bedford, and it’s possible that we may be able to run profitably on a considerably reduced scale at Manchester. However, our original rationale did not prove out."

5. Insurance writing business has lot of volume fluctuations. Which means there is work load at one time while some seasons maybe slack. However, Buffett choses not to lay off employees during the slack and not underwrite a business
   for the sake of doing it.

“You will notice that earned premiums in this segment were down somewhat from those of 1978. We hear a great many insurance managers talk about being willing to reduce volume in order to underwrite profitably, but we find that very few actually do so. Phil Liesche is an exception: if business makes sense, he writes it; if it doesn’t, he rejects it. It is our policy not to lay off people because of the large fluctuations in work load produced by such voluntary volume changes. We would rather have some slack in the organization from time to time than keep everyone terribly busy writing business on which we are going to
lose money.”

6. Buffett on Berkshire Hathaway’s shareholders

" In some ways, our shareholder group is a rather unusual one, and this affects our manner of reporting to you. For example, at the end of each year about 98% of the shares outstanding are held by people who also were shareholders at the beginning of the
year. Therefore, in our annual report we build upon what we have told you in previous years instead of restating a lot of material. You get more useful information this way, and we don’t
get bored."
" 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."

7. Buffett on Quarterly updates of performance

“In contrast, we include no narrative with our quarterly reports. Our owners and managers both have very long time-horizons in regard to this business, and it is difficult to say
anything new or meaningful each quarter about events of long-term significance.”

8. Buffett took over many companies and rather than taking all the control of all the operations in his hands, he chose to do final decision making and built up a team of good people and always appreciated their work in each of his letters.

“Your company is run on the principle of centralization of financial decisions at the top (the very top, it might be added), and rather extreme delegation of operating authority to a number of key managers at the individual company or business unit level. We could just field a basketball team with our corporate headquarters group (which utilizes only about 1500 square feet of space).”

“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.”

[aashka_trivedi]

A letter a day!

Letter #34 1980

Key learnings:

1. In the beginning of the letter Buffett has explained many micro accounting concepts. A good read if you want some clarity on accounting .

2. Buffet on reporting the retained earnings of the minority holdings in the portfolio:
   I found the explanation beautiful and so i am sharing an excerpt here:
   "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. "

3. According to Buffett, the best use of the retained earnings by any company can be repurchase of its own share .
   He writes
   “One usage of retained earnings we
   often greet with special enthusiasm when practiced by companies in which we have an
   investment interest is repurchase of their own shares. The reasoning is simple: if a fine
   business is selling in the market place for far less than intrinsic value, what more certain or
   more profitable utilization of capital can there be than significant enlargement of the interests
   of all owners at that bargain price? The competitive nature of corporate acquisition activity
   almost guarantees the payment of a full ‐ frequently more than full price when a company buys
   the entire ownership of another enterprise. But the auction nature of security markets often
   allows finely‐run companies the opportunity to purchase portions of their own businesses at a
   price under 50% of that needed to acquire the same earning power through the negotiated
   acquisition of another enterprise.”

4. Buffet on shifting to bonds against investing in direct equity
   “Our insurance companies will continue to make large investments in well‐run, favorably situated, non‐controlled companies that very often will pay out in dividends only small
   proportions of their earnings. Following this policy, we would expect our long‐term returns to
   continue to exceed the returns derived annually from reported operating earnings. Our
   confidence in this belief can easily be quantified: if we were to sell the equities that we hold
   and replace them with long‐term tax‐free bonds, our reported operating earnings would rise
   immediately by over $30 million annually. Such a shift tempts us not at all.”

5. A high inflation rate can make even the positive returns for the owners turn negative. In this letter Buffett has give a good comparison of taxation and inflation.

“Explicit income taxes alone, unaccompanied by any implicit inflation tax, never can turn a
positive corporate return into a negative owner return. (Even if there were 90% personal
income tax rates on both dividends and capital gains, some real income would be left for the
owner at a zero inflation rate.) But the inflation tax is not limited by reported income. Inflation
rates not far from those recently experienced can turn the level of positive returns achieved by a majority of corporations into negative returns for all owners, including those not required to pay explicit taxes. (For example, if inflation reached 16%, owners of the 60% plus of corporate America earning less than this rate of return would be realizing a negative real return ‐ even if income taxes on dividends and capital gains were eliminated.)”

6. The largest non controlled holding in the Berkshire Hathaway through its insurance companies was GEICO. A much talked about stock of the past where many famous investors like Peter Lynch too made money. In this letter he has stated the entire story of GEICO for those who are interested to read.

7. The reinsurance business continues to remain flat. Buffett has stated reasons for the same:
   “The reinsurance business continues to reflect the excesses and problems of the primary
   writers. Worse yet, it has the potential for magnifying such excesses. Reinsurance is
   characterized by extreme ease of entry, large premium payments in advance, and much delayed loss reports and loss payments. Initially, the morning mail brings lots of cash and few
   claims. This state of affairs can produce a blissful, almost euphoric, feeling akin to that
   experienced by an innocent upon receipt of his first credit card.”

8. Textile operations: Buffett has reduced the textile operations . He has separated manufacturing and sales division so that each can do business independently of each other.

9. It is also said that you should never invest with the borrowed money. This year Buffett has borrowed additional money and given a reason for the same

“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.”

10. A para I found worth quoting from this letter:
    “You learn a great deal about a person when you purchase a business from him and he then
    stays on to run it as an employee rather than as an owner. Before the purchase the seller
    knows the business intimately, whereas you start from scratch. The seller has dozens of
    opportunities to mislead the buyer ‐ through omissions, ambiguities, and misdirection. After
    the check has changed hands, subtle (and not so subtle) changes of attitude can occur and
    implicit understandings can evaporate. As in the courtship‐marriage sequence,
    disappointments are not infrequent.”

[karanthharsha999]

@aashka_trivedi
I am the only one in the classroom.
Please keep posting the letters without disappointment.
Thank you once again

[aashka_trivedi]

Sure. Thank you for reading

[aashka_trivedi]

A letter a day!

Letter #35 1981

Theme: Acquisitions

Key learnings:

1. In the last letter, Buffet has explained the retained earnings of the non controlled entities in detail. In this letter he shares that

“In aggregate, our non-controlled business interests have more favorable underlying economic characteristics than our controlled businesses. That’s understandable; the area of choice has been far wider. Small portions of exceptionally good businesses are usually available in the securities markets at reasonable prices. But such businesses are available for purchase in their entirety only rarely, and then almost always at high prices.”

2. Buffett has mentioned in this letter that if you are buying a company for 2x or 3x its turnover, there should be some potential in the
   same. Otherwise, its better to buy a small quantity.

" In other words, investors can always buy toads at the going price for toads If investors instead bankroll princesses who wish to pay double for the right to kiss the toad, those kisses had better pack some real dynamite. We’ve observed many kisses but very few miracles. Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses - even after their corporate backyards are knee-deep in unresponsive toads."

3. Buffet states 2 categories of companies which can turn out to be standout acquisitions:

1.The first involves companies that, through design or accident, have purchased only businesses that are particularly well adapted to an inflationary environment. Such favored business must have two characteristics: (1) an ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital. Managers of ordinary ability, focusing solely on acquisition possibilities meeting these tests, have achieved excellent results in recent decades. However, very few enterprises possess both characteristics, and competition to buy those that do has now become fierce to the point of being self-defeating.

2. The second category involves the managerial superstars - men who can recognize that rare prince who is disguised as a toad, and who have managerial abilities that enable them to peel away the disguise.

4. It is easier to correct mistakes in the non controlled business than in the controlled business.

5)5) Insurance underwritting business continue to suffer because of inflation and the underwritting policies abd Buffett projects 1982 as one of the
worst years as far as Insurance underwritting is concerned.

“As Pogo would say, “The future isn’t what it used to be.” Current pricing practices promise devastating results, particularly if the respite from major natural disasters that the industry has enjoyed in recent years should end. For underwriting experience has been getting worse in spite of good luck, not because of bad luck. In recent years hurricanes have stayed at sea and motorists have reduced their driving. They won’t always be so obliging.”

[aashka_trivedi]

A letter a day!

Letter #36 1982

Theme: Theme: Non controlled ownerships and merger & acquisitions.

Key learnings:

1. Buffett has previously stated importance of having appropriate yardsticks in order to measure the performance. In the times of underperformance, fund managers often forget the yardsticks.

"Yardsticks seldom are discarded while yielding favorable readings. But when results deteriorate, most managers favor disposition of the yardstick rather than disposition of the manager."

2. Prefer economic earnings over accounting earnings.

“We prefer a concept of “economic” earnings that includes all undistributed earnings, regardless of ownership percentage. In our view, the value to all owners of the retained earnings of a business enterprise is determined by the effectiveness with which those earnings are used ‐ and not by the size of one’s ownership percentage”

3. Accounting numbers are the beginning and not the end of valuation.

4. Purchasing a full company is a far more difficult job than purchasing few shares at a reasonable price.

5. In insurance, as elsewhere, the reaction of weak managements to
   weak operations is often weak accounting.

6)Businesses in industries with both substantial over‐capacity and a “commodity” product (undifferentiated in any customer‐important way by factors such as performance, appearance, service support, etc.) are prime candidates for profit troubles. These may be escaped, true, if prices or costs are administered in some manner and thereby insulated at least partially from normal market forces. This administration can be carried out (a) legally through government intervention (until recently, this category included pricing for
truckers and deposit costs for financial institutions), (b) illegally through collusion, or (c) “extralegally” through OPEC‐style foreign cartelization (with tag‐along benefits for domestic non cartel operators).

7)If, costs and prices are determined by full‐bore competition, there is more than ample capacity, and the buyer cares little about whose product or distribution services he uses, industry economics are almost certain to be unexciting. They may well be disastrous.
Hence the constant struggle of every vendor to establish and emphasize special qualities of product or service. This works with candy bars (customers buy by brand name, not by asking
for a “two‐ounce candy bar”) but doesn’t work with sugar (how often do you hear, “I’ll have a cup of coffee with cream and C & H sugar, please”).

8)8) In the insurance industry, there can be no surge in demand for insurance policies , rather the supply of the available insurance coverage must be controlled.

9. This year Berkshire has announce merger with Blue chip. (Holding company of see candy). Buffett prefers not issuing any shares to the existing shareholders unless they derive intrinsic value.

“Our share issuances follow a simple basic rule: we will not issue shares unless we receive as much intrinsic business value as we give. Such a policy might seem axiomatic. Why, you might ask, would anyone issue dollar bills in exchange for fifty‐cent pieces? Unfortunately, many corporate managers have been willing to do just that.”

A detailed write up given on the mergers part. It is very interesting to read.

10. In acquiring the companies, Buffett considers the below points:

(1) large purchases (at least $5 million of after-tax earnings),

(2) demonstrated consistent earning power (future projections are of little interest to us, nor are “turn-around” situations),

(3) businesses earning good returns on equity while employing little or no debt,

(4) management in place (we can’t supply it),

(5) simple businesses (if there’s lots of technology, we won’t understand it),

(6) an offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily,about a transaction when price is unknown).

[aashka_trivedi]

A letter a day!

Letter #37 1983

Theme: Principles of Berkshire Hathaway (general)

Key learnings:

1. Due to the merger with blue as stated in the 1981 letter, many new investors are now the shareholders of Berkshire Hathaway.
   In the beginning of the letter, Buffett has briefed them with the policies they follow at Berkshire, most of which is a repeated for those have read all the previous letters. (But it is a must read)

2. Acquisition of Nebraska Furniture Mart
   Buffett narrates the story of Mrs. Berklin that how she started Nebraska furniture mart. On acquiring it, he writes

" One question I always ask myself in appraising a business is how I would like, assuming I had ample capital and skilled personnel, to compete with it. I’d rather wrestle grizzlies than compete with Mrs. B and her progeny. They buy brilliantly, they operate at expense ratios competitors don’t even dream about, and they then pass on to their customers much of the savings. It’s the ideal business - one built upon exceptional value to the customer that in turn translates into exceptional economics for its owners."

Mrs Berklin sold her 90% of the business at the age of 90. But she still remains the chairman and ran the business. Inspiring!

3. Book value VS intrinsic value

Book value is an accounting concept, recording the accumulated financial input from both contributed capital and retained earnings. Intrinsic business value is an economic concept, estimating future cash output discounted to present value. Book value tells you what has been put in; intrinsic business value estimates what can be taken out.

Buffett narrates a practical example to explain this in a more simple manner:

“An analogy will suggest the difference. Assume you spend identical amounts putting each of two children through college. The book value (measured by financial input) of each child’s education would be the same. But the present value of the future payoff (the intrinsic business value) might vary enormously - from zero to many times the cost of the education. So, also, do businesses having equal financial input end up with wide variations in value.”

4.Never underestimate the power of goodwill (Both economic and accounting)

“You can live a full and rewarding life without ever thinking about Goodwill and its amortization. But students of investment and management should understand the nuances of the subject. My own thinking has changed drastically from 35 years ago when I was taught to favor tangible assets and to shun businesses whose value depended largely upon economic Goodwill. This bias caused me to make many important business mistakes of omission, although relatively few of commission.”

5)This year Charlie Munger has replaced Louie Vincenti as Chairman of Wesco.(For the very first time there is a mention of Charlie Munger in the letter)

6. Buffett has never believed in the stock split of the Berkshire Hathaway shares. He thinks this action is only beneficial to the non quality shareholders.

*" In large part, however, we feel that high quality ownership can be attracted and maintained if we consistently communicate our business and ownership philosophy - along with no other conflicting messages - and then let self selection follow its course. For example, self selection will draw a far different crowd to a musical event advertised as an opera than one advertised as a rock concert even though anyone can buy a ticket to either.

Through our policies and communications - our “advertisements” - we try to attract investors who will understand our operations, attitudes and expectations. (And, fully as important, we try to dissuade those who won’t.) We want those who think of themselves as business owners and invest in companies with the intention of staying a long time. And, we want those who keep their eyes focused on business results, not market prices."

7. One of the ironies of the market is people always focus on penny stocks or high turnover stocks.

“One of the ironies of the stock market is the emphasis on activity. Brokers, using terms such as “marketability” and “liquidity”, sing the praises of companies with high share turnover (those who cannot fill your pocket will confidently fill your ear). But investors should understand that what is good for the croupier is not good for the customer. A hyperactive stock market is the pickpocket of enterprise.”

---

“We are aware of the pie-expanding argument that says that such activities improve the rationality of the capital allocation process. We think that this argument is specious and that, on balance, hyperactive equity markets subvert rational capital allocation and act as pie shrinkers. Adam Smith felt that all non collusive acts in a free market were guided by an invisible hand that led an economy to maximum progress; our view is that casino-type markets and hair-trigger investment management act as an invisible foot that trips up and slows down a forward-moving economy.)”

[aashka_trivedi]

A letter a day!

Letter # 38 1984

Theme : Buybacks

Key learnings:

1. When companies with outstanding businesses and comfortable financial positions find their shares selling far
   below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases/buy backs.

2. Two main benefits of share buybacks 1. major repurchases at prices well below per-share intrinsic business value immediately increase, in a highly significant way, that value. When companies purchase their own stock, they often find it easy to get $2 of present value for $1. 2. By making repurchases when a company’s market value is well below its
   business value, management clearly demonstrates that it is given to actions that enhance the wealth of shareholders, rather than to actions that expand management’s domain but that do nothing for (or even harm) shareholders. Seeing this, shareholders and potential shareholders increase their estimates of future returns from the business. This upward revision, in turn, produces market prices more in line with intrinsic business value.

3. Nebaska furniture mart was introduced by Buffett in the last years letter. Investors continuously ask him how can this business do so well on which he replies

“I have been asked by a number of people just what secrets the Blumkins bring to their business. These are not very esoteric. All members of the family: (1) apply themselves with an enthusiasm and energy that would make Ben Franklin and Horatio Alger look like dropouts; (2) define with extraordinary realism their area of special competence and act decisively on all matters within it; (3) ignore even the most enticing propositions failing outside of that area of special competence; and, (4) unfailingly behave in a high-grade manner with everyone they deal with. (Mrs. B boils it down to “sell cheap and tell the truth”.)”

4. The see candies business is more of a seasonal one. The company does 40% volume before the Christmas and produces 75% of the profit. In order to handle the increase in the demand, there is no compromise on the quality as done by the competitors.

" Their solutions have in no way involved compromises in either quality of service or quality of product. Most of our larger competitors could not say the same. Though faced with somewhat less extreme peaks and valleys in demand than we, they add preservatives or freeze the finished product in order to smooth the production cycle and thereby lower unit costs. We reject such techniques, opting, in effect, for production headaches rather than product modification."

5. In the past letters we have seen that Buffett has highlighted the importance for creating a financial strength for the insurance business. In this letter he writes:

" For some years I have told you that there could be a day coming when our premier financial strength would make a real difference in the competitive position of our insurance operation. That day may have arrived. We are almost without question the strongest property/casualty insurance operation in the country, with a capital position far superior to that of well-known companies of much greater size."

6. While tracking/studying an insurance company, it is extremely important to check the financial strength of the business that can help at the time of adversities.

“Our financial strength is a particular asset in the business of structured settlements and loss reserve assumptions that we reported on last year. The claimant in a structured settlement and the insurance company that has reinsured loss reserves need to be completely confident that payments will be forthcoming for decades to come. Very few companies in the property/casualty field can meet this test of unquestioned long-term strength. (In fact, only a handful of companies exists with which we will reinsure our own liabilities.)”

7.The over performance by the stock relative to the performance of the business obviously
could not occur every year, and that in some years the stock must under perform the business.

8. Warren Buffett on the “The intelligent investor” book:

“In what I think is by far the best book on investing ever written - “The Intelligent Investor”, by Ben Graham - the last section of the last chapter begins with, “Investment is most intelligent when it is most businesslike.” This section is called “A Final Word”, and it is appropriately titled”

9. Unconventional behavior in investing which involves making risky bets can be done only by if we think of ourselves as business owners and not fund managers. Buffett says this in the context of the investment in the Washington Public power supply system
   bonds, the company which had been defaulted in the past.

"Most managers have very little incentive to make the intelligent-but-with-some-chance-of-looking-like-an-idiot decision. Their personal gain/loss ratio is all too obvious: if an unconventional decision works out well, they get a pat on the back and, if it works out poorly, they get a pink slip. (Failing conventionally is the route to go; as a group, lemmings may have a rotten image, but no individual lemming has ever received bad press.)

Our equation is different. With 47% of Berkshire’s stock, Charlie and I don’t worry about being fired, and we receive our rewards as owners, not managers. Thus we behave with Berkshire’s money as we would with our own. That frequently leads us to unconventional behavior both in investments and general business management."

10.Unrestricted earnings should be retained only when there is a reasonable
prospect - backed preferably by historical evidence or, when appropriate, by a thoughtful analysis of the future - that for every dollar retained by the corporation, at least one dollar of market value will be created for owners. This will happen only if the capital retained produces incremental earnings equal to, or above, those generally available to investors.

[aashka_trivedi]

A letter a day!

Letter # 39 1985

Key learnings

1. This year gain in the book value per share was 23.2% compounded annually. Buffett states 2 reasons that this performance may not be repeated.

1. Very Little opportunities to invest in the market as available in the previous 10 years.

2. Size of the capital is ten times more than with what they started.

2. Four factors that have helped in building value in Berkshire Hathaway;

1)purchase price.

2)a business with fine underlying economics.

3)an able management concentrating on the interests of shareholders

4)a buyer willing to pay full business value.

3. Always study your mistakes/errors both in investing and in other areas of life.

"Before doing so, however, we should first look at a failure at one of our smaller businesses. Our Vice Chairman, Charlie Munger, has always emphasized the study of mistakes rather than successes,
both in business and other aspects of life. He does so in the spirit of the man who said: “All I want to know is where I’m going to die so I’ll never go there.” You’ll immediately see why we make a good team: Charlie likes to study errors and I have generated ample material for him,particularly in our textile and insurance businesses."

4. Closure of textile business

Buffett acquired a majority stake in Berkshire Hathaway which was solely in textiles through Buffett Partnership Limited. In early 1967 cash generated by the textile operation was used to fund the entry into insurance via the purchase of National Indemnity Company. A gradual diversification into various businesses then followed. The textile business never became a good earner, not even in cyclical upturns, and hence it was decided to shut the same.

A detailed explanation of the closure of this business is given with the factors which led to the same. A must-read!

Buffett writes " The situation is suggestive of Samuel Johnson’s horse: “A horse that can count to ten is a remarkable horse - not a remarkable mathematician.” Likewise, a textile company that allocates capital brilliantly within its industry is a remarkable textile company - but not a remarkable business."

5. Always judge the increase in earnings with how much more capital was required to increase these earnings.

The financial characteristics of these businesses have allowed us to use a very large portion of the earnings they generate elsewhere. Corporate America, however, has had a different experience: in order to increase earnings significantly, most companies have needed to increase capital significantly also. The average American business has required about $5 of additional capital to generate an additional $1 of annual pre-tax earnings. That business, therefore, would have required over $300 million in additional capital from its owners in order to achieve an earnings performance equal to our group of three.

6. When returns on capital are ordinary, an earn-more-by-putting-up-more record is no great managerial achievement.

If the widget company consistently earned a superior return on capital throughout the period, or if capital employed only doubled during the CEO’s reign, the praise for him may be well deserved. But if return on capital was lackluster and capital employed increased in pace with earnings, applause should be withheld. A savings account in which interest was reinvested would achieve the same year-by-year increase in earnings - and, at only 8% interest, would quadruple its annual earnings in 18 years.

7. Berkshire has always believed in granting incentive compensation to the key managers and no stock options. This incentives will be paid purely on the basis of the performance and is no where related to the stock prices.They have also believed that the factors like age , seniority should not impact the bonus.

8. The insurance product now is priced as any other commodity for which a free market exists: when capacity is tight, prices will be set remuneratively; otherwise, they will not be.

9. In the reinsurance business it is very difficult to divide the amount of premium between various layers of risk takers. A detailed explanation on the challenges in this regard has been discussed in this letter.

10. In this letter Buffett explains that many insurers had taken the “except for” route to gather large capital. For example a clause in the insurance would state “ we would provide insurance cover except for florida tornados”

“In any business, insurance or otherwise, “except for” should be excised from the lexicon. If you are going to play the game, you must count the runs scored against you in all nine innings. Any manager who consistently says “except for” and then reports on the lessons he has learned from his mistakes may be missing the only important lesson - namely, that the real mistake is not the act, but the actor.”

[aashka_trivedi]

A letter a day!

Letter #40 1986

Theme: Team Management

Key learnings:

1. In order to manage Berkshire Hathaway, Charlie and Buffett does 2 things :

1). One is to attract and keep outstanding managers to run various operations.

2. Allocation of capital.

“Three factors make that so: we earn more money than average; we retain all that we earn; and, we are fortunate to have operations that, for the most part, require little incremental capital to remain competitive and to grow.”

2. Acqusition of the Fechheimer Bros. Co.

This company which is based out of Omaha was acquired by Berkshire. They purchased about 85% stake in the same. One interesting fact to note here

“You may be amused to know that neither Charlie nor I have been to Cincinnati, headquarters for Fechheimer, to see their operation. (And, incidentally, it works both ways: Chuck Huggins, who has been running See’s for 15 years, has never been to Omaha.) If our success were to depend upon insights we developed through plant inspections, Berkshire would be in big trouble. Rather, in considering an acquisition, we attempt to evaluate the economic characteristics of the business - its competitive strengths and weaknesses - and the quality of the people we will be joining. Fechheimer was a standout in both respects.”

3. One of the major cost increases in the insurance business was due to social and judicial inflation. Buffett writes on the same

" Today, social and judicial inflation are the major culprits; the cost of entering a courtroom has simply ballooned. Part of the jump in cost arises from skyrocketing verdicts, and part from the tendency of judges and juries to expand the coverage of insurance policies beyond that contemplated by the insurer when the policies were written."

4. Insurance business is very difficult to operate and one must be prepared for uncertainties.

Despite the difficulties we have had in reserving and the commodity economics of the
industry, we expect our insurance business to both grow and make significant amounts of money but progress will be distinctly irregular and there will be major unpleasant surprises from time to time. It’s a treacherous business and a wary attitude is essential. We must heed Woody Allen: “While the lamb may lie down with the lion, the lamb shouldn’t count on getting a whole lot of sleep.”

5. In this year the company purchased about $700 million of tax-exempt bonds. Buffett has written on bonds:

You might think that this commitment indicates a considerable enthusiasm for such bonds. Unfortunately, that’s not so: at best, the bonds are mediocre investments. They simply seemed the least objectionable alternative at the time we bought them, and still seem so. (Currently liking neither stocks nor bonds, I find myself the polar opposite of Mae West as she declared: "I like only two kinds of men - foreign and domestic)

[aashka_trivedi]

A letter a day!

Letter #41 1987

Key learnings:

1.Growth in the enterprise value is more important than growth in the book value.

"What counts, of course, is the rate of gain in per-share business value, not book value. In many cases, a corporation’s book value and business value are almost totally unrelated. For example, just before they went bankrupt, LTV and Baldwin-United published yearend audits showing their book values to be $652 million and $397 million, respectively. Conversely, Belridge Oil was sold to Shell in 1979 for $3.6 billion although its book value was only $177 million. "

2. Three important characteristics of superior businesses:

1)The current business value of these seven units is far above their historical book value.
2)A little capital is required to run these businesses, they can grow while concurrently making almost all of their earnings available for deployment in new opportunities.
3)These businesses are run by truly extraordinary managers.

3. Severe change in the business and exceptional returns usually dont mix.

“Experience, however, indicates that the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago. That is no argument for managerial complacency. Businesses always have opportunities to improve service, product lines, manufacturing techniques, and the like, and obviously these opportunities should be seized. But a business that constantly encounters major change also encounters many chances for major error. Furthermore, economic terrain that is forever shifting violently is ground on which it is difficult to build a fortress-like business franchise. Such a franchise is usually the key to sustained high returns.”

4. How to differentiate a good insurance business from others in the industry?

1. Financial Strength.
2. Maintenance of volume.

5. The investment success will not be produced by arcane formulae, computer programs or
   signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior
   from the super-contagious.

6.Buffett on borrowing money to invest in stocks:

"Good business or investment decisions will eventually produce quite satisfactory economic results, with no aid from leverage. Therefore, it seems to us to be both foolish and improper to risk what is important (including, necessarily, the welfare of innocent bystanders such as policyholders and employees) for some extra returns that are relatively unimportant. This view is not the product of either our advancing age or prosperity: Our opinions about debt have remained constant.

However, we are not phobic about borrowing. (We’re far from believing that there is no fate worse than debt.) We are willing to borrow an amount that we believe - on a worst-case basis will pose no threat to Berkshire’s well-being."

[aashka_trivedi]

A letter a day!

Letter #42 1988
Key learnings:

1. The supreme irony of business management is that it is far easier for an inadequate CEO to keep his job than it is for an inadequate subordinate.

2. In 1988, major purchases were made of Federal Home Loan Mortgage Pfd. (“Freddie Mac”) and Coca-Cola.

3. When should you involve in arbitrage trading?

(1) How likely is it that the promised event will indeed occur?
(2) How long will your money be tied up?
(3) What chance is there that something still better will transpire - a competing takeover bid, for example?
(4)What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?

“All this said, a warning is appropriate. Arbitrage has looked easy recently. But this is not a form of investing that guarantees profits of 20% a year or, for that matter, profits of any kind. As noted, the market is reasonably efficient much of the time: For every arbitrage opportunity we seized in that 63-year period, many more were foregone because they seemed properly priced.”

In this letter, he has also explained efficient market theory and its pros and cons. On arbitrage, he has written a concluding paragraph.

"An investor cannot obtain superior profits from stocks by simply committing to a specific
investment category or style. He can earn them only by carefully evaluating facts and continuously exercising discipline. Investing in arbitrage situations, per se, is no better a strategy than selecting a portfolio by throwing darts."

4. Listing of Berkshire Hathaway’s shares on NYSE.

Charlie and Buffett have listed down the goals of listed

1. First, we do not want to maximize the price at which Berkshire shares trade.

“Charlie and I are bothered as much by significant overvaluation as significant undervaluation. Both extremes will inevitably produce results for many shareholders that will differ sharply from Berkshire’s business results. If our stock price instead consistently mirrors business value, each of our shareholders will receive an investment result that roughly parallels the business results of Berkshire during his holding period.”

2. Second, they wish for very little trading activity.

“If we ran a private business with a few passive partners, we would be disappointed if those partners, and their replacements, frequently wanted to leave the partnership. Running a public company, we feel the same way. Our goal is to attract long-term owners who, at the time of purchase, have no timetable or price target for sale but plan instead to stay with us indefinitely.”

5. Buffett mentions David L Dodd in this letter who is one of his teachers. He has also co-authored the book named “Security Analysis” with Ben Graham.( His story is worth reading)

[aashka_trivedi]

A letter a day!

Letter #43 1989

Key learnings:

1. Two factors which has led to appreciation of Berkshire Hathaway’s performance:

1. the exceptional gains in intrinsic value that the portfolio companies have achieved;
2. Markets have appropriately corrected the prices of these companies.

2. Buffett writes on the method of operation adopted by them in the insurance business which have helped them in all the times:

“Our method of operation, incidentally, makes us a stabilizing force in the industry. We add huge capacity when capacity is short and we become less competitive only when capacity is abundant. Of course, we don’t follow this policy in the interest of stabilization - we follow it because we believe it to be the most sensible and profitable course of action. Nevertheless, our behavior steadies the market. In this case, Adam Smith’s invisible hand works as advertised.”

3. In this letters, he mentions about Ajit Jain, who is an Indo American and currently vice chairman of Insurance operations of Berkshire Hathaway.

If you want to read more about him, you can read it here:

Who is Ajit Jain? The Indian who may succeed Warren Buffett to head Berkshire...

4. Buffett writes in this letter how he bought coca cola shares. I will share an excerpt here

" This Coca-Cola investment provides yet another example of the incredible speed with which your Chairman responds to investment opportunities, no matter how obscure or well-disguised they may be. I believe I had my first Coca-Cola in either 1935 or 1936. Of a certainty, it was in 1936 that I started buying Cokes at the rate of six for 25 cents from Buffett & Son, the family grocery store, to sell around the neighborhood for 5 cents each. In this excursion into high-margin retailing, I duly observed the extraordinary consumer attractiveness and commercial possibilities of the product."

I continued to note these qualities for the next 52 years as Coke blanketed the world. During this period, however, I carefully avoided buying even a single share, instead allocating major portions of my net worth to street railway companies, windmill manufacturers, anthracite producers, textile businesses, trading-stamp issuers, and the like. (If you think I’m making this up, I can supply the names.) Only in the summer of 1988 did my brain finally establish contact with my eyes."

5. This year Berkshire Hathaway has also made some investments in the preference l shares . One of the companies is The Gillete Co.

“The preferred-stock structures we have negotiated will provide a mediocre return for us if industry economics hinder the performance of our investees, but will produce reasonably attractive results for us if they can earn a return comparable to that of American industry in general. We believe that Gillette, under Colman’s management, will far exceed that return and believe that John, Ed, and Andy will reach it unless industry conditions are harsh.”

6. In the last part of this letter, Buffett recalls his mistakes in the past 25 years.

1. My first mistake, of course, was in buying control of Berkshire. Though I knew its business - textile manufacturing - to be unpromising, I was enticed to buy because the price looked cheap.

2. Good jockeys will do well on good horses, but not on broken-down nags.

3. Easy does it. After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them