A letter a day!

[Sudeep_Minhas]

Hi Aashka

Congratulations on the discipline of putting out Berkshire Hathaway letters summary day after day.requires lot of laser focus and patience to successfully carry it out

I have started reading many times but left midway for one reason or other.

You inspire me.keep up the good work

I have heard from many wise men that Berkshire Hathaway letters are best compared to nomad-nick sleep, Giverny, terry smith or even Howard marks memos to name a few

Cheers to your indomitable spirit

As Charlie Munger says-Best thing you can do is show up everyday

[aashka_trivedi]

Thank you for appreciating my work.

[aashka_trivedi]

A letter a day!

Letter #44 1990

Key learnings:

1. The investors must always keep their guard up and use accounting numbers as the beginning, not an end, in their attempts to calculate true “economic earnings” accruing to them.

“Berkshire’s own reported earnings are misleading in a different, but important, way: We have huge investments in companies (“investees”) whose earnings far exceed their dividends and in which we record our share of earnings only to the extent of the dividends we receive. The extreme case is Capital Cities/ABC, Inc. Our 17% share of the company’s earnings amounted to more than $83 million last year. Yet only about $530,000 ($600,000 of dividends it paid us less some $70,000 of tax) is counted in Berkshire’s GAAP earnings. The residual $82 million-plus stayed with Cap Cities as retained earnings, which work for our benefit but go unrecorded on our books.”

“Our perspective on such “forgotten-but-not-gone” earnings is simple: The way they are accounted for is of no importance, but their ownership and subsequent utilization is all-important. We care not whether the auditors hear a tree fall in the forest; we do care who owns the tree and what’s next done with it.”

2. The non-insurance operations produced an after-tax return of about 51% in the year 1990. Buffett highlights 2 important factors behind this performance.

1)The leverage did not produce it: Almost all the major facilities are owned, not leased, and such small debt as these operations have is basically offset by the cash they hold.

2. The return was not earned from industries, such as cigarettes or network television stations, possessing spectacular economics for all participating in them. Instead, it came from a group of businesses operating in such prosaic fields as furniture retailing, candy, vacuum cleaners, and even steel warehousing. The extraordinary returns flow from outstanding operating managers, not fortuitous industry economics.

3. Borsheim’s is one of the fine jewelry retailers in which Berkshire has invested. If it operated only in Omaha which had a population of 6,00,00 at that time, it would fail to grow the sales by 18%. They were able to grow more through an online business which sold the jewelry across the country. One major factor which accelerated their sales was lesser operating costs in comparison to the competitor.

“We attract business nationwide because we have several advantages that competitors can’t match. The most important item in the equation is our operating costs, which run about 18% of sales compared to 40% or so at the typical competitor. (Included in the 18% are occupancy and buying costs, which some public companies include in “cost of goods sold.”) Just as Wal-Mart, with its 15% operating costs, sells at prices that high-cost competitors can’t touch and thereby constantly increases its market share, so does Borsheim’s. What works with diapers works with diamonds.”

4. Buffett has already talked about corporate synergies in his letters. He shares a practical example of the same:

“I experienced a counterrevolution. Regular readers of this report know that I have long scorned the boasts of corporate executives about synergy, deriding such claims as the last refuge of scoundrels defending foolish acquisitions. But now I know better: In Berkshire’s first synergistic explosion, NFM put a See’s candy cart in the store late last year and sold more candy than that moved by some of the full-fledged stores See’s operates in California. This success contradicts all tenets of retailing. With the Blumkins, though, the impossible is routine.”

5. Buffett has emphasized three points regarding the insurance business:

(1) While we expect our super-cat business to produce satisfactory results over, say, a decade, we’re sure it will produce absolutely terrible results in at least an occasional year;

(2) Our expectations can be based on little more than subjective judgments - for this kind of insurance, historical loss data are of very limited value to us as we decide what rates to charge today; and

(3) Though we expect to write significant quantities of super-cat business, we will do so only at prices we believe to be commensurate with risk. If competitors become optimistic, our volume will fall. This insurance has, in fact, tended in recent years to be woefully underpriced; most sellers have left the field on stretchers.

6. Measuring the insurance performance:

1)Combined ratio is the best ratio to measure the performance of the insurance business. Additionally one can use the comparison of underwriting loss to float(i.e premium) developed.

“This loss/float ratio, like any statistic used in evaluating insurance results, is meaningless over short time periods: Quarterly underwriting figures and even annual ones are too heavily based on estimates to be much good. But when the ratio takes in a period of years, it gives a rough indication of the cost of funds generated by insurance operations. A low cost of funds signifies a good business; a high cost translates into a poor business.”

2. Figuring a cost of funds for an insurance business allows anyone analyzing it to determine whether the operation has a positive or negative value for shareholders. If this cost (including the tax penalty) is higher than that applying to alternative sources of funds, the value is negative. If the cost is lower, the value is positive - and if the cost is significantly lower, the insurance business qualifies as a very valuable asset.

“In the insurance business, there is no statute of limitations on stupidity. The intrinsic value of our insurance business will always be far more difficult to calculate than the value of, say, our candy or newspaper companies. By any measure, however, the business is worth far more than its carrying value. Furthermore, despite the problems this operation periodically hands us, it is the one - among all the fine businesses we own - that has the greatest potential.”

7. Buffett on his succession

" Were I to die tomorrow, you could be sure of three things: (1) None of my stock would have to be sold; (2) Both a controlling shareholder and a manager with philosophies similar to mine would follow me; and (3) Berkshire’s earnings would increase by $1 million annually since Charlie would immediately sell our corporate jet, The Indefensible (ignoring my wish that it be buried with me)."

[AtulMehra]

33 years of letters in a day! Thanks to your work!

To summarise, reminds of recent talk by Munger, go for great!

Buffet’s success can be summarised in his bets on great people, great businesses, great timing on certain purchases (at the peak of pessimism), and a great structure in a permanent vehicle as Berkshire Hathaway.

The outcome of all this has been a great long term track record for him.

Great discipline from you, @aashka_trivedi for a letter a day! Thank you very much!

[karanthharsha999]

Hi
@aashka_trivedi
happy to see I have company.
Just a small change, perhaps you could change the heading to Berkshire Hathaway annual letters.

[aashka_trivedi]

A letter a day!

Letter # 45 1991

Key learnings:

1. In this letter, Buffett explains the characteristics of economic franchise (basically a franchise model which is sustainable)

1)An economic franchise arises from a product or service that:

(1) is needed or desired;
(2) is thought by its customers to have no close substitute and;
(3) is not subject to price regulation.

The existence of all three conditions will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital. Moreover, franchises can tolerate mis-management. Inept managers may diminish a franchise’s profitability, but they cannot inflict mortal damage.

2. What is a “Bob around category”?

A bob around category of business is that category of the business whose income stream will grow only on the deployment of the
additional capital by the owners.

3. 20 years in the candy store (See’s candy)

The profits at See’s grew even faster than sales, from $4.2 million pre-tax in 1972 to $42.4 million. For an increase in profits to be evaluated properly, it must be compared with the incremental capital investment required to produce it.

An important factor which Buffett and Charlie noticed in purchasing the See’s candy business was untapped pricing power. Indeed a necessary factor in the business like that of candies.

“In our See’s purchase, Charlie and I had one important insight: We saw that the business had untapped pricing power. Otherwise, we were lucky twice over. First, the transaction was not derailed by our dumb insistence on a $25 million price. Second, we found Chuck Huggins, then See’s executive vice-president, whom we instantly put in charge. Both our business and personal experiences with Chuck have been outstanding. One example: When the purchase was made, we shook hands with Chuck on a compensation arrangement -conceived in about five minutes and never reduced to a written contract - that remains unchanged to this day.”

4. Acquisition of H.H.Brown.

Brown was the leading North American manufacturer of work shoes and boots. Buffett has narrated the entire story how he got a chance to acquire this business.

Few characteristics of the shoe business:

1. Inventories are heavy because of wide range of size and styles. ( I checked the top three companies by market capital in this business, Bata India had the inventory and the inventory days, followed by Relaxo and Campus)

2. Substantial capital is also tied up in receivables. ( I checked the same for the above three companies receivables as a % of sale.They are negligible)

3)Imported shoes can remain a threat.

Why did Buffett end up acquiring H.H.Brown despite of the above risks?

In this kind of environment, only outstanding managers like Frank and the group developed by Mr. Heffernan can prosper.

A distinguishing characteristic of H. H. Brown is one of the most unusual compensation systems I’ve encountered - but one that warms my heart: A number of key managers are paid an annual salary of $7,800, to which is added a designated percentage of the profits of the company after these are reduced by a charge for capital employed. These managers therefore truly stand in the shoes of owners. In contrast, most managers talk the talk but don’t walk the walk, choosing instead to employ compensation systems that are long on carrots but short on sticks (and that almost invariably treat equity capital as if it were cost-free). The arrangement at Brown, in any case, has served both the company and its managers exceptionally well, which should be no surprise: Managers eager to bet heavily on their abilities usually have plenty of ability to bet on.

5. A mistake discussed by Buffett in this letter : Selling early

In early 1988, we decided to buy 30 million shares (adjusted for a subsequent split) of Federal National Mortgage Association (Fannie Mae), which would have been a $350-$400 million investment. We had owned the stock some years earlier and understood the company’s business. Furthermore, it was clear to us that David Maxwell, Fannie Mae’s CEO, had dealt superbly with some problems that he had inherited and had established the company as a financial powerhouse - with the best yet to come. I visited David in Washington and confirmed that he would not be uncomfortable if we were to take a large position.

After we bought about 7 million shares, the price began to climb. In frustration, I stopped buying (a mistake that, thankfully, I did not repeat when Coca-Cola stock rose similarly during our purchase program). In an even sillier move, I surrendered to my distaste for holding small positions and sold the 7 million shares we owned.

I wish I could give you a halfway rational explanation for my amateurish behavior vis-a-vis Fannie Mae. But there isn’t one. What I can give you is an estimate as of yearend 1991 of the approximate gain that Berkshire didn’t make because of your Chairman’s mistake: about $1.4 billion.

[aashka_trivedi]

A letter a day!

Letter #46 1992

Key learnings:

1. In the past, Berkshire had issued convertible bonds. This year, the bonds were converted into stock. So the total shares outstanding of Berkshire Hathaway stands at 11,52,547. One interesting fact to note is that at the time when Buffett Partnership Limited took over the control of Berkshire, the total shares outstanding were only 11,37,778.

“We have a firm policy about issuing shares of Berkshire, doing so only when we receive as much value as we give. Equal value, however, has not been easy to obtain, since we have always valued our shares highly. So be it: We wish to increase Berkshire’s size only when doing that also increases the wealth of its owners.”

2. Acquisition of Central States Indemnity, an insurer that makes monthly payments for credit-card holders who are unable themselves to pay because they have become disabled or unemployed.

“Coincidentally, this latest acquisition has much in common with our first, made 26 years ago. At that time, we purchased another Omaha insurer, National Indemnity Company (along with a small sister company) from Jack Ringwalt, another long-time friend. Jack had built the business from scratch and, as was the case with Bill Kizer, thought of me when he wished to sell. (Jack’s comment at the time: “If I don’t sell the company, my executor will, and I’d rather pick the home for it.”) National Indemnity was an outstanding business when we bought it and continued to be under Jack’s management. Hollywood has had good luck with sequels; I believe we, too, will.”

3. Buffett on growth VS value

Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.

In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value - in the hope that it can soon be sold for a still-higher price - should be labeled speculation (which is neither illegal, immoral nor - in our view - financially fattening).

4.When using DCF method, there is always a confusion as to which coupon rate to select for forecasting. Buffett has written on the same:

At Berkshire, we attempt to deal with this problem in two ways. First, we try to stick to businesses we believe we understand. That means they must be relatively simple and stable in character. If a business is complex or subject to constant change, we’re not smart enough to predict future cash flows. Incidentally, that shortcoming doesn’t bother us. What
counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know. An investor needs to do very few things right as long as he or she avoids big mistakes.

Second, and equally important, we insist on a margin of safety in our purchase price. If we calculate the value of a common stock to be only slightly higher than its price, we’re not interested in buying. We believe this margin-of-safety principle, so strongly emphasized by Ben Graham, to be the cornerstone of investment success.

5. An intelligent investor in common stocks will do better in the secondary market than he will do buying new issues.

The reason has to do with the way prices are set in each instance. The secondary market, which is periodically ruled by mass folly, is constantly setting a “clearing” price. No matter how foolish that price may be, it’s what counts for the holder of a stock or bond who needs or wishes to sell, of whom there are always going to be a few at any moment. In many instances, shares worth x in business value have sold in the market for 1/2x or less.

The new-issue market, on the other hand, is ruled by controlling stockholders and corporations, who can usually select the timing of offerings or, if the market looks unfavorable, can avoid an offering altogether.

6. Avoid companies which offer a lot of post retirement benefits.

In recent decades, no CEO would have dreamed of going to his board with the proposition that his company become an insurer of uncapped post-retirement health benefits that other corporations chose to install. A CEO didn’t need to be a medical expert to know that lengthening life expectancies and soaring health costs would guarantee an insurer a financial battering from such a business.

[aashka_trivedi]

A letter a day!

Letter #47 1993

Key learnings:

1. In the long run, it is the earnings growth that will matter and not the market price.

Two years ago, Coca-Cola and Gillette, both large holdings of ours, enjoyed market price increases that dramatically outpaced their earnings gains. In the 1991 Annual Report, I said that the stocks of these companies could not continuously overperform their businesses.

From 1991 to 1993, Coke and Gillette increased their annual operating earnings per share by 38% and 37% respectively, but their market prices moved up only 11% and 6%. In other words the companies overperformed their stocks, a result that no doubt partly reflects Wall Street’s new apprehension about brand names. Whatever the reason, what will count over time is the earnings performance of these companies. If they prosper, Berkshire will also prosper, though not in a lock-step manner.

(Buffett still holding Coca Cola - Quantity of 400,000,000, stake 9.2%, CMP $63.46 and vale $25,384,000,000, Stake in the company 7.4%).

2. Acquisition of Dexter shoes:

Berkshire Hathaway entered the shoe business with the purchase of H H brown in the year 1991. Next, it acquired Lowell Shoes at the end of the year 1992 which primarily focused on manufacturing of women’s and nurse’s shoes. This year it went on to acquire Dexter shoes, which is into the manufacturing of popular price men’s and women’s shoes.

"Five years ago we had no thought of getting into shoes. Now we have 7,200 employees in that industry, and I sing “There’s No Business Like Shoe Business” as I drive to work. So much for strategic plans.
At Berkshire, we have no view of the future that dictates what businesses or industries we will enter. Indeed, we think it’s usually poison for a corporate giant’s shareholders if it embarks upon new ventures pursuant to some grand vision."

3. As an investor, whenever we come across a story of a multi-bagger stock, we often think now it’s too late to buy it. Buffet writes on the same with the example of Coca-Cola.

“Yes, the competition there was in 1938 and in 1993 as well. But it’s worth noting that in 1938 .The Coca-Cola Co. sold 207 million cases of soft drinks (if its gallonage then is converted into the 192-ounce cases used for measurement today) and in 1993 it sold about 10.7 billion cases, a 50-fold increase in physical volume from a company that in 1938 was already dominant in its very major industry. Nor was the party over in 1938 for an investor: Though the $40 invested in 1919 in one share had (with dividends reinvested) turned into $3,277 by the end of 1938, a fresh $40 then invested in Coca-Cola stock would have grown to $25,000 by yearend 1993.”

4. The following factors can be used to judge the risk of the company apart from the beta:

1. The certainty with which the long-term economic characteristics of the business can be evaluated;
2. The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows;
3. The certainty with which management can be counted on to channel the rewards from the business to the shareholders rather than to itself;
4. The purchase price of the business;
5. The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor’s purchasing-power return is reduced from his gross return.

“These factors will probably strike many analysts as unbearably fuzzy, since they cannot be extracted from a data base of any kind. But the difficulty of precisely quantifying these matters does not negate their importance nor is it insuperable. Just as Justice Stewart found it impossible to formulate a test for obscenity but nevertheless asserted, “I know it when I see it,” so also can investors - in an inexact but useful way - “see” the risks inherent in certain investments without reference to complex equations or price histories.”

5. If you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you. It is apt simply to hurt your results and increase your risk. Rather than putting money into the new company, adding the same money to the top choices will be less risky.

6. In this letter, Buffett writes in detail about corporate governance. He has stated three types of corporate governance and what should shareholders/directors do in each case.

1. No controlling owner.
2. Controlling owner involved in the management.
3. Controlling owner not invovled in the management.

It is advisable to read this in detail from this letter.

7. Buffett on what will happen if for any reason is unable to continue to be an owner or/manager at Berkshire:

"After my death, all of my stock will go to my wife, Susie, should she survive me, or to a foundation if she dies before I do. In neither case will taxes and bequests require the sale of consequential amounts of stock.

When my stock is transferred to either my wife or the foundation, Berkshire will enter the third governance mode, going forward with a vitally interested, but non-management, owner and with a management that must perform for that owner. In preparation for that time, Susie was elected to the board a few years ago, and in 1993 our son, Howard, joined the board. These family members will not be managers of the company in the future, but they will represent the controlling interest should anything happen to me. Most of our other directors are also significant owners of Berkshire stock, and each has a strong owner-orientation"

P.S Third governance mode is controlling owner not involved in the mangement.

[aashka_trivedi]

A letter a day!

Letter #48 1994

Key learnings:

1. Even though you might have surplus capital, always wait for the right opportunity to park your funds.

"Nevertheless, we will stick with the approach that got us here and try not to relax our standards. Ted Williams, in The Story of My Life, explains why: “My argument is, to be a good hitter, you’ve got to get a good ball to hit. It’s the first rule in the book. If I have to bite at stuff that is out of my happy zone, I’m not a .344 hitter. I might only be a .250 hitter.” Charlie and I agree and will try to wait for opportunities that are well within our own “happy zone.”

2. Fear is the foe of the faddist, but the friend of the fundamentalist.

" A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results.

What we promise you - along with more modest gains - is that during your ownership of Berkshire, you will fare just as Charlie and I do. If you suffer, we will suffer; if we prosper, so will you. And we will not break this bond by introducing compensation arrangements that give us greater participation in the upside than the downside."

3. Book value VS intrinsic value
   The intrinsic value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.

He has explained the relationship between the book value and the intrinsic value through the case study of Scott Fetzer which they acquired in 1986. At the time of the acquisition, the book value of Scott was $172 million and Berkshire purchased it for $315 million which is almost close to double its book value.

Buffett paid a higher price because of his view that its current value is more than its book value. An entire case study is explained with the numbers in the letter, a must-read.

4. The intrinsic value is as important for managers as it is for investors. When managers are making capital allocation decisions - including decisions to repurchase shares - it’s vital that they act in ways that increase per-share intrinsic value and avoid moves that decrease it. This principle may seem obvious but we constantly see it violated. And, when misallocations occur, shareholders are hurt.

5. Due to its strong financial strength, Berkshire had 2 advantages in the insurance business

1). It had the ability to protect the insured against big catastrophe events without being default.

2). It had the capability to write an insurance policy for an amount that no one in its peers can write.

“Given the risks we accept, Ajit and I constantly focus on our worst case,” knowing, of course, that it is difficult to judge what this is, since you could conceivably have a Long Island hurricane, a California earthquake, and Super Cat X all in the same year. Additionally, insurance losses could be accompanied by non-insurance troubles. For example, were we to have super-cat losses from a large Southern California earthquake, they might well be accompanied by a major drop in the value of our holdings in See’s, Wells Fargo and Freddie Mac.

All things considered, we believe our worst-case insurance loss from a super-cat is now about $600 million after-tax, an amount that would slightly exceed Berkshire’s annual earnings from other sources. If you are not comfortable with this level of exposure, the time to sell your Berkshire stock is now, not after the inevitable mega-catastrophe."

6. If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring, the payoff is the same as if you had correctly analyzed
   an investment alternative characterized by many constantly shifting and complex variables.

7. Try to price, rather than time, purchases.

8. Before looking at the new investments, consider adding to old ones. ( This was said in the last letter also)

[aashka_trivedi]

A letter a day!

Letter #49 1995

Key learnings:

1. Many times, due to high valuations quoted at the time of acquisitions, the shareholders of the acquiring company mostly face the damages.

In any case, why potential buyers even look at projections prepared by sellers baffles me. Charlie and I never give them a glance, but instead, keep in mind the story of the man with an ailing horse. Visiting the vet, he said: “Can you help me? Sometimes my horse walks just fine and sometimes he limps.” The vet’s reply was pointed: “No problem - when he’s walking fine, sell him.” In the world of mergers and acquisitions, that horse would be peddled as Secretariat.

2. Acquisition of Helzberg Diamond shop

Helzberg diamond shop was started by Barnett Helzberg, Jr., who owned four shares of Berkshire and had also been at the 1994 meeting. He pitched the company to Buffett as he wanted to free himself from the management of the company.

" We completed the Helzberg purchase in 1995 by means of a tax-free exchange of stock, the only kind of transaction that interested Barnett. Though he was certainly under no obligation to do so, Barnett shared a meaningful part of his proceeds from the sale with a large number of his associates. When someone behaves that generously, you know you are going to be treated right as a buyer."

3. Acquisition of R.C Willey home furnishings

R.C. Willey is an amazing story. Bill(A friend of Irv from Nebraska Furniture Mart) took over the business from his father-in-law in 1954 when sales were about $250,000. From this tiny base, Bill employed Mae West’s philosophy: “It’s not what you’ve got - it’s what you do with what you’ve got.” Aided by his brother, Sheldon, Bill has built the company to its 1995 sales volume of $257 million, and it accounted for over 50% of the furniture business in Utah.

Buffett on retailing business:

“Retailing is a tough business. During my investment career, I have watched a large number of retailers enjoy terrific growth and superb returns on equity for a period, and then suddenly nosedive, often all the way into bankruptcy. This shooting-star phenomenon is far more common in retailing than it is in manufacturing or service businesses. In part, this is because a retailer must stay smart, day after day. Your competitor is always copying and then topping whatever you do. Shoppers are meanwhile beckoned in every conceivable way to try a stream of new merchants. In retailing, to coast is to fail.”

4. Purchase of 100% share of GEICO corporation

The entire story is narrated by Buffett how he came across GEICO through his teacher/mentor Mr Ben Graham. And later in 1995, went on to acquire the full company.

" GEICO, of course, must continue both to attract good policyholders and keep them happy. It must also reserve and price properly. But the ultimate key to the company’s success is its rock-bottom operating costs, which virtually no competitor can match. In 1995, moreover, Tony and his management team pushed underwriting and loss adjustment expenses down further to 23.6% of premiums, nearly one percentage point below 1994’s ratio. In business, I look for economic castles protected by unbreachable “moats.” Thanks to Tony and his management team, GEICO’s moat widened in 1995."

5. Any company’s level of profitability is determined by three items:
   (1) what its assets earn;
   (2) what its liabilities cost;
   (3) its utilization of “leverage” - that is, the degree to which its assets are funded by liabilities rather than by equity.

6. Insurance operations

Few examples of insurance being undertaken by Berkshire Hathaway

1. The life of Mike Tyson for a sum that is large initially and that,
   fight-by-fight, gradually declines to zero over the next few years.

2. Lloyd’s against more than 225 of its “names” dying during the
   year.

3. The launch, and a year of orbit, of two Chinese
   satellites.

Buffett writes on the same :

"Berkshire is sought out for many kinds of insurance, both super-cat and large single-risk, because (1) our financial strength is unmatched, and insureds know we can and will pay our losses under the most adverse of circumstances; (2) we can supply a quote faster than anyone in the business; and (3) we will issue policies with limits larger than anyone else is prepared to write.

Most of our competitors have extensive reinsurance treaties and lay off much of their business. While this helps them avoid shock losses, it also hurts their flexibility and reaction time. As you know, Berkshire moves quickly to seize investment and acquisition opportunities; in insurance, we respond with the same exceptional speed. On another important point, large coverages don’t frighten us but, on the contrary, intensify our interest. We have offered a policy under which we could have lost $1 billion; the largest coverage that a client accepted was $400 million"

7. Exchanged cap cities shares for Disney shares plus cash.

"I first became interested in Disney in 1966, when its market valuation was less than $90 million, even though the company had earned around $21 million pre-tax in 1965 and was sitting with more cash than debt. At Disneyland, the $17 million Pirates of the Caribbean ride would soon open. Imagine my excitement - a company selling at only five times rides!

Duly impressed, Buffett Partnership Ltd. bought a significant amount of Disney stock at a split-adjusted price of 31› per share. That decision may appear brilliant, given that the stock now sells for $66. But your Chairman was up to the task of nullifying it: In 1967 I sold out at 48› per share.
Oh well - we’re happy to be once again a large owner of a business with both unique assets and outstanding management."

[aashka_trivedi]

I am sharing one highlight reel from the 1994 AGM.

In this Charlie and Buffett have talked about the insurance business, the danger of derivatives, Splitting of Berkshire Hathaway shares.

One of the shareholders present in the AGM asked a question to Buffett:

“What is your next goal in life now since you are the richest man in the country?
He replied " To be the oldest man in the country”

Watch the full video here : 1994 Berkshire Hathaway Annual Meeting

[aashka_trivedi]

A letter a day!

Letter #50 1996

Key learnings:

1. Acquisition of Kanas Bankers Surety:

If you are also anti-social like Buffett, you can consider attending some social events post reading this story.

You might be interested in the carefully-crafted and sophisticated acquisition strategy that allowed Berkshire to nab this deal. Early in 1996 I was invited to the 40th birthday party of my nephew’s wife, Jane Rogers. My taste for social events being low, I immediately, and in my standard, gracious way, began to invent reasons for skipping the event. The party planners then countered brilliantly by offering me a seat next to a man I always enjoy, Jane’s dad, Roy Dinsdale - so I went.

The party took place on January 26. Though the music was loud - Why must bands play as if they will be paid by the decibel? - I just managed to hear Roy say he’d come from a directors meeting at Kansas Bankers Surety, a company I’d always admired. I shouted back that he should let me know if it ever became available for purchase.

On February 12, I got the following letter from Roy: “Dear Warren: Enclosed is the annual financial information on Kansas Bankers Surety. This is the company that we talked about at Janie’s party. If I can be of any further help, please let me know.” On February 13, I told Roy we would pay $75 million for the company - and before long we had a deal. I’m now scheming to get invited to Jane’s next party.

2. Selling fine businesses on “scary” news is usually a bad decision.

"Robert Woodruff, the business genius who built Coca-Cola over many decades and who owned a huge position in the company, was once asked when it might be a good time to sell Coke stock. Woodruff had a simple answer: “I don’t know. I’ve never sold any.”

3. Competitive advantages of Berkshire’s super cat ( high amount) insurance business:

1. The parties buying reinsurance know that they can and will pay under the most adverse of circumstances.
2. After a mega-catastrophe, insurers might well find it difficult to obtain reinsurance even though their need for coverage would then be particularly great. At such a time, Berkshire would without question have very substantial capacity available - but it will naturally be its long-standing clients that have first call on it.
3. Our final competitive advantage is that we can provide dollar coverages of a size neither matched nor approached elsewhere in the industry. Insurers looking for huge covers know that a single call to Berkshire will produce a firm and immediate offering.

“In insurance, it is essential to remember that virtually all surprises are unpleasant, and with that, in mind, we try to price our super-cat exposures so that about 90% of total premiums end up being eventually paid out in losses and expenses. Over time, we will find out how smart our pricing has been, but that will not be quick. The super-cat business is just like the investment business in that it often takes a long time to find out whether you knew what you were doing”.

4. Inactivity is also a type of intelligent behavior. When carried out capably, an investment strategy of this type will often result in its practitioner owning a few securities that will come to represent a very large portion of his portfolio.

“This investor would get a similar result if he followed a policy of purchasing an interest in, say, 20% of the future earnings of a number of outstanding college basketball stars. A handful of these would go on to achieve NBA stardom, and the investor’s take from them would soon dominate his royalty stream. To suggest that this investor should sell off portions of his most successful investments simply because they have come to dominate his portfolio is akin to suggesting that the Bulls trade Michael Jordan because he has become so important to the team.”

5. Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses.

Note that word “selected”: You don’t have to be an expert on every company or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.

6. To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing, or emerging markets. You may, in fact, be better off knowing nothing of these.

7. Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten, and twenty years from now. Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock.

8. 8. USAir

Buffett purchased preferred stocks of USAir and in this letter, he regrets the same,

“I liked and admired Ed Colodny, the company’s then-CEO, and I still do. But my analysis of USAir’s business was both superficial and wrong. I was so beguiled by the company’s long history of profitable operations, and by the protection that ownership of senior security seemingly offered me, that I overlooked the crucial point: USAir’s revenues would increasingly feel the effects of an unregulated, fiercely-competitive market whereas its cost structure was a holdover from the days when regulation protected profits. These costs, if left unchecked, portended disaster, however reassuring the airline’s past record might be. (If history supplied all of the answers, the Forbes 400 would consist of librarians.)”

[newbie_007]

Keep up the good work! Thank you for summarising.

[aashka_trivedi]

A letter a day!

Letter #51 1997

Key learnings:

1. Unconvential commitments

Buffett has written in this letter that when he unable to find an investment opportunity , they choose to invest in quality short term investments. He had invested in the following unconvential investments:

1. The derivative contracts for 14.0 million barrels of oil.
2. Silver.
3. A long-term zero-coupon obligations of the U.S. Treasury.

“In purchasing zeros, rather than staying with cash-equivalents, we risk looking very foolish: A macro-based commitment such as this never has anything close to a 100% probability of being successful. However, you pay Charlie and me to use our best judgment – not to avoid embarrassment – and we will occasionally make an unconventional move when we believe the odds favor it. Try to think kindly of us when we blow one. Along with President Clinton, we will be feeling your pain: The Munger family has more than 90% of its net worth in Berkshire and the Buffetts more than 99%.”

2. Prospective purchasers should much prefer sinking prices.Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come,
   they are elated when stock prices rise and depressed when they fall.

“So smile when you read a headline that says “Investors lose as market falls.” Edit it in your mind to “Disinvestors lose as market falls – but investors gain.” Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other. (As they say in golf matches: “Every putt makes someone happy.”)”

3. Float and cost of float in an insurance business

The float is money insurer’s have but don’t own. In an insurance operation, float arises because premiums are received before losses are paid, an interval that sometimes extends over many years. During that time, the insurer invests the money.
Typically, this pleasant activity carries with it a downside: The premiums that an insurer takes in usually do not cover the losses and expenses it eventually must pay. That leaves it running an “underwriting loss,” which is the cost of float. An insurance business has value if its cost of float over time is less than the cost the company would otherwise incur to obtain funds. But the business is a lemon if its cost of float is higher than market rates for money.

"Since 1967, when we entered the insurance business, our float has grown at an annual compounded rate of 21.7%. Better yet, it has cost us nothing, and in fact has made us money. Therein lies an accounting irony: Though our float is shown on our balance sheet as a liability, it has had a value to Berkshire greater than an equal amount of net worth would have had.

The expiration of several large contracts will cause our float to decline during the first quarter of 1998, but we expect it to grow substantially over the long term. We also believe that our cost of float will continue to be highly favorable."

4. Buffett on buying businesses on cash instead of issuing shares

“Our problem has been that we own a truly marvelous collection of businesses, which means that trading away a portion of them for something new almost never makes sense. When we issue shares in a merger, we reduce your ownership in all of our businesses – partly-owned companies such as Coca-Cola, Gillette and American Express, and all of our terrific operating companies as well. An example from sports will illustrate the difficulty we face: For a baseball team, acquiring a player who can be expected to bat .350 is almost always a wonderful event – except when the team must trade a .380 hitter to make the deal.”

[aashka_trivedi]

A letter a day!

Letter #52 1998

Key learnings:

1. Acquisition of Executive Jet Aviation

This is the same company from which Warren Buffett purchased his personal jet. Its CEO, Rich Santulli, created the fractional ownership industry in 1986, by visualizing an important new way of using planes. Then he combined guts and talent to turn his idea into a major business. It fraction ownership you can own say 1/8th of plan rather than buying the entire plan and have to pay for maintenance and fuel expenses on the basis of hours flown.

Buffett on the business model of EJA

"In many cases our clients, both corporate and individual, own fractions of several different planes and can therefore match specific planes to specific missions. For example, a client might own /16th of three different jets (each giving it 150 hours of flying time), which in total give it a virtual fleet, obtained for a small fraction of the cost of a single plane.
Significantly, it is not only small businesses that can benefit from fractional ownership. Already, some of America’s largest companies use NetJets as a supplement to their own fleet. This saves them big money in both meeting peak requirements and in flying missions that would require their wholly-owned planes to log a disproportionate amount of dead-head hours."

2. conomics of property-casuality insurance business

This has already been covered in the previous letters, however with the acquisition of the general Re , it has again been explained in depth.

The key determinants are:
(1) the amount of float that thebusiness generates;
(2) its cost; and
(3) most important of all, the long-term outlook for both of these factors.

3. Portfolio actions:

"During the year, we slightly increased our holdings in American Express, one of our three largest commitments, and left the other two unchanged. However, we trimmed or substantially cut many of our smaller positions. Here, I need to make a confession (ugh): The portfolio actions I took in 1998 actually decreased our gain for the year. In particular, my decision to sell McDonald’s was a very big mistake. Overall, you would have
been better off last year if I had regularly snuck off to the movies during market hours."

( A major part of letter consists of accounting related issues which are not so relevant today so havnt discussed the same)

[aashka_trivedi]

A letter a day!

Letter #53 1999

Key learnings:

1. Berkshire had been consistently spending money on marketing for its GEICO insurance business, despite of that the greatest contributor to get new business had been word of mouth recommendations from the existing policy holders.

Apart from advertising, the company also spent money on hiring sales counselors which made the policy holders happy with their services.

2. Berkshire had acquired Executive Jet Aviation. In this letter , Buffett talks about its competitive advantages:

“EJA enjoys another important advantage in that its two largest competitors are both subsidiaries of aircraft manufacturers and sell only the aircraft their parents make. Though these are fine planes, these competitors are severely limited in the cabin styles and mission capabilities they can offer. EJA, in contrast, offers a wide array of planes from five suppliers. Consequently, we can give the customer whatever he needs to buy — rather than his getting what the competitor’s parent needs to sell.”

From the perspective of a retail investor, I consider EJA as playing premiumization, i.e something which is not meant for all. In Indian markets, we can relate it to Ethos Limited, Sula Vineyards Limited or even Delta Corp limited for that matter.

3. Acquisition in the furniture business

Those who have been following the letter since start, they would have identified a pattern in purchase decisions made by Buffett ie. multiple acquisitions of business in similar industry. Be it furniture or insurance, Buffett tried to get the best of all the companies available in that industry.

“Each of our furniture operations is number one in its territory. We now sell more furniture than anyone else in Massachusetts, New Hampshire, Texas, Nebraska, Utah and Idaho. Last year Star’s Melvyn Wolff and his sister, Shirley Toomim, scored two major successes: a move into San Antonio and a significant enlargement of Star’s store in Austin. There’s no operation in the furniture retailing business remotely like the one assembled by Berkshire. It’s fun for me and profitable for you. W. C. Fields once said, “It was a woman who drove me to drink, but unfortunately I never had the chance to thank her.” I don’t want to make that mistake. My thanks go to Louie, Ron, and Irv Blumkin for getting me started in the furniture business and for unerringly guiding me as we have assembled the group we now have.”

4. Acquisition of Mid-American Energy:

MidAmerican Energy, was an electricity utility company . These kind of companies are complicated because they are governed by variety of regulations. There, Berkshire avoided taking a stake that would give them controlling rights.

“Though there are many regulatory constraints in the utility industry, it’s possible that we will make additional commitments in the field. If we do, the amounts involved could be large.”

5. Shoe business

The major constraint faced by the shoe business was approximately 93% of the 1.3 billion pairs of shoes purchased in the country came from abroad, where extremely low-cost labor is the rule. Due to this, the shoe business couldn’t perform well.

“Counting both Dexter and H. H. Brown, we are currently the leading domestic manufacturer of shoes, and we are likely to continue to be. We have loyal, highly-skilled workers in our U.S. plants, and we want to retain every job here that we can. Nevertheless, in order to remain viable, we are sourcing more of our output internationally. In doing that, we have incurred significant severance and relocation costs that are included in the earnings we show in the table.”

6. Buffett on tech companies:

"We made a few portfolio changes in 1999. As I mentioned earlier, several of the companies in which we have large investments had disappointing business results last year. Nevertheless, we believe these companies have important competitive advantages that will endure over time. This attribute, which makes for good long-term investment results, is one Charlie and I occasionally believe we can identify. More often, however, we can’t — not at least with a high degree of conviction. This explains, by the way, why we don’t own stocks of tech companies, even though we share the general view that our society will be transformed by their products and services. Our problem — which we can’t solve by studying up — is that we have no insights into which participants in the tech field possess a truly durable competitive advantage.

Our lack of tech insights, we should add, does not distress us. After all, there are a great many business areas in which Charlie and I have no special capital allocation expertise. For instance, we bring nothing to the table when it comes to evaluating patents, manufacturing processes, or geological prospects. So we simply don’t get into judgments in those fields.

7. Stock repurchase

There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds — cash plus sensible borrowing capacity — beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value.

[aashka_trivedi]

A letter a day!

Letter #54 2000

Key learnings:

1. Acquisition of CORT business services:

Operating out of 117 showrooms, CORT was the national leader in “rent-to-rent” furniture, primarily used in offices but also by temporary occupants of apartments. This business, it should be noted, has no similarity to “rent-to-own” operations, which usually involve the sale of home furnishings and electronics to people having limited income and poor credit.

2. Acquisition of Ben Bridge Jeweller.

There was an already existing business of “Helzberg Diamonds” owned by Berkshire. This business was in a similar line.

For the ones who have been tracking IPOs, it is always advisable to see the use of proceeds which the company plans to make through the IPO money. To give an example:

“In their typically classy way, the Bridges allocated a substantial portion of the proceeds from their sale to the hundreds of co-workers who had helped the company achieve its success. We’re proud to be associated with both the family and the company.”

I would be happy if I am associated with this kind of company as an investor.

3. Acquisition of Benjamin More Paints company:

“In late August, Charlie and I met with Richard Roob and Yvan Dupuy, past and present CEOs of Benjamin Moore. We liked them; we liked the business; and we made a $1 billion cash offer on the spot. In October, their board approved the transaction, and we completed it in December. Benjamin Moore has been making paint for 117 years and has thousands of independent dealers that are a vital asset to its business. Make sure you specify our product for your next paint job.”

4. Agonizing over errors is a mistake. But acknowledging and analyzing them can be useful, though that practice is rare in corporate boardrooms.

5. Few of the mistakes which happened due to massive advertising expenses in GEICO

For the first time ever, even after spending money on advertising, the company experience increased costs in obtaining new business. Buffett has stated reasons for the same:

"First, in our advertising, we have pushed “frequency” very hard, and we probably overstepped in certain media. We’ve always known that increasing the number of messages through any medium would eventually produce diminishing returns. The third ad in an hour on a given cable channel is simply not going to be as effective
as the first.

Second, we may have already picked much of the low-hanging fruit. Clearly, the willingness to do business with a direct marketer of insurance varies widely among individuals: Indeed, some percentage of Americans ¾ particularly older ones ¾ are reluctant to make direct purchases of any kind. Over the years, however, this reluctance will ebb. A new generation with new habits will find the savings from direct purchase of their auto insurance too compelling to ignore."
6. A bird in the hand is better than two in the bush.

The oracle was Aesop and his enduring, though somewhat incomplete, investment insight was “a bird in the hand is worth two in the bush.” To flesh out this principle, you must answer only three questions. How certain are you that there are indeed birds in the bush? When will they emerge and how many will there be? What is the risk-free interest rate (which we consider to be the yield on long-term U.S. bonds)? If you can answer these three questions, you will know the maximum value of the bush ¾ and the maximum number of the birds you now possess that should be offered for it. And, of course, don’t literally think birds. Think dollars.

7. Investing VS speculation

"The line separating investment and speculation, which is never bright and clear, becomes blurred still
further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities ¾ that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future ¾ will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hand"

8. 2021 is considered as a year on IPO boom where Indian equity market witnessed 60 + IPOs. Similarly, 1995 to 2000 was considered as a DOT COM bubble which was bursted in the year 2000. Buffett has written on the same :

"What actually occurs in these cases is wealth transfer, often on a massive scale. By shamelessly merchandising birdless bushes, promoters have in recent years moved billions of dollars from the pockets of the public to their own purses (and to those of their friends and associates). The fact is that a bubblemarket has allowed the creation of bubble companies, entities designed more with an eye to making money off investors rather than for them. Too often, an IPO, not profits, was the primary goal of a company’s promoters. At bottom, the “business model” for these companies has been the old-fashioned chain letter, for which many fee-hungry investment bankers acted as eager postmen.
But a pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learns some very old lessons: First, many in Wall Street ¾ a community in which quality control is not prized ¾ will sell investors anything they will buy. Second, speculation is most dangerous when it looks easiest."

[aashka_trivedi]

A letter a day!

Letter #55 2001

Key learnings :

1. Acquisition of fruit of the loom

In every year’s letter, there are many acquisitions being undertaken by Berkshire Hathaway. I only share the ones which are worth reading.

In August 1955, Buffett was one of the 5 employees of the Graham-Newman Corporation. At that point in time Ben Graham, Jerry Newman, and Howard Newman were his bosses. They controlled a company cal P&R (Philadelphia and Reading Coal and Iron). The business had excess cash and it purchased Union UnderwearCompany from Jack Goldfarb for $15
million. Union (though it was then only a licensee of the name) produced Fruit of the Loom underwear. John Holland was responsible for Fruitís operations in its most bountiful years. In 1996, however, John retired, and management loaded the company with debt, in part to make a series of acquisitions that proved disappointing. Bankruptcy followed. John was then rehired, and he undertook a major reworking of operations.

Buffett on its acquisition :

“Stepping into Fruitís bankruptcy proceedings, we made a proposal to creditors to which we attached no financing conditions, even though our offer had to remain outstanding for many months. We did, however, insist on a very unusual proviso: John had to be available to continue serving as CEO after we took over. To us, John and the brand are Fruitís key assets. I was helped in this transaction by my friend and former boss, Micky Newman, now 81. What goes around truly does come around”

2. Principles of insurance underwriting:

Buffett has stated three key principles which can make a good insurance business;

Many of the biggest and best-known companies regularly deliver mediocre results. What counts in this business is underwriting discipline. The winners are those that unfailingly stick to three key principles:

1. They accept only those risks that they are able to properly evaluate (staying within their circle of competence) and that, after they have evaluated all relevant factors including remote loss
   scenarios, carry the expectancy of profit. These insurers ignore market-share considerations and are sanguine about losing business to competitors that are offering foolish prices or policy conditions.

2. They limit the business they accept in a manner that guarantees they will suffer no aggregation of losses from a single event or from related events that will threaten their solvency. They ceaselessly search for possible correlations among seemingly-unrelated risks.

3. They avoid business involving moral risk: No matter what the rate, trying to write good contracts with bad people doesn’t work. While most policyholders and clients are honorable and ethical, doing business with a few exceptions is usually expensive, sometimes extraordinarily so.

4. Supercat insurance business,

On Sept 11, 2001 there was a terrorist attack on twin towers in America. Buffett has expressed his views on this kind of risk in this letter. He says that the probability of such mind-boggling disasters, though likely very low at present, is not zero and the probabilities are increasing in an irregular and immeasurable manner.

"Why, you might ask, didnít I recognize the above facts before September 11th? The answer, sadly, is that I did but I did not convert thought into action. I violated the Noah rule: Predicting rain doesnít count; building arks does. I consequently let Berkshire operate with a dangerous level of risk at General Re in particular. I am sorry to say that much risk for which we havenít been compensated remains on our books, but it is running off by the day.

The bottom-line today is that we will write some coverage for terrorist-related losses, including a few noncorrelated policies with very large limits. But we will not knowingly expose Berkshire to losses beyond what we can comfortably handle. We will control our total exposure, no matter what the competition does."

The company covered the following policies post the event:

(1) $578 million of property coverage for a South American refinery once a loss
there exceeds $1 billion; (2) $1 billion of non-cancelable third-party liability coverage for losses arising from acts of terrorism at several large international airlines; (3) £500 million of property coverage on a large North Sea oil platform, covering losses from terrorism and sabotage, above £600 million that the insured retained or reinsured elsewhere; and (4) significant coverage on the Sears Tower, including losses caused by terrorism, above a $500 million threshold. We have written many other jumbo risks as well, such as protection for the World Cup Soccer
Tournament and the 2002 Winter Olympics. In all cases, however, we have attempted to avoid writing groups of policies from which losses might seriously aggregate. We will not, for example, write coverages on a large number of office and apartment towers in a single metropolis without excluding losses from both a nuclear explosion and the fires that would follow it.

4. Bad terminology is the enemy of good thinking. When companies or investment professionals use terms such as EBITDA and pro forma, they want you to unthinkingly accept concepts that are dangerously flawed.

5. Loss development and insurance accounting.

It is clearly difficult for an insurer to put a figure on the ultimate cost of all reported and unreported events. But the ability to do so with reasonable accuracy is vital. Otherwise, the insurerís managers wonít know what its actual loss costs are and how these compare to the premiums being charged.

“When it becomes evident that reserves at past reporting dates understated the liability that truly existed at the time, companies speak of ìloss development. In the year discovered, these shortfalls penalize reported earnings because the ìcatch-upî costs from prior years must be added to current-year costs when results are calculated. This is what happened at General Re in 2001: a staggering $800 million of loss costs that actually occurred in earlier years, but that were not then recorded, were belatedly recognized last year and charged against current earnings. The mistake was an honest one, I can assure you of that. Nevertheless, for several years, this under reserving caused us to believe that our costs were much lower than they truly were, an error that contributed to woefully inadequate pricing. Additionally, the overstated profit figures led us to pay substantial incentive compensation that we should not have and to incur income taxes far earlier than was necessary.”

6. Dexter Shoe business

Dexter’s shoe business continues to make losses. The problem of imported shoes which has been stated earlier is the main reason for the same.

“I have made three decisions relating to Dexter that have hurt you in a major way: (1) buying it in the first place; (2) paying for it with stock and (3) procrastinating when the need for changes in its operations was obvious. I would like to lay these mistakes on Charlie (or anyone else, for that matter) but they were mine. Dexter, prior to our purchase ñ and indeed for a few years after ñ prospered despite the low-cost foreign competition that was brutal. I concluded that Dexter could continue to cope with that problem, and I was wrong.”

[aashka_trivedi]

A letter a day!

Letter #56 2002

Key learning :

1. To be a winner, work with winners.

Buffett has written this in context of employment of excellent managers. He has often stated in his letters that his only task is identifying business with good economic characteristics run by good managers.

2. Acquisition of Northern natural gas.

From its beginnings in the 1930s, Northern Natural was one of Omaha’s premier businesses, run by CEOs who regularly distinguished themselves as community leaders. Then, in July, 1985, the company – which in 1980 had been renamed InterNorth – merged with Houston Natural Gas, a business less than half its size. The companies announced that the enlarged operation would be headquartered in Omaha, with InterNorth’s CEO continuing in that job.
Within a year, those promises were broken. By then, the former CEO of Houston Natural had taken over the top job at InterNorth, the company had been renamed, and the headquarters had been moved to Houston. These switches were orchestrated by the new CEO – Ken Lay – and the name he chose was Enron.
Fast forward 15 years to late 2001. Enron ran into the troubles and borrowed money from Dynegy, putting up the Northern Natural pipeline operation as collateral. The two companies quickly had a falling out, and the pipeline’s ownership moved to Dynegy. That company, in turn, soon encountered severe financial problems of its own.
MEHC received a call from Dynegy, which was looking for a quick and certain cash sale of the pipeline.

“When 2001 began, Charlie and I had no idea that Berkshire would be moving into the pipeline business. But upon completion of the Kern River expansion, MEHC will transport about 8% of all gas used in the U.S. We continue to look for large energy-related assets, though in the electric utility field PUHCA constrains what we can do.”

3. In this letter, Buffett has discussed in detail about derivatives. Those of you interested can give it a read.

The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. Knowledge of how dangerous they are has already permeated the electricity and gas businesses, in which the eruption of major troubles caused the use of derivatives to diminish dramatically. Elsewhere, however, the derivatives business continues to expand unchecked. Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts.
Charlie and I believe Berkshire should be a fortress of financial strength – for the sake of our owners, creditors, policyholders and employees. We try to be alert to any sort of megacatastrophe risk, and that posture may make us unduly apprehensive about the burgeoning quantities of long-term derivatives contracts and the massive amount of uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.

4. Corporate governance.
   The directors should behave as if there was a single absentee owner, whose long-term interest they should try to further in all proper ways. This means that directors must get rid of a manager who is mediocre or worse, no matter how likable he may be.

“ Directors must react as did the chorus-girl bride of an 85-year- old multimillionaire when he asked whether she would love him if he lost his money. “Of course,” the young beauty replied, “I would miss you, but I would still love you.”

The current cry is for “independent” directors. It is certainly true that it is desirable to have directors who think and speak independently – but they must also be business-savvy, interested and shareholder- oriented. In my 1993 commentary, those are the three qualities I described as essential.

5. Audit committees can’t audit. Only a company’s outside auditor can determine whether the earnings that a management purports to have made are suspect.

6. Three suggestions for investor’s

1. beware of companies displaying weak accounting.

2. unintelligible footnotes usually indicate untrustworthy management. If you can’t understand a footnote or other managerial explanation, it’s usually because the CEO doesn’t want you to.

3. be suspicious of companies that trumpet earnings projections and growth expectations. Businesses seldom operate in a tranquil, no-surprise environment, and earnings simply don’t advance smoothly .

“Charlie and I not only don’t know today what our businesses will earn next year – we don’t even know what they will earn next quarter. We are suspicious of those CEOs who regularly claim they do know the future – and we become downright incredulous if they consistently reach their declared targets. Managers that always promise to “make the numbers” will at some point be tempted to make up the numbers.”

[aashka_trivedi]

A letter a day!

Letter # 57 2003

Key learnings:

1. In this letter, Buffett has continued his discussion on corporate governance. He has stated the situation of mutual fund managers in corporate America as well the board of directors.
   He writes:

In addition to being independent, directors should have business savvy, a shareholder orientation, and a genuine interest in the company. The rarest of these qualities is business savvy – and if it is lacking,the other two are of little help. Many people who are smart, articulate and admired have no real understanding of business. That’s no sin; they may shine elsewhere. But they don’t belong on corporate boards. Similarly, I would be useless on a medical or scientific board (though I would likely be welcomed by a chairman who wanted to run things his way). My name would dress up the list of directors, but I wouldn’t know enough to critically evaluate proposals. Moreover, to cloak my ignorance, I would keep my mouth shut (if you can imagine that). In effect, I could be replaced, without loss, by a potted plant.

2. For the insurance business, the float is wonderful,if it doesn’t come at a higher price. The cost of float is determined by the underwriting results, meaning how losses and expenses are paid in comparison to the premium received.

3. 2002 was the very first time Berkshire Hathaway started focusing on other foreign currency markets. In the year 2003, they have increased the same.

“We have – and will continue to have – the bulk of Berkshire’s net worth in U.S. assets. But in recent years our country’s trade deficit has been force-feeding huge amounts of claims on, and ownership in, America to the rest of the world. For a time, foreign appetite for these assets readily absorbed the supply. Late in 2002, however, the world started choking on this diet, and the dollar’s value began to slide against major currencies. Even so, prevailing exchange rates will not lead to a material letup in our trade deficit. So whether foreign investors like it or not, they will continue to be flooded with dollars. The consequences of this are anybody’s guess. They could, however, be troublesome – and reach, in fact, well beyond currency markets.”