Brief notes on the 1979 Berkshire Hathaway Shareholder Letter

  • Buffett continues to espouse return on equity as the preferred metric for economic performance, provided it is adjusted, where necessary, to capture economic reality.
  • The scorecard for investment results must take both inflation and taxes into account.
  • Buffett underscores outstanding management as a key driver of a successful business, particularly in insurance which tends to “magnify, to an unusual degree, human managerial talent – or the lack of it”.
  • Buffett suggest that it probably makes sense to pay-up for great businesses – those that produce high returns on tangible capital employed – rather than purchase statistical bargains in mediocre or subpar businesses.
  • Early on, Buffett showed the discipline to walk away from insurance business if it could not be underwritten with an expectation of a profit.
  • Successful investing in insurance requires the ability to tolerate lumpy returns.
  • Buffett is disinterested in market trends or fads.
  • Even sophisticated managers can ignore reality if it is too painful to deal with or if it requires a difficult change in direction. (See the example of how the insurance industry reacted to losses on long-term bonds.)
  • Lending money at a fixed price for an extended duration (long-term bonds) is inherently risky in an inflationary world. This is why Buffett favors convertible bonds which function as if they have shortened maturities.
  • It generally doesn’t pay to be clever when the tide is running against you.
  • You usually have to pay up to purchase a high-quality business.
  • “It is difficult to say anything new or meaningful each quarter about events of long-term significance.”
  • Buffett takes pride in running a very lean operation at the top.
  • Buffett wants a shareholder base that understands Berkshire Hathaway and has rational expectations.
  • Buffett likes the trade-offs inherent in running a decentralized operation: whatever he misses by not having more controls he gains in cost savings and responsiveness.
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Brief notes on the 1978 Berkshire Hathaway Shareholder Letter

  • GAAP financial statements are merely a starting point to understand the economics of a business.
  • Berkshire is best understood by looking at its various segments.
  • Buffett tries to provide segmented information to investors (“partners”) in the same form that he likes to see it.
  • One-time capital gains should not be used in evaluating the performance of any given single year. Nevertheless, they are a meaningful component of Berkshire’s longterm performance.
  • Buffett does not believe it is possible to forecast short-term stock market prices.
  • Return on equity may be overstated if balance sheet assets, such as property and equipment, are carried materially below replacement cost.
  • Textiles is a lousy business characterized by slow capital turnover, low profit margins, poor returns on capital.
  • Attempts to improve profitability may yield little benefit if a business’s competitors are able to make the same improvements, i.e. differentiating products, lowering costs, increasing productivity, changing product mix, etc. [Author's note: Buffett will later write that this is akin to standing on your tippy toes at a parade.]
  • When it come to controlling costs, management’s past track record is a meaningful indicator of future performance.
  • As long as a business is generating at least modest returns, Buffett will consider non-economic factors when deciding to remain in the business.
  • The hallmarks of Berkshire’s highly successful insurance operations were already on display in 1978: discipline, growth, realism, conservative expectations, and recognition of the tremendous power of low-cost float coupled with investment skill.
  • Buffett reiterates his investment criteria: “(1) businesses we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) priced very attractively.”
  • Buffett chides pension fund managers for investing heavily when the market was richly valued and investing relatively little at bargain prices.
  • Buffett sought blocks of stock for Berkshire’s insurance portfolios at valuations lower than what they would “command in negotiated sales”.
  • As a net buyer of securities, Buffett prefers share prices to stay undervalued rather than quickly re-pricing to unattractive levels.
  • Buffett’s policy is to concentrate holdings.
  • Forgoing control is completely rational when 1) a meaningful portion of a business can be purchased in the market for less than it would cost to create it, 2) the business has relatively certain prospects, and 3) possesses proven management. See the SAFECO example.
  • Buffett praises investee companies’ reinvestment of retained earnings, provided it is done at attractive returns. This anticipates his concept of look-through earnings.
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Links of Interest – March 14, 2014

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Brief notes on the 1977 Berkshire Hathaway Shareholder Letter

  • The best measure of business performance is return on equity, although allowances must made for items that can cloud the metric’s economic meaning, such as high levels of debt or goodwill. Using this metric allows investors to put earnings growth into context.
  • Reinsurance generates high levels of float for investment relative to premiums written. [Author's note: It is no coincidence that Buffett put a great deal of emphasis on growing Berkshire's reinsurance business.]
  • Successful insurance operations require the discipline to turn away unprofitable business. Also, insurance operations typically enjoy few important competitive advantages. This makes insurance management particularly important.
  • When investing for the longterm, day-to-day price fluctuations tell little or nothing about the ultimate results that will be achieved. Results will be determined by the economic performance of the underlying business.
  • A key investing concept is to determine where a business will be in 10 to 20 years. A current snapshot, without this longterm view, can be very misleading.  Berkshire Hathaway’s performance from 1955 to 1964 provides a stark example.
  • Buffett purchased Capital Cities in 1977 at approximately 8 times earnings: $10.9 million in shares generating $1.3 million in look-through earnings. This was a 50% discount to Buffett’s estimate of the valuation level required to purchase the entire company. [Author's note: Moreover, it was a business with numerous hard-to-find advantages.] 
  • Buffett has simple and clear investment criteria: “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.”
  • In banking investments, Buffett pays attention to return on assets.
  • Buffett likes businesses such as See’s that require little additional capital to grow and that can grow operating earnings even in an industry that is experiencing no unit growth. [Author's note: In See's case, this was done through raising prices.]
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Motiwala Capital – 2013 Letter to investors | Motiwala Capital

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Links of Interest – December 20, 2013

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Mohnish Pabrai | Boston College Presentation November 19, 2013

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Links of Interest – December 6, 2013

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Great quote from Tom Murphy provides an investing template of what to look for

There are not many great businesses that come along in a lifetime. In 1954, television was just starting. People were losing a lot of money in the business, but it was about to explode. Because of the limited availability of licenses, there was limited competition, and so it exploded over the next thirty or forty years. I was very fortunate to be in broadcasting. The business is not capital intensive, nor is it labor intensive. There was a little government involvement but never any price controls. In the last forty or fifty years, broadcasting has been one of the great businesses of this nation. It’s less so now because of synchronous satellite, cable competition, and things like that, but it’s still a very good business.

Tom Murphy

(read entire article; quote on page 4)

Checklist for thinking about great businesses

  1. they are scarce
  2. clear and long runway of growth
  3. limited competition
  4. not capital or labor intensive
  5. minimal government involvement
  6. [a major plus to have a great manager like Tom Murphy]

It is a powerful idea that finding just one business like this and having the courage of your convictions along with patience can produce wealth.

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Links of Interest – November 15, 2013

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