Monthly Archives: April 2014

Links of Interest – April 25, 2014

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.

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.