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.]