054: Investing Intensive 1987-91

Table of Contents

1. 1987 Letter
2. 1988 Letter
3. 1989 Letter
4. 1990 Letter
5. 1991 Letter

This issue does not and is not meant to fully summarize or recap the Berkshire Hathaway shareholder letters. Rather, it includes the tidbits I found interesting and wanted to highlight during my reading. Always do your own reading and come to your own conclusions about Mr. Buffett’s opinions.

How to find the quotations: It is difficult to cite specific sections of a given letter because there are no consistent page numbers and the sections are not numbered. The easiest way to find the quote is to open a PDF of the letter and use the search feature.

1. 1987 Berkshire Hathaway Letter, dated February 29, 1988

1987 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: net worth, and per-share book value. But what counts is business value, not book value.

Highlights:

  • This letter was about holding. Holding on to good companies without being sure where the market is going. Interestingly, he never mentioned Black Monday or the market events once in this letter. Instead, he focused on when to sell? I suppose it was a popular topic during a market crash.
    • “Whenever Charlie and I buy common stocks for Berkshire’s insurance companies (leaving aside arbitrage purchases, discussed later) we approach the transaction as if we were buying into a private business. We look at the economic prospects of the business, the people in charge of running it, and the price we must pay. We do not have in mind any time or price for sale. Indeed, we are willing to hold a stock indefinitely so long as we expect the business to increase in intrinsic value at a satisfactory rate. When investing, we view ourselves as business analysts – not as market analysts, not as macroeconomic analysts, and not even as security analysts.” (emphasis mine) One question I often have is how long I plan to hold a company, what would make me sell? This is a great reminder that Buffett and Munger intend to hold a business FOREVER. Forever. It’s not a five year plan. It’s not a twenty year plan. It’s a forever plan. Only if things change do they sell (and they are quite good at selling, when things change – this is not a rule that has held them back from selling).
    • This one: “Charlie and I let our marketable equities tell us by their operating results – not by their daily, or even yearly, price quotations – whether our investments are successful.” How many times do I hear how everyone’s portfolio is doing? It does not matter in the long run. Business results matter.
    • However, then he kind of contradicts himself from all of the above: “Sometimes, of course, the market may judge a business to be more valuable than the underlying facts would indicate it is. In such a case, we will sell our holdings. Sometimes, also, we will sell a security that is fairly valued or even undervalued because we require funds for a still more undervalued investment or one we believe we understand better.”
    • “We are quite content to hold any security indefinitely, so long as the prospective return on equity capital of the underlying business is satisfactory, management is competent and honest, and the market does not overvalue the business.”
    • And then, back towards the hold-forever-plan: “However, our insurance companies own three marketable common stocks that we would not sell even though they became far overpriced in the market. In effect, we view these investments exactly like our successful controlled businesses – a permanent part of Berkshire rather than merchandise to be disposed of once Mr. Market offers us a sufficiently high price.” Then, later: “…we would rather achieve a return of X while associating with people whom we strongly like and admire than realize 110% of X by exchanging these relationships for uninteresting or unpleasant ones.” So…hold until the market overvalues it…unless it’s a company you love and want to truly keep forever. I think?
  • Made a big point at the very top about the difference between business value and book value, again. On the heels of his description of trying and failing to sell Berkshire’s textile mill machinery for its book value, he’s yet again making the point for another year that book value is not reliable when evaluating a business. “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. At Berkshire, however, the two valuations have tracked rather closely, with the growth rate in business value over the last decade moderately outpacing the growth rate in book value. This good news continued in 1987.”

Checklist points:

  • Financial evaluation 101, on page 1.
    • Operating earnings of their seven business units had “operating earnings before interest and taxes” of $180 million. But who cares?
    • “By itself, this figure says nothing about economic performance. To evaluate that, we must know how much total capital – debt and equity – was needed to produce these earnings.”
    • Equity was $175 million. Debt cost $2 million that year.
    • After-tax earnings were $100 million….”a return of about 57% on equity capital.”
    • This quick run-down reminds me of how Mohnish Pabrai describes evaluating and pricing a potential investment on one sheet of paper, no spreadsheets. (He’s a financial genius so let’s keep that mind for some perspective, but still can take the point.) What Mr. Buffett has done here is similar. What’s most important to know? Operating earnings, minus debt. How much was equity? Get that answer. Now add in tax expenses, and calculate after-tax return on equity capital. Two answers, before and after taxes. Move on. There are a lot more calculations that I can do, and should do, to understand a company, but a lot of the time this simple calculation gives gives great insight and perspective.
  • Quality. Listed the key attributes of his various businesses, and I wrote next to the first one, Nebraska Furniture Mart, “Quality.” What he described was a quality business providing quality service to its customers. “NFM will continue to grow and prosper by following Mrs. B’s maxim: “Sell cheap and tell the truth.””
    • Then, again with the newspaper, with multiple editions and providing more news in its pages than most other newspapers despite being the dominant in its market. Quality.
    • At See’s Candy, after they discontinued two favorite truffles: “Two, it turned out, were badly missed by our customers, who wasted no time in letting us know what they thought of our judgment: “A pox on all in See’s who participated in the abominable decision…;” “May your new truffles melt in transit, may they sour in people’s mouths, may your costs go up and your profits go down…;” “We are investigating the possibility of obtaining a mandatory injunction requiring you to supply…;” You get the picture. In all, we received many hundreds of letters. Chuck not only reintroduced the pieces, he turned this miscue into an opportunity. Each person who had written got a complete and honest explanation in return. Said Chuck’s letter: “Fortunately, when I make poor decisions, good things often happen as a result…;” And with the letter went a special gift certificate.” (I’m totally with everyone who wrote in, Sprüngli created a special edition vanilla truffle a few years ago and it was so heavenly, I still think about that moment I tasted it in the airport shop, on my way home to the US for Christmas. I bought a huge box to bring home, then asked every time I went in to the main shop downtown if they were bringing it back and finally one day, the answer was yes! They said so many people asked about it. Chocolate does that to you.)
    • Fetzer’s businesses – made the World Books better and updated. Quality.

Particular points of candor:

  • This was about insurance, but good to keep in mind about all accounting for all businesses. “Nevertheless, auditors annually certify the numbers given them by management and in their opinions unqualifiedly state that these figures “present fairly” the financial position of their clients. The auditors use this reassuring language even though they know from long and painful experience that the numbers so certified are likely to differ dramatically from the true earnings of the period. Despite this history of error, investors understandably rely upon auditors’ opinions. After all, a declaration saying that “the statements present fairly” hardly sounds equivocal to the non-accountant….If it is to depict the true state of affairs, we believe the standard opinion letter to shareholders of a property-casualty company should read something like: “We have relied upon representations of management in respect to the liabilities shown for losses and loss adjustment expenses, the estimate of which, in turn, very materially affects the earnings and financial condition herein reported. We can express no opinion about the accuracy of these figures. Subject to that important reservation, in our opinion, etc.””
  • At the time, the trade deficit was high and inflation was still fairly high. I read the following and felt he was talking about the US right now. “The faith that foreigners are placing in us may be misfounded. When the claim checks outstanding grow sufficiently numerous and when the issuing party can unilaterally determine their purchasing power, the pressure on the issuer to dilute their value by inflating the currency becomes almost irresistible. For the debtor government, the weapon of inflation is the economic equivalent of the “H” bomb, and that is why very few countries have been allowed to swamp the world with debt denominated in their own currency. Our past, relatively good record for fiscal integrity has let us break this rule, but the generosity accorded us is likely to intensify, rather than relieve, the eventual pressure on us to inflate. If we do succumb to that pressure, it won’t be just the foreign holders of our claim checks who will suffer. It will be all of us as well.”

I was also struck by:

  • Consistently mentioned his excellent managers by name and noted the high returns are due to their influence. In other words, we wouldn’t see those returns without them. I don’t think this is a point that can be overstated.
  • Nice summary of Ben Graham’s Mr. Market in the “Marketable Securities – Permanent Holdings” section.
  • First mention of buying Solomon Bros. preferred stock – fateful purchase!

2. 1988 Berkshire Hathaway Letter, dated February 28, 1989

1988 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: net worth, and per-share book value, again noting that intrinsic business value is what matters.

Highlights:

  • This letter was about the market. He got into arbitrage and Efficient Market Theory.
  • He says the economy is different now. “Berkshire’s past rates of gain in both book value and business value were achieved under circumstances far different from those that now exist. Anyone ignoring these differences makes the same mistake that a baseball manager would were he to judge the future prospects of a 42-year-old center fielder on the basis of his lifetime batting average.” Point taken.
  • He followed his format of praising the managers of his businesses in detail, because he know they make the difference.
  • “We do not have, never have had, and never will have an opinion about where the stock market, interest rates, or business activity will be a year from now.”
  • Detailed description of Efficient Market Theory. “Observing correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day.”

Checklist points:

  • “…three key questions: (1) Approximately how much is this company worth? (2) What is the likelihood that it can meet its future obligations? and (3) How good a job are its managers doing, given the hand they have been dealt?”
    • But. “In most cases, answers to one or more of these questions are somewhere between difficult and impossible to glean from the minimum GAAP presentation. The business world is simply too complex for a single set of rules to effectively describe economic reality for all enterprises, particularly those operating in a wide variety of businesses, such as Berkshire.”
  • I wonder if there’s any public company that meets this criteria? “The cornerstone for both enterprises is Mrs. B’s creed: “Sell cheap and tell the truth.” Other fundamentals at both businesses are: (1) single store operations featuring huge inventories that provide customers with an enormous selection across all price ranges, (2) daily attention to detail by top management, (3) rapid turnover, (4) shrewd buying, and (5) incredibly low expenses. The combination of the last three factors lets both stores offer everyday prices that no one in the country comes close to matching.”
    • I could make a good argument that, now, online stores are a “single store”. In a way, Amazon and Costco both meet this criteria.
  • On how powerful certain types of industries are, to be able to move prices with inflation while keeping customers happy – and that it’s reflected in the price: “Take the breakfast cereal industry, whose return on invested capital is more than double that of the auto insurance industry (which is why companies like Kellogg and General Mills sell at five times book value and most large insurers sell close to book). The cereal companies regularly impose price increases, few of them related to a significant jump in their costs. Yet not a peep is heard from consumers.”
  • “We don’t understand the CEO who wants lots of stock activity, for that can be achieved only if many of his owners are constantly exiting.” I would love to find another CEO who talks this way about his own stock.

Particular points of candor:

  • Super interesting: his description of how a bad CEO can stay in the position for years and years. “…it is far easier for an inadequate CEO to keep his job than it is for an inadequate subordinate.”
    • “One reason is that performance standards for his job seldom exist. When they do, they are often fuzzy or they may be waived or explained away, even when the performance shortfalls are major and repeated.”
    • “Another important, but seldom recognized, distinction between the boss and the foot soldier is that the CEO has no immediate superior whose performance is itself getting measured. The sales manager who retains a bunch of lemons in his sales force will soon be in hot water himself. It is in his immediate self-interest to promptly weed out his hiring mistakes. Otherwise, he himself may be weeded out. An office manager who has hired inept secretaries faces the same imperative. But the CEO’s boss is a Board of Directors that seldom measures itself and is infrequently held to account for substandard corporate performance. If the Board makes a mistake in hiring, and perpetuates that mistake, so what? … Finally, relations between the Board and the CEO are expected to be congenial. At board meetings, criticism of the CEO’s performance is often viewed as the social equivalent of belching. No such inhibitions restrain the office manager from critically evaluating the substandard typist.”
    • “These points should not be interpreted as a blanket condemnation of CEOs or Boards of Directors: Most are able and hard-working, and a number are truly outstanding. But the management failings that Charlie and I have seen make us thankful that we are linked with the managers of our three permanent holdings. They love their businesses, they think like owners, and they exude integrity and ability.” (emphasis mine)
  • Detailed discussion of using cash holdings for his arbitrage activities, which for him means buying and selling around a merger. “…the pursuit of profits from an announced corporate event such as sale of the company, merger, recapitalization, reorganization, liquidation, self-tender, etc. In most cases the arbitrageur expects to profit regardless of the behavior of the stock market. The major risk he usually faces instead is that the announced event won’t happen.”
    • Rules for arbitrage according to Mr. Buffett: “To evaluate arbitrage situations you must answer four questions: (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? and (4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?”
    • “…we participate only in transactions that have been publicly announced. We do not trade on rumors or try to guess takeover candidates. We just read the newspapers, think about a few of the big propositions, and go by our own sense of probabilities.” … “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.”

I was also struck by:

  • He bought Borsheim’s jewelry store this year! It’s such an institution at the annual meeting now that it’s fun to see when it joined.
  • He bought Coca-Cola for the first time this year! Big year.
  • Memorial for David L. Dodd, co-author of Security Analysis with Benjamin Graham. I found his words so sweet, because Dodd is almost always mentioned as an afterthought to Graham, but here Mr. Buffett says they had a regular correspondence until Dodd’s death. “Later, through dozens of letters, he continued my education right up until his death.” How extraordinary.

3. 1989 Berkshire Hathaway Letter, dated March 2, 1990

1989 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: net worth, and per-share book value. What counts, however, is intrinsic value. BUT! This is new, on how to calculate intrinsic value: “With perfect foresight, this number can be calculated by taking all future cash flows of a business – in and out – and discounting them at prevailing interest rates. So valued, all businesses, from manufacturers of buggy whips to operators of cellular phones, become economic equals.”

Highlights:

  • This letter was about the current moves he’s been making: bonds, buying Coca-Cola, and his past mistakes.
  • I’d love to write a description of my companies exactly as he does, year-after-year. Short, mostly about management, describes the elements of success, and is candid about challenges.
  • He drew a distinction between two types of investments, both of which he has made: (1) businesses in which “we understand the company’s economics and therefore believe we can make a reasonably intelligent guess about its future,” and (2) businesses in which they cannot forecast the future. “This does not mean that we predict a negative future for these industries: we’re agnostics, not atheists. Our lack of strong convictions about these businesses, however, means that we must structure our investments in them differently from what we do when we invest in a business appearing to have splendid economic characteristics. In one major respect, however, these purchases are not different: We only want to link up with people whom we like, admire, and trust. John Gutfreund at Salomon, Colman Mockler, Jr. at Gillette, Ed Colodny at USAir, and Andy Sigler at Champion meet this test in spades.”
    • I find this fascinating, and I wonder if he will eat his words later. It sounds to me like the first type are well-understood long-term investments of the sort he chooses now, and the second type are more of a cigar-butt bought-cheap bet but still hoping it’s a good business run by a good person. We know Solomon didn’t work out too well. I’m interested to read what happened with the others he mentions here in category 2.
  • Detailed history and description of zero-coupon bonds and savings bonds generally.

Checklist points:

  • “…our performance to date has benefited from a double-dip: (1) the exceptional gains in intrinsic value that our portfolio companies have achieved; (2) the additional bonus we realized as the market appropriately “corrected” the prices of these companies, raising their valuations in relation to those of the average business.” I like this! The goal is to double-dip.
  • On choosing wonderful management and business relationships, and specifically why he chooses not to sell a company run by someone he respects for potentially higher returns elsewhere: “…we think it makes little sense for us to give up time with people we know to be interesting and admirable for time with others we do not know and who are likely to have human qualities far closer to average. That would be akin to marrying for money – a mistake under most circumstances, insanity if one is already rich.”
  • In the last letter, he listed the elements of highly successful stores like Borsheim’s and Nebraska Furniture Mart. Here, he expanded on the theme, and I still see the parallels to an online store. “Because of the huge volume it does at one location, the store can maintain an enormous selection across all price ranges. For the same reason, it can hold its expense ratio to about one-third that prevailing at jewelry stores offering comparable merchandise. The store’s tight control of expenses, accompanied by its unusual buying power, enable it to offer prices far lower than those of other jewelers. These prices, in turn, generate even more volume, and so the circle goes ’round and ’round. The end result is store traffic as high as 4,000 people on seasonally-busy days.”
  • STANDARD. “Our advice: Whenever an investment banker starts talking about EBDIT – or whenever someone creates a capital structure that does not allow all interest, both payable and accrued, to be comfortably met out of current cash flow net of ample capital expenditures – zip up your wallet.”

Particular points of candor:

  • His first polemic against EBIT! “To induce lenders to finance even sillier transactions, they introduced an abomination, EBDIT – Earnings Before Depreciation, Interest and Taxes – as the test of a company’s ability to pay interest. Using this sawed-off yardstick, the borrower ignored depreciation as an expense on the theory that it did not require a current cash outlay. Such an attitude is clearly delusional. At 95% of American businesses, capital expenditures that over time roughly approximate depreciation are a necessity and are every bit as real an expense as labor or utility costs. Even a high school dropout knows that to finance a car he must have income that covers not only interest and operating expenses, but also realistically-calculated depreciation. He would be laughed out of the bank if he started talking about EBDIT.”
  • He titled an entire section, “Mistakes of the First Twenty-Five Years (A Condensed Version)” and then fully went into them. “My first mistake, of course, was in buying control of Berkshire.” Hahahah.

Mr. Buffett’s List of Mistakes:

  • Buying cheap businesses. Examples: Berkshire, and a department store. “I bought at a substantial discount from book value, the people were first-class, and the deal included some extras – unrecorded real estate values and a significant LIFO inventory cushion. How could I miss?” I include these details because I can’t count the number of times I’ve heard this pitch from a fellow value investor about some company that has these elements. It sounds great! But those companies are cheap for a reason. “So-o-o – three years later I was lucky to sell the business for about what I had paid…I could give you other personal examples of “bargain-purchase” folly but I’m sure you get the picture: It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. But now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class managements.”
  • Even a great manager can’t save a bad business. “That leads right into a related lesson: Good jockeys will do well on good horses, but not on broken-down nags. Both Berkshire’s textile business and Hochschild, Kohn had able and honest people running them. The same managers employed in a business with good economic characteristics would have achieved fine records. But they were never going to make any progress while running in quicksand.”
  • Avoid difficult business problems. “The finding may seem unfair, but in both business and investments it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult.”
  • The Institutional Imperative matters. “(1) As if governed by Newton’s First Law of Motion, an institution will resist any change in its current direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated….”Charlie and I have attempted to concentrate our investments in companies that appear alert to the problem.”
  • “I learned to go into business only with people whom I like, trust, and admire.”
  • Mistakes of omission (no details mentioned, but they clearly rankle).

I was also struck by:

  • “Time is the friend of the wonderful business, the enemy of the mediocre.”

4. 1990 Berkshire Hathaway Letter, dated March 1, 1991

1990 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: net worth, and per-share book value. (No immediate mention of intrinsic value, though he does mention it later.)

Highlights:

  • This letter was about new purchases and why he made them.
  • Very interesting, on the ongoing relationship of price-to-intrinsic value over the course of ownership. “Berkshire’s corporate gains will produce an identical gain for a specific shareholder only if he eventually sells his shares at the same relationship to intrinsic value that existed when he bought them. For example, if you buy at a 10% premium to intrinsic value; if intrinsic value subsequently grows at 15% a year; and if you then sell at a 10% premium, your own return will correspondingly be 15% compounded. (The calculation assumes that no dividends are paid.) If, however, you buy at a premium and sell at a smaller premium, your results will be somewhat inferior to those achieved by the company. Ideally, the results of every Berkshire shareholder would closely mirror those of the company during his period of ownership.” When it comes to Berkshire, he’s clearly saying you do not sell when the price reaches intrinsic value.
  • Appendix A – Benjamin Graham’s 1936 satire on accounting. Worth reading for the laughs and the lessons.
  • Appendix B – an absolutely lovely letter to an unnamed business owner, offering to buy the business.

Checklist points:

  • Operating costs can make the difference. “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.”
  • Over and over and over, he references quality. “[Gillette’s] success in shaving products has come not from marketing savvy (though it exhibits that talent repeatedly) but has instead resulted from its devotion to quality. This mind-set has caused it to consistently focus its energies on coming up with something better, even though its existing products already ranked as the class of the field.”

Particular points of candor:

  • When he introduced his purchase of Well Fargo, he did so with a rather magnificent slam on the banking business – implying Wells is different. It’s ironic to read this 30 years later and after a major Wells Fargo banking scandal of exactly the sort he described here, in 1990. “The banking business is no favorite of ours. When assets are twenty times equity – a common ratio in this industry – mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last year when discussing the “institutional imperative:” the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so.”

I was also struck by:

  • “My own role in operations may best be illustrated by a small tale concerning my granddaughter, Emily, and her fourth birthday party last fall. Attending were other children, adoring relatives, and Beemer the Clown, a local entertainer who includes magic tricks in his act. Beginning these, Beemer asked Emily to help him by waving a “magic wand” over “the box of wonders.” Green handkerchiefs went into the box, Emily waved the wand, and Beemer removed blue ones. Loose handkerchiefs went in and, upon a magisterial wave by Emily, emerged knotted. After four such transformations, each more amazing than its predecessor, Emily was unable to contain herself. Her face aglow, she exulted: “Gee, I’m really good at this.” And that sums up my contribution to the performance of Berkshire’s business magicians – the Blumkins, the Friedman family, Mike Goldberg, the Heldmans, Chuck Huggins, Stan Lipsey and Ralph Schey. They deserve your applause.”

5. 1991 Berkshire Hathaway Letter, dated February 28, 1992

1991 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: net worth, and per-share book value. (No mention of intrinsic value, but huge mention of the price rise of Coca-Cola and Gillette, in a slightly apologetic way “the valuations of these two companies rose far faster than their earnings.”)

Highlights:

  • This letter was about Solomon, though he barely mentioned Solomon. In August 1991, Buffett found out that a couple of traders at Solomon had been breaking securities laws, and the firm’s leaders knew about it but did nothing. It’s a long saga, and if you search online for a Fortune article by Carol Loomis, it’s well worth reading (for Fortune subscribers it’s here). In this letter, Buffett titles the section “A Second Job,” and does not describe what happened. Instead, he simply says Berkshire is well-run without him being there every day, and the company is in good hands.
  • The letter feels like a low point. He wrote about his multiple mistakes of omission. His airline investment was down. It felt like he couldn’t write about Solomon so he wrote about other things, but his heart wasn’t in it.

Checklist points:

  • Franchises v. Businesses.
    • “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.”
    • “In contrast, “a business” earns exceptional profits only if it is the low-cost operator or if supply of its product or service is tight. Tightness in supply usually does not last long. With superior management, a company may maintain its status as a low-cost operator for a much longer time, but even then unceasingly faces the possibility of competitive attack.”
    • “What in the past caused buyers to value a dollar of earnings from media far higher than a dollar from steel was that the earnings of a media property were expected to constantly grow (without the business requiring much additional capital), whereas steel earnings clearly fell in the bob-around category. Now, however, expectations for media have moved toward the bob-around model.”

Particular points of candor:

  • He wanted to buy Fannie Mae, but stopped when the price rose. “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.”

I was also struck by:

  • Look-Through Earnings. He’s talked about how he views the earnings of partially-held companies as look-through earnings, but here he says something useful for individuals: “We also believe that investors can benefit by focusing on their own look-through earnings. To calculate these, they should determine the underlying earnings attributable to the shares they hold in their portfolio and total these. The goal of each investor should be to create a portfolio (in effect, a “company”) that will deliver him or her the highest possible look-through earnings a decade or so from now. An approach of this kind will force the investor to think about long-term business prospects rather than short-term stock market prospects, a perspective likely to improve results. It’s true, of course, that, in the long run, the scoreboard for investment decisions is market price. But prices will be determined by future earnings. In investing, just as in baseball, to put runs on the scoreboard one must watch the playing field, not the scoreboard.” (emphasis mine)

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