055: Investing Intensive 1992-96

Table of Contents

(Quick Check-In)
1. 1992 Letter
2. 1993 Letter
3. 1994 Letter
4. 1995 Letter
5. 1996 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.

Quick Check-In:

This always happens to me. I expect it now, but it’s still frustrating. As I go along on a project, I realize that I wish I had been taking a certain kind of notes or piece of data the whole time. Inevitably, I go back and start over and get the info, and it’s annoying and time-consuming and there’s no other way. This time, I want to go back and take actual checklist points from all the letters so far, and put them into a nice bullet-point checklist (in addition to my long-form notes). I may try to create the time and energy to do so.

However, I’m in the swing of the reading now, and starting to rely on getting some or all of a letter’s wisdom as part of my day. A nice shift from feeling like it was a bit of a chore a few weeks ago. How is your reading rhythm going?

1. 1992 Berkshire Hathaway Letter, dated March 1, 1993

1992 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: per-share book value mentioned first (change from the past, in which he would cite net worth first). Net worth then cited second, along with a long paragraph detailing how many new shares were issued this year, and it becomes clear – it’s said this way because some of the increase in the net worth came from issuance of new stock.

Highlights:

  • This letter was about basics. Accounting. Valuation. Acquisitions.
  • “In the search [for an acquisition], we adopt the same attitude one might find appropriate in looking for a spouse: It pays to be active, interested and open-minded, but it does not pay to be in a hurry.”

Checklist points:

  • Success based on Look-Through Earnings, again mentioned, with even more emphasis looking into the future. “When we allocate capital today, we are thinking about what will maximize look-through earnings in 2000.”
    • “We’ve previously discussed look-through earnings, which consist of: (1) the operating earnings reported in the previous section, plus; (2) the retained operating earnings of major investees that, under GAAP accounting, are not reflected in our profits, less; (3) an allowance for the tax that would be paid by Berkshire if these retained earnings of investees had instead been distributed to us. Though no single figure can be perfect, we believe that the look-through number more accurately portrays the earnings of Berkshire than does the GAAP number.”
  • Hugely important section on how he values companies, under “Common Stock Investments”. Highly recommend going and reading it because every sentence is nuanced. “We want the business to be one (a) that we can understand; (b) with favorable long-term prospects; (c) operated by honest and competent people; and (d) available at a very attractive price.” We have seen cause to make only one change in this creed: Because of both market conditions and our size, we now substitute “an attractive price” for “a very attractive price.””
    • “But how, you will ask, does one decide what’s “attractive”?” YES! He goes on to say that value and growth are not the dichotomy many stock analysts say they are. (I have been saying this for years! I about fell out of my chair when I read this.) “Growth is always a component in the calculation of value…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…”
    • “Whether appropriate or not, the term “value investing” is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics – a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield – are in no way inconsistent with a “value” purchase. Similarly, business growth, per se, tells us little about value….Growth benefits investors only when the business in point can invest at incremental returns that are enticing – in other words, only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor….Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return.” (emphasis mine)
  • Adding a note about pension obligations is a great addition to my checklist because it’s not common these days, and that means I’ll probably miss checking it in the one company that does have pension obligations. “Charlie and I have tended to avoid companies with significant post-retirement liabilities.”
  • Insane level of return, and one that I want on my checklist. “Scott Fetzer now operates with a significantly smaller investment in both inventory and fixed assets than it had when we bought it in 1986. This means the company has been able to distribute more than 100% of its earnings to Berkshire during our seven years of ownership while concurrently increasing its earnings stream – which was excellent to begin with – by a lot.”

Particular points of candor:

  • A prediction! “Charlie Munger, Berkshire’s Vice Chairman and my partner, and I are virtually certain that the return over the next decade from an investment in the S&P index will be far less than that of the past decade, and we are dead certain that the drag exerted by Berkshire’s expanding capital base will substantially reduce our historical advantage relative to the index. Making the first prediction goes somewhat against our grain: We’ve long felt that the only value of stock forecasters is to make fortune tellers look good…However, it is clear that stocks cannot forever overperform their underlying businesses, as they have so dramatically done for some time, and that fact makes us quite confident of our forecast that the rewards from investing in stocks over the next decade will be significantly smaller than they were in the last.”
    • Hindsight is fun. I ran a really quick calculation on a random website S&P calculator, so take it for the unverified internet information it is, but it says the total S&P 500 return, with dividends reinvested and adjusted for inflation:
      • March 1983 – March 1993: 187.909%
      • March 1993 – March 2003: 76.478%
    • Mr. Buffett was not only correct, he was massively, hugely, absolutely correct.
    • Just for fun, I carried the ten-year returns out until today:
      • March 2003 – March 2013: 76.764%
      • March 2013 – May 2021: 172.158%
    • The numbers would change based on which ten-year periods one chose, but still this is real world information. When Mr. Buffett saw returns like we are seeing now, he told everyone it couldn’t go on, and it didn’t.
  • Ajit! He’s been mentioned a few times in previous letters in a list of the insurance managers, but this time he got a shout-out all his own. “Ajit Jain, who runs our reinsurance operation, is simply the best in this business. In combination, these strengths guarantee that we will stay a major factor in the super-cat business so long as prices are appropriate.”

I was also struck by:

  • Tax disadvantage for relative performance against an index fund. Interesting. “A second important factor to consider – and one that significantly hurts our relative performance – is that both the income and capital gains from our securities are burdened by a substantial corporate tax liability whereas the S&P returns are pre-tax. To comprehend the damage, imagine that Berkshire had owned nothing other than the S&P index during the 28-year period covered. In that case, the tax bite would have caused our corporate performance to be appreciably below the record shown in the table for the S&P. Under present tax laws, a gain for the S&P of 18% delivers a corporate holder of that index a return well short of 13%. And this problem would be intensified if corporate tax rates were to rise. This is a structural disadvantage we simply have to live with; there is no antidote for it.”
  • That he gave virtually no information about Solomon Bros. in this letter. Berkshire shareholders owned Solomon – I think it would have been appropriate to include some real information here.
  • That he says at the very end that Mrs. B., of Nebraska Furniture Mart fame, left the company in 1989?! What? I went back and read the 1989 letter, and he did indeed report it to shareholders then, I just missed it. And, now, in 1992, she’s back. Long live Mrs. B.

2. 1993 Berkshire Hathaway Letter, dated March 1, 1994

1993 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: per-share book value, then net worth, again because of issuance of new stock.

Highlights:

  • This letter was about assessing companies with prices going up and down, using moat, managment, and value.
  • Great definitions. Clear and short. “Book value is an accounting term that measures the capital, including retained earnings, that has been put into a business. Intrinsic value is a present-value estimate of the cash that can be taken out of a business during its remaining life. At most companies, the two values are unrelated.” (emphasis mine)

Checklist points:

  • Standard of success he cites for brand companies is operating earnings per share. “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.”
  • To assess a moat: “Moreover, both Coke and Gillette have actually increased their worldwide shares of market in recent years. The might of their brand names, the attributes of their products, and the strength of their distribution systems give them an enormous competitive advantage, setting up a protective moat around their economic castles.” (emphasis mine)
  • “The average company, in contrast, does battle daily without any such means of protection. As Peter Lynch says, stocks of companies selling commodity-like products should come with a warning label: “Competition may prove hazardous to human wealth.”“
  • Three types of management structures: “Though the legal responsibility of directors is identical throughout, their ability to effect change differs in each of the cases.”
  • (1) “The first, and by far most common, board situation is one in which a corporation has no controlling shareholder….For the boards just discussed, I believe the directors ought to be relatively few in number – say, ten or less – and ought to come mostly from the outside. The outside board members should establish standards for the CEO’s performance and should also periodically meet, without his being present, to evaluate his performance against those standards. The requisites for board membership should be business savvy, interest in the job, and owner-orientation.”
  • (2) “The second case is that existing at Berkshire, where the controlling owner is also the manager. At some companies, this arrangement is facilitated by the existence of two classes of stock endowed with disproportionate voting power. In these situations, it’s obvious that the board does not act as an agent between owners and management and that the directors cannot effect change except through persuasion. Therefore, if the owner/manager is mediocre or worse – or is over-reaching – there is little a director can do about it except object.”
  • (3) “The third governance case occurs when there is a controlling owner who is not involved in management. This case, examples of which are Hershey Foods and Dow Jones, puts the outside directors in a potentially useful position. If they become unhappy with either the competence or integrity of the manager, they can go directly to the owner (who may also be on the board) and report their dissatisfaction….Logically, the third case should be the most effective in insuring first-class management….the owner is neither judging himself nor burdened with the problem of garnering a majority. He can also insure that outside directors are selected who will bring useful qualities to the board….If the controlling owner is intelligent and self-confident, he will make decisions in respect to management that are meritocratic and pro-shareholder. Moreover – and this is critically important – he can readily correct any mistake he makes.”

Particular points of candor:

  • He’s said over and over that Capital Cities / ABC was a permanent holding…until the story on media changed. In 1992 he acted on that change. “in 1986 we bought three million shares of Capital Cities/ABC for $172.50 per share and late last year sold one-third of that holding for $630 per share.”
  • Valuable section on “risk” and volatility in the market. “We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it. In stating this opinion, we define risk, using dictionary terms, as “the possibility of loss or injury.” Academics, however, like to define investment “risk” differently, averring that it is the relative volatility of a stock or portfolio of stocks – that is, their volatility as compared to that of a large universe of stocks… For owners of a business – and that’s the way we think of shareholders – the academics’ definition of risk is far off the mark, so much so that it produces absurdities. For example, under beta-based theory, a stock that has dropped very sharply compared to the market – as had Washington Post when we bought it in 1973 becomes “riskier” at the lower price than it was at the higher price. Would that description have then made any sense to someone who was offered the entire company at a vastly-reduced price? In fact, the true investor welcomes volatility.“
  • “In our opinion, the real risk that an investor must assess is whether his aggregate after-tax receipts from an investment (including those he receives on sale) will, over his prospective holding period, give him at least as much purchasing power as he had to begin with, plus a modest rate of interest on that initial stake.”
  • “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.”
  • “…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. I cannot understand why an investor of that sort elects to put money into a business that is his 20th favorite rather than simply adding that money to his top choices – the businesses he understands best and that present the least risk, along with the greatest profit potential. In the words of the prophet Mae West: “Too much of a good thing can be wonderful.””

I was also struck by:

  • Katharine Graham retired from The Washington Post Company. End of an era for that company and, in many ways, for newspapers.
  • The way Mr. Buffett describes Don Keough’s retirement from Coca-Cola shows what a difference management can make. “The impressions I formed in those days about Don were a factor in my decision to have Berkshire make a record $1 billion investment in Coca-Cola in 1988-89. Roberto Goizueta had become CEO of Coke in 1981, with Don alongside as his partner. The two of them took hold of a company that had stagnated during the previous decade and moved it from $4.4 billion of market value to $58 billion in less than 13 years. What a difference a pair of managers like this makes, even when their product has been around for 100 years.” (emphasis mine)

3. 1994 Berkshire Hathaway Letter, dated March 7, 1995

1994 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.

Highlights:

  • This letter was about intrinsic value. What does Berkshire own and how can we evaluate it, in context, to understand intrinsic value?
  • I really like this way of contextualizing business ownership as a portion of an entire industry, like, I own a certain amount of all razor blade sales, or all soft drinks sales. “A few statistics will illustrate their significance: In 1994, Coca-Cola sold about 280 billion 8-ounce servings and earned a little less than a penny on each. But pennies add up. Through Berkshire’s 7.8% ownership of Coke, we have an economic interest in 21 billion of its servings, which produce “soft-drink earnings” for us of nearly $200 million. Similarly, by way of its Gillette stock, Berkshire has a 7% share of the world’s razor and blade market (measured by revenues, not by units), a proportion according us about $250 million of sales in 1994. And, at Wells Fargo, a $53 billion bank, our 13% ownership translates into a $7 billion “Berkshire Bank” that earned about $100 million during 1994.”
  • Intrinsic value is HIGHLY subjective and fuzzy. “Anyone calculating intrinsic value necessarily comes up with a highly subjective figure that will change both as estimates of future cash flows are revised and as interest rates move.”
    • Book value does NOT equal intrinsic value. He’s hammered this message to us in every letter I can remember, and now he’s devoted an entire section of his letter to the same message. Were people not getting his point? My guess, because he went into how his company Scott Fetzer’s acquisition premium was recorded on his books, is that he was being forced to record the value of a subsidiary at a very different number than he thought appropriate. “The difference between Scott Fetzer’s intrinsic value and its carrying value on Berkshire’s books is now huge.” Still, every year, the variation on the same theme of being frustrated with accounting rules.
    • In his example of a college education, Mr. Buffett makes the well-taken point that the book value (its cost) can be exceedingly more, or exceedingly less, than its intrinsic value (future earnings, leaving aside the qualitative benefits of the educational experience, connections made, etc.). “In all cases, what is clear is that book value is meaningless as an indicator of intrinsic value.”
    • In his example of his acquisition of the company Scott Fetzer, he proves that earnings rising without book value rising (it actually fell from the time of purchase) is not only possible, it is highly desirable.

Checklist points:

  • I love this term “happy zone”: “…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.””
  • Checklist point: will this business hit home runs for me? “We achieved our gains through the efforts of a superb corps of operating managers who get extraordinary results from some ordinary-appearing businesses. Casey Stengel described managing a baseball team as “getting paid for home runs other fellows hit.” That’s my formula at Berkshire, also.”
  • Valuation check: on his Scott Fetzer example, he gave a view into how he viewed his purchase price. He paid almost 2x book value for the company, and a little less than 8x the 1986 earnings.
  • “At Berkshire, we have rejected many merger and purchase opportunities that would have boosted current and near-term earnings but that would have reduced per-share intrinsic value. Our approach, rather, has been to follow Wayne Gretzky’s advice: “Go to where the puck is going to be, not to where it is.””
  • To evaluate management’s compensation – aka, their incentives: “His bonus increases when earnings on additional capital exceed a meaningful hurdle charge. But our bonus calculation is symmetrical: If incremental investment yields sub-standard returns, the shortfall is costly to Ralph as well as to Berkshire. The consequence of this two-way arrangement is that it pays Ralph – and pays him well – to send to Omaha any cash he can’t advantageously use in his business. It has become fashionable at public companies to describe almost every compensation plan as aligning the interests of management with those of shareholders. In our book, alignment means being a partner in both directions, not just on the upside. Many “alignment” plans flunk this basic test, being artful forms of “heads I win, tails you lose.””
  • “Before looking at new investments, we consider adding to old ones.” Checklist: is this new business really better than the ones I already own?

Particular points of candor:

  • Ugh, yes. “We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen.”
  • Another section on his mistakes. Who writes mistakes in a letter to shareholders?! How I wish there were others who did this.
    • Mistake in selling: sold Capital Cities / ABC “at $63; at year-end 1994, the price was $85.25. (The difference is $222.5 million for those of you who wish to avoid the pain of calculating the damage yourself.) When we purchased the stock at $17.25 in 1986, I told you that I had previously sold our Cap Cities holdings at $4.30 per share during 1978-80, and added that I was at a loss to explain my earlier behavior. Now I’ve become a repeat offender. Maybe it’s time to get a guardian appointed.”
    • Mistake in buying: USAir preferred stock. “In the 1990 Annual Report I correctly described this deal as an “unforced error,” meaning that I was neither pushed into the investment nor misled by anyone when making it. Rather, this was a case of sloppy analysis, a lapse that may have been caused by the fact that we were buying a senior security or by hubris….Before this purchase, I simply failed to focus on the problems that would inevitably beset a carrier whose costs were both high and extremely difficult to lower….When deregulation came along, it did not immediately change the picture: The capacity of low-cost carriers was so small that the high-cost lines could, in large part, maintain their existing fare structures. During this period, with the longer-term problems largely invisible but slowly metastasizing, the costs that were non-sustainable became further embedded. As the seat capacity of the low-cost operators expanded, their fares began to force the old-line, high-cost airlines to cut their own. The day of reckoning for these airlines could be delayed by infusions of capital (such as ours into USAir), but eventually a fundamental rule of economics prevailed: In an unregulated commodity business, a company must lower its costs to competitive levels or face extinction. This principle should have been obvious to your Chairman, but I missed it.” (emphasis mine)
    • Thought especially important was his statement that the day of reckoning can be delayed by infusions of capital. SO common now. For many investors, it’s very hard to tell the difference between a cash infusion that is throwing good money after bad (even one with Mr. Buffett’s imprimatur), and a cash infusion that will push a company into owning its market and a defensible moat. Here, he says the difference is that airlines are a commodity business.

I was also struck by:

  • “We try to price, rather than time, purchases. In our view, it is folly to forego buying shares in an outstanding business whose long-term future is predictable, because of short-term worries about an economy or a stock market that we know to be unpredictable. Why scrap an informed decision because of an uninformed guess? We purchased National Indemnity in 1967, See’s in 1972, Buffalo News in 1977, Nebraska Furniture Mart in 1983, and Scott Fetzer in 1986 because those are the years they became available and because we thought the prices they carried were acceptable. In each case, we pondered what the business was likely to do, not what the Dow, the Fed, or the economy might do.”

4. 1995 Berkshire Hathaway Letter, dated March 1, 1996

1995 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: net worth, then per-share book value along with information about a small increase of shares outstanding.

Highlights:

  • This letter was about expanding Berkshire. Acquisitions. 100% acquisition of GEICO. Class B Berkshire stock.
  • Ha! “There’s no reason to do handsprings over 1995’s gains. This was a year in which any fool could make a bundle in the stock market. And we did. To paraphrase President Kennedy, a rising tide lifts all yachts.”
  • Huge change in Berkshire’s stock structure, with the issuance of Class B shares worth 1/30th the Class A. At the time of writing, Berkshire stock was $36,000 per share. They created the lower class to discourage a secondary market of lower-priced Berkshire “clone” shares with speculative buyers and sellers.

Checklist points:

  • He’s said something like this for years. Letter after letter. But it hit me differently this time. “Charlie Munger, Berkshire’s Vice Chairman and my partner, and I want to build a collection of companies – both wholly- and partly-owned – that have excellent economic characteristics and that are run by outstanding managers.” This time, I took it as – what more of a checklist do I need? Two checkpoints, at basis. Don’t lose sight of it in all the details.
  • “Buying a retailer without good management is like buying the Eiffel Tower without an elevator.”
  • If possible to know, how does the CEO compensate others in the business? Share the wealth? “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.”
  • Retail business? Breachable moat. “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. In contrast to this have-to-be-smart-every-day business, there is what I call the have-to-be-smart-once business.“
  • “Any company’s level of profitability is determined by three items: (1) what its assets earn; (2) what its liabilities cost; and (3) its utilization of “leverage” – that is, the degree to which its assets are funded by liabilities rather than by equity. Over the years, we have done well on Point 1, having produced high returns on our assets. But we have also benefitted greatly – to a degree that is not generally well-understood – because our liabilities have cost us very little.”

Particular points of candor:

  • Ah. What NOT to look for in a management team. “Talking to Time Magazine a few years back, Peter Drucker got to the heart of things: “I will tell you a secret: Dealmaking beats working. Dealmaking is exciting and fun, and working is grubby. Running anything is primarily an enormous amount of grubby detail work . . . dealmaking is romantic, sexy. That’s why you have deals that make no sense.””
  • Cheap v. wonderful snagged him again. “Alas, I sold my entire GEICO position in 1952 for $15,259, primarily to switch into Western Insurance Securities. This act of infidelity can partially be excused by the fact that Western was selling for slightly more than one times its current earnings, a p/e ratio that for some reason caught my eye. But in the next 20 years, the GEICO stock I sold grew in value to about $1.3 million, which taught me a lesson about the inadvisability of selling a stake in an identifiably-wonderful company.”
  • Remember last year – the regret over putting a cash infusion into an airline? Clearly he didn’t think GEICO was a commodity business. He believed in its moat. “In the early 1970’s, after Davy retired, the executives running GEICO made some serious errors in estimating their claims costs, a mistake that led the company to underprice its policies – and that almost caused it to go bankrupt. The company was saved only because Jack Byrne came in as CEO in 1976 and took drastic remedial measures. Because I believed both in Jack and in GEICO’s fundamental competitive strength, Berkshire purchased a large interest in the company during the second half of 1976, and also made smaller purchases later. By yearend 1980, we had put $45.7 million into GEICO and owned 33.3% of its shares.” (emphasis mine)
  • I just love this story. So relatable. “One more bit of history: 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.”

I was also struck by:

  • He was talking about the insurance business here, but it applies to his investing as well. Lumpy, rather than smooth! “We will get hit from time to time with large losses. Charlie and I, however, are quite willing to accept relatively volatile results in exchange for better long-term earnings than we would otherwise have had. In other words, we prefer a lumpy 15% to a smooth 12%. Since most managers opt for smoothness, we are left with a competitive advantage that we try to maximize. We do, though, monitor our aggregate exposure in order to keep our “worst case” at a level that leaves us comfortable.”
  • He mentioned two businesses that had bad years due to changing technology: newspaper and encyclopedias. These are dying industries. It appears he knew at the time, but held hope they’d be able to transition to digital. Curious about his comments on them in the future letters.

5. 1996 Berkshire Hathaway Letter, dated February 28, 1997

1996 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 (noting some newly issued stock and the new Class B shares).

Highlights:

  • This letter was about being a long-term investor, the way he is a long-term investor. He shared a tremendously important framework for reviewing long-term prospects of companies, explained B shares again
  • He mentions that he wrote an Owner’s Manual for new shareholders early in the letter, and it’s wonderful. I’m not adding it to my reading list right now, as plowing through the letters is quite enough for me, but I’ve read it before and might add it at the end of our Investing Intensive.
  • Framework of companies. The Inevitables and the Highly Probables are wanted. The Impostors are not.
    • “Companies such as Coca-Cola and Gillette might well be labeled “The Inevitables.” Forecasters may differ a bit in their predictions of exactly how much soft drink or shaving-equipment business these companies will be doing in ten or twenty years. Nor is our talk of inevitability meant to play down the vital work that these companies must continue to carry out, in such areas as manufacturing, distribution, packaging and product innovation. In the end, however, no sensible observer – not even these companies’ most vigorous competitors, assuming they are assessing the matter honestly – questions that Coke and Gillette will dominate their fields worldwide for an investment lifetime….Obviously many companies in high-tech businesses or embryonic industries will grow much faster in percentage terms than will The Inevitables. But I would rather be certain of a good result than hopeful of a great one. Of course, Charlie and I can identify only a few Inevitables, even after a lifetime of looking for them. Leadership alone provides no certainties: Witness the shocks some years back at General Motors, IBM and Sears, all of which had enjoyed long periods of seeming invincibility. Though some industries or lines of business exhibit characteristics that endow leaders with virtually insurmountable advantages, and that tend to establish Survival of the Fattest as almost a natural law, most do not. Thus, for every Inevitable, there are dozens of Impostors, companies now riding high but vulnerable to competitive attacks. Considering what it takes to be an Inevitable, Charlie and I recognize that we will never be able to come up with a Nifty Fifty or even a Twinkling Twenty. To the Inevitables in our portfolio, therefore, we add a few “Highly Probables.””

Checklist points:

  • “Berkshire probably ranks number one among large American corporations in the percentage of its shares held by owners with a long-term view.” What is the turnover of the stock? How many long-term holders? What is the shareholder base like?
  • Stress-test the portfolio: what happens if there’s an earthquake, fire, pandemic, etc.? “I have mentioned that a mega-catastrophe might cause a catastrophe in the financial markets, a possibility that is unlikely but not far-fetched. Were the catastrophe a quake in California of sufficient magnitude to tap our coverage, we would almost certainly be damaged in other ways as well. For example, See’s, Wells Fargo and Freddie Mac could be hit hard. All in all, though, we can handle this aggregation of exposures. In this respect, as in others, we try to “reverse engineer” our future at Berkshire, bearing in mind Charlie’s dictum: “All I want to know is where I’m going to die so I’ll never go there.” (Inverting really works: Try singing country western songs backwards and you will quickly regain your house, your car and your wife.) If we can’t tolerate a possible consequence, remote though it may be, we steer clear of planting its seeds. That is why we don’t borrow big amounts and why we make sure that our super-cat business losses, large though the maximums may sound, will not put a major dent in Berkshire’s intrinsic value.”
  • What is the potential for loss of focus? “Loss of focus is what most worries Charlie and me when we contemplate investing in businesses that in general look outstanding. All too often, we’ve seen value stagnate in the presence of hubris or of boredom that caused the attention of managers to wander. That’s not going to happen again at Coke and Gillette, however – not given their current and prospective managements.”

Particular points of candor:

  • “Our portfolio shows little change: We continue to make more money when snoring than when active.”
  • A new era cometh. “Though it was a close decision, Charlie and I have decided to enter the 20th Century. Accordingly, we are going to put future quarterly and annual reports of Berkshire on the Internet, where they can be accessed via http://www.berkshirehathaway.com. We will always “post” these reports on a Saturday so that anyone interested will have ample time to digest the information before trading begins….At some point, we may stop mailing our quarterly reports and simply post these on the Internet. This move would eliminate significant costs….The drawback to Internet-only distribution is that many of our shareholders lack computers. Most of these holders, however, could easily obtain printouts at work or through friends.”

I was also struck by:

  • It’s just SO making a better typewriter in the age of the computer. Their encyclopedia company really didn’t see the internet coming. “World Book, however, did not find it easy: Despite the operation’s new status as the only direct-seller of encyclopedias in the country (Encyclopedia Britannica exited the field last year), its unit volume fell. Additionally, World Book spent heavily on a new CD-ROM product that began to take in revenues only in early 1997, when it was launched in association with IBM….Overall, the company has gone a long way toward assuring its long-term viability in both the print and electronic marketplaces.”
  • The annual meeting grew large enough to move to a 10,000 seat arena, and I’m so jealous of everyone who went back in these days. Buffett threw out the first pitch at the baseball game, invited everyone to Gorat’s Steakhouse, and promoted all the Berkshire companies. It just sounds like a great time. (It still is, but now with many more people and more commercialization around it – but I’m one of the new ones so I can’t complain. Which I’m not! I just wish I had been part of it back then.)

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