Please find our notes on all of Buffett’s letters going back to the late
1950s. Enjoy!
1958
- Largest position is
20-25% of assets
1959
- Dow Jones average was
up 20%; 10% of managers outperformed
- Would rather sustain
the penalties resulting from over-conservatism than face the consequences of
error, resulting from the adoption of a “New Era” philosophy where trees grow
to the sky
- Largest investment is
35% of assets – partially an investment trust owning 30-40 securities of high
quality; substantial discount from asset value based on market value of their
securities and a conservative appraisal of operating business
1960
- Dow Jones average
declined 6% (Buffett +22%); 90% of managers outperformed
- Largest position (35%)
was Sanborn; operating map business wilted over the last 20 years, but
investment portfolio blossomed; control situation – separated map from
securities
1961
- Buffett’s avenues of
investment break down into three categories: (1) undervalued securities
(“generals”) – largest category, nothing to say about corporate policies and no
time table as to when undervaluation may correct itself. Many times generals
represent a form of “coattail riding” where we feel the dominating stockholder
group has plans for the conversion of unprofitable or under-utilized assets to
a better use. Usually has 5-10% positions in each of 5-6 generals, with smaller
positions in another 10-15. Many times these take years to work out. Difficult
at time of purchase to know any reason why they should appreciate in price.
However, because of this lack of glamour or anything pending which might create
immediate favorable market action, they are available at very cheap prices.
Generals behave very much like the Dow Jones average. During sharply advancing
years, this section of the portfolio turns in the best results. Also the most
vulnerable in a declining market. (2) “Work-outs” – securities whose financial
results depend on corporate action rather than supply and demand factors
created by buyers and sellers of securities. They have a timetable we can
predict, within reasonable error limits, when we will get how much and what
might upset the applecart. Corporate events – mergers, liquidations,
reorganizations, spin-offs. Produces reasonably stable earnings from year to
year irrespective of the course of the Dow. The gross profits in many workouts
appear quite small (trade-off for predictability and short holding period). Has
been second largest category. Might be in 10-15 of these at any given time. (3)
Control – we either control the company or take a very large position and
attempt to influence policies of the company. Efforts should be measured over
several years.
- Measure conservatism
by observing performance in a down market
1962
- Investment performance
must be judged over a period of time with such a period including both
advancing and declining markets
- Buffett much prefers a
five-year test, but feels three years is an absolute minimum for judging performance;
if any three-year or longer period produces poor results, we all should start
looking around for other places to have our money. An exception to the latter
statement would be three years covering a speculative explosion in a bull
market
- Our avenues of
investment break down into three categories. (1) Generals – generally
undervalued securities
- Dempster Mill is
present control situation – 73% owned. Its operations for the past decade have
been characterized by static sales, low inventory turnover, and virtually no
profits in relation to invested capital. When control is obtained, the
all-important value is the assets, not the market quote for a piece of paper.
Last year, our Dempster holding was valued by applying discounts to various
assets – 85% A/R, 60% inventory, 25% prepaid expenses, net PP&E estimated
net auction value (60%). After trying to work with management to improve
margins, reduce overhead, etc., they weren’t cutting it so someone else was
brought in.
- You will be right over
the course of many transactions if your hypotheses are correct, your facts are
correct, and your reasoning is correct. True conservatism is only possible
through knowledge and reason.
- Office has an ample
supply of Pepsi on hand
1963
- A variation of a few %
points has an enormous effect on the success of a compounding program
- Our three investment
categories are not differentiated by their expected profitability over an
extended period of time
- Workouts: Texas
National Petroleum. Risk of stockholder disapproval was nil – the deal was
negotiated by controlling stockholders, and the price was a good one. No
anti-trust problems.
- Dempster Mill
(control): experience shows you can buy 100 situations like this (selling well
under book value, breaking even, tough industry, unimpressive mgmt) and have
perhaps 70 or 80 work out to reasonable profits in one to three years. Just why
any particular one should do so is hard to say at the time of purchase, but the
group expectancy is favorable, whether the impetus is form an improved industry
situation, a takeover offer, a change in investor psychology, etc.
- Our business is one
requiring patience. It has little in common with a portfolio of high-flying
glamour stocks and during periods of popularity for the latter, we may appear
quite stodgy.
1964
- Generals: what we
really like to see is a condition where the company is making substantial
progress in terms of improving earnings, increasing asset values, etc., but
where the market price of the stock is doing very little while we continue to
acquire it.
- My opinion is that the
first job of any investment management organization is to analyze its own
techniques and results before pronouncing judgment on the managerial abilities
and performance of the major corporate entities of the US.
- We derive no comfort
because important people, vocal people, or great numbers of people agree with
us. Nor do we derive comfort if they don’t. A public opinion poll is no
substitute for thought.
- Four revised
investment categories: (1) Generals – Private Owner Basis: generally
undervalued stocks, determined by quantitative standards but with considerable
attention also paid to the qualitative factor. The issues lack glamour
/catalysts or market sponsorship. Their main qualification is their bargain
price. Many times we have the desirable “two strings to our box” situation
where we should either achieve appreciation of market prices from external
factors or from the acquisition of a controlling position in a business at a
bargain price. (2) Generals – Relatively Undervalued: securities selling at
prices relatively cheap compared to securities of the same general quality.
Because of large size, does not feel value to a private owner to be a
meaningful concept. In the great majority of cases we simply do not know enough
about the industry or company to come to sensible judgments – in that
situation, we pass. This is a new category. (3) Workouts: securities with a
timetable. They arise from corporate activity that has already been publically
announced. Risks include anti-trust or other negative gov’t action, stockholder
disapproval, withholding of tax rulings, etc. More steady profits from year to
year. (4) Controls: these are rarities but are often of significant size.
Controls develop from the general – private owner category. They result from
situations where a cheap security does nothing pricewise for such an extended
period of time that we are able to buy a significant percentage of the
company’s stock.
- More investment sins
are probably committed by otherwise quite intelligent people because of “tax
considerations” than from any other cause. It is extremely improbably that 20
stocks selected from 3,000 choices are going to prove to be the optimum
portfolio both now and a year from now at entirely different prices (both for
the selections and the alternatives) prevailing at the later date.
1965
- We criticize a
corporate management for failure to use the best of tools to keep it aware of
the progress of a complicated industrial organization. We can hardly be excused
for failure to provide ourselves with equal tools to show the efficiency of our
own efforts to handle other people’s money…systems of performance measurement
are not automatically included in the data processing programs of most
investment management organizations. The sad fact is that some seem to prefer
not to know how well or poorly they are doing
- Berkshire is a delight
to own. There is no question that the state of the textile industry is the
dominant factor in determining the earning power of the business…while a
Berkshire is hardly going to be as profitable as a Xerox, Fairchild Camera, or
National Video in a hypertensed market, it is a very comfortable sort of thing
to own
- We diversify
substantially less than most investment operations. We might invest up to 40%
of our net worth in a single security under conditions coupling an extremely
high probability that our facts and reasoning are correct with a very low
probability that anything could drastically change the underlying value of the
investment
- We have to work
extremely hard to find just a very few attractive investment situations. Such a
situation is one where my expectations of performance is at least 10% per annum
superior to the Dow
- The question always
is, “How much do I put in number one (ranked by expectation of relative
performance) and how much do I put in number eight?” This depends to a great
degree on the wideness of the spread between the mathematical expectation of
number one versus number eight. It also depends upon the probability that
number one could turn in a really poor relative performance
- There is one thing of
which I can assure you. If good performance of the fund is even a minor
objective, any portfolio encompassing one hundred stocks (whether the manager
is handling one thousand dollars or one billion dollars) is not being operated
logically. The addition of the one hundredth stock simply can’t reduce the
potential variance in portfolio performance sufficiently to compensate for the
negative effect its inclusion has on the overall portfolio expectation
- Has probably only had
five or six situations where a position exceeded 25%
1966
- We will not go into
businesses where technology which is way over my head is crucial to the
investment decision. I know about as much about semiconductors or integrated
circuits as I do of the mating habits of the chrzaszcz (Polish May bug)
- You can see how hard
it is to develop replacement ideas – we came up with nothing during the
remainder of the year despite lower stock prices, which should have been
conductive to finding such opportunities
1967
- Worst performance in
history in the “Workout” section. Investment in controlled companies was a
similar drag on relative performance, but this is to be expected in strong
markets. Acquired two new enterprises – Associated Cotton Shops and National
Indemnity. Generals were up 72%, mostly driven by one security.
- Berkshire is facing
real difficulties in the textile business. Sees no prospect of a good return on
the assets employed in the textile business. Will be a substantial drag on
relative performance if the Dow continues to advance.
- The really sensational
ideas I have had over the years have been heavily weighted toward the
qualitative side where I have had a “high-probability insight”
- Such statistical
bargains have disappeared over the years. Whatever the cause, the result has been
the virtual disappearance of the bargain issue as determined quantitatively –
and thereby our bread and butter.
- Consistently I have
told partners that unless our performance was better than average, the money
should go elsewhere. In recent years, this idea has gained momentum throughout
the investment community. Now others are measuring investment performance much
more frequently than three years, even monthly. More and more money is
participating on a shorter and shorter time span. This is resulting in more
speculation.
- I am out of step with
present conditions. On one point, however, I am clear. I will not abandon a
previous approach whose logic I understand even though it may mean foregoing
large, and apparently easy, profits to embrace an approach which I don’t fully
understand, have not practiced successfully and which, possibly, could lead to
substantial permanent loss of capital.
- Longer-term goal: the
lesser of 9% per annum or a 5% point advantage over the Dow
1968
- Dow Jones average up
8% (Buffett +59%)
- Everything went right;
don’t expect a repeat
- The quality and
quantity of ideas is presently at an all-time low
1969
- Opportunities for
investment that are open to the analyst who stresses quantitative factors have
virtually disappeared, after rather steadily drying up over the past twenty
years
- Our $100M of assets
further eliminates a large portion of this seemingly barren investment world,
since commitments of less than about $3M cannot have a real impact on our
overall performance, and this virtually rules out companies with less than
$100M market cap
- A swelling interest in
investment performance has created an increasingly short-term oriented and more
speculative market
- Intends to retire and
return all money to partners; limited return objectives has not resulted in him
spending more limited time on investments as he wanted to do
In 1970, as chairman of
Berkshire Hathaway, Buffett began writing his now-famous annual letters to
shareholders.
1971
- Extraordinarily good
year for property and casualty insurance industry; traditional business is
non-standard insured, which does well when standard markets become tight due to
unprofitable industry underwriting; continues to have underwriting
profitability as a goal
1972
- Diversification moves
of recent years have established a significantly higher base of normal earning
power
- Three major acquisitions
of recent years have all worked out exceptionally well
- Underwriting profit
caused many new entrants and reduced rates substantially; too risky now
- Bank subsidiary
maintained industry leadership in profitability – after-tax earnings of 2.2% on
average deposits
1973
- Our textile, banking,
and most insurance operations had good years, but certain segments of the
insurance business turned in poor results. Overall, our insurance business
continues to be a most attractive area in which to employ capital
- Merging with
Diversified Retailing, a chain of popular-priced women’s apparel stores and
also conducts a reinsurance business. It’s most important asset is 16% of the
stock of Blue Chip Stamps.
- Blue Chip’s trading
stamp business has declined drastically over the past year or so, but it has
important sources of earning power in its See’s Candy Shops subsidiary as well
as Wesco Financial Corporation, a 54% owned subsidiary engaged in the savings and
loan business. We expect Blue Chip Stamps to achieve satisfactory earnings in
future years related to capital employed, although certainly at a much lower
level than would have been achieved if the trading stamp business had been
maintained at anything close to former levels.
- Purchased Sun
Newspaper, located in Omaha
1974
- Operating results for
1974 overall were unsatisfactory due to the poor performance of our insurance
business. Return on beginning shareholders’ equity was 10%, lowest since 1970
- Insurance underwriting
turned dramatically worse
1975
- On April 28, 1975 we
acquired Waumbec Mills Incorporated and Waumbec Dyeing and Finishing Co., Inc.
located in Manchester, New Hampshire. These companies have long sold woven
goods into the drapery and apparel trade. Such drapery materials complement and
extend the line already marketed through the Home Fabrics Division of Berkshire
Hathaway. In the period prior to our acquisition, the company had run at a very
substantial loss, with only about 55% of looms in operation and the finishing
plant operating at about 50% of capacity. Losses continued on a reduced basis
for a few months after acquisition. Outstanding efforts by our manufacturing,
administrative and sales people now have produced major improvements, which,
coupled with the general revival in textiles, have moved Waumbec into a
significant profit position.
- Economic inflation,
with the increase in cost of repairing humans and property far outstripping the
general rate of inflation, produced ultimate loss costs which soared beyond
premium levels established in a different cost environment.
- In 1965, two New
England textile mills were the company’s only sources of earning power and,
before Ken Chace assumed responsibility for the operation, textile earnings had
been erratic and, cumulatively, something less than zero subsequent to the
merger of Berkshire Fine Spinning and Hathaway Manufacturing. Since 1964, net
worth has been built to $92.9 million, or $94.92 per share. We have acquired
total, or virtually total ownership of six businesses through negotiated
purchases for cash (or cash and notes) from private owners, started four
others, purchased a 31.5% interest in a large affiliate enterprise and reduced
the number of outstanding shares of Berkshire Hathaway to 979,569. Overall,
equity per share has compounded at an annual rate of slightly over 15%.
1976
- You will notice that
our major equity holdings are relatively few. We select such investments on a
long-term basis, weighing the same factors as would be involved in the purchase
of 100% of an operating business: (1) favorable long-term economic
characteristics; (2) competent and honest management; (3) purchase price
attractive when measured against the yardstick of value to a private owner; and
(4) an industry with which we are familiar and whose long-term business
characteristics we feel competent to judge. It is difficult to find investments
meeting such a test, and that is one reason for our concentration of holdings.
We simply can’t find one hundred different securities that conform to our
investment requirements. However, we feel quite comfortable concentrating our
holdings in the much smaller number that we do identify as attractive.
1977
- When companies
announce “record” earnings, make sure equity capital has not been growing
faster than earnings. Return on equity capital is a more appropriate measure of
managerial economic performance.
- Textile business /
industry has proved very challenging to forecast
- The nature of the
insurance business magnifies the effect which individual managers have on
company performance – products are only promises, it is not difficult to be
licensed, and rates are an open book
1978
- Merger with
Diversified Retailing Company adds two new complications – increased ownership
of Blue Chip Stamps to 58%; most be fully consolidated on B/S
- Such a grouping of
balance sheet and earnings items – some wholly owned, some partly owned – tends
to obscure economic reality more than illuminate it
- 19.4% ROE
- The textile industry
illustrates how producers of relatively undifferentiated goods in capital
intensive businesses must earn inadequate returns except under conditions of
tight supply or real shortage. As long as excess productive capacity exists,
prices tend to reflect direct operating costs rather than capital employed.
Such a supply-excess condition appears likely to prevail most of the time in
the textile industry, and our expectations are for profits of relatively modest
amounts in relation to capital.
- Happy for wholly-owned
businesses to retain all of their earnings if they can utilize funds at
attractive rates. Cuts the other way in industries with low capital
requirements, or if mgmt has a record of plowing capital into projects of low
profitability; then earnings should be paid out or used to repurchase shares –
often by far the most attractive option for capital utilization
1979
- Continues to feel that
the ratio of operating earnings to shareholders’ equity with all securities
valued at cost is the most appropriate way to measure any singe year’s
operating performance
- The primary test of
managerial economic performance is the achievement of a high earnings rate on
equity capital employed (without undue leverage, accounting gimmickry, etc) and
not the achievement of consistent gains in EPS
- Even a business
earning 20% on capital can produce a negative real return for its owners under
inflationary conditions. When the inflation rate plus tax on capital /
dividends exceeds the rate of return earned on equity by the business, the
investor’s purchasing power (real capital) shrinks even though he consumes
nothing at all
- Purchased Waumbec
Mills several years ago – bought well below working capital of the business,
got very substantial amounts of machinery and real estate for less than
nothing. But the purchase was a mistake – new problems arose as fast as old
problems were tamed. Concluded that “turnarounds” seldom turn, and that the
same energies and talent are much better employed in a good business purchased
at a fair price than in a poor business purchased at a bargain price.
- Listed on the NASDAQ
1980
- Share repurchase: if a
fine business is selling in the market place for far less than intrinsic value,
what more certain or profitable use of capital can there be than significant
enlargement of the interests of all owners at that bargain price?
- When a management with
a reputation for brilliance tackles a business with a reputation for poor
fundamental economics, it is the reputation of the business that remains
intact.
- The GEICO and American
Express situations, extraordinary business franchises with a localized
excisable cancer (needing a skilled surgeon), should be distinguished from the
true “turnaround” situation in which the managers need to pull off a corporate
Pygmalion.
- Acquisition
preferences run toward businesses that generate cash, not those that consume
it. As inflation intensifies, more and more companies find that they must spend
all funds they generate internally just to maintain their existing physical
volume of business. There is a certain mirage-like quality to such operations.
However attractive the earnings numbers, we remain leery of businesses that
never seem able to convert such pretty numbers into no-strings-attached cash.
1981
- Most high-premium
takeovers have three motivations: (1) lenders, business seldom are deficient in
animal spirits and often relish increased activity and challenge; (2) most
organizations measure and compensate themselves by the yardstick of size than
by any other yardstick; (3) many managements believe their skills will do
wonders for the profitability of a target company.
- Some acquisition
records have been dazzling. Two major categories stand out: (1) companies that
are particularly well adapted to an inflationary environment – can increase
prices rather easily (even when product demand is flat and capacity is not
fully utilized) without fear of significant loss of either market share or unit
volume – and have the ability to accommodate large dollar volume increases in
business (often produced more by inflation than by real growth) with only minor
additional investment of capital. Managers of ordinary ability, focusing solely
on acquisition possibilities meeting these tests, have achieved excellent
results in recent decades. (2) managerial superstars who can recognize that
rare prince who is disguised as a toad.
- Logically, a company
with historic and prospective high returns on equity should retain much or all
of its earnings so that shareholders can earn premium returns on enhanced
capital. Conversely, low returns on corporate equity would suggest a very high
dividend payout so that owners could direct capital toward more attractive
areas.
1982
- In many industries,
differentiation simply can’t be made meaningful. A few producers in such
industries may consistently do well if they have a cost advantage that is both
wide and sustainable. By definition such exceptions are few, and, in many
industries, are non-existent. For the great majority of companies selling
“commodity” products, a depressing equation of business economics prevails:
persistent over-capacity without administered prices (or costs) equals poor
profitability. Over-capacity may eventually self-correct, but such corrections
are often long delayed. When they finally occur, the rebound to prosperity
frequently produces a pervasive enthusiasm for expansion that, within a few
years, again creates over-capacity and a new profitless environment. In other
words, nothing fails like success.
- M&A buyers using
stock as currency for the purchase – has no problems if the stock is selling in
the market at full intrinsic value. But suppose it is selling at only half
intrinsic value. In that case, the buyer is faced with the unhappy prospect of
using a substantially undervalued currency to make its purchase. The buyer is
making a partial sale of itself – and that is what the issuance of shares to
make an acquisition amounts to. In effect, the acquirer must give up $2 of
value to receive $1 of value.
- Once management shows
itself insensitive to the interests of owners, shareholders will suffer a long
time from the price/value ratio afforded their stock (relative to other
stocks), no matter what assurances management gives that the value-diluting
action taken was a one-of-a-kind event.
- Other things being
equal, the highest stock market prices relative to intrinsic business value are
given to companies whose managers have demonstrated their unwillingness to
issue shares at any time on terms unfavorable to the owners of the business.
1983
- Recommends a five-year
test as a rough yardstick of economic performance. If the five-year average
annual gain falls much below the return on equity earned over the period by
American industry in aggregate, red lights should start flashing. “When ideas
fail, words come in very handy.”
- Economic and
accounting goodwill can, and usually do, differ enormously
- Strong preference for
businesses that possess large amounts of enduring goodwill and that utilize a
minimum of tangible assets
- Those who cannot fill
your pocket will confidently fill your ear
- We are aware of the
pie-expanding argument that says that such activities improve the rationality
of the capital allocation process. We think that this argument is specious and
that, on balance, hyperactive equity markets subvert rational capital allocation
and act as pie shrinkers.
- Consumer franchises
are a prime source of economic goodwill. Other sources include governmental
franchisers not subject to profit regulation, such as TV stations, and an
enduring position as the low cost producer in an industry.
- Businesses needing
little in the way of tangible assets simply are hurt the least during
inflationary times.
1984
- Major repurchases at
prices well below intrinsic per-share intrinsic business value immediately
increase, in a highly significant way, that value. When companies purchase
their own stock, they often find it easy to get $2 of present value for $1.
Corporate acquisition programs almost never do as well and, in a discouragingly
large number of cases, fail to get anything close to $1 of value for each $1
expended.
- By making repurchases
when a company’s market value is well below its business value, management
clearly demonstrates that it is given to actions that enhance the wealth of
shareholders, rather than to actions that expand management’s domain but that
do nothing for (or even harm) shareholders. Seeing this, shareholders and
potential shareholders increase their estimates of future returns from the
business. This upward revision produces market prices more in line with
intrinsic business value.
- The great majority of
operating businesses have a limited upside potential unless more capital is
continuously invested in them. That is so because most businesses are unable to
significantly improve their average returns on equity – even under inflationary
conditions.
- Most managers have
very little incentive to make the
intelligent-but-with-some-chance-of-looking-like-an-idiot decision. If an
unconventional decision works out well, they get a pat on the back and, if it
works out poorly, they get a pink slip. (Failing conventionally is the route to
go; as a group, lemmings may have a rotten image, but no individual lemming has
ever received bad press.)
- When should earnings
be retained vs distributed? All earnings are not created equal. In many
businesses particularly those that have high asset/profit ratios – inflation
causes some or all of the reported earnings to become artificial. The
artificial portion – let’s call these earnings “restricted” – cannot, if the
business is to retain its economic position, be distributed as dividends. Were
these earnings to be paid out, the business would lose ground in one or more of
the following areas: its ability to maintain its unit volume of sales, its
long-term competitive position, its financial strength. No matter how
conservative its payout ratio, a company that consistently redistributes
restricted earnings is destined for oblivion unless equity capital is otherwise
infused.
- Unrestricted earnings
may be retained or distributed. Unrestricted earnings should be retained only
when there is a reasonable prospect – backed preferably by historical evidence
or, when appropriate, by a thoughtful analysis of the future – that for every
dollar retained by the corporation, at least one dollar of market value will be
created for owners. This will happen only if the capital retained produces
incremental earnings equal to, or above, those generally available to
investors.
- Must guess what rate
earned on reinvested earnings is. Reinvest if earnings can be expected to earn
high returns. Pay earnings out if low returns are the likely outcome of
reinvestment.
- Many corporations that
consistently show good returns on both equity and overall incremental capital
have employed a large portion of retained earnings on an economically
unattractive basis. Their marvelous core businesses, however, whose earnings
growth YoY, camouflage repeated failures in capital allocation elsewhere.
1985
- My conclusion from my
own experiences and from much observation of other businesses is that a good
managerial record (measured by economic returns) is far more a function of what
business boat you get into than it is of how effectively you row. Should you
find yourself in a chronically-leaking boat, energy devoted to changing vessels
is likely to be more productive than energy devoted to patching leaks.
- The average American
business has required about $5 of additional capital to generate an additional
$1 of annual pre-tax earnings. When returns on capital are ordinary, an
earn-more-by-putting-up-more record is no great managerial achievement.
Quadruple the capital committed to a savings account and you will quadruple
your earnings.
- Many stock options in
the corporate world have gained in value simply because management retained earnings,
not because it did well with the capital in its hands. The bearer of a
fixed-price option bears no capital costs at all. Option holders have no
downside. Options should be priced at true business value, not at bargain
prices.
- “We do not put a cap on
bonuses, and the potential for rewards is not hierarchical. The manager of a
relatively small unit can earn far more than the manager of a larger unit if
results indicate he should. We believe, further, that such factors as seniority
and age should not affect incentive compensation. A 20 year old who can hit
.300 is as valuable to us as a 40 year old performing as well.”
- Commodity businesses
achieve good levels of profitability only when prices are fixed or when
capacity is short. Managers quickly add to capacity when prospects start to
improve and capital is available.
1986
- The smaller the
additions to net worth and the more earnings returned to shareholders, the less
impact capital allocation decisions have on a company's economics
- Businesses are
characterized as having very strong market positions, very high returns on
capital, and best mgmt teams
- Acquisition criteria:
(1) demonstrated consistent earnings power - not interested in projections or
turnarounds; (2) good returns on equity with little to no debt; (3) mgmt in
place; (4) simple businesses
- Owner earnings:
reported earnings plus D&A, plus other non-cash charges, less average capex
for PP&E that the business requires to fully maintain its long-term
competitive position and its unit volume.
1987
- Severe change and
exceptional returns usually don’t mix. Most investors, of course, behave as if
just the opposite were true. That is, they usually confer the highest P/E
ratios on exotic-sounding businesses that hold out the promise of feverish
change. That prospect lets investors fantasize about future profitability
rather than face today’s business realities. Experience, however, indicates
that the best business returns are usually achieved by companies that are doing
something quite similar today to what they were doing five or ten years ago.
- A business that
constantly encounters major change also encounters many chances for major
error. Furthermore, economic terrain that is forever shifting violently is
ground on which it is difficult to build a fortress-like business franchise.
Such a franchise is usually the key to sustained high returns.
- Economic excellence
test: average ROE of over 20% for ten years, and no year worse than 15%. Only
25 of 1,000 companies met the test. 24 / 25 of them outperformed the S&P
500 over the 10 years. Most use very little leverage (really good businesses
usually don’t need to borrow). The companies are in businesses that, on
balance, seem rather mundane. Most sell non-sexy products or services in much
the same manner as they did ten years ago. Concentrating on a single winning
business theme is what usually produces exceptional economics.
- An investor will
succeed by coupling good business judgment with an ability to insulate his
thoughts and behavior from the super-contagious emotions that swirl about that
marketplace.
- We try to buy into
businesses with favorable long-term economics. Our goal is to find an
outstanding business at a sensible price, not a mediocre business at a bargain
price.
- Management changes,
like marital changes, are painful, time-consuming, and chancy.
1988
- Our experience with
newly-minted MBAs has not been that great. Their academic records always look
terrific and the candidates always know just what to say; but too often they
are short on personal commitment to the company and general business savvy.
It’s difficult to teach a new dog old tricks.
- The supreme irony of
business management is that it is far easier for an inadequate CEO to keep his
job than it is for an inadequate subordinate. If a secretary, say, is hired for
a job that requires typing ability of at least 80 words a minute and turns out
to be capable of only 50 words a minute, she will lose her job in no time.
There is a logical standard for this job; performance is easily measured; and
if you can’t make the grade, you’re out. Similarly, if new sales people fail to
generate sufficient business quickly enough, they will be let go. Excuses will
not be a substitute for orders. However, a CEO who doesn’t perform is
frequently carried indefinitely. 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.
- Long-term bonds: will
become enthused only when we become enthused about prospects for long-term
stability in the purchasing power of money
- To evaluate arbitrage
situations, you must be able to 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.?
- Berkshire’s arbitrage
activities differ from those of many arbitrageurs. First, we participate in
only a few, and usually very large, transactions each year. Most practitioners
buy into a great many deals perhaps 50 or more per year. With that many irons
in the fire, they must spend most of their time monitoring both the progress of
deals and the market movements of the related stocks.
- 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.
- An investor cannot
obtain superior profits from stocks by simply committing to a specific
investment category or style. He can earn them only by carefully evaluating
facts and continuously exercising discipline. Investing in arbitrage
situations, per se, is no better than selecting a portfolio by throwing darts.
1989
- Normally, the CEO of a
consumer products company, drawing on his natural inclinations or experience,
will cause either marketing or finance to dominate the business at the expense
of the other discipline.
- Make sure free cash
flow (operating earnings plus D&A less normalized capex) is adequate to
cover both interest and modest reductions in debt
- At 95% of American
businesses, capex that over time roughly equal depreciation are a necessity and
are every bit as real an expense as labor or utility costs.
- First mistake was
buying Berkshire – knew textile manufacturing was unpromising, but enticed to
buy because the price looked cheap. If you buy a stock at a sufficiently low
price, there will usually be some hiccup in the fortunes of the business that
gives you a chance to unload at a decent profit, even though the long-term
performance of the business may be terrible. “Cigar butt” approach to investing.
- Unless you are a
liquidator, that kind of approach to buying businesses is foolish. First, the
original “bargain” price probably will not turn out to be such a steal after
all. In a difficult business, no sooner is one problem solved than another
surfaces. Second, any initial advantage you secure will be quickly eroded by
the low return that the business earns.
- It’s far better to buy
a wonderful company at a fair price than a fair company at a wonderful price
- Good jockeys will do
well on good horses, but not on broken-down nags
- 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. However, a great investment
opportunity can occur when a marvelous business encounters a one-time huge, but
solvable, problem.
- Rationality frequently
wilts when the institutional imperative comes into play: (1) 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, etc., will be
mindlessly imitated.
- It’s no sin to miss a
great opportunity outside one’s area of competence.
1990
- Nebraska Furniture
Mart, Borsheim’s, etc., are like Walmart in that their operating costs are at
rock bottom – 15% vs peers around 40%. This allows for huge volume to be
generated by underpricing competition, allowing the companies to carry the
broadest selection of merchandise available anywhere.
- The most common cause
of low prices is pessimism – sometimes pervasive, sometimes specific to a
company or industry. We want to do business in such an environment, not because
we like pessimism but because we like the prices it produces. It’s optimism
that is the enemy of the rational buyer.
- In a business selling
a commodity-type product, it’s impossible to be a lot smarter than your dumbest
competitor.
1991
- 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. Moreover, franchises can
tolerate mismanagement (won’t result in mortal damage but perhaps diminished
profitability).
- 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. Businesses can be killed by inept management.
1992
- If plantings made
confidently are repeatedly followed by disappointing harvests, something is
wrong with the farmer. (Or perhaps with the farm: investors should understand
that for certain companies, and even for some industries, there simply is no
good LT strategy).
- Just as you should be
suspicious of managers who pump up short-term earnings by accounting maneuvers,
asset sales and the like, so also should you be suspicious of those managers
who fail to deliver for extended periods and blame it on their LT focus.
- How does one decide
what’s an “attractive” valuation? Most analysts feel they must choose between
value and growth approaches, but they are really joined at the hip. Growth is
always a component in the calculation of value, constituting a variable whose
importance can range from negligible to enormous and whose impact can be
negative as well as positive. The term “value investing” is redundant.
- Growth benefits
investors only when the business in point can invest at incremental returns
that are enticing – in other words, when each dollar used to finance the growth
creates over a dollar of LT market value. In the case of low return businesses
requiring incremental funds, growth hurts the investor.
- The investment shown
by the DCF to be the cheapest is the one that the investor should purchase –
irrespective of whether the business grows or doesn’t, displays volatility or
smoothness in its earnings, or carries high price or low in relation to its
current earnings and book value.
- 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.
This is hard to find because most high-return businesses need relatively little
capital. Shareholders of such a business usually will benefit if it pays out
most of its earnings in dividends or makes significant stock repurchases.
- The worst business to
own is one that must, or will, do the opposite – that is, consistently employ
ever-greater amounts of capital at very low rates of return.
- Estimating future cash
flow is very difficult. That is why Berkshire sticks to what it knows – simple
and stable businesses. If a business is complex or subject to constant change,
we’re not smart enough to predict future cash flows…what counts for most people
in investing is not how much they know, but rather how realistically they
define what they don’t know. An investor needs to do very few things right as
long as he or she avoids big mistakes.
- Second, and equally
important, we insist on a margin of safety in our purchase price. If we
calculate the value of a common stock to be only slightly higher than its
price, we’re not interested in buying. This is a cornerstone of investment
success.
- IPO market: ruled by
controlling stockholders and corporations, who can usually select the timing of
offerings or, if the market looks unfavorable, can avoid an offering
altogether. Understandably, these sellers are not going to offer any bargains.
They unload only when they feel the market is overpaying.
- A competitively-beset
business such as an airline requires far more managerial skill than does a
business with fine economics. Unfortunately, though, the near-term reward for
skill in the airline business is simply survival, not prosperity.
- In making
acquisitions, Berkshire has tended to avoid companies with significant
post-retirement liabilities. Lengthening life expectancies and soaring health
costs would guarantee an insurer a financial battering from such a business of
insuring uncapped post-retirement health benefits. In health care, open-ended
promises have created open-ended liabilities that in a few cases loom so large
as to threaten the global competitiveness of major American industries.
- Stock options are a
cost. Doesn’t believe “no cash-no cost” argument / accounting. Companies incur
costs when they deliver something of value to another party and not just when
cash changes hands.
- At some companies,
corporate overhead runs 10% or more of sales. This makes HQ not only hurt
earnings, but more importantly slashes capital values.
1993
- An investor should
ordinarily hold a small piece of an outstanding business with the same tenacity
that an owner would exhibit if he owned all of that business
- 1938 Fortune story on
Coke stock: “Several times every year a weighty and serious investor looks long
and with profound respect at Coke’s record, but comes regretfully to the
conclusion that he is looking too late. The specters of saturation and competition
rise before him…it would be hard to name any company comparable in size to Coke
and selling, as Coke does, an unchanged product that can point to a ten-year
record anything like Coke’s.”
- Coke sold 207M cases
of soft drinks in 1938 and 10.7B cases in 1993, a 50-fold increase. $40
invested in Coke in 1938 would have grown to $25,000 by yearend 1993.
- Willing to settle for
one good idea per year – it’s just too hard to make hundreds of smart decisions
- Believes this strategy
actually carries less risk – it raises 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
- Gillette and Coke:
dominant market shares – the might of their brand names, the attributes of
their products, and the strength of their distribution systems set up a
protective moat around their economic castles
- You may consciously
purchase a risky investment – one that indeed has a significant possibility of
causing loss or injury – if you believe that your gain, weighted for
probabilities, considerably exceeds your loss, comparably weighted, and if you
can commit to a number of similar, but unrelated opportunities. Adopt the
outlook of the casino that owns a roulette wheel – needs to see lots of action
because it is favored by probabilities, but will refuse to accept a single,
huge bet
- 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
- Believes boards should
have 10 or fewer members and ought to come mostly from the outside
- The best case to
insure first-class management is when there is a controlling owner not involved
in management – board can go to them. The owner is neither judging himself nor
burdened with the problem of garnering a majority
1994
- We have usually made
our best purchases when apprehensions about some macro event were at a peak
- Most major
acquisitions reduce the wealth of the acquirer’s shareholders because the
acquirer typically gives up more intrinsic value than it receives
- Compensation
misalignment: stock options – typical agreement does not periodically increase
the option price to compensate for the fact that retained earnings are building
up the wealth of the company
- Before looking at new
investments, we consider adding to old ones.
- In an unregulated
commodity business, a company must lower its costs to competitive levels or
face extinction
1995
- Most deals do damage
to the shareholders of the acquiring company. The seller of a business
practically always knows far more about it than the buyer and also picks the
time of sale – a time when the business is likely to be walking “just fine”
- 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 to 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.
1996
- We think it foolish
for an insurance company to pay bonuses that are tied to overall corporate
results when great work on one side of the business – underwriting or
investment – could conceivably be completely neutralized by bad work on the
other. If you bat .350 at Berkshire, you can be sure you will get paid
commensurately even if the rest of the team bats .200.
- We continue to make
more money when snoring than when active. The art of investing in public
companies successfully is little different from the art of successfully
acquiring subsidiaries. In each case you simply want to acquire, at a sensible
price, a business with excellent economics and able, honest management.
Thereafter, you need only monitor whether these qualities are being preserved.
- When carried out
capably, an investment strategy of that type will often result in its
practitioner owning a few securities that will come to represent a very large
portion of his portfolio.
- To suggest an investor
should sell off portions of his most successful investments simply because they
have come to dominate his portfolio is akin to suggesting that the Bulls trade
Michael Jordan because he has become so important to the team.
- We favor businesses
and industries unlikely to experience major change – we are searching for
operations that we believe are virtually certain to possess enormous
competitive strength 10-20 years from now. A fast-changing industry may offer
the chance for huge wins, but it precludes the certainty we seek
- Obviously many
companies in high-tech businesses or embryonic industries will grow much faster
in percentage terms than will “The Inevitables” (Coke, Gillette, etc). But I
would rather be certain of a good result than hopeful of a great one
- 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 GM, IBM, and
Sears. 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 Imposters, companies now riding high
but vulnerable to competitive attacks
- Considering what it
takes to be an Inevitable, we recognize that we will never be able to come up
with a Nifty Fifty or even a Twinkling Twenty
- You can pay too much
for even the best of businesses. Investors making purchases in an overheated
market need to recognize that it may often take an extended period for the
value of even an outstanding company to catch up with the price they paid.
- A far more serious
problem occurs when the management of a great company gets sidetracked and
neglects its wonderful base business while purchasing other businesses that are
so-so or worse. When that happens, the suffering of investors is often
prolonged. Loss of focus is what most worries us 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
- You don’t have to be
an expert on every company, or even many. You only have to be able to evaluate
companies within your circle of competence. The size of that circle is not very
important; knowing its boundaries, however, is vital
- To invest
successfully, you need not understand beta, efficient markets, modern portfolio
theory, option pricing, or emerging markets. You may, in fact, be better off
knowing nothing of these. Investment students need only two well-taught courses
– how to value a business and how to think about market prices
- Your goal as an
investor should simply be to purchase, at a rational price, a part interest in
an easily-understandable business whose earnings are virtually certain to be
materially higher 5-20 years from now. Over time, you will find only a few
companies that meet these standards – so when you see one that qualifies, you
should buy a meaningful amount of stock.
- If you aren’t willing
to own a stock for ten years, don’t even think about owning it for ten minutes
1997
- Ted Williams carved
the strike zone into 77 cells, each the size of a baseball. Swinging only at
balls in his “best” cell, he knew, would allow him to bat .400; reaching for
balls in his “worst” spot, the low outside corner of the strike zone, would
reduce him to .230. In other words, waiting for the fat pitch would mean a trip
to the Hall of Fame; swinging indiscriminately would mean a ticket to the
minors
- Paying a takeover
premium does not make sense for any acquirer unless (a) its stock is overvalued
relative to the acquiree’s or (b) the two enterprises will earn more combined
than they would separately
- Only in fairy tales
are emperors told that they are naked
- In the presence of low
interest rates, every dollar of earnings becomes more valuable
1998
- Restructuring charge
is often used to manipulate earnings; a large chunk of costs that should
properly be attributed to a number of years is dumped into a single quarter,
typically one already fated to disappoint investors. M&A is also used to
increase liabilities immediately and substantially for future infusions of
“earnings”
1999
- We don’t own tech
stocks even though we share the general view that our society will be
transformed by their products and services. We have no insights into which
participants in the tech field possess a truly durable competitive advantage
- Our lack of tech
insights does not distress us. There are a great many business areas in which
we have no special capital allocation expertise. For instance, we bring nothing
to the table when it comes to evaluating patents, manufacturing processes, or
geological prospects. So we simply don’t get into judgments in those fields.
- If we have a strength,
it is in recognizing when we are operating well within our circle of competence
and when we are approaching the perimeter. Predicting the LT economics of
companies that operate in fast-changing industries is simply far beyond our
perimeter. If others claim predictive skill in those industries – and seem to
have their claims validated by the behavior of the stock market – we neither
envy nor emulate them. Instead, we just stick with what we understand.
- There is only one
combination of facts that makes it advisable for a company to repurchase its
shares: first, the company has available funds – cash plus sensible borrowing
capacity – beyond the near-term needs of the business and, second, finds its
stock selling in the market below intrinsic value.
- We feel confident in
estimating intrinsic value for only a portion of traded equities and then only
when we employ a range of values, rather than some pseudo-precise figure
2000
- “A bird in the hand is
worth two in the bush” – to flesh out this principle, you must answer only
three questions. How certain are you that there are indeed birds in the bush?
When will they emerge and how many will there be? What is the risk-free
interest rate (which we consider to be the yield on the LT US bonds)? If you
can answer these questions, you will know the maximum value of the bush – and
the maximum number of the birds you now possess that should be offered for it.
- Common yardsticks such
as dividend yield, the ratio of price to earnings or to book value, and even
growth rates have nothing to do with valuation except to the extent they
provide clues to the amount and timing of cash flows into and from the business
- Growth can destroy
value if it requires cash inputs in the early years of a project or enterprise
that exceed the discounted value of the cash that those assets will generate in
later years
- Market commentators
and investment managers who glibly refer to “growth” and “value” styles as
contrasting approaches to investment are displaying their ignorance, not their
sophistication. Growth is simply a component – usually a plus, sometimes a minus
– in the value equation
- Using precise numbers
is, in fact, foolish; working with a range of possibilities is the better
approach. Usually, the range must be so wide that no useful conclusion can be
reached.
- We make no attempt to
pick the few winners that will emerge from an ocean of unproven enterprises.
We’re not smart enough to do that, and we know it.
- References to EBITDA
make us shutter – does management think the tooth fairy pays for capex?
- We think it is both
deceptive and dangerous for CEOs to predict growth rates of their companies
- I would wager you a
very significant sum that fewer than 10 of the 200 most profitable companies in
the 2000 will attain 15% annual growth in EPS over the next 20 years
2001
- We never buy junk
bonds when they are first issued – they often live up to their name
2002
- You need to understand
what “pro forma” / non-GAAP earnings really are
- Derivatives are time
bombs for the parties that deal in them and the economic system. These
instruments call for money to change hands at some future date, with the amount
to be determined by one or more reference items, such as interest rates, stock
prices, or currency values. Their ultimate value also depends on the
creditworthiness of the counterparties to them. Generated earnings are often
wildly overstated because today’s earnings are in a significant way based on
estimates whose inaccuracy may not be exposed for many years.
- Unless we see a very
high probability of at least 10% pre-tax returns (6.5%-7% after tax), we will
sit on the sidelines (50/61 years have seen investment). Occasionally,
successful investing requires inactivity.
- Concentrates on
conservatively financed businesses with strong competitive strengths, run by
able and honest people
- Boardroom atmosphere:
it’s almost impossible to raise the question of whether the CEO should be
replaced or to question a proposed acquisition that has been endorsed by the
CEO. Outside directors who regularly meet without the CEO is preferred.
Directors should be business-savvy, interested, and shareholder-friendly.
- Three suggestions for
investors: first, beware of companies displaying weak accounting. If a company
still does not expense options, or if its pension assumptions are fanciful,
watch out. When managements take the low road in aspects that are visible, it
is likely they are following a similar path behind the scenes. Trumpeting
EBITDA is a pernicious practice. Doing so implies that depreciation is not
truly an expense, given that it is a non-cash charge. That’s nonsense. Second,
unintelligible footnotes usually indicate untrustworthy management. If you
can’t understand a footnote or other managerial explanation, it’s usually
because the CEO doesn’t want you to. Finally, be suspicious of companies that
trumpet earnings projections and growth expectations. Businesses seldom operate
in a tranquil, no-surprise environment, and earnings simply don’t advance
smoothly.
2003
- Entered the FX market
for the first time ever. Increasingly bearish on the dollar due to high trade
deficits. The cemetery for seers has a huge section set aside for macro
forecasters. We have seldom seen others make them with sustained success.
- Books: Bull! By Maggie
Mahar. The Smartest Guys in the Room by Bethany McLean. In an Uncertain World
by Bob Rubin.
2004
- Investors should
remember that excitement and expenses are their enemies. And if they insist on
trying to time their participation in equities, they should try to be fearful
when others are greedy and greedy only when others are fearful
- Stock investments are
viewed as fractional ownerships in business; do not buy and sell based on chart
patterns, brokers’ opinions, or estimates of near-term earnings
- John Keynes: it is
better for reputation to fail conventionally than to succeed unconventionally
- Three questions that
truly count: First, does the company have the right CEO? Second, is he/she
overreaching in terms of compensation? Third, are proposed acquisitions more
likely to create or destroy per-share value?
2005
- Intrinsic value
calculation: the more uncertain the future of a business, the more possibility
there is that the calculation will be wildly off-base. Berkshire’s intrinsic
value can be more precisely calculated than can the intrinsic value of most
companies (relatively-stable earnings streams, great liquidity, minimum debt)
- A crucial, but often
ignored, point: when a management proudly acquires another company for stock,
the shareholders of the acquirer are concurrently selling part of their
interest in everything they own
- If a CEO’s
compensation plan grants him 10-year options, his incentive is clear: skip
dividends entirely and use all of the earnings to repurchase stock. If earnings
never grow and the company trades at the same multiple, he can become very rich
from doing nothing at all
2006
- Size seems to make
many organizations slow-thinking, resistant to change, and smug. Of the ten
non-oil companies having the largest market capitalization in 1965, only one
made the 2006 list
- Independent thinking,
emotional stability, and a keen understanding of both human and institutional
behavior is vital to LT investment success
- When we use
incentives, they are always tied to the operating results for which a given CEO
has authority
2007
- It's better to have a
part interest in the Hope Diamond than to own all of a rhinestone
- A truly great business
must have an enduring "moat" that protects excellent ROIC
- Our criterion of
"enduring" causes us to rule out companies in industries prone to
rapid and continuous change
- A moat that must be
continuously rebuilt will eventually be no moat at all. This criterion
eliminates the business whose success depends on having a great manager
- Prototype of a dream
business: See's Candy. The boxed-chocolates industry is unexciting - per capita
consumption in the US is extremely low and doesn't grow. Only three companies
have earned more than token profits over the last 40 years. Earned 60% pre-tax
on invested capital. Two factors helped minimize the funds required for
operations. First, the product was sold for cash, and that eliminated A/R.
Second, the production and distribution cycle was short, minimizing
inventories.
- It's far better to
have an ever-increasing stream of earnings with virtually no major capital requirements
- The worst sort of
business is one that grows rapidly, requires significant capital to engender
the growth, and then earns little or no money. Think airlines.
- Evaluates progress of
investments not by price performance any given year but rather through two
tests: (1) improvement in earnings, adjusted for industry conditions; and (2)
whether their "moats" have widened during the year
- Stock options are a
large and obvious expense
- Also look at the
return assumption within pension expense - the expense could be understated
2008
- Price is what you pay,
value is what you get
- Beware the investment
activity that produces applause; the great moves are usually greeted by yawns
2009
- Book value supplies
the most useful tracking device for changes in intrinsic value
- Avoid businesses if
you can't evaluate their futures, no matter how exciting their products might
be
- Stick with businesses
whose profit picture for decades to come seems reasonably predictable
2010
- The
"what-will-they-do-with-the-money" factor must always be evaluated
along with the "what-do-we-have-now" calculation in order to arrive
at a sensible estimate of a company's intrinsic value
2011
- Favor share repurchase
when two conditions are met: first, a company has ample funds to take care of
the operational and liquidity needs of its business; second, its stock is
selling at a material discount to the company's intrinsic business value,
conservatively calculated
2012
- It is far better to
buy a wonderful business at a fair price than to buy a fair business at a
wonderful price
- Collection of
companies earn 16.3% after-tax return on net tangible assets
2013
- Hopes to build
Berkshire’s per-share intrinsic value by (1) constantly improving the basic
earning power of our many subsidiaries; (2) further increasing earnings through
bolt-on M&A; (3) benefiting from the growth of our investees; (4)
repurchasing Berkshire shares when they are available at a meaningful discount
to intrinsic value; and (5) making an occasional large acquisition. We will
also try to maximize results for you by rarely, if ever, issuing Berkshire
shares
- Serious investors
should understand the disparate nature of intangible assets: Some truly deplete
over time while others in no way lose value. With software, for example,
amortization charges are very real expenses. Charges against other intangibles
such as the amortization of customer relationships, however, arise through
purchase-accounting rules and are clearly not real costs. GAAP accounting draws
no distinction between the two types of charges. Both, that is, are recorded as
expenses when earnings are calculated – even though from an investor’s
viewpoint they could not be more different.
- Every dime of
depreciation expense we report, however, is a real cost. And that’s true at
almost all other companies as well. When Wall Streeters tout EBITDA as a
valuation guide, button your wallet.
- Of course, a business
with terrific economics can be a bad investment if the purchase price is
excessive.
We have paid substantial
premiums to net tangible assets for most of our businesses, a cost that is
reflected in the large figure we show for goodwill. Overall, however, we are
getting a decent return on the capital we have deployed in this sector.
Furthermore, the intrinsic value of these businesses, in aggregate, exceeds
their carrying value by a good margin.
- Certain
fundamentals of investing:
- You don’t need to be
an expert in order to achieve satisfactory investment returns. But if you
aren’t, you must recognize your limitations and follow a course certain to work
reasonably well. Keep things simple and don’t swing for the fences. When
promised quick profits, respond with a quick “no.”
- Focus on the future
productivity of the asset you are considering. If you don’t feel comfortable
making a rough estimate of the asset’s future earnings, just forget it and move
on. No one has the ability to evaluate every investment possibility. But
omniscience isn’t necessary; you only need to understand the actions you
undertake.
- If you instead focus
on the prospective price change of a contemplated purchase, you are
speculating. There is nothing improper about that. I know, however, that I am
unable to speculate successfully, and I am skeptical of those who claim
sustained success at doing so. Half of all coin-flippers will win their first
toss; none of those winners has an expectation of profit if he continues to
play the game. And the fact that a given asset has appreciated in the recent
past is never a reason to buy it.
- With my two small
investments, I thought only of what the properties would produce and cared not
at all about their daily valuations. Games are won by players who focus on the
playing field – not by those whose eyes are glued to the scoreboard. If you can
enjoy Saturdays and Sundays without looking at stock prices, give it a try on
weekdays.
- Forming macro opinions
or listening to the macro or market predictions of others is a waste of time.
Indeed, it is dangerous because it may blur your vision of the facts that are
truly important. (When I hear TV commentators glibly opine on what the market
will do next, I am reminded of Mickey Mantle’s scathing comment: “You don’t
know how easy this game is until you get into that broadcasting booth.”)
- My two purchases were
made in 1986 and 1993. What the economy, interest rates, or the stock market
might do in the years immediately following – 1987 and 1994 – was of no
importance to me in making those investments. I can’t remember what the
headlines or pundits were saying at the time. Whatever the chatter, corn would
keep growing in Nebraska and students would flock to NYU.
- Owners of stocks,
however, too often let the capricious and often irrational behavior of their
fellow owners cause them to behave irrationally as well. Because there is so
much chatter about markets, the economy, interest rates, price behavior of
stocks, etc., some investors believe it is important to listen to pundits –
and, worse yet, important to consider acting upon their comments.
- During the
extraordinary financial panic that occurred late in 2008, I never gave a
thought to selling my farm or New York real estate, even though a severe
recession was clearly brewing. And, if I had owned 100% of a solid business
with good long-term prospects, it would have been foolish for me to even
consider dumping it. So why would I have sold my stocks that were small
participations in wonderful businesses? True, any one of them might eventually
disappoint, but as a group they were certain to do well. Could anyone really
believe the earth was going to swallow up the incredible productive assets and
unlimited human ingenuity existing in America?
- Our analysis is very
similar to that which we use in buying entire businesses. We first have to
decide whether we can sensibly estimate an earnings range for five years out,
or more. If the answer is yes, we will buy the stock (or business) if it sells
at a reasonable price in relation to the bottom boundary of our estimate. If,
however, we lack the ability to estimate future earnings – which is usually the
case – we simply move on to other prospects. In the 54 years we have worked
together, we have never foregone an attractive purchase because of the macro or
political environment, or the views of other people. In fact, these subjects
never come up when we make decisions.
- It’s vital, however,
that we recognize the perimeter of our “circle of competence” and stay well
inside of it. Even then, we will make some mistakes, both with stocks and
businesses. But they will not be the disasters that occur, for example, when a
long-rising market induces purchases that are based on anticipated price
behavior and a desire to be where the action is.
