MPE 16: Financial Management: Report on

Berkshire Hathaway Letters [1977 - 1981]

Contents

1. Summary of Letters [1977 1981]

.2 - 5
2. Berkshire Hathaway Year wise Glimpses.
67
3. References
.7

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PREPARED BY:
Anupam Roy.
Ashish Naidu.
Sumit Mishra.
Uddipan Pal.
Vijayakumar
Kattamanchi.

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BERKSHIRE HATHAWAY MAJOR CONCLUSIONS FROM LETTERS (1977-1981)

Warren Buffet belongs to the Graham & Dodd school of Value Investing. Major
conclusions from
the letters to shareholders from 1977-1981 are as follows :
1. Stock Markets are the best place to buy businesses at discounted prices
bargains in business
2. Stock Selection Criteria
a) Businesses we can understand.
b) With favorable long-term prospects.
c) Operated by honest & competent people, extraordinary properties &
management quality
d) Priced very attractively.
e) Businesses with higher intrinsic value than the common stock price.
3. It is difficult to predict stock market movements in the short run.
4. Institutional investors are not always right.
5. Investors should have concentrated portfolios.
6. Return on Capital employed (ROCE) is a good measure of the business
strength.
7. Avoid investing in companies with a relatively undifferentiated goods/product
pipeline.
8. Invest in businesses where tail-winds prevail rather than head winds.
9. Low returns are a result of slow capital turnover & low profit margins.
Improved
profit
margins
involve
product
differentiation,
lowered
manufacturing costs more efficient use of equipment & people.
10.Buffet prefers acquisition of small fractions of businesses as common stocks
@ bargain prices for which little enthusiasm exists in contrast to general
corporate trend of acquisition activity in which much enthusiasm exists.
11.Managerial economic performance is determined by higher earnings rate on
equity capital rather than gains in EPS.
12.Buffet agrees to organizations which hold their entire profits & pump it back
into the business provided they can provide a higher rate of return on the
profits reinvested.
13.Berkshire acquisitions are based on maximizing real economic benefits. He
quotes We would rather buy 10% of Wonderful Business T at X per share
than 100% of T at 2X per share
14.Buffet further divides businesses into 2 categories:
a) Businesses well adapted to inflationary environment
b) Extraordinary Businesses disguised as ordinary or below ordinary ones.
Business adapted to inflationary environment:
These businesses have characteristics:
1) Ability to increase prices easily without fear of loss of market share &
volume.
2) Ability to accommodate large dollar volume increases in business with low
additional investment capital.
Extraordinary Business disguised as ordinary ones:
Buffet states that he is not good enough to identify these managerial
superstars.
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Buffett focuses on the micro (specific companies) but hes always mindful of the
macro. And he certainly understands that his success couldnt have happened
without riding the biggest macro wave of the last 100 years the amazing growth of
the US economy.
Who has ever benefited during the past 238 years by betting against America? If
you compare our countrys present condition to that existing in 1776, you have to
rub your eyes in wonder. In my lifetime alone, real per-capita US output has
sixfolded. My parents could not have dreamed in 1930 of the world their son would
see.
He quotes that it is very difficult to beat the market no matter how bright you are
with an example where a commentator interpreted that the book value of Berkshire
Hathaway in 1964 could have bought ounce of gold & 15 yrs later with much
blood sweat & tears the book value produced will buy the same ounce of gold.
Buffet further states in 1982 that American businesses are currently bad
businesses economically producing less for their individual investors after-tax than
the tax-exempt passive rate of return on money. But American equity capital, in
aggregate, produces no value-added for individual investors.If the causes of long4 | Page

term inflation can be tempered, passive returns are likely to fall and the intrinsic
position of American equity capital should significantly improve. Many businesses
that now must be classified as economically bad would be restored to the good
category under such circumstances.
BERKSHIRE HATHWAY STATISTICS

Buffet shares that on GAAP basis, during the present managements term of
seventeen years, book value has increased from $19.46 per share to $526.02 per
share, or 21.1% compounded annually. This rate of return number is highly likely to
drift downward in future years.
Conventional accounting only allows less than half of our earnings iceberg to
appear above the surface, in plain view. Within the corporate world such a result is
quite rare; in our case it is likely to be recurring

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Berkshire Hathaway Year wise Glimpses

1977 78

After merging Berkshire Fine Spinning Associates with Hathaway

Manufacturing Company in 1955, these were the beginning of the years when
Warren Buffet started interacting with shareholders by publishing the
shareholder letters.
Most of the companies owned by Berkshire define record earnings as a new
high in earnings per share.
Operating earnings on beginning equity capital amounted to 19%, slightly
better than last year.
Few shareholders question the wisdom of remaining in textile business.
10 years completion of Berkshire in the Insurance industry.
600 % growth in last 10 years in the aggregate insurance premium [$22
million to $151 million].
Cypress Insurance Company was purchased in cash.
Home state Auto continues to make excellent progress in 1977 but was
disappointing in 1978.
Insurance investments grew from $134.6 million to $252.8 million.
Makes realized capital gains of $6.9 million and unrealized capital gains of
$74 million PBT.
Illinois National Bank [Purchased in 1969] continued to achieve a rate of
earnings on assets about three times that of most large banks.
Berkshire increases equity interest in Blue Chip Stamps, and owns
approximately 36 1/2% at the end of 1977.

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Merger with Diversified retailing company.

1979
-

Accounting profession decides that equity securities owned by insurance

companies must be carried on the balance sheet at market value. However,
since this could significantly distort the operating performance percentage
because of wide year-to-year market value changes in the net worth figure,
Berkshire decides to continue to report operating performance measured
against beginning net worth, with securities valued at cost.
Had a reasonably good operating performance but not as good as the
previous year.
Book Value of share rises to $ 335.85 per share. A gain of 20.5 %
compounded annually. However, Inflation remains a cause of concern in order
to continue to achieve this gain on a continuous basis.
Acquires total ownership of thirteen businesses [from the base of textile
business] through negotiated purchases from private owners for cash, and
have started six others.
Textile and Retailing shows a diminishing significance over the years as
compared to the insurance business.
Insurance underwriting ratio decreased from 98.2% to 97.1%.
Home state was disappointing in this year due to data processing,
administrative and personnel problems.
Cypress Insurance company purchase turns out to be an absolute gem.
Berkshire enters into the specialized area of surety reinsurance.
Berkshire feels that very long term bonds are of less yield and a mistake
made by them.
Last year for Illinois National Bank and Trust Company as a subsidiary of
Berkshire Hathaway as the Bank Holding Company Act of 1969 requires that
they divest the bank by December 31, 1980.
NASDAQ trading was initiated in the stock of Berkshire Hathaway. This means
that the stock now is quoted on the Over-the-Counter page of the Wall Street
journal under Additional OTC Quotes.

1980
-

Operating earnings improved to $ 41.9 million in 1980 from $36.0 million in

1979.
As per the GAAP requirement, all Blue Chip income and expense items are
included in full in Berkshires Consolidated Statement of Earnings, with the
40% ownership interest of others in Blue Chips net earnings.
In last sixteen years, book value per share with insurance-held equities
valued at market increased from $19.46 to $400.80, or 20.5% compounded
annually.
The largest non-controlled holding[7.2 million shares] of GEICO Corp., equal
to about a 33% equity interestwould qualify as an investee holding and
would require Berkshire to reflect a proportionate share of GEICOs earnings
in their own.
The insurance industrys underwriting picture continues to rise from 100.6 in
1979 to an estimated 103.5 in 1980.
Home and Auto insurance continues to make good progress.
Home state was disappointing again consecutively in this year.

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Berkshire cuts the scope of their textile business. Operations at Waumbec

Mills were terminated, reluctantly but necessarily.

1981
-

Operating earnings of $39.7 million in 1981 amounted to 15.2% of beginning

equity capital compared to 17.8% in 1980.
Berkshire continues to seek the acquisition of businesses in their entirety.
They are prepared to pay a fairly fancy price for a business if they feel that
they are reasonably confident of what they are getting.
The book value of share increases to $526.02 per share, or 21.1%
compounded annually.
Berkshire feels that the future of Insurance companies is bleak due to the
abandonment of their underwriting discipline and writing businesses at any
price in order to avoid negative cash flow.

References: 1. http://www.berkshirehathaway.com/letters/letters.html
2. https://en.wikipedia.org/wiki/Berkshire_Hathaway

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