Learnings from Berkshire Letters

Excerpts from Warren Buffett's letters to shareholders that are worth revisiting. Expand the arrow keys to read. 

1977

  • We believe a more appropriate measure of managerial economic performance to be return on equity capital.

  • It is comforting to be in a business where some mistakes can be made and yet a quite satisfactory overall performance can be achieved.

  • One of the lessons your management has learned - and, unfortunately, sometimes re-learned - is the importance of being in businesses where tailwinds prevail rather than headwinds.

  • Most of our large stock positions are going to be held for many years and the scorecard on our investment decisions will be provided by business results over that period, and not by prices on any given day.  Just as it would be foolish to focus unduly on short-term prospects when acquiring an entire company, we think it equally unsound to become mesmerized by prospective near term earnings or recent trends in earnings when purchasing small pieces of a company; i.e., marketable common stocks.

  • We select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety.  We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price.  

  • We ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term. In fact, if their business experience continues to satisfy us, we welcome lower market prices of stocks we own as an opportunity to acquire even more of a good thing at a better price.

  • When prices are appropriate, we are willing to take very large positions in selected companies, not with any intention of taking control and not foreseeing sell-out or merger, but with the expectation that excellent business results by corporations will translate over the long term into correspondingly excellent market value and dividend results for owners, minority as well as majority.

1978

  • We make no attempt to predict how security markets will behave; successfully forecasting short term stock prices is something we think neither we nor anyone else can do.  

  • Obvious approaches to improved profit margins involve differentiation of product, lowered manufacturing costs through more efficient equipment or better utilization of people…

  • We get excited enough to commit a big percentage… to equities only when we find (1) businesses we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) priced very attractively.  We usually can identify a small number of potential investments meeting requirements (1), (2) and (3), but (4) often prevents action.

  • Our policy is to concentrate holdings.  We try to avoid buying a little of this or that when we are only lukewarm about the business or its price.  When we are convinced as to attractiveness, we believe in buying worthwhile amounts.

  • While there may be less excitement and prestige in sitting back and letting others do the work, we think that is all one loses by accepting a passive participation in excellent management.

  • We are not at all unhappy when our wholly-owned businesses retain all of their earnings if they can utilize internally those funds at attractive rates.  Why should we feel differently about retention of earnings by companies in which we hold small equity interests, but where the record indicates even better prospects for profitable employment of capital?

  • Our experience has been that the manager of an already high-cost operation frequently is uncommonly resourceful in finding new ways to add to overhead, while the manager of a tightly-run operation usually continues to find additional methods to curtail costs, even when his costs are already well below those of his competitors.

  • It is a real pleasure to work with managers who enjoy coming to work each morning and, once there, instinctively and unerringly think like owners.

1979

  • 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 earnings per share.

  • Both our operating and investment experience cause us to conclude 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.

  • In contrast, we include no narrative with our quarterly reports.  Our owners and managers both have very long time-horizons in regard to this business, and it is difficult to say anything new or meaningful each quarter about events of long-term significance.

  • Your company is run on the principle of centralization of financial decisions at the top (the very top, it might be added), and rather extreme delegation of operating authority to a number of key managers at the individual company or business unit level.  We could just field a basketball team with our corporate headquarters group (which utilizes only about 1500 square feet of space).

1980

  • “...the value of those retained earnings is determined by the use to which they are put and the subsequent level of earnings produced by that usage.

  • Our view, we warn you, is non-conventional.  But we would rather have earnings for which we did not get accounting credit put to good use in a 10%-owned company by a management we did not personally hire, than have earnings for which we did get credit put into projects of more dubious potential by another management - even if we are that management.

  • One usage of retained earnings we often greet with special enthusiasm when practiced by companies in which we have an investment interest is repurchase of their own shares.  The reasoning is simple: if a fine business is selling in the market place for far less than intrinsic value, what more certain or more profitable utilization of capital can there be than significant enlargement of the interests of all owners at that bargain price?  The competitive nature of corporate acquisition activity almost guarantees the payment of a full - frequently more than full price when a company buys the entire ownership of another enterprise. But the auction nature of security markets often allows finely-run companies the opportunity to purchase portions of their own businesses at a price under 50% of that needed to acquire the same earning power through the negotiated acquisition of another enterprise.)

  • We continue to achieve a long-term return on equity that considerably exceeds the average of our yearly returns.  The major factor causing this pleasant result is a simple one: the retained earnings of those non-controlled holdings we discussed earlier have been translated into gains in market value.

  • Of course, this translation of retained earnings into market price appreciation is highly uneven (it goes in reverse some years), unpredictable as to timing, and unlikely to materialize on a precise dollar-for-dollar basis.  And a silly purchase price for a block of stock in a corporation can negate the effects of a decade of earnings retention by that corporation. But when purchase prices are sensible, some long-term market recognition of the accumulation of retained earnings almost certainly will occur.  Periodically you even will receive some frosting on the cake, with market appreciation far exceeding post-purchase retained earnings.

  • Unfortunately, earnings reported in corporate financial statements are no longer the dominant variable that determines whether there are any real earnings for you, the owner.  For only gains in purchasing power represent real earnings on investment.  If you (a) forego ten hamburgers to purchase an investment; (b) receive dividends which, after tax, buy two hamburgers; and (c) receive, upon sale of your holdings, after-tax proceeds that will buy eight hamburgers, then (d) you have had no real income from your investment, no matter how much it appreciated in dollars.  You may feel richer, but you won’t eat richer.

  • Explicit income taxes alone, unaccompanied by any implicit inflation tax, never can turn a positive corporate return into a negative owner return. (Even if there were 90% personal income tax rates on both dividends and capital gains, some real income would be left for the owner at a zero inflation rate.) But the inflation tax is not limited by reported income.  Inflation rates not far from those recently experienced can turn the level of positive returns achieved by a majority of corporations into negative returns for all owners, including those not required to pay explicit taxes. 

  •  Of course, earnings and dividends per share usually will rise if significant earnings are “saved” by a corporation; i.e., reinvested instead of paid as dividends.  

  • A thrifty wage earner, likewise, could achieve regular annual increases in his total income without ever getting a pay increase - if he was willing to take only half of his paycheck in cash (his wage “dividend”) and consistently add the other half (his “retained earnings”) to a savings account. 

  • For capital to be truly indexed, return on equity must rise, i.e., business earnings consistently must increase in proportion to the increase in the price level without any need for the business to add to capital - including working capital - employed.  (Increased earnings produced by increased investment don’t count.

  • 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.

  • This ostrich-like behavior - selling the better assets and keeping the biggest losers - while less painful in the short term, is unlikely to be a winner in the long term.

  • The most attractive opportunities may present themselves at a time when credit is extremely expensive - or even unavailable.  At such a time we want to have plenty of financial firepower.

  • Under all circumstances, we plan to operate with plenty of liquidity, with debt that is moderate in size and properly structured, and with an abundance of capital strength.  Our return on equity is penalized somewhat by this conservative approach, but it is the only one with which we feel comfortable.

  • Before the purchase the seller knows the business intimately, whereas you start from scratch.  The seller has dozens of opportunities to mislead the buyer - through omissions, ambiguities, and misdirection.  After the check has changed hands, subtle (and not so subtle) changes of attitude can occur and implicit understandings can evaporate.  As in the courtship-marriage sequence, disappointments are not infrequent.

1981

  • While market values track business values quite well over long periods, in any given year the relationship can gyrate capriciously.  Market recognition of retained earnings also will be unevenly realized among companies.  

  • We would rather buy 10% of Wonderful Business T at X per share than 100% of T at 2X per share. Most corporate managers prefer just the reverse, and have no shortage of stated rationales for their behavior.

  • Leaders, business or otherwise, seldom are deficient in animal spirits and often relish increased activity and challenge.  At Berkshire, the corporate pulse never beats faster than when an acquisition is in prospect.

  • Most organizations, business or otherwise, measure themselves, are measured by others, and compensate their managers far more by the yardstick of size than by any other yardstick.

  • Many managements apparently were overexposed in impressionable childhood years to the story in which the imprisoned handsome prince is released from a toad’s body by a kiss from a beautiful princess. Consequently, they are certain their managerial kiss will do wonders for the profitability of Company Target.

  • ...favored business must have two characteristics: (1) an ability to 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 (2) an 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.

  • we find values most easily obtained through the open-market purchase of fractional positions in companies with excellent business franchises and competent, honest managements. We never expect to run these companies, but we do expect to profit from them.

  • The accounting rules that entirely ignore these undistributed earnings diminish the utility of our annual return on equity calculation, or any other single year measure of economic performance.

  • Over half of the large gain in Berkshire’s net worth during 1981 - it totaled $124 million, or about 31% - resulted from the market performance of a single investment, GEICO Corporation.  

  •  The returns from passive capital outstrip the returns from active capital.  This is an unpleasant fact for both investors and corporate managers and, therefore, one they may wish to ignore.  But facts do not cease to exist, either because they are unpleasant or because they are ignored.

  • 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.  

  • Berkshire continues to retain its earnings for offensive, not defensive or obligatory, reasons.  But in no way are we immune from the pressures that escalating passive returns exert on equity capital.

1982

  • Clearly “accounting” earnings can seriously misrepresent economic reality.

  • We prefer a concept of “economic” earnings that includes all undistributed earnings, regardless of ownership percentage.

  • In our view, the value to all owners of the retained earnings of a business enterprise is determined by the effectiveness with which those earnings are used - and not by the size of one’s ownership percentage.

  • If you have owned .01 of 1% of Berkshire during the past decade, you have benefited economically in full measure from your share of our retained earnings, no matter what your accounting system.

  • ...managers and investors alike must understand that accounting numbers are the beginning, not the end, of business valuation.

  • Within this gigantic auction arena, it is our job to select businesses with economic characteristics allowing each dollar of retained earnings to be translated eventually into at least a dollar of market value.  Despite a lot of mistakes, we have so far achieved this goal. In doing so, we have been greatly assisted by Arthur Okun’s patron saint for economists - St. Offset.

  • In some cases, that is, retained earnings attributable to our ownership position have had insignificant or even negative impact on market value, while in other major positions a dollar retained by an investee corporation has been translated into two or more dollars of market value.

  • Satisfactory as our partial-ownership approach has been, what really makes us dance is the purchase of 100% of good businesses at reasonable prices.  We’ve accomplished this feat a few times (and expect to do so again), but it is an extraordinarily difficult job - far more difficult than the purchase at attractive prices of fractional interests.

  • As we look at the major acquisitions that others made during 1982, our reaction is not envy, but relief that we were non-participants.  For in many of these acquisitions, managerial intellect wilted in competition with managerial adrenaline The thrill of the chase blinded the pursuers to the consequences of the catch.  Pascal’s observation seems apt: “It has struck me that all men’s misfortunes spring from the single cause that they are unable to stay quietly in one room.”

  • Our partial-ownership approach can be continued soundly only as long as portions of attractive businesses can be acquired at attractive prices.

  • The market, like the Lord, helps those who help themselves.  But, unlike the Lord, the market does not forgive those who know not what they do.  For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.

  • Berkshire’s economic goal remains to produce a long-term rate of return well above the return achieved by the average large American corporation.  Our willingness to purchase either partial or total ownership positions in favorably-situated businesses, coupled with reasonable discipline about the prices we are willing to pay, should give us a good chance of achieving our goal.

  • Year-to-year variances, however, cannot consistently be in our favor.  Even if our partially-owned businesses continue to perform well in an economic sense, there will be years when they perform poorly in the market.  At such times our net worth could shrink significantly. We will not be distressed by such a shrinkage; if the businesses continue to look attractive and we have cash available, we simply will add to our holdings at even more favorable prices.

  • ...nostalgia should be weighted heavily in stock selection.

  • In a given year, it is possible for an insurer to show almost any profit number it wishes, particularly if it (1) writes “long-tail” business (coverage where current costs can be only estimated, because claim payments are long delayed), (2) has been adequately reserved in the past, or (3) is growing very rapidly.

  • There are indications that several large insurers opted in 1982 for obscure accounting and reserving maneuvers that masked significant deterioration in their underlying businesses. In insurance, as elsewhere, the reaction of weak managements to weak operations is often weak accounting. (“It’s difficult for an empty sack to stand upright.”)

  • Businesses in industries with both substantial over-capacity and a “commodity” product (undifferentiated in any customer-important way by factors such as performance, appearance, service support, etc.) are prime candidates for profit troubles.

  • If, however, costs and prices are determined by full-bore competition, there is more than ample capacity, and the buyer cares little about whose product or distribution services he uses, industry economics are almost certain to be unexciting. They may well be disastrous.

  • Hence the constant struggle of every vendor to establish and emphasize special qualities of product or service. This works with candy bars (customers buy by brand name, not by asking for a “two-ounce candy bar”) but doesn’t work with sugar (how often do you hear, “I’ll have a cup of coffee with cream and C & H sugar, please”).

  • “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.”

  • “Our share issuances follow a simple basic rule: we will not issue shares unless we receive as much intrinsic business value as we give.”

  • “Managers who want to expand their domain at the expense of owners might better consider a career in government.”

  • Companies often sell in the stock market below their intrinsic business value. But when a company wishes to sell out completely, in a negotiated transaction, it inevitably wants to - and usually can - receive full business value in whatever kind of currency the value is to be delivered. If cash is to be used in payment, the seller’s calculation of value received couldn’t be easier. If stock of the buyer is to be the currency, the seller’s calculation is still relatively easy: just figure the market value in cash of what is to be received in stock. Meanwhile, the buyer wishing to use his own stock as currency for the purchase has no problems if the stock is selling in the market at full intrinsic value.

  • There are three ways to avoid destruction of value for old owners when shares are issued for acquisitions: 

    • True busines-value-for-business-value merger

    • Acquirer’s stock sells at or above its intrinsic business value 

    • Acquirer to go ahead with the acquisition, but then subsequently repurchase a quantity of shares equal to the number issued in the merger 

1983

  • Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our shareholders as owner-partners, and of ourselves as managing partners.  We do not view the company itself as the ultimate owner of our business assets but, instead, view the company as a conduit through which our shareholders own the assets.

  • Our long-term economic goal is to maximize the average annual rate of gain in intrinsic business value on a per-share basis. 

  • We are certain that the rate of per-share progress will diminish in the future - a greatly enlarged capital base will see to that.  But we will be disappointed if our rate does not exceed that of the average large American corporation.

  • Our preference would be to reach this goal by directly owning a diversified group of businesses that generate cash and consistently earn above-average returns on capital.  

  • We rarely use much debt and, when we do, we attempt to structure it on a long-term fixed rate basis.  We will reject interesting opportunities rather than over-leverage our balance sheet. This conservatism has penalized our results but it is the only behavior that leaves us comfortable…

  • We will not diversify by purchasing entire businesses at control prices that ignore long-term economic consequences to our shareholders.  We will only do with your money what we would do with our own, weighing fully the values you can obtain by diversifying your own portfolios through direct purchases in the stock market.

  • We feel noble intentions should be checked periodically against results.  We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained.  To date, this test has been met. We will continue to apply it on a five-year rolling basis. As our net worth grows, it is more difficult to use retained earnings wisely

  • We will issue common stock only when we receive as much in business value as we give.  This rule applies to all forms of issuance - not only mergers or public stock offerings, but stock for-debt swaps, stock options, and convertible securities as well.  We will not sell small portions of your company - and that is what the issuance of shares amounts to - on a basis inconsistent with the value of the entire enterprise.

  • ...we react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures.

  • ...gin rummy managerial behavior (discard your least promising business at each turn) is not our style.  We would rather have our overall results penalized a bit than engage in it.

  • We also believe candor benefits us as managers: the CEO who misleads others in public may eventually mislead himself in private.

  • Good investment ideas are rare, valuable and subject to competitive appropriation just as good product or business acquisition ideas are.  Therefore, we normally will not talk about our investment ideas. 

  • One question I always ask myself in appraising a business is how I would like, assuming I had ample capital and skilled personnel, to compete with it.

  • It’s the ideal business - one built upon exceptional value to the customer that in turn translates into exceptional economics for its owners.

  • We never take the one-year figure very seriously.  After all, why should the time required for a planet to circle the sun synchronize precisely with the time required for business actions to pay off?  Instead, we recommend not less than a five-year test as a rough yardstick of economic performance. 

  • Red lights should start flashing if the five-year average annual gain falls much below the return on equity earned over the period by American industry in aggregate.

  • During the 19-year tenure of present management, book value has grown from $19.46 per share to $975.83, or 22.6% compounded annually.  Considering our present size, nothing close to this rate of return can be sustained. Those who believe otherwise should pursue a career in sales, but avoid one in mathematics.

  • Book value is an accounting concept, recording the accumulated financial input from both contributed capital and retained earnings.  Intrinsic business value is an economic concept, estimating future cash output discounted to present value. Book value tells you what has been put in; intrinsic business value estimates what can be taken out. 

  • An analogy will suggest the difference.  Assume you spend identical amounts putting each of two children through college. The book value (measured by financial input) of each child’s education would be the same.  But the present value of the future payoff (the intrinsic business value) might vary enormously - from zero to many times the cost of the education. So, also, do businesses having equal financial input end up with wide variations in value.

  • ...book value consisted of textile assets that could not earn, on average, anything close to an appropriate rate of return.  In the terms of our analogy, the investment in textile assets resembled investment in a largely-wasted education.

  •  You can live a full and rewarding life without ever thinking about Goodwill and its amortization.  But students of investment and management should understand the nuances of the subject. My own thinking has changed drastically from 35 years ago when I was taught to favor tangible assets and to shun businesses whose value depended largely upon economic Goodwill.  This bias caused me to make many important business mistakes of omission, although relatively few of commission

  • ...you should be aware that Charlie and I believe that Berkshire possesses very significant economic Goodwill value above that reflected in our book value.

  • In our opinion, three factors largely account for the unusual acceptance of the News in the community.   (1) A stable population is more interested and involved in the activities of its community than is a shifting population - and, as a result, is more interested in the content of the local daily paper.  Increase the movement in and out of a city and penetration ratios will fall. (2) The News has a reputation for editorial quality and integrity. (3) The News lives up to its name - it delivers a very unusual amount of news. 

  • We often are asked why Berkshire does not split its stock.  The assumption behind this question usually appears to be that a split would be a pro-shareholder action.  We disagree. Let me tell you why:

    • One of our goals is to have Berkshire Hathaway stock sell at a price rationally related to its intrinsic business value.  (But note “rationally related”, not “identical”: if well-regarded companies are generally selling in the market at large discounts from value, Berkshire might well be priced similarly.) The key to a rational stock price is rational shareholders, both current and prospective.

    • If the holders of a company’s stock and/or the prospective buyers attracted to it are prone to make irrational or emotion-based decisions, some pretty silly stock prices are going to appear periodically.  Manic-depressive personalities produce manic-depressive valuations. Such aberrations may help us in buying and selling the stocks of other companies. But we think it is in both your interest and ours to minimize their occurrence in the market for Berkshire.

    •  To obtain only high quality shareholders is no cinch.  Mrs. Astor could select her 400, but anyone can buy any stock.  Entering members of a shareholder “club” cannot be screened for intellectual capacity, emotional stability, moral sensitivity or acceptable dress.  Shareholder eugenics, therefore, might appear to be a hopeless undertaking.

    • In large part, however, we feel that high quality ownership can be attracted and maintained if we consistently communicate our business and ownership philosophy - along with no other conflicting messages - and then let self selection follow its course.  For example, self selection will draw a far different crowd to a musical event advertised as an opera than one advertised as a rock concert even though anyone can buy a ticket to either.

    • Through our policies and communications - our “advertisements” - we try to attract investors who will understand our operations, attitudes and expectations. (And, fully as important, we try to dissuade those who won’t.) We want those who think of themselves as business owners and invest in companies with the intention of staying a long time.  And, we want those who keep their eyes focused on business results, not market prices.

    • Investors possessing those characteristics are in a small minority, but we have an exceptional collection of them.  I believe well over 90% - probably over 95% - of our shares are held by those who were shareholders of Berkshire or Blue Chip five years ago.  And I would guess that over 95% of our shares are held by investors for whom the holding is at least double the size of their next largest. Among companies with at least several thousand public shareholders and more than $1 billion of market value, we are almost certainly the leader in the degree to which our shareholders think and act like owners.  Upgrading a shareholder group that possesses these characteristics is not easy.

    • Were we to split the stock or take other actions focusing on stock price rather than business value, we would attract an entering class of buyers inferior to the exiting class of sellers.  At $1300, there are very few investors who can’t afford a Berkshire share. Would a potential one-share purchaser be better off if we split 100 for 1 so he could buy 100 shares? Those who think so and who would buy the stock because of the split or in anticipation of one would definitely downgrade the quality of our present shareholder group. (Could we really improve our shareholder group by trading some of our present clear-thinking members for impressionable new ones who, preferring paper to value, feel wealthier with nine $10 bills than with one $100 bill?) People who buy for non-value reasons are likely to sell for non-value reasons.  Their presence in the picture will accentuate erratic price swings unrelated to underlying business developments.

    • We will try to avoid policies that attract buyers with a short-term focus on our stock price and try to follow policies that attract informed long-term investors focusing on business values. just as you purchased your Berkshire shares in a market populated by rational informed investors, you deserve a chance to sell - should you ever want to - in the same kind of market.  We will work to keep it in existence.

    • One of the ironies of the stock market is the emphasis on activity.  Brokers, using terms such as “marketability” and “liquidity”, sing the praises of companies with high share turnover (those who cannot fill your pocket will confidently fill your ear).  But investors should understand that what is good for the croupier is not good for the customer. A hyperactive stock market is the pickpocket of enterprise.

    • For example, consider a typical company earning, say, 12% on equity.  Assume a very high turnover rate in its shares of 100% per year. If a purchase and sale of the stock each extract commissions of 1% (the rate may be much higher on low-priced stocks) and if the stock trades at book value, the owners of our hypothetical company will pay, in aggregate, 2% of the company’s net worth annually for the privilege of transferring ownership.  This activity does nothing for the earnings of the business, and means that 1/6 of them are lost to the owners through the “frictional” cost of transfer. (And this calculation does not count option trading, which would increase frictional costs still further.)

    • All that makes for a rather expensive game of musical chairs.  Can you imagine the agonized cry that would arise if a governmental unit were to impose a new 16 2/3% tax on earnings of corporations or investors?  By market activity, investors can impose upon themselves the equivalent of such a tax.

    • Days when the market trades 100 million shares (and that kind of volume, when over-the-counter trading is included, is today abnormally low) are a curse for owners, not a blessing - for they mean that owners are paying twice as much to change chairs as they are on a 50-million-share day.  If 100 million-share days persist for a year and the average cost on each purchase and sale is 15 cents a share, the chair-changing tax for investors in aggregate would total about $7.5 billion - an amount roughly equal to the combined 1982 profits of Exxon, General Motors, Mobil and Texaco, the four largest companies in the Fortune 500.

    • These companies had a combined net worth of $75 billion at yearend 1982 and accounted for over 12% of both net worth and net income of the entire Fortune 500 list.  Under our assumption investors, in aggregate, every year forfeit all earnings from this staggering sum of capital merely to satisfy their penchant for “financial flip-flopping”.  In addition, investment management fees of over $2 billion annually - sums paid for chair-changing advice - require the forfeiture by investors of all earnings of the five largest banking organizations (Citicorp, Bank America, Chase Manhattan, Manufacturers Hanover and J. P. Morgan).  These expensive activities may decide who eats the pie, but they don’t enlarge it.

    • (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.  Adam Smith felt that all noncollusive acts in a free market were guided by an invisible hand that led an economy to maximum progress; our view is that casino-type markets and hair-trigger investment management act as an invisible foot that trips up and slows down a forward-moving economy.)

    • Contrast the hyperactive stock with Berkshire.  The bid-and-ask spread in our stock currently is about 30 points, or a little over 2%.  Depending on the size of the transaction, the difference between proceeds received by the seller of Berkshire and cost to the buyer may range downward from 4% (in trading involving only a few shares) to perhaps 1 1/2% (in large trades where negotiation can reduce both the market-maker’s spread and the broker’s commission).  Because most Berkshire shares are traded in fairly large transactions, the spread on all trading probably does not average more than 2%.

    • Meanwhile, true turnover in Berkshire stock (excluding inter-dealer transactions, gifts and bequests) probably runs 3% per year.  Thus our owners, in aggregate, are paying perhaps 6/100 of 1% of Berkshire’s market value annually for transfer privileges. By this very rough estimate, that’s $900,000 - not a small cost, but far less than average.  Splitting the stock would increase that cost, downgrade the quality of our shareholder population, and encourage a market price less consistently related to intrinsic business value. We see no offsetting advantages.

  • ...businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess return is economic Goodwill.

  • Asset-heavy businesses generally earn low rates of return – rates that often barely provide enough capital to fund the inflationary needs of the existing business, with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses.

  • ...a disproportionate number of the great business fortunes built up during the inflationary years arose from ownership of operations that combined intangibles of lasting value with relatively minor requirements for tangible assets. In such cases earnings have bounded upward in nominal dollars, and these dollars have been largely available for the acquisition of additional businesses.

  • We believe managers and investors alike should view intangible assets from two perspectives:

  1. In analysis of operating results – that is, in evaluating the underlying economics of a business unit – amortization charges should be ignored. What a business can be expected to earn on unleveraged net tangible assets, excluding any charges against earnings for amortization of Goodwill, is the best guide to the economic attractiveness of the operation. It is also the best guide to the current value of the operation’s economic Goodwill.

  2. In evaluating the wisdom of business acquisitions, amortization charges should be ignored also. They should be deducted neither from earnings nor from the cost of the business. This means forever viewing purchased Goodwill at its full cost, before any amortization. Furthermore, cost should be defined as including the full intrinsic business value – not just the recorded accounting value – of all consideration given, irrespective of market prices of the securities involved at the time of merger and irrespective of whether pooling treatment was allowed. For example, what we truly paid in the Blue Chip merger for 40% of the Goodwill of See’s and the News was considerably more than the $51.7 million entered on our books. This disparity exists because the market value of the Berkshire shares given up in the merger was less than their intrinsic business value, which is the value that defines the true cost to us.

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