Category Archives: Berkshire Hathaway Project

Berkshire Hathaway Annual Letter, 1979

Warren Buffett speaking to a group of students...The 1979 Chairman’s Newsletter represents Buffett’s first since Berkshire Hathaway went public on NASDAQ.  Not that this distinction changes Buffett’s approach much.  Indeed, he argues that Berkshire Hathaway is targeting long-term shareholders, and with about “98% of the shares outstanding [at the end of the year] are held by people who also were shareholders at the beginning of the year,” they were achieving that goal.  

 

More directly interesting and worth considering for early stage companies and investing are a few key points.

 

One is a theme that discussed in other Letters: namely, the focus on investing in a great company at a fair price versus seeking a bargain investment in a less-than-great company.  He discusses this in his comparison of Berkshire Hatahway’s Textile businesses relative to some of the the other assets.  Specifically, he compares textiles to network television stations, which then were pretty hard to replace and cash generating cows.

 

Our textile business also continues to produce some cash, but at a low rate compared to capital employed. This is not a reflection on the managers, but rather on the industry in which they operate. In some businesses – a network TV station, for example – it is virtually impossible to avoid earning extraordinary returns on tangible capital employed in the business. And assets in such businesses sell at equally extraordinary prices, one thousand cents or more on the dollar, a valuation reflecting the splendid, almost unavoidable, economic results obtainable. Despite a fancy price tag, the “easy” business may be the better route to go.

We can speak from experience, having tried the other route. Your Chairman made the decision a few years ago to purchase Waumbec Mills in Manchester, New Hampshire, thereby expanding our textile commitment. By any statistical test, the purchase price was an extraordinary bargain; we bought well below the working capital of the business and, in effect, got very substantial amounts of machinery and real estate for less than nothing. But
the purchase was a mistake. While we labored mightily, new problems arose as fast as old problems were tamed.

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. Although a mistake, the Waumbec acquisition has not been a disaster. Certain portions of the operation are proving to be valuable additions to our decorator line (our strongest franchise) at New Bedford, and it’s possible that we may be able to run profitably on a considerably reduced scale at Manchester. However, our original rationale did not prove out.

 

The second nugget I got from this letter is the detailed, concrete thinking on how business drivers might affect future business results.  In this letter, Buffett talks about an increasing performance in his auto insurance business.  Fewer claims were submitted, yielding better profits.  Simple business, insurance!  :)  Buffett points out though that in 1979 oil prices had soared.  They’d soared to such a degree that people were changing their driving habits, specifically by driving less. Less driving led to fewer accidents.  Fewer accidents led to better profits for Buffett.  Buffett calls this out as likely temporary.  If and when gas prices fall, driving will increase, and the temporary gift of lower claims will evaporate.  A solid, cogent example of the types of detailed drivers that we all need to think about in business to anticipate how a business might evolve and change over time.

 

Third, another useful theme Buffett talks about a lot: you attract the investors you deserve.

 

In large part, companies obtain the shareholder constituency that they seek and deserve. If they focus their thinking and communications on short-term results or short-term stock market consequences they will, in large part, attract shareholders who focus on the same factors. And if they are cynical in their treatment of investors, eventually that cynicism is highly likely to be returned by the investment community.

 

His description comparing how you attract and manage a relationship with investors to running a restaurant is terrific.

 

Phil Fisher, a respected investor and author, once likened the policies of the corporation in attracting shareholders to those of a restaurant attracting potential customers. A
restaurant could seek a given clientele – patrons of fast foods, elegant dining, Oriental food, etc. – and eventually obtain an appropriate group of devotees. If the job were expertly done, that clientele, pleased with the service, menu, and price level offered, would return consistently. But the restaurant could not change its character constantly and end up with a happy and stable clientele. If the business vacillated between French cuisine and take-out chicken, the result would be a revolving door of confused and dissatisfied customers.

So it is with corporations and the shareholder constituency they seek. You can’t be all things to all men, simultaneously seeking different owners whose primary interests run from high current yield to long-term capital growth to stock market pyrotechnics, etc.

 

Great writeup in 1979, I look forward to reading the 1980 one.

 

 

 

 

 

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Great Start-up Lesson from Berkshire Hathaway Letter, 1978

Quick follow-up from yesterday’s post on the 1978 Berkshire Hathaway Annual Shareholder’s Letter, authored by Warren Buffett.  It’s a great lesson around running lean and frugal, applicable to any manager in business, any start-up in particular.

Buffett updates his shareholders on Berkshire Hathaway’s Banking business, specifically its Illinois National Bank and Trust Company.  It described its long-term performance, which had been “first-class” since opening its doors in 1931.

The experiential lesson though is a great one:

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.  No one has demonstrated this latter ability better than Gene Abegg [the founder of Illinois National Bank and Trust Company].

If you are going to be known as one type of manager, be “the manager of the tightly run operation… find[ing] additional methods to curtail costs, even when his costs are already well below those of his competitors.”

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Day 2 : Berkshire Hathaway Letter, 1978

The second Berkshire Hataway letter, authored by Chairman Warren Buffett, is a treat to read.  Starting with a bunch of clarifications on accounting owing to a merger, he then dives in to his discussion on performance during the year.

A few key observations from the 1978 letter.

Value focus means low prices.  

Buffett has been remarkably consistent and long-term in his view on investment approach.  He says the same thing here in 1978 that he says today, which is :

We get excited enough to commit [investment] 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.

In his 1978 letter though, he specifically calls out the difficulty in finding opportunities that fit gate #4–an attractive price.

We usually can identify a small number of potential investments meeting requirements (1), (2) and (3), but (4) often prevents action.

This is a useful lesson for investors everywhere.  Whether growth or value focused–price matters.

A quick side note.  This has some interesting and at times difficult implications for venture.  For super hot companies, valuations and prices can get very hot very fast.  For example, Facebook’s Series A price was rumored to be near $100m on a post-money valuation.  This was way back 6 years ago.  At the time, it would have seemed to many to have been unreasonably high.  Now, it looks like it was an extreme bargain.

 

Minority/non-controlling common stock purhcases versus outright acquisition

Buffett again talked about bucking the fashion of M&A activities in favor of buying non-controlling blocks of common stock on the open market.  His rationale here is simple:

[Our] program of acquisition of small fractions of businesses (common stocks) at bargain prices, for which little enthusiasm exists, contrasts sharply with general corporate acquisition activity, for which much enthusiasm exists.  It seems quite clear to us that either corporations are making very significant mistakes in purchasing entire businesses at prices prevailing in negotiated transactions and takeover bids, or that we eventually are going to make considerable sums of money buying small portions of such businesses at the greatly discounted valuations prevailing in the stock market.

He tweaks pension fund managers who are move their money in and out of stocks with prevailing sentiment, as opposed to pushing to drive to find something to buy cheap and sell dera.

Work with great teams

Buffett closes his letter with an explanation of a recent acquisition of therAssociated Retail Stores, a Chicago-based women’s clothing store.

His description of the founders of the business, still involved at later ages is terrific:

 Ben is now 75 and, like Gene Abegg, 81, at Illinois National and Louie Vincenti, 73, at Wesco, continues daily to bring an almost passionately proprietary attitude to the business.  This group of top managers must appear to an outsider to be an overreaction on our part to an OEO bulletin on age discrimination.  While unorthodox, these relationships have been exceptionally rewarding, both financially and personally.  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.  We are associated with some of the very best.

An inspiring statement to be able to make as an investor about the leaders of a company you’re involved in.

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Day 1 : Berkshire Hathaway Annual Letter 1977

This post starts off the Berkshire Hathaway Project, a series where I’ll read all the annual shareholder letters that Berkshire Hathaway Chairman Warren Buffett has written.

The first letter that I found on the web site  is from 1977.  Disco was big. The Steelers were awesome.  And the economy was moribund.   As I read the letter, a few elements jumped out, useful for anyone in business–tech or otherwise.

Have an approach.  Buffett talks about in the letter the decision the Berkshire Hathaway has taken towards buying up less than controlling shares of companies it believes in.

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.

Our experience has been that pro-rata portions of truly outstanding businesses sometimes sell in the securities markets at very large discounts from the prices they would command in negotiated transactions involving entire companies. 

Consequently, bargains in business ownership, which simply are not available directly through corporate acquisition, can be obtained indirectly through stock ownership.  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….

This is an unorthodox view, but one we believe to be sound.

Clearly, Berkshire Hathaway had an approach.  And if you read Buffett’s statements over time, the 4 key elements they look for when investing have remained unchanged over the many, many years he’s been investing.

What is interesting in this snippet is the clear willingness to focus on buying non-controlling shares of companies and common stock, if he were convinced that the propsect was a good one.  He basically justifies this view on two fronts.  First, he can buy in more cheaply–makes sense. And, he clearly signals that when he buys in and doesn’t control, he’s making a direct bet on management.

It’s an approach.  Clearly one that’s worked.  The lesson: an approach, have one.

Market dynamics matter. 

I’ve written before about the importance of big market opportunities in being critically important for a startup.  That a great team in a crumby market will get trumped by the crumbiness of the market.  Interestingly, Buffett makes this exact same case in this letter, from 1977.

In his note, he compares and contrasts the performance of two portfolio businesses within Berkshire Hathaway: its textile business and its insurance business.  Both textiles and insurance had great management teams, according to Buffett.  But the market dymaics were totally different, leading to different results.

It is comforting to be in [the insurance] business where some mistakes can be made and yet a quite satisfactory overall performance can be achieved.  In a sense, this is the opposite case from our textile business where even very good management probably can average only modest results.

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.

Again, sage advice that I agree with–aiming for a  big market opportunity makes a tremendous difference.

Recognizing the role of shareholders.

Buffett’s tone in the letter is one that strikes me as doing a great job dileneating the different stakeholders’ roles in the venture.  He discusses the accomplishments and diligence of the different management teams building the different businesses.  He also uses a lot of ‘you’s and ‘your’s’ to reinforce that the shareholders are indeed the owners of the business. See quote above as example.

Deft touch.

 

 

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The Berkshire Hathaway Project

I remember back in 2006, well before the financial crisis of 2008, reading one of Warren Buffett‘s Shareholder‘s Letters that he authors every year to the shareholders of Berkshire Hathaway.

His foresight in his 2005 letter was prescient, and foretold with chilling clarity the financial crisis of 2008 and the huge impact that derivatives trading had in that market collapse.  In the 2005 letter, he talked about Berkshire Hathway’s long-term attempts to get out of their own derivatives business, which they’d inherited as a part of their acquisition of General Reinsurance.  He talks first about how he’d taken years to try and get out of Gen Re‘s derivative positions, and how they’d wind that down too slowly and in too costly a way.  But he then also makes the following statement as a reflection on this for the broader market:

Our experience should be particularly sobering because we were a better-than-average candidate
to exit gracefully. Gen Re was a relatively minor operator in the derivatives field. It has had the good
fortune to unwind its supposedly liquid positions in a benign market, all the while free of financial or other
pressures that might have forced it to conduct the liquidation in a less-than-efficient manner. Our
accounting in the past was conventional and actually thought to be conservative. Additionally, we know of
no bad behavior by anyone involved.

It could be a different story for others in the future. Imagine, if you will, one or more firms (troubles often spread) with positions that are many multiples of ours attempting to liquidate in chaotic markets and under extreme, and well-publicized, pressures. This is a scenario to which much attention
should be given now rather than after the fact.   The time to have considered – and improved – the reliability of New Orleans’ levees was before Katrina.

(emphasis added.)

He basically called the CDO crash of 2008 exactly, didn’t he?!

As I thought about how insightful and prescient that report was, I wondered if there might be more useful treasure in the whole series of Shareholder Letters.  So starting tonight, I’m going to start reading one Berkshire Hathaway letter per year and write a quick set of observations from the perch of today.

Not sure it’ll be useful, though I expect it’ll be interesting reading indeed.

 

 

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