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.