Berkshire Hathaway Annual Letters

Key Takeaways

Under Consideration — to be added.

Interconnections

Under Consideration — to be added.

Highlights

• In addition to the cyclical nature of our business, there are other reasons why a strong financial condition is advisable.
  • Guiding principle of having stable cash foundation has been there from the beginning
• During the year, we curtailed our production about 15 per cent in an attempt to avoid building inventories. We maintained satisfactory inventory levels but our curtailment resulted in the loss of certain categories of skilled help which will be required if we are to fully utilize our plant capacity. Therefore, abnormally high training costs will be incurred before we again run full.
  • Slowing down production to save in inventory costs has its own inherent costs
• We operated at close to normal levels, with some equipment idle only because of our inability to quickly obtain and train sufficient people.
  • Just having capacity in your assets isn’t enough
• We expect that there will be years in the future when the order of relative profitability is reversed, reflecting different stages in both the insurance and textile cycles. However, we believe it is an added factor of strength to have these two unrelated sources of earnings rather than to be solely exposed to the conditions of one industry, as heretofore.
  • Diversify your industry exposure
• Our “home-state” operations-Cornhusker Casualty Company, formed in early 1970 as a 100% owned subsidiary of National Indemnity, writing standard business through Nebraska agents only-is off to a strong start. The combination of big-company capability and small-company accessibility is providing to be a strong marketing tool with first class agents.
  • [[Valued Empyrean]] empowers this with something like Value Resources driving capability and its affiliates delivering accessibility
• We inaugurated our “home-state” insurance operation in 1970 by the formation of Cornhusker Casualty Company. To date, this has worked well from both a marketing and an underwritiìng standpoint. We have therefore further developed this approach by the formation of Lakeland Fire & Casualty Company in Minnesota during 1971, and Texas United Insurance in 1972. Each of these companies will devote its entire efforts to a single state seeking to bring the agents and insureds of its area a combination of large company capability and small company accessibility and sensitivity.
  • Hyper local divisions. “Think global, act local.”
• Thus, we will continue to map our financial future for maximum financial strength in our subsidiaries as well as at the parent company level.
• Our three major acquisitions of recent years have all worked out exceptionally well-from both the financial and human standpoints. In all three cases, the founders were major sellers and received significant proceeds in cash-and, in all three cases, the same individuals, Jack Ringwalt, Gene Abegg and Vic Raab, have continued to run the businesses with undiminished energy and imagination which have resulted in further improvement of the fine records previously established. We will continue to search for logical extensions of our present operations, and also for new operations which will allow us to continue to employ our capital effectively.
  • Investing in people as much as businesses #[[Human Capital]]
• Textile demand remained unusually strong throughout 1973. Our main problems revolved around shortages of fiber, which complicated operations and resulted in something less than full utilization of loom capacity. Prices of some fibers skyrocketed during the year.
  • It’s not enough to foresee market improvements; you have to do things to position yourself to take advantage, like commodity price derivatives
• We again experienced a decline in volume. Competition was intense, and we passed up the chance to match rate-cutting by more optimistic underwriters. There currently are faint indications that some of these competitors are learning of the inadequacy of their rates (and also of their loss reserves) which may result in easing of market velops. If so, we may again experience volume increases.
  • They chose sound business operations as opposed to caving to market pressures
• In that state we virtually had to start over during 1973 as the initial management we selected proved incapable of underwriting successfully.
  • The key to managing management is knowing when to make a change
• A contributing factor in our unsatisfactory earnings at Home and Auto during 1973 was an accounting system which was not bringing information to management on a sufficiently timely basis. This situation now is being corrected.
  • The importance of efficient systems #[[Systems Thinking]]
• In spite of the large unrealized loss at year-end, we would expect satisfactory results from the portfolio over the longer term.
  • #[[Long Term Thinking]]
• At this time it appears that insurers must experience even more devastating underwriting results before they take appropriate pricing action.
  • Disagree and commit; recognize the mistake the market is making and don’t just follow along
• He has cancelled a great many contracts where prices are totally inadequate, and is making no attempt to increase volume except in areas where premiums are commensurate with risk.
• We can’t blame external insurance industry conditions for this mistake. In retrospect, it is apparent that our management simply did not have the underwriting information and the pricing knowledge necessary to be operating in the area.
  • Don’t blame a scapegoat even when it would be easy, face reality. Connect to quote about the person you could never give bad news to
• Many of our competitors are in a substantially weakened financial position, and our strong capital picture leaves us prepared to grow significantly when condition become right.
  • Be lean in times of struggle and prepare to reap when the harvest comes
• With poor underwriting and with generally weakened capital ratios throughout the insurance industry, such a higher level of liquidity is appropriate and comforting. It eliminates the possible temptation to write business at any price, simply to maintain cash flow, which is a major problem faced by many companies.
  • Diversify to enable level-headedness
• The market value of our bond portfolio will continue to move in both directions in response to changes in the general level of yields but we do not consider such movements, and the unrealized gains and losses that they produce, to be of great importance as long as adequate liquidity is maintained.
  • #[[Long Term Thinking]]
• Therefore, we continue to look for ways to increase further our scale of operations while avoiding major capital investment in new fixed assets which we consider unwise, considering the relatively low returns historically earned on large scale investment in new textile equipment.
  • How can we invest in the business without massive capital outlays?
• Our equity investments are heavily concentrated in a few companies which are selected based on favorable economic characteristics, competent and honest management, and a purchase price attractive when measured against the yardstick of value to a private owner.
  • How to price
• When such criteria are maintained, our intention is to hold for a long time; indeed, our largest equity investment is 467,150 shares of Washington Post “B” stock with a cost of $10.6 million, which we expect to hold permanently.
  • How to hold
• We consider such market fluctuation of minor mportance as our liquidity and general financial strength make it highly improbable that bonds will have to be sold at times other than those of our choice.
• Although relatively small, with sales of a little over $2 million, it consistently has generated favorable earnings. Positioned as we now are with respect to income taxes the addition of a solid source of taxable income is particularly welcome.
• While 1975 was a major disappointment, efforts will continue to develop growing and diversified sources of earnings. Our objective is a conservatively financed and highly liquid business possessing extra margins of balance sheet strength consistent with the fiduciary obligations inherent in the banking and insurance industries-which will produce a long term rate of return on equity capital exceeding that of American industry as a whole.
• Overall, we expect a good year in insurance in 1977. Volume is high and present rate levels should allow profitable underwriting. Longer term, however, there are significant negatives in the insurance picture. Auto lines, in particular, seem highly vulnerable to pricing and regulatory problems produced by political and social factors beyond the control of individual companies.
  • Never celebrate for too long. Fearful when others are greedy #[[Manage Expectations]]
• 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.
  • #[[Investing 101 2.0]]
• Cost control is an important factor in the bank’s success. Employment is still at about the level existing at the time of purchase in 1969 despite growth in consumer time deposits from $30 million to $90 million and considerable expansion in other activities such as trust, travel and data processing.
  • Be dogmatic about cutting costs
• Capital gains or losses realized directly by Berkshire Hathaway Inc. or its insurance subsidiaries are not included in our calculation of operating earnings. While too much attention should not be paid to the figure for any single year, over the longer term the record regarding aggregate capital gains or losses obviously is of significance.
• Most companies define “record” earnings as a new high in earnings per share. Since businesses year to year to their equity base, we find nothing particularly noteworthy in customarily add from management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding.
• We have mistakenly predicted better results in each of the last two years. This may say something about our forecasting abilities, the nature of the textile industry, or both.
  • Recognize your weaknesses #Forecasting
• A few shareholders have questioned the wisdom of remaining in the textile business which, over the longer term, is unlikely to produce returns on capital comparable to those available in many Businesses. Our reasons are several: (1) Our mills in both New Bedford and Manchester are among the largest employers in each town.
  • “You have to be careful when you start talking about cost synergies because those are usually people.” [[Mitt Romney]]
• It is comforting to be in a 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.
  • A mediocre idea can sometimes succeed in a favorable market, but even good ideas will likely die in an unfavorable market
• Insurance companies offer standardized policies which can be copied by anyone. Their only products are promises. It is not difficult to be licensed, and rates are an open book. There are no important advantages from trademarks, patents, location, corporate longevity, raw material sources, etc., and very little consumer differentiation to produce insulation from competition. It is commonplace, in corporate annual reports, to stress the difference that people make. Sometimes this is true and sometimes it isn’t. But there is no question that the nature of the insurance business magnifies the effect which individual managers have on company performance. We are very fortunate to have the group of managers that are associated with us.
  • The less you can count on competitive moats the more important management is
• 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.
  • #[[Long Term Thinking]]
• 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 satisty 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.
  • Confidence and conviction
• While control would give us the opportunity-and the responsibility-to manage operations and resources, we would not be able to provide management in either of those respects equal to that now in place. In effect, we can obtain a better management result through non-control than control. This is an unorthodox view, but one we believe to be sound.
  • Sometimes better not to control the company
• Such a grouping of Balance Sheet and Earnings items-some wholly owned, some partly owned-tends to obscure economic reality more than illuminate it. In fact, it represents a form of presentation that we never prepare for internal use during the year and which is of no value to us in any management activities.
  • Understanding the difference between necessary accounting and operational accounting
• The textile industry illustrates in textbook style how producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage.
  • #[[Post Mortem]]
• It is not easy to buy a good insurance business, but our experience has been that it is easier to buy one than create one.
  • Build vs. Buy
• 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.
  • #Conviction
• SAFECO is a much better insurance operation than our own (although we believe certain segments of ours are much better than average), is better than one we could develop and far better than any in which we might negotiate purchase of a controlling interest. Yet our purchace of SAFECO was made at substantially under book value. We paid less than 100 cents on the dollar for the best company in the business, when far more than 100 cents on the dollar is being paid for mediocre companies in corporate transactions. And there is no way to start a new operation-with necessarily uncertain prospects-at less than 100 cents on the dollar.
  • Mix of minority equity positions and control acquisitions
• Of course, with a minor interest we do not have the right to direct or even influence management policies of SAFECO. But why should we wish to do this? The record would indicate that they do a better job of managing their operations than we could do ourselves. 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. Because, quite clearly, if one controlled a company run as well as SAFECO, the proper policy also would be to sit back and let management do its job.
  • Let management do their job
• 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.
  • Know the type of managers to look for
• 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. In our view, many businesses would be better understood by their shareholder owners, as well as the general public, if managements and financial analysts modified the primary emphasis they place upon earnings per share, and upon yearly changes in that figure.
  • Earnings on equity capital employed #ROI
• 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.
  • High return categories
• 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.
  • #Turnarounds #[[Private Equity]]
• We would rather have some slack in the organization from time to time than keep everyone terribly busy writing business on which we are going to lose money.
  • #Focus
• We very much like the companies in which we have major investments, and plan no changes to try to attune ourselves to the markets of a specific year.
• The bank and its management have treated us exceptionally well and, if we have to sell, we want to be sure that they are treated equally as well. A spin-off still is a possibility if a fair price along with a proper purchaser cannot be obtained by early fall. You simply can’t buy high quality businesses at the sort of price/earnings multiple likely to prevail on our bank sale.
  • Selling a business
• 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. But when you do receive a communication from us, it will come from the fellow you are paying to run the business. Your Chairman has a firm belief that owners are entitled to hear directly from the CEO as to what is going on and how he evaluates the business, currently and prospectively. You would demand that in a private company; you should expect no less in a public company, A once-a-year report of stewardship should not be turned over to a staff specialist or public relations consultant who is unlikely to be in a position to talk frankly on a manager-to-owner basis.
  • #[[Annual Letters]]
• We don’t expect a public relations document when our operating managers tell us what is going on, and we don’t feel you should receive such a document. 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.
  • You get the shareholders that you deserve #[[Annual Letters]]
• 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.
  • #[[Annual Letters]]
• So we hope to continue to have a very low turnover among our owners, reflecting a constituency that understands our operation, approves of our policies, and shares our expectations. And we hope to deliver on those expectations.
• Because everyone has a great deal to do, a very great deal gets done.
• We have written in past reports about the disappointments that usually result from purchase and operation of “turnaround” businesses. Literally hundreds of turnaround possibilities in dozens of industries have been described to us over the years and, either as participants or as observers, we have tracked performance against expectations. Our conclusion is that, with few exceptions, 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.
  • #Turnarounds
• The forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.
  • #Forecasting
• 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.
• However attractive the earnings numbers, we remain leery of businesses that never seem able to convert such pretty numbers into no-strings-attached cash.
  • Cash is king
• But we try to avoid small commitments-“If something’s not worth doing at all it’s not worth doing well”.
  • Connect to Spencer Calvert comment
• In the long run, managements stressing accounting appearance over economic substance usually achieve little of either.
• But we will not normally pay a lot in any purchase for what we are supposed to bring to the party-for we find that we ordinarily don’t bring a lot.
  • Focus on confidence in the business rather than your ability to “fix it.” #Turnarounds
• During 1981 we came quite close to a major purchase involving both a business and a manager we liked very much. However, the price finally demanded, considering alternative uses for the funds involved, would have left our owners worse off than before the purchase. The empire would have been larger, but the citizenry would have been poorer.
  • Big picture thinking
• Currently, 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.
• For example, last year your Chairman volunteered his expert opinion on the the aluminum business. Several minor adjustments to that opinion-now aggregating approximately 180 degrees-have since been required.
  • Willingness to change your mind #[[Spirit of Humility]]
• Lack of control, in effect, often has turned out to be an economic plus.
  • More control = more risk
• Like virginity, a stable price level seems capable of maintenance, but not of restoration.
• While investors and managers must place their feet in the future, their memories and nervous systems often remain plugged into the past.
  • The pace of change requires an ability to adjust your thinking
• Beware of “dividends” that can be paid out only if someone promises to replace the capital distributed.
  • #Dividends
• There is no danger, however, in forecasting that 1982 will be the worst year in recent history for insurance underwriting. That result already has been guaranteed by present pricing behavior, coupled with the term nature of the insurance contract.
  • Insurance pricing gives a glimpse into the future
• If you make a mistake in pricing, you have to live with it for an uncomfortable period of time.
  • #Valuation
• Whatever the reasons, we believe it is true that virtually no major property-casualty insurerdespite protests by the entire industry that rates are inadequate and great selectivity should be exercised-has been willing to turn down business to the point where cash flow has turned significantly negative. Absent such a willingness, prices will remain under severe pressure.
  • When no one will be reasonable then everyone will suffer
• One of the largest brokerage houses claiming to hold stock for sixty of its clients (about 4% of our shareholder population), apparently transmitted our letter about three weeks after receipt-too late for any of the sixty to participate. (Such lassitude did not pervade all departments of that firm; it billed Berkshire for mailing services within six days of that belated and ineffectual action.)
  • Sassy; talking about their charitable contribution plan
• You should be suspicious of such an assertion. Yardsticks seldom are discarded while yielding favorable readings. But when results deteriorate, most managers favor disposition of the yardstick rather than disposition of the manager. To managers faced with such deterioration, a more flexible measurement system often suggests itself: just shoot the arrow of business performance into a blank canvas and then carefully draw the bullseye around the implanted arrow.
  • Measuring performance
• This is not a criticism of accounting procedures. We would not like to have the job of designing a better system. It’s simply to say that managers and investors alike must understand that accounting numbers are the beginning, not the end, of business valuation.
  • #Accounting
• However, this very unevenness and irregularity offers advantages to the value-oriented purchaser of fractional portions of businesses. This investor may select from almost the entire array of major American corporations, including many far superior to virtually any of the businesses that could be bought in their entirety in a negotiated deal. And fractional-interest purchases can be made in an auction market where prices are set by participants with behavior patterns that sometimes resemble those of an army of manic-depressive lemmings. #[[Public Equity]]
• 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.”
  • Staying quiet in a room
• In insurance, as elsewhere the reaction of weak management to weak operations is often weak accounting. (“It’s difficult for an empty sack to stand upright.”)
• In many industries, differentiation simply can’t be made meaningful. A few producers in such industries 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. #Competition
• What finally determines levels of long-term profitability in such industries is the ratio of supply-tight to supply-ample years. Frequently that ratio is dismal. (It seems as if the most recent supply-tight period in our textile business-it occurred some years back-lasted the better part of a morning.)
  • The thinnest of margins
• The company-state negotiated prices included specific profit allowances and, when loss data indicated that current prices were unprofitable, both company managements and state regulators expected that they would act together to correct the situation. Thus, most of the pricing actions of the giants of the industry were “gentlemanly”, predictable, and profit-producing. Of prime importance-and in contrast to the way most of the business world operated-insurance companies could legally price their way to profitability even in the face of substantial over-capacity.
  • Price fixing leads to inefficient markets
• Most business and investment analysis also comes from the rear-view mirror. It seems clear to us, however, that only one condition will allow the insurance industry to achieve significantly improved underwriting results. That is the same condition that will allow better results for the aluminum, copper or corn producer-a major narrowing of the gap between demand and supply. Unfortunately, there can be no surge in demand for insurance policies comparable to one the might produce a market tightness in copper or aluminum. Rather, the supply of available insurance cou erage must be curtailed. “Supply”, in this context, is mental rather than physical: plants or companies need not be shut; only the willingness of underwriters to sign their names need be curtailed.
  • Stop paying crazy prices! #[[Prisoner’s Dilemma]]
• When supply ultimately contracts, large amounts of business will be available for the few with large capítal capacity, a willingness to commit it, and an in-place distríbution system. We would expect great opportunities for our insurance subsidiaries at such a time.
  • We hope people will wise up. But if they don’t we’ll be waiting in the wings with cash.
• But when the buyer makes a partial sale of itself-and that is what the issuance of shares to make an acquisition amounts to-it can customarily get no higher value set on its shares than the market chooses to grant it.
• For gold valued as gold cannot be purchased intelligently through the utilization of gold -or even silver-valued as lead. If, however, the thirst for size and action is strong enough, the acquirer’s manager will find ample rationalizations for such a value-destroying issuance of stock. Friendly investment bankers will reassure him as to the soundness of his actions. (Don’t ask the barber whether you need a haircut.)
• Managers who want to expand their domain at the expense of owners might better consider a career in government.
• But if it hurts the old owners to utilize shares on a 100% basis, it very likely hurts on a 51% basis. After all, a man is not charmed if a spaniel defaces his lawn, just because it’s a spaniel and not a St. Bernard.
• Scoring touchdowns is more exhilarating than recovering one’s fumbles. But, when a fumble has occurred, recovery is important and we heartily recommend damage-repair repurchases that turn a bad stock deal into a fair cash deal.
• (While deals often fail in practice, they never fail in projections-if the CEO is visibly panting over a prospective acquisition, subordinates and consultants will supply the requisite projections to rationalize any price.) Should the calculation produce numbers that are immediately positive-that is, anti-dilutive-for the acquirer, no comment is thought to be necessary.
• Managers and directors might sharpen their thinking by asking themselves if they would sell 100% of their business on the same basis they are being asked to sell part of it. And if it isn’t smart to sell all on such a basis, they should ask themselves why it is smart to sell a portion. A cumulation of small managerial stupidities will produce a major stupidity-not a major triumph. (Las Vegas has been built upon the wealth transfers that occur when people engage in seemingly-small disadvantageous capital transactions.)
• We will not equate activity with progress or corporate size with owner-wealth.
• We will not engage in unfriendly transactions. We can promise complete confidentiality and a very fast answer as to possible interest- customarily within five minutes.
• A compact organization lets all of us spend our time managing the business rather than managing each other. Charlie Munger, my partner in management, will continue to operate from Los Angeles whether or not the Blue Chip merger occurs. Charlie and I are interchangeable in business decisions. Distance impedes us not at all: we’ve always found a telephone call to be more productive than a half-day committee meeting. #Management #[[People Ops]] #Partnership
• Both Ben and Phil ran their businesses for Berkshire with every bit of the care and driíve that the would have exhibited had they personally owned 100% of these businesses. No rules were necessary to enforce or even encourage this attitude; it was embedded in the character of these men long before came on the scene. Their good character became our good fortune. If we can continue to attract manag ers with the qualities of Ben and Phil, you need not worry about Berkshire’s future.
  • #Management
• 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 considering our fiduciary obligations to policyholders, depositors, lenders and the many equity holders who have committed unusually large portions of their net worth to our care. #Debt
• 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.
  • Return on accumulated capital; only keep it if we can invest it profitably
• You should be fully aware of one attitude Charlie and I share that hurts our financial performance: regardless of price, we have no interest at all in selling any good businesses that Berkshire owns, and are very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations. We hope not to repeat the capital-allocation mistakes that led us into such sub-par businesses. And we react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures. (The projections will be dazzling-the advocates will be sincere-but, in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand.) Nevertheless, 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. #[[Buy and Never Sell]]
• We also believe candor benefits us as managers: the CEO who misleads others in public may eventually mislead himself in private.
• Last year, in discussing how managers with bright, but adrenalin-soaked minds scramble after foolish acquisitions, I quoted Pascal: “It has struck me that all the misfortunes of men spring from the single cause that they are unable to stay quietly in one room.” Even Pascal would have left the room for Mrs. Blumkin.
  • Find the people you love to work with
• 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. I’d rather wrestle grizzlies than compete with Mrs. B and her progeny. They buy brilliantly, they operate at expense ratios competitors don’t even dream about, and they then pass on to their customers much of the savings. It’s the ideal business-one built upon exceptional value to the customer that in turn translates into exceptional economics for its owners. #Competition
• During 1983 our book value increased from $737.43 per share to $975.83 per share, or by 32%. 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. (Watch out for our explanation if that occurs as Goethe observed, “When ideas fail, words come in very handy.”) #Forecasting
• 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. #Forecasting
• 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.
  • Intrinsic vs. book value
• 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.
• To date our experience has been better than we originally anticipated, In aggregate, we have received far more than a dollar of market value gain for every dollar of earnings retained.
  • An example of a good steward of capital is the ability to turn retained earnings into increased value efficiently
• These retained earnings could well have no immediate effect on market prices of the securities. Over time, however, we feel they will have real meaning.
• We believe a paper’s penetration ratio to be the best measure of the strength of its franchise. Papers with unusually high penetration in the geographical area that is of prime interest to major local retailers, and with relatively little circulation elsewhere, are exceptionally efficient buys for those retailers. Low-penetration papers have a far less compelling message to present to advertisers.
  • This is true of most businesses, but especially ad-based ones.
• 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.
  • Which communities thrive economically but have low population turnover? #[[City Building]]
• Properly written and edited, a full serving of news makes our paper more valuable to the reader and contributes to our unusual penetration ratio.
  • You can afford to monetize less if you build a better product
• We also think our financial strength should recommend us to companies wishing to transfer loss reserves. In such transactions, other insurance companies pay us lump sums to assume all (or a specified portion of) future loss payments applicable to large blocks of expired business. Here also, the company transferring such claims needs to be certain of the transferee’s financial strength for many years to come. Again, most of our competitors soliciting such business appear to us to have a financial condition that is materially inferior to ours.
  • You miss the chance to participate in a frothy market, wait until it goes to crap, and then with your preserved financial strength you can pick up the secondary positions you want to buy that other people overpaid for.
• 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.
• 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?
• 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.
• Any unleveraged business that requires some net tangible assets to operate (and almost all do) is hurt by inflation. Businesses needing little in the way of tangible assets simply are hurt the least.
• Operations that appear to be winners based upon perspective (1) may pale when viewed from perspective (2). A good business is not always a good purchase-although it’s a good place to look for one.
• Accomplishing this will require a few big ideas-small ones just won’t do. Charlie Munger, my partner in general management, and I do not have any such ideas at present, but our experience has been that they pop up occasionally. (How’s that for a strategic plan?)
  • This is why Tracy Britt Cool left Berkshire. Bigger funds move up market exposing a long tail of businesses that they’ll no longer compete for
• The key word is “demonstrated”. A manager who consistently turns his back on repurchases, when these clearly are in the interests of owners, reveals more than he knows of his motivations. No matter how often or how eloquently he mouths some public relations-inspired phrase such as “maximizing shareholder wealth” (this season’s favorite), the market correctly discounts assets lodged with him. His heart is not listening to his mouth-and, after a while, neither will the market.
• We try to avoid compromise of these standards, although we find doing nothing the most difficult task of all. (One English statesman attributed his country’s greatness in the nineteenth century to a policy of “masterly inactivity”. This is a strategy that is far easier for historians to commend than for participants to follow.)
  • Connect to Pascal quote in 1983 letter
• Mrs. B, Chairman of the Board, is now 91, and recently was quoted in the local newspaper as saying, “I come home to eat and sleep, and that’s about it. I can’t wait until it gets daylight so I can get back to the business”. Mrs. B is at the store seven days a week, from opening to close, and probably makes more decisions in a day than most CEOS do in a year (better ones, too).
• NFM’s low mark-ups are possible because of its exceptional efficiency: operating expenses (payroll, occupancy, advertising, etc.) are about 16.5% of sales versus 35.6% at Levitz.
  • Every line item on the P&L can be seen as an efficiency monitor
• I have been asked by a number of people just what secrets the Blumkins bring to their business. These are not very esoteric. All members of the family: (1) apply themselves with an enthusiasm and enthat would make Ben Franklin and Horatio Alger look like dropouts; (2) define with extraordinary ergy realism their area of special competence and act decisively on all matters within it; (3) ignore even the most enticing propositions failing outside of that area of special competence; and, (4) unfailingly behave in a high-grade manner with everyone they deal with. (Mrs. B boils it down to “sell cheap and tell the truth”.)
• “Wasted” circulation-as the advertisers call it -hurts profitability: expenses of a newspaper are determined largely by gross circulation while advertising revenues (usually 70%–80% of total revenues) are responsive only to useful circulation. Our penetration of the Buffalo retail market is exceptional; advertisers can reach almost all of their potential customers using only the News.
  • Core competency is penetration; connect to story in Made to Stick about using as many names as possible (might have been Good to Great)
• The economics of a dominant newspaper are excellent, among the very best in the business world. Owners, naturally, would like to believe that their wonderful profitability is achieved only because they unfailingly turn out a wonderful product. That comfortable theory wilts before an uncomfortable fact. While first-class newspapers make excellent profits, the profits of third-rate papers are as good or better-as long as either class of paper is dominant within its community. Of course, product quality may have been crucial to the paper in achieving dominance. We believe this was the case at the News, in very large part because of people such as Alfred Kirchhofer who preceded us. Once dominant, the newspaper itself, not the marketplace, determines just how good or how bad the will be. Good or bad, it will prosper. That is not true of most businesses: inferior quality generраper ally produces inferior economics. But even a poor newspaper is a bargain to most citizens simply because of its “bulletin board” value. Other things being equal, a poor product will not achieve quite the level of readership achieved by a first-class product. A poor product, however, will still remain essential to most citizens, and what commands their attention will command the attention of advertisers.
  • Building a good product vs. building a niche monopoly
• I like for you to be able to count on what I say.
• Most managers have very little incentive to make the intelligent-but-with-some-chance-oflooking-like-an-idiot decision. Their personal gain/loss ratio is all too obvious: 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.) Our equation is different. With 47% of Berkshire’s stock, Charlie and I don’t worry about being fired, and we receive our rewards as owners, not managers. Thus we behave with Berkshire’s money as we would with our own. That frequently leads us to unconventional behavior both in investments and general business management. #Incentives
• Billy Rose described the problem of over-diversification: “If you have a harem of forty women, you never get to know any of them very well.” #Diversification
• Restricted earnings need not concern us further in this dividend discussion. Let’s turn to the muchmore-valued unrestricted variety. These earnings may, with equal feasibility, be retained or distributed. In our opinion, management should choose whichever course makes greater sense for the owners of the business. This principle is not universally accepted. For a number of reasons managers like to withhold unrestricted, readily distributable earnings from shareholders-to expand the corporate empire over which the managers rule, to operate from a position of exceptional financial comfort, etc. But we believe there is only one valid reason for retention. 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.
  • Ratios for measuring different types of #Efficiency
• Managers of high-return businesses who consistently employ much of the cash thrown off by those businesses in other ventures with low returns should be held to account for those allocation decisions, regardless of how profitable the overall enterprise is.
  • #[[Innovator’s Dilemma]] - if you try to make forward thinking disruptive investments and fail, you won’t be trusted with future capital to keep experimenting
• Berkshire’s meetings are a different story. The number of shareholders attending grows a bit each year and we have yet to experience a silly question or an ego-inspired commentary. Instead, we get a wide variety of thoughtful questions about the business. Because the annual meeting is the time and place for these, Charlie and I are happy to answer them all, no matter how long it takes. (We cannot, however, respond to written or phoned questions at other times of the year; one-person-at-a time reporting is a poor use of management time in a company with 3000 shareholders.) The only business matters that are off limits at the annual meeting are those about which candor might cost our company real money. Our activities in securities would be the main example.
• It’s true that our insurance companies currently hold major positions in companies with exceptional underlying economics and outstanding managements, just as they did in 1974. But current market prices generously appraise these attributes, whereas they were ignored in 1974. Today’s valuations mean that our insurance companies have no chance for future portfolio gains on the scale of those achieved in the past.
  • “Priced in”
• You might think that institutions, with their large staffs of highly-paid and experienced investment professionals, would be a force for stability and reason in financial markets. They are not: stocks heavily owned and constantly monitored by institutions have often been among the most inappropriately valued.
• Ben Graham told a story 40 years ago that illustrates why investment professionals behave as they do: An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. “You’re qualified for residence”, said St. Peter, “but, as you can see, the compound reserved for oil men is packed. There’s no way to squeeze you in.” After thinking a moment, the prospector asked if he might say just four words to the present occupants. That seemed harmless to St. Peter, so the prospector cupped his hands and yelled, “Oil discovered in hell.” Immediately the gate to the compound opened and all of the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in and make himself comfortable. The prospector paused. “No,” he said, “I think I’ll go along with the rest of the boys. There might be some truth to that rumor after all.”
• We thus benefited from four factors: a bargain purchase price, a business with fine underlying economics, an able management concentrating on the interests of shareholders, and a buyer willing to pay full business value. While that last factor is the only one that produces reported earnings, we consider identification of the first three to be the key to building value for Berkshire shareholders. In selecting common stocks, we devote our attention to attractive purchases, not to the possibility of attractive sales.
  • If you focus on the first three the fourth will likely follow
• Security profits in a given year bear similarities to a college graduation ceremony in which the knowledge gained over four years is recognized on a day when nothing further is learned.
• Our Vice Chairman, Charlie Munger, has always emphasized the study of mistakes rather than successes, both in business and other aspects of life. He does so in the spirit of the man who said: “All I want to know is where I’m going to die so I’ll never go there.” You’ll immediately see why we make a good team: Charlie likes to study errors and I have generated ample material for him, particularly in our textile and insurance businesses. #[[Post Mortem]]
• We felt, however, that the business would be run much better by a long-time employee whom. we immediately selected to be president, Ken Chace. In this respect we were 100% correct: Ken and his recent successor, Garry Morrison, have been excellent managers, every bit the equal of managers at our more profitable businesses.
  • Entrepreneurship through employment
• I won’t close down businesses of sub-normal profitability merely to add a fraction of a point to our corporate rate of return. However, I also feel it inappropriate for even an exceptionally profitable company to fund an operation once it appears to have unending losses in prospect. Adam Smith would disagree with my first proposition, and Karl Marx would disagree with my second; the middle ground is the only position that leaves me comfortable.
• But the promised benefits from these textile investments were illusory. Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industrywide. Viewed individually, each company’s capital investment decision appeared cost-effective and rational; viewed collectively, the decisions neutralized each other and were irrational (just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes). After each round of investment, all the players had more money in the game and returns remained anemic.
  • “Proprietary” competitive advantages are what you need
• The situation is suggestive of Samuel Johnson’s horse: “A horse that can count to ten is a remarkable horse-not a remarkable mathematician.” Likewise, a textile company that allocates capital brilliantly within its industry is a remarkable textile company-but not a remarkable business.
  • A company could be the most impressive SMB SaaS company around; that doesn’t mean it’s the absolute best company around.
• While an increase in earnings from $8 million to $72 million sounds terrific-and usually is-you should not automatically assume that to be the case. You must first make sure that earnings were not severely depressed in the base year. If they were instead substantial in relation to capital employed, an even more important point must be examined: how much additional capital was required to produce the additional earnings?
  • True believer in capital efficiency
• The average American business has required about $5 of additional capital to generate an additional $1 of annual pre-tax earnings. #Efficiency
• When returns on capital are ordinary, an earn-more-by-putting-up-more record is no great managerial achievement. You can get the same result personally while operating from your rocking chair. just quadruple the capital you commit to a savings account and you will quadruple your earnings. You would hardly expect hosannas for that particular accomplishment. Yet, retirement announcements regularly sing the praises of CEOS who have, say, quadrupled earnings of their widget company during their reignwith no one examining whether this gain was attributable simply to many years of retained earnings and the workings of compound interest.
• In fact, the business project in which you would wish to have an option frequently is a project in which you would reject ownership. (I’ll be happy to accept a lottery ticket as a gift-but I’ll never buy one.)
• First, stock options are inevitably tied to the overall performance of a corporation. Logically, therefore, they should be awarded only to those managers with overall responsibility. Managers with itlited areas of responsibility should have incentives that pay off in relation to results under their control. The .350 hitter expects, and also deserves, a big payoff for his performance-even if he plays for a cellardwelling team. And the .150 hitter should get no reward-even if he plays for a pennant winner. Only those with overall responsibility for the team should have their rewards tied to its results. #Incentives
• We believe good unit performance should be rewarded whether Berkshire stock rises, falls, or stays even. Similarly, we think average performance should earn no special rewards even if our stock should soar. “Performance”, furthermore, is defined in different ways depending upon the underlying economics of the business: in some our managers enjoy tailwinds not of their own making, in others they fight unavoidable headwinds. #Incentives
• Obviously, all Berkshire managers can use their bonus money (or other funds, including borrowed money) to buy our stock in the market. Many have done just that-and some now have large holdings. By accepting both the risks and the carrying costs that go with outright purchases, these managers truly walk in the shoes of owners.
  • Make owners
• Patrick Henry approach: “I have but one lamp by which my feet are guided, and that is the lamp of experience.”
  • This works when the data is consistent
• Out with Patrick Henry and in with Pogo: “The future ain’t what it used to be.”
  • And then there is what happens when you’re in unprecedented territory
• The burgeoning uncertainties of the business, coupled with the entry into reinsurance of many unsophisticated participants, worked in recent years in favor of issuing companies writing a small net line: they were able to keep a far greater percentage of the premiums than the risk. By doing so, the issuing companies sometimes made money on business that was distinctly unprofitable for the issuing and reinsuring companies combined.
  • Always dangerous when the risk becomes decoupled from the reward (e.g. 2008 financial crisis) #[[Risk Management]]
• In any business, insurance or otherwise, “except for” should be excised from the lexicon. If you are going to play the game, you must count the runs scored against you in all nine innings. Any manager who consistently says “except for” and then reports on the lessons he has learned from his mistakes may be missing the only important lesson-namely, that the real mistake is not the act, but the actor.
  • E.g. Community-adjusted EBITDA
• We are equally indebted to Jack for an achievement that eludes most outstanding leaders: he found managers to succeed him who have talents as valuable as his own. By his skill in identifying, attracting and developing Bill and Lou, Jack extended the benefits of his managerial stewardship well beyond his tenure. #[[Don’t die with your music in you]]
• We hope to develop more of this business, and industry conditions suggest that we could: a significant number of companies are generating more business than they themselves can pro dently handle. Our financial strength makes us an attractive partner for such companies.
  • People don’t stop having ideas so it’s a good opportunity to have the financial strength to act on those ideas
• Most institutional investors in the early 1970s, on the other hand, regarded business value as of only minor relevance when they were deciding the prices at which they would buy or sell. This now seems hard to believe. However, these institutions were then under the spell of academics at prestigious business schools who were preaching a newly-fashioned theory: the stock market was totally efficiel, therefore calculations of business value-and even thought, itself-were of no importance in investment activities. (We are enormously indebted to those academics: what could be more advantageous n tellectual contest-whether it be bridge, chess, or stock selection than to have opponents who have been taught that thinking is a waste of energy?)
  • Efficienct Market
• Tou will notice that we had a significant holding in Beatrice Companies at yearend. This is a shortterm arbitrage holding-in effect, a parking place for money (though not a totally safe one, since deals sometimes fall through and create substantial losses). We sometimes enter the arbitrage field when we have more money than ideas, but only to participate in announced mergers and sales. We would be a lot happier if the funds currently employed on this short-term basis found a long-term home. At the moment, however, prospects are bleak.
  • We prefer good long term ideas #[[Long Term Thinking]]
• The Scott Fetzer purchase illustrates our somewhat haphazard approach to acquisitions. We have no master strategy, no corporate planners delivering us insights about socioeconomic trends, and no staff to investigate a multitude of ideas presented by promoters and intermediaries. Instead, we simply hope that something sensible comes along-and, when it does, we act. #[[Simplify and Intensify]]
• Charlie Munger, our Vice Chairman, and I really have only two jobs. One is to attract and keep outstanding managers to run our various operations. This hasn’t been all that difficult. Usually the managers came with the companies we bought, having demonstrated their talents throughout careers that spanned a wide variety of business circumstances. They were managerial stars long before they knew us, and our main contribution has been to not get in their way. This approach seems elementary: if my job were to manage a golf team—and if Jack Nicklaus or Arnold Palmer were willing to play for me-neither would get a lot of directives from me about how to swing. Some of our key managers are independently wealthy (we hope they all become so), but that poses no threat to their continued interest: they work because they love what they do and relish the thrill of outstanding performance. They unfailingly think like owners (the highest compliment we can pay a manager) and find all aspects of their business absorbing. #Talent
• Charlie and I know that the right players will make almost any team manager look good. We subscribe to the philosophy of Ogilvy & Mather’s founding genius, David Ogilvy: “If each of us hires people who are smaller than we are, we shall become a company of dwarfs. But, if each of us hires people who are bigger than we are, we shall become a company of giants.” #Management #Leadership #Hiring
• We intend to continue our practice of working only with people whom we like and admire. This policy not only maximizes our chances for good results, it also ensures us an extraordinarily good time. On the other hand, working with people who cause your stomach to churn seems much like marrying for money-probably a bad idea under any circumstances, but absolute madness if you are already rich.
  • Connect to Charlie’s advice about “only work with people you respect.”
• See’s has a one-of-a-kind product “personality” produced by a combination of its candy’s delicious taste and moderate price, the company’s total control of the distribution process, and the exceptional service provided by store employees. Chuck rightfully measures his success by the satisfaction of our customers, and his attitude permeates the organization. Few major retailing companies have been able to sustain such a customer-oriented spirit, and we owe Chuck a great deal for keeping it alive and well at See’s.
  • Vertical integration allows you to control the entire customer experience (e.g. the Apple Store)
• World Book continues to dominate the U.S. direct-sales encyclopedia market-and for good reasons. Extraordinarily well-edited and priced at under 5 cents per page, these bookS are a gain for youngster and adult alike. You may find one editing technique interesting: World Book ranks over 44,000 words by difficulty. Longer entries in the encyclopedia include only the most easily comprehended words in the opening sections, with the difficulty of the material gradually escalating as the exposition proceeds. As a result, youngsters can easily and profitably read to the point at which subject matter gets too difficult, instead of immediately having to deal with a discussion that mixes up words requiring college-level comprehension with others of fourth-grade level.
  • (1) Customer obsession. (2) Good lesson on any [[Curriculum]] developed for general audiences #Education
• About 98% of the stock at the end of each year is owned by people who were owners at the start of the year.
  • Funds or collections of shareholders, if assembled correctly, could much more effectively be leveraged as a collaborative body #[[Fifth Partners]]
• If our success were to depend upon insights we developed through plant inspections, Berkshire would be in big trouble. Rather, in considering an acquisition, we attempt to evaluate the economic characteristics of the business-its competitive strengths and weaknesses-and the quality of the people we will be joining. #[[Due Diligence]]
• [[Pricing]] behavior in the insurance industry continues to be exactly what can be expected in a commodity-type business. Only under shortage conditions are high profits achieved, and such conditions don’t last long. When the profit sun begins to shine, long-established insurers shower investors with new shares in order to build capital. In addition, newly-formed insurers rush to sell shares at the advantageous prices available in the new-issue market (prices advantageous, that is, to the insiders promoting the company but rarely to the new shareholders). These moves guarantee future trouble: capacity soars, competidve juices flow, and prices fade.
• Interestingly, we were the slowest-growing large insurer in the years immediately preceding 1985. In fact, we shrank-and we will do so again from time to time in the future. Our large swings in volume do not mean that we come and go from the insurance marketplace. Indeed, we are its most steadfast participant, always standing ready, at prices we believe adequate, to write a wide variety of high-limit coverages. The swings in our volume arise instead from the here-today, gone-tomorrow behavior of other insurers. When most insurers are “gone,” because their capital is inadequate or they have been frightened by losses, insureds rush to us and find us ready to do business. But when hordes of insurers are “here,” and are slashing prices far below expectable costs, many customers naturally leave us in order to take advantage of the bargains temporarily being offered by our competition. Our firmness on prices works no hardship on the consumer: he is being bombarded by attractively priced insurance offers at those times when we are doing little business. And it works no hardship on our employees: we don’t engage in layoffs when we experience a cyclical slowdown at one of our generallyprofitable insurance operations. This no-layoff practice is in our self-interest. Employees who fear that large layoffs will accompany sizable reductions in premium volume will understandably produce scads of business through thick and thin (mostly thin).
  • Perform to consistent expectations, be a steady employer, maintain good business, good employees, and financial strength.
• The difference between GEICO’s costs and those of its competitors is a kind of moat that protects a valuable and much-sought-after business castle. No one understands this moat-around-the-castle concept better than Bill Snyder, Chairman of GEICO. He continually widens the moat by driving down costs still more, thereby defending and strengthening the economic franchise. Between 1985 and 1986, GEICO’s total expense ratio dropped from 24.1% to the 23.5% mentioned earlier and, under Bill’s leadership, the ratio is almost certain to drop further. If it does-and if GEICO maintains its service and underwriting standards-the company’s future will be brilliant indeed.
  • If you have better margins or better retention than most then you have a natural economic [[Competitive Moat]]
• These are not only terrific figures but, fully as important, they have been achieved in the right way. Lou has consistently invested in undervalued common stocks that, individually, were unlikely to present him with a permanent loss and that, collectively, were close to risk-free.
  • #[[Investment Returns]] - There is an ocean of unsung investment professionals in the [[LP]] world who generate best-in-class returns. Figure out how to better understand those returns. “Everyone can’t be a top quartile fund.”
• Current ly liking neither stocks nor bonds, I find myself the polar opposite of Mae WVest as she declared: “I like only two kinds of men-foreign and domestic.”
• What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable. And the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful. #[[Fearful when others are greedy; greedy when others are fearful]]
• This attitude may seem old-fashioned in a corporate world in which activity has become the order of the day. The modern manager refers to his “portfolio” of businesses-meaning that all of them are candidates for “restructuring” whenever such a move is dictated by Wall Street preferences, operating conditions or a new corporate “concept.” (Restructuring is defined narrowly, however: it extends only to dumping offending businesses, not to dumping the officers and directors who bought the businesses in the first place. “Hate the sin but love the sinner” is a theology as popular with the Fortune 500 as it is with the Salvation Army.)
  • #[[Family of Companies]] #[[Let me know if this is helpful]]
• Despite the enthusiasm for activity that has swept business and financial America, we will stick with our ‘til-death-do-us-part policy. It’s the only one with which Charlie and I are comfortable, it produces decent results, and it lets our managers and those of our investees run their businesses free of distractions.
• Many of our businesses, both those we own in whole and in part, possess such franchises. Consequently, reductions in their taxes largely end up in our pockets rather than the pockets of our customers. While this may be impolitic to state, it is impossible to deny. If you are tempted to believe otherwise, think for a moment of the most able brain surgeon or lawyer in your area, Do you really expect the fees of this expert (the local “franchise-holder” in his or her specialty) to be reduced now that the top personal tax rate is being cut from 50% to 28%?
  • #Taxes #[[Radical Candor]]
• It should be emphasized that the two columns depict identical economics-i.e., the same sales, wages, taxes, etc. And both “companies” generate the same amount of cash for owners. Only the accounting is different. So, fellow philosophers, which column presents truth? Upon which set of numbers should managers and investors focus? #[[Accounting]]
• What does all this mean for owners? Did the shareholders of Berkshire buy a business that earned $40.2 million in 1986 or did they buy one earning $28.6 million? Were those $11.6 million of new charges a real economic cost to us? Should investors pay more for the stock of Company O than of Company N? And, if a business is worth some given multiple of earnings, was Scott Fetzer worth considerably more the day before we bought it than it was worth the following day? If we think through these questions, we can gain some insights about what may be called “owner earnings.” These represent (a) reported earnings plus (b) depreciation, depletion, amortization, and certain other non-cash charges such as Company N’s items (1) and (4) less (c) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume. (If the business requires additional working capital to maintain its competitive position and unit volume, the increment also should be included in (c). However, businesses following the LIFO inventory method usually do not require additional working capital if unit volume does not change.) Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since( c) must be a guess-and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes-both for investors in buying stocks and for managers in buying entire businesses. We agree with Keynes’s observation: “I would rather be vaguely right than precisely wrong.” #[[Owner Earnings]]
• “Cash Flow”, true, may serve as a shorthand of some utility in descriptions of certain real estate businesses or other enterprises that make huge initial outlays and only tiny outlays thereafter. A company whose only holding is a bridge or an extremely long-lived gas field would be an example. But “cash flow” is meaningless in such businesses as manufacturing, retailing, extractive companies, and utilities because, for them, ( c) is always significant. To be sure, businesses of this kind may in a given year be able to defer capital spending. But over a five- or ten-year period, they must make the investment-or the business decays. Why, then, are “cash flow” numbers so popular today? In answer, we confess our cynicism: we believe these numbers are frequently used by marketers of businesses and securities in attempts to justify the unjustifiable (and thereby to sell what should be the unsalable). When (a)-that is, GAAP earningslooks by itself inadequate to service debt of a junk bond or justify a foolish stock price, how convenient it becomes for salesmen to focus on (a) + (b). But you shouldn’t add (b) without subtracting (c) : though dentists correctly claim that if you ignore your teeth they’ll go away, the same is not true for (c) . The company or investor believing that the debt-servicing ability or the equity valuation of an enterprise can be quuoaky qpe measured by totaling (a) and (b) while ignoring (c) is headed for certain trouble.
  • #[[Cash Flow]]; What capital investments will the business require in the future?
• Questioning GAAP figures may seem impious to some. After all, what are we paying the accountants for if it is not to deliver us the “truth” about our business. But the accountants’ job is to record, not to evaluate. The evaluation job falls to investors and managers. Accounting numbers, of course, are the language of business and as such are of enormous help anyone evaluating the worth of a business and tracking its progress. Charlie and I would be lost without these numbers: they invariably are the starting point for us in evaluating our own businesses and those of others. Managers and owners need to remember, however, that accounting is but an aid to business thinking, never a substitute for it.
• You have a right to question that second assertion. After all, CEOS seldom tell their shareholders that they have assembled a bunch of turkeys to run things. Their reluctance to do so makes for some strange annual reports. Oftentimes, in his shareholders’ letter, a CEO will go on for pages detailing corporate performance that is woefully inadequate. He will nonetheless end with a warm paragraph describing his managerial comrades as “our most precious asset.” Such comments sometimes make you wonder what the other assets can possibly be. #Management
• With managers like ours, my partner, Charlie Munger, and I have little to do with operations. in fact, it is probably fair to say that if we did more, less would be accomplished. We have no corporate meetings, no corporate budgets, and no performance reviews (though our managers, of course, oftentimes find such procedures useful at their operating units). After all, what can we tell the Blumkins about home furnishings, or the Heldmans about uniforms?
  • True owner mentality among managers
• There’s not a lot new to report about these businesses-and that’s good, not bad. 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 price-earnings 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. For such investor-dreamers, any blind date is preferable to one with the girl next door, no matter how desirable she may be.
  • Consistency and reliability
• 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. That is no argument for managerial complacency. Businesses always have opportunities to improve service, product lines, manufacturing techniques, and the like, and obviously these opportunities should be seized. But 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.
  • The more uncertainty the more you have to forecast and plan without any reliable data #Forecasting
• It’s vital, of course, for a newspaper to cover national and international news well and in depth. But it is also vital for it to do what only a local newspaper can: promptly and extensively chronicle the personally-important, otherwise-unreported details of community life. Doing this job well requires a very broad range of news-and that means lots of space, intelligently used. #Journalism
• Charlie and I do not believe in flexible operating budgets, as in “Non-direct expenses can be X if revenues are Y, but must be reduced if revenues are Y-5%.“ Should we really cut our news hole at the Buffalo News, or the quality of product and service at See’s, simply because profits are down during a given year or quarter? Or, conversely, should we add a staff economist, a corporate strategist, an institutional advertising campaign or something else that does Berkshire no good simply because the money currently is rolling in?
• Candy stores are fun to visit, but most have not been fun for their owners. From what we can learn, practically no one besides See’s has made significant profits in recent years from the operation of candy shops. Clearly, Chuck’s record at See’s is not due to a rising industry tide. Rather, it is a one-of-a-kind performance.
  • Pop n’ Sweets? Maybe a one-off culture case? Soda is a Mormon vice #[[Fifth Partners]] #[[Sodalicious]]
• The insurance industry is cursed with a set of dismal economic characteristics that make for a poor long-term outlook: hundreds of competitors, ease of entry, and a product that cannot be differentiated in any meaningful way. In such a commodity-like business, only a very low-cost operator or someone operating in a protected, and usually small, niche can sustain high profitability levels. When shortages exist, however, even commodity businesses flourish. The insurance industry enjoyed that kind of climate for a while but it is now gone. One of the ironies of capitalism is that most managers in commodity industries abhor shortage conditions-even though those are the only circumstances permitting them good returns. Whenever shortages appear, the typical manager simply can’t wait to expand capacity and thereby plug the hole through which money is showering upon him. This is cisely what insurance managers did in 1985-87, confirming again Disraeli’s observation: “What we learn from history is that we do not learn from history.”
• Our second method of differentiating ourselves is the total indifference to volume that we maintain. In 1989, we will be perfectly willing to write five times as much business as we write in 1988–or only one-fifth as much. We hope, of course, that conditions will allow us large volume. But we cannot control market prices. If they are unsatisfactory, we will simply do very little business. No other major insurer acts with equal restraint.
• Whenever Charlie and I buy common stocks for Berkshire’s insurance companies (leaving aside arbitrage purchases, discussed later) we approach the transaction as if we were buying into a private business. We look at the economic prospects of the business, the people in charge of running it, and the price we must pay. We do not have in mind any time or price for sale. Indeed, we are willing to hold a stock indefinitely so long as we expect the business to increase in intrinsic value at a satisfactory rate. When investing, we view ourselves as business analysts-not as market analysts, not as macroeconomic analysts, and not even as security analysts. #[[Investing 101 2.0]]
• Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for vou.
• Indeed, if you aren’t certain that understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.’ #Valuation
• Our attitude, however, fits our personalities and the way we want to live our lives. Churchill once said, “You shape your houses and then they shape you.” We know the manner in which we wish to be shaped. For that reason, we would rather achieve a return of X while associating with people whom we strongly like and admire than realize 110% of X by exchanging these relationships for uninteresting or unpleasant ones.
  • Connect to Munger quote about working with people you respect
• Our goal is to find an outstanding business at a sensible price, not a mediocre business at a bargain price.
• It must be noted that your Chairman, always a quick study, required only 20 years to recognize how important it was to buy good businesses. In the interim, I searched for “bargains”-and had the misfortune to find some. My punishment was an education in the economics of short-line farm implement manufacturers, third-place department stores, and New England textile manufacturers. Of course, Charlie and I may misread the fundamental economics of a business. When that happens, we will encounter problems whether that business is a wholly-owned subsidiary or a marketable security, although it is usually far easier to exit from the latter. (Indeed, businesses can be misread: Witness the European reporter who, after being sent to this country to profile Andrew Carnegie, cabled his editor, “My God, you’ll never believe the sort of money there is in running libraries.”)
• We have “professional” investors, those who manage many billions, to thank for most of this turmoil. Instead of focusing on what businesses will do in the years ahead, many prestigious money managers now focus on what they expect other money managers to do in the days ahead. For them, stocks are merely tokens in a game, like the thimble and flatiron in Monopoly.
• Volatility caused by money managers who speculate irrationally with huge sums will offer the true investor more chances to make intelligent investment moves. He can be hurt by such volatility only if he is forced, by either financial or psychological pressures, to sell at untoward times.
• Good business or investment decisions will eventually produce quite satisfactory economic results, with no aid from leverage. Therefore, it seems to us to be both foolish and improper to risk what is important (including, necessarily, the welfare of innocent bystanders such as policyholders and employees) for some extra returns that are relatively unimportant. This view is not the product of either our advancing age or prosperity: Our opinions about debt have remained constant. #Debt
• Therefore, we simply borrow when conditions seem non-oppressive and hope that we will later find intelligent expansion or acquisition opportunities, which-as we have said-are most likely to pop up when conditions in the debt market are clearly oppressive. Our basic principle is that if you want to shoot rare, fast-moving elephants, you should always carry a loaded gun.
• First, I’ll offer my customary disclaimer: Despite the shortcomings of generally accepted accounting principles (GAAP), I would hate to have the job of devising a better set of rules. The limitations of the existing set, however, need not be inhibiting: CEOS are free to treat GAAP statements as a beginning rather than an end to their obligation to inform owners and creditors-and indeed they should. After all, any manager of a subsidiary company would find himself in hot water if he reported barebones GAAP numbers that omitted key information needed by his boss, the parent corporation’s CEO. Why, then, should the CEO himself withhold information vitally useful to his bosses—the shareholder-owners of the corporation? What needs to be reported is data-whether GAAP, non-GAAP, or extra-GAAP-that helps financially-literate readers answer three key questions: (1) Approximately how much is this company worth? (2) What is the likelihood that it can meet its future obligations? and (3) How good a job are its managers doing, given the hand they have been dealt?
  • Reporting and accountability and data. Regardless of the system or standard
• As long as investorsincluding supposedly sophisticated institutions-place fancy valuations on reported “earnings” that march steadily upward, you can be sure that some managers and promoters will exploit GAAP to produce such numbers, no matter what the truth may be. Over the years, Charlie and I have observed many accounting-based frauds of staggering size. Few of the perpetrators have been punished many have not even been censured. It has been far safer to steal large sums with a pen than small sums with a gun. #Fraud
• To those of you who are uninterested in accounting, I apologize for this dissertation. I realize that of many you do not pore over our figures, but instead hold Berkshire primarily because you know that (1) Charlie and I have the bulk of our money in Berkshire; (2) we intend to run things so that your gains or losses are in direct proportion to ours; and (3) the record has so far been satisfactory. There is nothing necessarily wrong with this kind of “faith” approach to investing. Other shareholders, however, prefer an “analysis” approach and we want to supply the information they need. In our own investing, we search for situations in which both approaches give us the same answer.
  • Gut + [[Data in Investing]]
• At Berkshire, associations like these last a long time. We do not remove superstars from our lineup merely because they have attained a specified age-whether the traditional 65, or the 95 reached by Mrs. B on the eve of Hanukkah in 1988. Superb managers are too scarce a resource to be discarded simply because a cake gets crowded with candles. Moreover, 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 difficult to teach a new dog old tricks.
  • Value of experience
• It truly does pay to advertise, as long as you have something worthwhile to offer. #[[Marketing]]
• You won’t be surprised to learn that this family brings to the jewelry business precisely the same approach that the Blumkins bring to the furniture business. The cornerstone for both enterprises is Mrs. B’s creed: “Sell cheap and tell the truth.” Other fundamentals at both businesses are: (1) single store operations featuring huge inventories that provide customers with an enormous selection across all price ranges, (2) daily attention to detail by top management, (3) rapid turnover, (4) shrewd buying, and (5) incredibly low expenses. The combination of the last three factors lets both stores offer everyday prices that no one in the country comes close to matching.
  • Look for case studies of ultra low-cost businesses e.g. [[Costco]]
• Their performance, which we have observed at close range, contrasts vividly with that of CEOS, which we have fortunately observed from a safe distance. Sometimes these CEOs clearly do not belong in their jobs; their positions, nevertheless, are usually secure. 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 accepted as 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. At too many companies, the boss shoots the arrow of managerial performance and then hastily paints the bullseye around the spot where it lands.
  • Performance expectations for [[Management]]
• Finally, relations between the Board and the CEO are expected to be congenial. At board meetings, criticism of the CEO’s performance is often viewed as the social equivalent of belching. No such inhibitions restrain the office manager from critically evaluating the substandard typist. #[[Board Meetings]]
• 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 of deals and the market movements of the related stocks. This is not how Charlie nor I wish to spend our lives. (What’s the sense in getting rich just to stare at a progress ticker tape all day?) #Focus
• The preceding discussion about arbitrage makes a small discussion of “efficient market theory” (EMT) also seem relevant. This doctrine became highly fashionable-indeed, almost holy scripture in academic circles during the 1970s. Essentially, it said that analyzing stocks was useless because all public information about them was appropriately reflected in their prices. In other words, the market always knew everything. As a corollary, the professors who taught EMT said that someone throwing darts at the stock tables could select a stock portfolio having prospects just as good as one selected by the brightest, most hard-working security analyst. Amazingly, EMT was embraced not only by academics, but by many investment professionals and corporate managers as well. Observing correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day. #[[Efficient Market Theory]]
• Over the 63 years, the general market delivered just under a 10% annual return, including dividends. That means $1,000 would have grown to $405,000 if all income had been reinvested. A 20% rate of return, however, would have produced $97 million. That strikes us as a statistically-significant differential that might, conceivably, arouse one’s curiosity. Yet proponents of the theory have never seemed interested in discordant evidence of this type. True, they don’t talk quite as much about their theory today as they used to. But no one, to my knowledge, has ever said he was wrong, no matter how many thousands of students he has sent forth misinstructed. EMT, moreover, continues to be an integral part of the investment curriculum at major business schools. Apparently, a reluctance to recant, and thereby to demystify the priesthood, is not limited to theologians. #[[Efficient Market Theory]]
• 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 a strategy than selecting a portfolio by throwing darts. #[[Investing 101 2.0 Wiki]]
• Second, we wish for very little trading activity. If we ran a private business with a few passive partners, we would be disappointed if those partners, and their replacements, frequently wanted to leave the partnership. Running a public company, we feel the same way. Our goal is to attract long-term owners who, at the time of purchase, have no timetable or price target for sale but plan instead to stay with us indefinitely. We don’t understand the CEO who wants lots of stock activity, for that can be achieved only if many of his owners are constantly exiting. At what other organization-school, club, church, etc.-do leaders cheer when members leave? (However, if there were a broker whose livelihood depended upon the membership turnover in such organizations, you could be sure that there would be at least one proponent of activity, as in: “There hasn’t been much going on in Christianity for a while; maybe we should switch to Buddhism next week.”) #[[Long Term Thinking]]
  • Investors who hesitate to invest because of a lack of trading activity are like the man who wanted to get married in the state with the most favorable divorce laws
• In Berkshire’s investments, Charlie and I have employed the principles taught by Dave and Ben Graham. Our prosperity is the fruit of their intellectual tree.
  • Give credit where credit is due #[[My Mentors]]
• We face another obstacle: In a finite world, high growth rates must self-destruct. If the base from which the growth is taking place is tiny, this law may not operate for a time. But when the base balloons, the party ends: A high growth rate eventually forges its own anchor. #[[Growth]]
• Imagine that Berkshire had only $1, which we put in a security that doubled by yearend and was then sold. Imagine further that we used the after-tax proceeds to repeat this process in each of the next 19 years, scoring a double each time. At the end of the 20 years, the 34% capital gains tax that we would have paid on the profits from each sale would have delivered about $13,000 to the government and we would be left with about $25,250. Not bad. If, however, we made a single fantastic investment that itself doubled 20 times during the 20 years, our dollar would grow to $1,048,576. Were we then to cash out, would pay a 34% tax of roughly $356,500 and be left with about $692,000. The sole reason for this staggering difference in results would be the timing of tax payments. Interestingly, the government would gain from Scenario 2 in exactly the same 27:1 ratio as we-taking in taxes of $356,500 vs. $13,000–though, admittedly, it would have to wait for its money. We have not, we should stress, adopted our strategy favoring long-term investment commitments because of these mathematics. Indeed, it is possible we could earn greater after-tax returns by moving rather frequently from one investment to another. Many years ago, that’s exactly what Charlie and I did. Now we would rather stay put, even if that means slightly lower returns. Our reason is simple: We have found splendid business relationships to be so rare and so enjoyable that we want to retain all we develop. This decision is particularly easy for us because we feel that these relationships will producegood-though perhaps not optimal-financial results. Considering that, we think it makes little sense for us to give up time with people we know to be interesting and admirable for time with others we do not know and who are likely to have human qualities far closer to average. That would be akin to marrying for money-a mistake under most circumstances, insanity if one is already rich. #Taxes #[[Long Term Thinking]]
• The question you must decide is whether these undistributed earnings are as valuable to us as those we report. We believe they are-and even think they may be more valuable. The reason for this a-bird-in-the-bush-may-be-worth-two-in-the-hand conclusion is that earnings retained by these investees will be deployed by talented, owner-oriented managers who sometimes have better uses for these funds in their own businesses than we would have in ours. I would not make such a generous assessment of most managements, but it is appropriate in these cases.
  • The decision to retain earnings is the same as evaluating a new investment. Where could the capital most profitably be put to work? #[[Capital Allocation]]
• Most of these managers have no need to work for a living; they show up at the ballpark because they like to hit home runs. And that’s exactly what they do.
  • Connect to Mungers advice on career
• NFM and Borsheim’s follow precisely the same formula for success: (1) unparalleled depth and breadth of merchandise at one location; (2) the lowest operating costs in the business; (3) the shrewdest of buying, made possible in part by the huge volumes purchased; (4) gross margins, and therefore prices, far below competitors’; and (5) friendly personalized service with family members on hand at all times. #Retail #Costco
• Though we purchased Fechheimer four years ago, Charlie and I have never visited any of its plants or the home office in Cincinnati. We’re much like the lonesome Maytag repairman: The Heldman managerial product is so good that a service call is never needed.
  • But businesses that any idiot could run Quote
• In most industries, capacity is described in physical terms. In the insurance world, however, capacity is customarily described in financial terms; that is, it’s considered appropriate for a company to write no more than X dollars of business if it has Y dollars of net worth. In practice, however, constraints of this sort have proven ineffective. Regulators, insurance brokers, and customers are all slow to discipline companies that strain their resources. They also acquiesce when companies grossly overstate their true capital. Hence, a company can write a great deal of business with very little capital if it is so inclined. At bottom, therefore, the amount of industry capacity at any particular moment primarily depends on the mental state of insurance managers.
  • Can you get into a commodity business and then specialize in the weaknesses of the market? (e.g. self-control and capital reserves?)
• All this understood, it is not very difficult to prognosticate the industry’s profits. Good profits will be realized only when there is a shortage of capacity. Shortages will occur only when insurers are frightened. That happens rarely-and most assuredly is not happening now.
  • Build your business on the ability to spot other people’s irrational behavior ONLY if you’re able to remain fairly rational yourself
• We have no interest in writing insurance that carries a mathematical expectation of loss; we experience enough disappointments doing transactions we believe to carry an expectation of profit.
• This posture is one few insurance managements will assume. Typically, they are willing to write scads of business on terms that almost guarantee them mediocre returns on equity. But they do not want to expose themselves to an embarrassing single-quarter loss, even if the managerial strategy that cause the loss promises, over time, to produce superior results. I can understand their thinking: What is best for their owners is not necessarily best for the managers. Fortunately Charlie and I have both total job security and financial interests that are identical with those of our shareholders. We are willing to look foolish as long as we don’t feel we have acted foolishly.
  • Put yourself in a position to do what is actually best, not what looks best.
• They in turn have demonstrated some confidence in us, insisting in each case that our preferreds have unrestricted voting rights on a fully-converted basis, an arrangement that is far from standard in corporate finance. In effect they are trusting us to be intelligent owners, thinking about tomorrow instead of today, just as we are trusting them to be intelligent managers, thinking about tomorrow as well as today.
• Enter some ingenious and, in this case, highly useful investment bankers (led, I’m happy to say, by Salomon Brothers). #[[Investment Banking]]
• Later, as the adrenalin of deal-makers surged, businesses began to be purchased at prices so high that all free cash flow necessarily had to be allocated to the payment of interest. That left nothing for the paydown of debt. In effect, a Scarlett O’Hara “I’ll think about it tomorrow” position in respect to principal payments was taken by borrowers and accepted by a new breed of lender, the buyer of original-issue junk bonds. Debt now became something to be refinanced rather than repaid. The change brings to mind a New Yorker cartoon in which the grateful borrower rises to shake the hand of the bank’s lending officer and gushes: “I don’t know how I’ll ever repay you.” #Debt
• Soon borrowers found even the new, lax standards intolerably binding. To induce lenders to finance even sillier transactions, they introduced an abomination, EBDIT-Earnings Before Depreciation, Interest and Taxes-as the test of a company’s ability to pay interest. Using this sawed-off yardstick, the borrower ignored depreciation as an expense on the theory that it did not require a current cash outlay.
  • Evils of [[EBITDA]]
• When they make these offerings, investment bankers display their humorous side: They dispense income and balance sheet projections extending five or more years into the future for companies they barely had heard of a few months earlier. If you are shown such schedules, I suggest that you join in the fun: Ask the investment banker for the one-year budgets that his own firm prepared as the last few years began and then compare these with what actually happened. #Forecasting
• Some time ago Ken Galbraith, in his witty and insightful The Great Crasb, coined a new economic term: “the bezzle,” defined as the current amount of undiscovered embezzlement. This financial creature has a magical quality: The embezzlers are richer by the amount of the bezzle, while the embezzlees do not yet feel poorer.
  • Compare to Poor Charlie’s Almanack, “Febezzelment”
• Wall Street welcomed this invention with the enthusiasm less-enlightened folk might reserve for the wheel or the plow. Here, finally, was an instrument that would let the Street make deals at prices no longer limited by actual earning power. The result, obviously, would be more transactions: Silly prices will always attract sellers. And, as Jesse Unruh might have put it, transactions are the mother’s milk of finance.
• But in the end, alchemy, whether it is metallurgical or financial, fails. A base business can not be transformed into a golden business by tricks of accounting or capital structure. The man claiming to be a financial alchemist may become rich. But gullible investors rather than business achievements will usually be the source of his wealth.
• No financial instrument is evil per se; it’s just that some variations have far more potential for mischief than others.
  • More about the persons intent than the tool that is used.
• Our comments about investment bankers may seem harsh. But Charlie and I-in our hopelessly old-fashioned way-believe that they should perform a gatekeeping role, guarding investors against the promoter’s propensity to indulge in excess. Promoters, after all, have throughout time exercised the same judgment and restraint in accepting money that alcoholics have exercised in accepting liquor. At a minierefore, the banker’s conduct should rise to that of a responsible bartender who, when necessary, refuses the profit from the next drink to avoid sending a drunk out on the highway. In recent years, unfortunately, many leading investment firms have found bartender morality to be an intolerably restrictive standard. Lately, those who have traveled the high road in Wall Street have not encountered heavy traffic. #[[Investment Banking]]
• 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. I call this the “cigar butt” approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit. 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- never is there just one cockroach in the kitchen. Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and prompdly take either course, you can realize a high return. But the investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful business, the enemy of the mediocre. #[[Value Investing]]
• It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. But now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class managements. That leads right into a related lesson: Good jockeys will do well on good horses, but not on broken-down nags. Both Berkshire’s textile business and Hochschild, Kohn had able and honest people running them. The same managers employed in a business with good economic characteristics would have achieved fine records. But they were never going to make any progress while running in quicksand. I’ve said many times that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. I just wish I hadn’t been so energetic in creating examples. My behavior has matched that admitted by Mae West: “I was Snow White, but I drifted.”
  • “Quality leaders need good businesses to lead.” #Management
• A further related lesson: Easy does it. After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers.
• Overall, however, we’ve done better by avoiding dragons than by slaying them.
  • You never have to invest
• My most surprising discovery: the overwhelming importance in business of an unseen force that we might call “the institutional imperative.” In business school, I was given no hint of the imperative’s existence and I did not intuitively understand it when I entered the business world. I thought then that decent, intelligent, and experienced managers would automatically make rational business decisions. But I learned over time that isn’t so. Instead, rationality frequently wilts when the institutional imperative comes into play. For example: (1) As if governed by Newton’s First Law of Motion, 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 or whatever, will be mindlessly imitated.
  • If your investment thesis only works if it requires significant change then you should discount your returns by 60% or more
• After some other mistakes, I learned to go into business only with people whom I like, trust, and admire. Conversely, we do not wish to join with mirable qualities, no matter how attractive the prospects of their business. We’ve never succeeded in making a good deal with a bad depossess managers who lack adperson.
  • Compare to Poor Charlie’s Almanack about working for people you respect
• Some of my worst mistakes were not publicly visible. These were stock and business purchases whose virtues I understood and yet didn’t make. It’s no sin to miss a great opportunity outside one’s area of competence. But I have passed on a couple of really big purchases that were served up to me on a platter and that I was fully capable of understanding. For Berkshire’s shareholders, myself included, the cost of this thumb-sucking has been huge.
  • Like me not investing in a mutual fund on March 24th or not angel investing in Lambda or Primer.
• A small chance of distress or disgrace cannot, in our view, be offset by a large chance of extra returns. If your actions are sensible, you are certain to get good results; in most such cases, leverage just moves things along faster. Charlie and I have never been in a big hurry: We enjoy the process far more than the proceeds-though we have learned to live with those also. #Debt
• Much of the extra value that exists in our businesses has been created by the managers now running them. Charlie and I feel free to brag about this group because we had nothing to do with developing the skills they possess: These superstars just came that way. Our job is merely to identify talented managers and provide an environment in which they can do their stuff. Having done it, they send their cash to headquarters and we face our only other task: the intelligent deployment of these funds.
  • Like in finding a spouse, don’t look for someone you can fix, or whose glaring flaws you think you can patch over with your own strengths. Find people who will excel with or without you. #[[Two Complete People]]
• Our perspective on such “forgotten-but-not-gone” earnings is simple: The way [[Retained Earnings]] are accounted for is of no importance, but their ownership and subsequent utilization is all-important. We care not whether the auditors hear a tree fall in the forest; we do care who owns the tree and what’s next done with it.
• Charlie and I were surprised at developments this past year in the media industry, including newspapers such as our Buffalo News. The business showed far more vulnerability to the early stages of a recession than has been the case in the past. The question is whether this erosion is just part of an aberrational cycle-to be fully made up in the next upturn-or whether the business has slipped in a way that permanently reduces intrinsic business values. Since I didn’t predict what has happened, you may question the value of my prediction about what will happen. Nevertheless, I’ll proffer a judgment: While many media businesses will remain economic marvels in comparison with American industry generally, they will prove considerably less marvelous than I, the industry, or lenders thought would be the case only a few years ago.
  • Rapid changes in an environment (e.g. recession, COVID, etc.) can expose trends that were likely already happening but that may have been accelerated. Connect to tweet https://twitter.com/andrew__reed/status/1263557813680263168?s=21
• Most important of all, the number of both print and electronic advertising channels has substantially increased. As a consequence, advertising dollars are more widely dispersed and the pricing power of ad vendors has diminished.
  • Find the chart of advertising channels where newspapers plummet
• Cutting product quality is not a proper response to adversity. #Product
• In looking at the figures for our non-insurance operations, you will see that net worth increased by only $47 million in 1990 although earnings were $133 million. This does not mean that our managers are in any way skimping on investments that strengthen their business franchises or that promote growth. Indeed, they diligently pursue both goals. But they also never deploy capital without good reason. The result: In the past five years they have funneled well over 80% of their earnings to Charlie and me for use in new business and investment opportunities. #[[Capital Allocation]]
• We want to emphasize three points: (1) While we expect our super-cat business to produce satisfactory results over, say, a decade, we’re sure it will produce absolutely terrible results in at least an occasional year; (2) Our expectations can be based on little more than subjective judgments-for this kind of insurance, historical loss data are of very limited value to us as we decide what rates to charge today; and (3) Though we expect to write significant quantities of super-cat business, we will do so only at prices we believe to be commensurate with risk. If competitors become optimistic, our volume will fall. This insurance has, in fact, tended in recent years to be woefully underpriced; most sellers have left the field on stretchers.
  • Set [[Expectations]] for the long and short term
• At the other extreme, malpractice insurance covering the potential liabilities of doctors, lawyers and accountants produces a very high amount of float compared to annual premium volume. The float materializes because claims are often brought long after the alleged wrongdoing takes place and because their payment may be still further delayed by lengthy litigation. The industry calls malpractice and certain other kinds of liability insurance “longtail” business, in recognition of the extended period during which insurers get to hold large sums that in the end will go to claimants and their lawyers (and to the insurer’s lawyers as well).
  • Create businesses with the longest [[Working Capital]] cycles
• During 1990 we held about $1.6 billion of float slated eventually to find its way into the hands of others. The underwriting loss we sustained during the year was $27 million and thus our insurance operation produced funds for us at a cost of about 1.6%. As the table shows, we managed in some years to underwrite at a profit and in those instances our cost of funds was less than zero. In other years, such as 1984, we paid a very high price for float. In 19 years out of the 24 we have been in insurance, though, we have developed funds at a cost below that paid by the government. #[[Cost of Capital]]
• Figuring a cost of funds for an insurance business allows anyone analyzing it to determine whether the operation has a positive or negative value for shareholders. If this cost (including the tax penalty) is higher than that applying to alternative sources of funds, the value is negative. If the cost is lower, the value is positive-and if the cost is significantly lower, the insurance business qualifies as a very valuable asset. #[[Cost of Capital]]
• The intrinsic value of our insurance business will always be far more difficult to calculate than the value of, say, our candy or newspaper companies. By any measure, however, the business is worth far more than its carrying value. Furthermore, despite the problems this operation periodically hands us, it is the one-among all the fine businesses we own-that has the greatest potential.
• Lethargy bordering on sloth remains the cornerstone of our investment style: This year we neither bought nor sold a share of five of our six major holdings. #[[Buy and Never Sell]] #[[Long Term Thinking]]
• With Wells Fargo, we think we have obtained the best managers in the business, Carl Reichardt and Paul Hazen. In many ways the combination of Carl and Paul reminds me of another-Tom Murphy and Dan Burke at Capital Cities/ABC. First, each pair is stronger than the sum of its parts because each partner understands, trusts and admires the other. Second, both managerial teams pay able people well, but abhor having a bigger head count than is needed. Third, both attack costs as vigorously when profits are at record levels as when they are under pressure. Finally, both stick with what they understand and let their abilities, not their egos, determine what they attempt. (Thomas J. Watson Sr. of IBM followed the same rule: “I’m no genius,” he said. “I’m smart in spots-but I stay around those spots.”) #Management #[[Circle of Competence]]
• Investors who expect to be ongoing buyers of investments throughout their lifetimes should adopt a similar attitude toward market fluctuations; instead many illogically become euphoric when stock prices rise and unhappy when they fall. They show no such confusion in their reaction to food prices: Knowing they are forever going to be buyers of food, they welcome falling prices and deplore price increases. (It’s the seller of food who doesn’t like declining prices.) Similarly, at the Buffalo News we would cheer lower prices for newsprint-even though it would mean marking down the value of the large inventory of newsprint we always keep on hand-because we know we are going to be perpetually buying the product. Identical reasoning guides our thinking about Berkshire’s investments. We will be buying businesses or small parts of businesses, called stocks-year in, year out as long as I live (and longer, if Berkshire’s directors attend the seances I have scheduled). Given these intentions, declining prices for businesses benefit us, and rising prices hurt us. The most common cause of low prices is pessimism-some times pervasive, some times 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. None of this means, however, that a business or stock is an intelligent purchase simply because it is unpopular; a contrarian approach is just as foolish as a follow-the-crowd strategy. What’s required is thinking rather than polling. Unfortunately, Bertrand Russell’s observation about life in general applies with unusual force in the financial world: “Most men would rather die than think. Many do.”
• In the final chapter of The Intelligent Investor Ben Graham forcefully rejected the dagger thesis: “Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, Margin of Safety.” Forty-two years after reading that, I still think those are the right three words. The failure of investors to heed this simple message caused them staggering losses as the 1990s began.
• All of this seems impossible now. When these misdeeds were done, however, dagger-selling investment bankers pointed to the “scholarly” research of academics, which reported that over the years the higher interest rates received from low-grade bonds had more than compensated for their higher rate of default. Thus, said the friendly salesmen, a diversified portfolio of junk bonds would produce greater net returns than would a portfolio of highgrade bonds. (Beware of past-performance “proofs” in finance: If history books were the key to riches, the Forbes 400 would consist of librarians.)
  • What WILL happen is not a pure extrapolation of what HAS happened
• In making the USAir purchase, your Chairman displayed exquisite timing: I plunged into the business at almost the exact moment that it ran into severe problems, (No one pushed me; in tennis parlance, I committed an “unforced error.”) The company’s troubles were brought on both by industry conditions and by the post-merger difficulties it encountered in integrating Piedmont, an affliction I should have expected since almost all airline mergers have been followed by operational turmoil.
  • Why do investors so rarely think about hindsight error (e.g. [[Post-Mortem]] on [[Scalefactor]])? Feels like [[Warren Buffett]] is acknowledging that he fell victim to “this time it will be different.”
• Most business owners spend the better part of their lifetimes building their businesses. By experience buiit upon endless repetition, they sharpen their skills in merchandising, purchasing, personnel selection, etc. It’s a learning process, and mistakes made in one year often contribute to competence and success in succeeding years. If the sole motive of the present owners is to cash their chips and put the business behind them-and plenty of sellers fall in this category-either type of buyer that I’ve just described is satisfactory. But if the sellers’ business represents the creative work of a lifetime and forms an integral part of their personality and sense of being, buyers of either type have serious flaws.
  • Go get the entire Appendix B from 1990 letter and connect to [[The Messy Marketplace]]
• The size of our equity capital-which now totals $7.4 billion-makes it certain that we cannot maintain our past rate of gain or, for that matter, come close to doing so. As Berkshire grows, the universe of opportunities that can significantly influence the company’s performance constantly shrinks. When we were working with capital of $20 million, an idea or business producing $1 million of profit added five percentage points to our return for the year. Now we need a $370 million idea (i.e., one contributing over $550 million of pre-tax profit) to achieve the same result. And there are many more ways to make $1 million than to make $370 million.
  • Law of large numbers? If this TAM view is true why does every buyout move upmarket with buyouts?
• At the Harvard Business School last year, a student asked me when I planned to retire and I replied, “About five to ten years after I die.”
• We also believe that investors can benefit by focusing on their own look-through earnings. To calculate these, they should determine the underlying earnings attributable to the shares they hold in their portfolio and total these. The goal of each investor should be to create a portfolio (in effect, a “company”) that will deliver him or her the highest possible look-through earnings a decade or so from now. An approach of this kind will force the investor to think about long-term business prospects rather than shorterm stock market prospects, a perspective likely to improve results. It’s true, of course, that, in the long run, the scoreboard for investment decisions is market price. But prices will be determined by future earnings. In investing, Just as in baseball, to put runs on the scoreboard one must watch the playing field, not the scoreboard.
  • True KPIs, not lagging indicators
• The fact is that newspaper, television, and magazine properties have begun to resemble businesses more fhan franchises in their economic behavior. Let’s take a quick look at the characteristics separating these two clases of enterprise, keeping in mind, however, that many operations fall in some middle ground and can best be descnibed as weak franchises or strong businesses. An economic franchise arises from a product or service that: (1) is needed or desired; (2) is dhought by in customers to have no close substitute and; (3) is not subject to price regulation. The existence of al taree conditions will be demonstrated by a company’s ability to regularly price its produuct or service aggressively and thereby to eam high rates of return on capital. Moreover, franchises can tolerate mis-management. Inept managers may diminish a franchise’s profitability, but they cannot inflict mortal damage. In contrast, “a business” earns exceptional profits only if it is the low-cost operator or if supply of ins produc or service is tight. Tightmess in supply usually does not last long. With superior management, a company may maintain its status as a low-cost operator for a much longer time, but even then unceasingly faces the possibility of competitive attack. And a business, unlike a franchise, can be killed by poor management.
  • Exonomic Franchise vs. a business
• Until recently, media properties possessed the three characteristics of a franchise and consequently could both price aggressively and be managed loosely. Now, however, consumers looking for information and entertainment (their primary interest being the latter) enjoy greatly broadened choices as to where to find them. Unfortunately, demand can’t expand in response to this new supply: 500 million American eyeballs and a 24-hour day are all that’s available. The result is that competition has intensified, markets have fragmented, and the media industry has lost some-though far from all-of its franchise strength.
  • Commoditization of [[Journalism]]
• For an increase in profits to be evaluated properly, it must be compared with the incremental capital investment required to produce it. On this score, See’s has been astounding: The company now operates comfortably with only $25 million of net worth, which means that our beginning base of $7 million has had to be supplemented by only $18 million of reinvested earnings. Meanwhile, See’s remaining pre-tax profits of $410 million were distributed to Blue Chip/Berkshire during the 20 years for these companies to deploy (after payment of taxes) in whatever way made most sense.
  • Measuring capital efficiency on a culumative basis (e.g. cumulative cash burn to get to ARR)
• After Mr. Heffernan died late in 1990, his family decided to sell the company-and here we got lucky. I had known Frank for a few years but not well enough for him to think of Berkshire as a possible buyer. He instead gave the assignment of selling Brown to a major investment banker, which failed also to think of us. But last spring Frank was playing golf in Florida with John Loomis, a long-time friend of mine as well as a Berkshire shareholder, who is always on the alert for something that might fit us. Hearing about the impending sale of Brown, John told Frank that the company should be right up Berkshire’s alley, and Frank promptly gave me a call. I thought right away that we would make a deal and before long it was done.
  • You never know what relationship will become a deal so you sort of just have to have a lot of them #Networking
• A distinguishing characteristic of H. H. Brown is one of the most unusual compensation systems I’ve encountered-but one that warms my heart: A number of key managers are paid an annual salary of $7,800, to which is added a designated percentage of the profits of the company after these are reduced by a charge for capital employed. These managers therefore truly stand in the shoes of owners. In contrast, most managers talk the talk but don’t walk the walk, choosing instead to employ compensation systems that are long on carrots but short on sticks (and that almost invariably treat equity capital as if it were cost-free). The arrangement at Brown, in any case, has served both the company and its managers exceptionally well, which should be no surprise: Managers eager to bet heavily on their abilities usually have plenty of ability to bet on.
  • Sounds like employee ownership; #Teamshares
• In the long run, of course, trouble awaits managements that paper over operating problems with accounting maneuvers. Eventually, managements of this kind achieve the same result as the seriouslyill patient who tells his doctor: “I can’t afford the operation, but would you accept a small payment to touch up the xrays?”
• We price this business expecting to pay out, over the long term, about 90% of the premiums we receive. In any given year, however, we are likely to appear either enormously profitable or enormously unprofitable. That is true in part because GAAP accounting does not allow us to set up reserves in the catastrophe-free years for losses that are certain to be experienced in other years. In effect, a one-year accounting cycle is ill-suited to the nature of this business-and that is a reality you should be aware of when you assess our annual results.
  • Know what your measuring period should be
• Thinking insurers know that when “the big one” comes, many reinsurers who found it easy to write policies will find it difficult to write checks. (Some reinsurers can say what Jackie Mason does: “I’m fixed for life-as long as I don’t buy anything.”) Berkshire’s ability to fulfill all its commitments under conditions of even extreme adversity is unquestioned.
  • It’s easy to take a customer; how easy are they to keep? Incremental cost of a customer
• If my universe of business possibilities was limited, say, to private companies in Omaha, I would, first, try to Assess the long-term economic characteristics of each business; second, assess the quality of the people in charge of running it; and, third, try to buy into a few of the best operations at a sensible price. I certainly would not wish to own an equal part of every business in town. Why, then, should Berkshire take a different tack when dealing with the larger universe of public companies? And since finding great businesses and outstanding managers is so difficult, why should we discard proven products? (I was tempted to say “the real thing.”) Our motto is: “If at first you do succeed, quit trying.” John Maynard Keynes, whose brilliance as a practicing investor matched his brilliance in thought, wrote a letter to a business associate, F. C. Scott, on August 15, 1934 that says it all: “As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence…One’s knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence.”
  • Counter argument to a diversified portfolio #Diversification #[[Family of Companies]]
• Post-mortems prove useful for hospitals and football teams; why not for businesses and investors? #[[Post-Mortem]]
• There is no tougher job in corporate America than running an airline: Despite the huge amounts of equity capital that have been injected into it, the industry, in aggregate, has posted a net loss since its birth after Kitty Hawk,
• We have a firm policy about issuing shares of Berkshire, doing so only when we receive as much value as we Faual value, however, has not been easy to obtain, since we have always valued our shares highly, So be it: We twish to increase Berkshire’s size only when doing that also increases the wealth of its owners Those two objectives do not necessarily go hand-in-hand as an amusing but value-destroying experience in QuE past illustrates. On that occasion, we had a significant investment in a bank whose management was hell-bent on expansion, (Aren’t they all?) When our bank wooed a smaller bank, its owner demanded a stock swap on a bacis abet valued the acquiree’s net worth and earning power at over twice that of the acquirer’s. Our management-visibly in heat-quickly capitulated. The owner of the acquiree then insisted on one other condition: “You must promise me” he said in effect, “that once our merger is done and I have become a major shareholder, you’ll never again make a deal this dumb.”
• Of all our activities at Berkshire, the most exhilarating for Charlie and me is the acquisition of a business with excellent economic characteristics and a management that we like, trust and admire. Such acquisitions are not easy to make but we look for them constantly. In the search, we adopt the same attitude one might find appropriate in looking for a spouse: It pays to be active, interested and open-minded, but it does not pay to be in a hurry.
  • Joy in the journey. #[[Long Term Thinking]]
• 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 long-term focus. (Even Alice, after listening to the Queen lecture her about “jam tomorrow,” finally insisted, “It must come sometimes to jam today.”)
  • Balance of [[Long Term Thinking]] and short term
• The saying, “a fool and his money are soon invited everywhere,” applies in spades in reinsurance, and we actually reject more than 98% of the business we are offered. Our ability to choose between good and bad proposals reflects a management strength that matches our financial strength: Ajit Jain, who runs our reinsurance operation, is simply the best in this business. In combination, these strengths guarantee that we will stay a major factor in the super-cat business so long as prices are appropriate.
  • Be selective until you find a good one. Then be greedy and double down.
• This means that in 21 years out of the 26 years we have been in the insurance business we have beaten the Government’s rate, and often we have done so by a wide margin. (If, on average we didn’t beat the Government’s rate, there would be no economic reason for us to be in the business.)
  • The lifeblood of Berkshire
• But how, you will ask, does one decide what’s “attractive”? In answering this question, most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth.” Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing. We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are 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. In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value-in the hope that it can soon be sold for a still-higher price-should be labeled speculation (which is neither illegal, immoral nor-in our view-financially fattening). #[[Value Investing]]
• Growth benefits investors only when the business in point can invest at incremental returns that are enticingin other words, only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor.
  • Growing efficiently
• 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. 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. Unfortunately, the first type of business is very hard to find: 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. #[[Capital Allocation]]
• 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.
• A competitively-beset business such as USAir 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.
  • Strong talent in a bad market
• Managers thinking about accounting issues should never forget one of Abraham Lincoln’s favorite riddles: “How many legs does a dog have if you call his tail a leg?” The answer: “Four, because calling a tail a leg does not make it a leg.” It behooves managers to remember that Abe’s right even if an auditor is willing to certify that the tail is a leg.
• This time around, Mrs. B graciously offered to sign a non-compete agreement-and I, having been incautious on this point when she was 89, snapped at the deal. Mrs. B belongs in the Guinness Book of World Records on many counts. Signing a non-compete at 99 merely adds one more.
• Finally, you can establish a partnership with people to whom you are making gifts, fund it with Berkshire shares, and simply give percentage interests in the partnership away each year. These interests can be for any value that you select. If the value is $10,000 or less, the gift will be tax-free.
  • Fund a “family” stock portfolio
• At Berkshire, we have no view of the future that dictates what businesses or industries we will enter. Indeed, we think it’s usually poison for a corporate giant’s shareholders if it embarks upon new ventures pursuant to some grand vision. We prefer instead to focus on the economic characteristics of businesses that we wish to own and the personal characteristics of managers with whom we wish to associate-and then to hope we get lucky in finding the two in combination. At Dexter, we did.
  • Balancing thematic vs. opportunistic investing
• Harold and Peter can be sure that they will get to run their business-an activity they dearly love-exactly as they did before the merger. At Berkshire, we do not tell .400 hitters how to swing.
• We’ve previously discussed look-through earnings, which we believe more accurately portray the earnings of Berkshire than does our GAAP result. As we calculate them, look-through earnings consist of: (1) the operating earnings reported in the previous section, plus; (2) the retained operating earnings of major investees that, under GAAP accounting, are not reflected in our profits, less; (3) an allowance for the tax that would be paid by Berkshire if these retained earnings of investees had instead been distributed to us. The “operating earnings” of wnich we speak here exclude capital gains, special accounting items and major restructuring charges.
  • Calculating the earnings of a [[Holding Company]]: laser focused on [[Capital Allocation]] and returns regardless of where in the [[Family of Companies]] they leave the capital
• That is a tough goal, but one that we expect you to hold us to. In the past, we’ve criticized the managenar practice of shooting the arrow of performance and then painting the target, centering it on whatever point the aon happened to hit. We will instead risk embarrassment by painting first and shooting later. #Accountability
• As interest rates have fallen, however, the value of float has substantially declined. Therefore, the data that we have provided in the past are no longer useful for year-to-year comparisons of industry profitability. A company writing at the same combined ratio now as in the 1980’s today has a far less attractive business than it did then.
  • What would [[Warren Buffett]] build his business on today? Still insurance float? Software margins? (e.g. [[Tiny Capital]]) https://twitter.com/sirocapital/status/1338935889054064640?s=21
• As you can see, in our insurance operation last year we had the use of $2.6 billion at no cost; in fact we were paid $31 million, our underwriting profit, to hold these funds. This sounds good -is good-but is far from as good as it sounds.
• One caution: There has recently been a substantial increase in reinsurance capacity. Close to $5 billion of equity capital has been raised by reinsurers, almost all of them newly-formed entities. Naturally these new entrants are hungry to write business so that they can justify the projections they utilized in attracting capital. This new competition won’t affect our 1994 operations; we’re filled up there, primarily with business written in 1993. But we are now seeing signs of price deterioration. If this trend continues, we will resign ourselves to much-reduced volume, keeping ourselves available, though, for the large, sophisticated buyer who requires a super-cat insurer with large capacity and a sure ability to pay losses.
  • Similar thing happening in [[Venture Capital]] driving up valuations #[[Investment Returns]]
• Considering the similarity of this year’s list and the last, you may decide your management is hopelessly comatose. But we continue to think that it is usually foolish to part with an interest in a business that is both understandable and durably wonderful. Business interests of that kind are simply too hard to replace.
  • Don’t trade for the sake of trading
• In our view, what makes sense in business also makes sense in stocks: 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. Earlier I mentioned the financial results that could have been achieved by investing $40 in The Coca-Cola Co. in 1919. In 1938, more than 50 years after the introduction of Coke, and long after the drink was firmly established as an American icon, Fortune did an excellent story on the company. In the second paragraph the writer reported: “Several times every year a weighty and serious investor looks long and with profound respect at Coca-Cola’s record, but comes regretfully to the conclusion that he is looking too late. The specters of saturation and competition rise before him.” Yes, competition there was in 1938 and in 1993 as well. But it’s worth noting that in 1938 The Coca-Cola Co. sold 207 million cases of soft drinks (if its gallonage then is converted into the 192-ounce cases used for measurement today) and in 1993 it sold about 10.7 billion cases, a 50-fold increase in physical volume from a company that in 1938 was already dominant in its very major industry. Nor was the party over in 1938 for an investor: Though the $40 invested in 1919 in one share had (with dividends reinvested) turned into $3,277 by the end of 1938, a fresh $40 then invested in Coca-Cola stock would have grown to $25,000 by yearend 1993. I can’t resist one more quote from that 1938 Fortune story: “It would be hard to name any company comparable in size to Coca-Cola and selling, as Coca-Cola does, an unchanged product that can point to a ten-year record anything like Coca-Cola’s.” In the 55 years that have since passed, Coke’s product line has broadened somewhat, but it’s remarkable how well that description still fits.
  • “You think [[Shopify]] is going to 10x from here?”
• For owners of a business-and that’s the way we think of shareholders-the academics’ definition of risk is far off the mark, so much so that it produces absurdities. For example, under beta-based theory, a stock that has dropped very sharply compared to the market-as had Washington Post when we bought it in 1973-becomes “riskier” at the lower price than it was at the higher price. Would that description have then made any sense to someone who was offered the entire company at a vastly-reduced price? #[[Risk Management]]
• In assessing risk, a beta purist will disdain examining what a company produces, what its competitors are doing, or how much borrowed money the business employs, He may even prefer not to know the company’s name, What he treasures is the price history of its stock. In contrast, we’ll happily forgo knowing the price history and instead will seek whatever information will further our understanding of the company’s business. After we buy a stock, consequently, we would not be disturbed if markets closed for a year or two. We don’t need a daily quote on our 100% position in See’s or H. H. Brown to validate our well-being, Why, then, should we need a quote on our 7% interest in Coke?
  • Every investment should be approached as if it were a [[Buy and Never Sell]] investment
• In our opinion, the real risk that an investor must assess is whether his aggregate after-tax receipts from an investment (including those he receives on sale) will, over his prospective holding period, give him at least as much purchasing power as he had to begin with, plus a modest rate of interest on that initial stake. Though this risk cannot be calculated with engineering precision, it can in some cases be judged with a degree of accuracy that is useful. The primary factors bearing upon this evaluation are: 1) The certainty with which the long-term economic characteristics of the business can be evaluated; 2) The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows; 3) The certainty with which management can be counted on to channel the rewards from the business to the shareholders rather than to itself; 4) The purchase price of the business; 5) The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor’s purchasing-power return is reduced from his gross return.
  • Develop a highly trained gut
• These factors will probably strike many analysts as unbearably fuzzy, since they cannot be extracted from a data base of any kind. But the difficulty of precisely quantifying these matters does not negate their importance nor is it insuperable. Just as Justice Stewart found it impossible to formulate a test for obscenity but nevertheless asserted, “I know it when I see it,” so also can investors-in an inexact but useful way-”see” the risks innelent in certain investments without reference to complex equations or price histories.
• As Peter Lynch says, stocks of companies selling commodity-like products should come with a warning label: “Competition may prove hazardous to human wealth.” #Competition
• For example, a business that must deal with fast-moving technology is not going to lend itself to reliable evaluations of its long-term economics. Did we foresee thirty years ago what would transpire in the television-manufacturing or computer industries? Of course not. (Nor did most of the investors and corporate managers who enthusiastically entered those industries.) Why, then, should Charlie and I now think we can predict the future of other rapidly-evolving businesses? We’ll stick instead with the easy cases. Why search for a needle buried in a haystack when one is sitting in plain sight? Of course, some investment strategies-for instance, our efforts in arbitrage over the years-require wide diversification. If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually-independent commitments. Thus, 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. Most venture capitalists employ this strategy. Should you choose to pursue this course, you Should adopt the outlook of the casino that owns a roulette wheel, which will want to see lots of action because it is favored by probabilities, but will refuse to accept a single, huge bet.
  • We instead have to track massive [[Trends]] and the companies riding them
• Paradoxically, when “dumb” money acknowledges its limitations, it ceases to be dumb. On the other hand, if you are a know-something investor, able to understand business economics and to find nve to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversi1ication makes no sense for you. It is apt simply to hurt your results and increase your risk. 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. In the words of the prophet Mae West: “Too much of a good thing can be wonderful.”
  • Where are you dumb? And where can you be smart?
• The first, and by far most common, board situation is one in which a corporation has no controlling shareholder. In that case, I believe directors should behave as if there is a single absentee owner, whose long-term interest they should try to further in all proper ways.
  • Being a board member; connect to 2002 letter
• The second case is that existing at Berkshire, where the controlling owner is also the manager. At some companies, this arrangement is facilitated by the existence of two classes of stock endowed with disproportionate voting power. In these situations, it’s obvious that the board does not act as an agent between owners and management and that the directors cannot effect change except through persuasion. Therefore, if the owner/manager is mediocre or worse-or is over-reaching-there is little a director can do about it except object. If the directors having no connections to the owner/manager make a unified argument, it may well have some effect. More likely it will not. If change does not come, and the matter is sufficiently serious, the outside directors should resign. Their resignation will signal their doubts about management, and it will emphasize that no outsider is in a position to correct the owner/manager’s shortcomings. The third governance case occurs when there is a controlling owner who is not involved in management. This case, examples of which are Hershey Foods and Dow Jones, puts the outside directors in a potentially useful position. If they become unhappy with either the competence or integrity of the manager, they can go directly to the owner (who may also be on the board) and report their dissatisfaction. This situation is ideal for an outside director, since he need make his case only to a single, presumably interested owner, who can forthwith effect change if the argument is persuasive.
• We’ve yet to find a CEO who believes he should personally fund the charities favored by his shareholders. Why, then, should they foot the bill for his picks?
• A fat wallet, however, is the enemy of superior investment results. And Berkshire now has a net worth of $11.9 billion compared to about $22 million when Charlie and I began to manage the company. Though there are as many good businesses as ever, it is useless for us to make purchases that are inconsequential in relation to Berkshire’s capital. (As Charlie regularly reminds me, “If something is not worth doing at all, it’s not worth doing well.”)| We now consider a security for purchase only if we believe we can deploy at least $100 million in it. Given that minimum, Berkshire’s investment universe has shrunk dramatically.
  • Tracy Britt-Cole and the difficulty of firms having to move up market as they grow, exposing a long tail of smaller investment opportunities
• What we promise you-along with more modest gains-is that during your ownership of Berkshire, you will fare just as Charlie and I do. If you suffer, we will suffer; if we prosper, so will you. And we will not break this bond by introducing compensation arrangements that give us a greater participation in the upside than the downside. #Incentives
• It’s far better to own a significant portion of the Hope diamond than 100% of a rhinestone, and the companies just mentioned easily qualify as rare gems. Best of all, we aren’t limited to simply a few of this breed, but instead possess a growing collection. Stock prices will continue to fluctuate-sometimes sharply-and the economy will have its ups and down. Over time, however, we believe it highly probable that the sort of businesses we own will continue to increase in value at a satisfactory rate..
  • Volatility is unavoidable. Business that have rapidly fluctuating operations are not.
• We define intrinsic value as the discounted value of the cash that can be taken out of a business during its re maining life. Anyone calculating intrinsic value necessarily comes up with a highly subjective figure that W change both as estimates of future cash flows are revised and as interest rates move. Despite its fuzziness, however, intrinsic value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
• For this exercise, we will ignore the important non-economic benefits of an education and focus strictly on its economic value. First, we must estimate the earnings that the graduate will receive over his lifetime and subtract from that figure an estimate of what he would have earned had he lacked his education. That gives us an excess earnings figure, which must then be discounted, at an appropriate interest rate, back to graduation day. The dollar result equals the intrinsic economic value of the education. Some graduates will find that the book value of their education exceeds its intrinsic value, which means that whoever paid for the education didn’t get his money’s worth. In other cases, the intrinsic value of an education will far exceed its book value, a result that proves capital was wisely deployed. In all cases, what is clear is that book value is meaningless as an indicator of intrinsic value.
  • Cost of [[Education]]
• The reasons for Ralph’s success are not complicated. Ben Graham taught me 45 years ago that in investing it is not necessary to do extraordinary things to get extraordinary results. In later life, I have been surprised to find that this statement holds true in business management as well. What a manager must do is handle the basics well and not get diverted. That’s precisely Ralph’s formula. He establishes the right goals and never forgets what he set out to do. On the personal side, Ralph is a joy to work with. He’s forthright about problems and is self-confident without being self-important. #Management
• For example, in contemplating business mergers and acquisitions, many managers tend to focus on whether the transaction is immediately dilutive or anti-dilutive to earnings per share (or, at financial institutions, to per-share book value). An emphasis of this sort carries great dangers. Going back to our college-education example, imagine that a 25-year-old first-year MBA student is considering merging his future economic interests with those of a 25vear-old day laborer. The MBA student, a non-earner, would find that a “share-for-share” merger of his equity interest in himself with that of the day laborer would enhance his near-term earnings (in a big way!). But what could be sillier for the student than a deal of this kind?
  • Dilution / accretion fails of M&A and considering future potential
• Our approach, rather, has been to follow Wayne Gretzky’s advice: “Go to where the puck is going to be, not to where it is.” As a result, our shareholders are now many billions of dollars richer than they would have been if we had used the standard catechism.
• The sad fact is that most major acquisitions display an egregious imbalance: They are a bonanza for the shareholders of the acquiree; they increase the income and status of the acquirer’s management; and they are a honey pot for the investment bankers and other professionals on both sides. But, alas, they usually reduce the wealth of the acquirer’s shareholders, often to a substantial extent. That happens because the acquirer typically gives up more intrinsic value than it receives. Do that enough, says John Medlin, the retired head of Wachovia Corp., and “you are running a chain letter in reverse.” #look-it-up
• In setting compensation, we like to hold out the promise of large carrots, but make sure their delivery is tied directly to results in the area that a manager controls. When capital invested in an operation is significant, we also both charge managers a high rate for incremental capital they employ and credit them at an equally high rate for capital they release. The product of this money’s-not-free approach is definitely visible at Scott Fetzer. If Ralph can employ incremental funds at good returns, it pays him to do so: His bonus increases when earnings on additional capital exceed a meaningful hurdle charge. But our bonus calculation is symmetrical: If incremental investment yields substandard returns, the shortfall is costly to Ralph as well as to Berkshire. The consequence of this two-way arrangement is that it pays Ralph-and pays him well-to send to Omaha any cash he can’t advantageously use in his business.
  • Imagine some high flying Silicon Valley companies (e.g. [[WeWork]]) if compensation had been tied to return on incremental cash burn vs. “growth” without a [[Cost of Capital]] context
• I can’t resist mentioning that our compensation arrangement with Ralph Schey was worked out in about five minutes, immediately upon our purchase of Scott Fetzer and without the “help” of lawyers or compensation consultants. This arangement embodies a few very simple ideas-not the kind of terms favored by consultants who cannot easily send a large bill unless they have established that you have a large problem (and one, of course, that requires an annual review). Our agreement with Ralph has never been changed. It made sense to him and to me in 1986, and it makes sense now. Our compensation arrangements with the managers of all our other units are similarly simple, though the terms of each agreement vary to fit the economic characteristics of the business at issue, the existence in some cases of partial ownership of the unit by managers, etc.
• At Berkshire, only Charlie and I have the managerial responsibility for the entire business. Therefore, we are the only parties who should logically be compensated on the basis of what the enterprise does as a whole. Even so, that is not a compensation arrangement we desire. We have carefully designed both the company and our jobs so that we do things we enjoy with people we like. Equally important, we are forced to do very few boring or unpleasant tasks. We are the beneficiaries as well of the abundant array of material and psychic perks that flow to the heads of corporations. Under such idyllic conditions, we don’t expect shareholders to ante up loads of compensation for which we have no possible need. #Compensation
• Float is money we hold but don’t own.
  • What businesses have the greatest working capital dynamics? Connect to Robert Smith talking about software contracts as 2nd lien debt
• An insurance business is profitable over time if its cost of float is less than the cost the company would othingur to obtain funds. But the business has a negative value if the cost of its float is higher than market rates for money.
  • There is always a [[Cost of Capital]], even if just “time spent”
• The reason we must repeat this caution is that our “super-cat” business (which sells policies that insurance and reinsurance companies buy to protect themselves from the effects of mega-catastrophes) was again highly profitable. Since truly major catastrophes occur infrequently, our super-cat business can be expected to show large profits in most years but occasionally to record a huge loss. In other words, the attractiveness of our super-cat business will take many years to measure. Certainly 1994 should be regarded as close to a best-case.
  • “The balance always comes due.” Preferable [[Working Capital]] dynamics will always be lumpy the more upfront they are.
• Super-cat policies are small in number, large in size and non-standardized. Therefore, the underwriting of this business requires far more judgment than, say, the underwriting of auto policies, for which a mass of data is available. Here Berkshire has a major advantage: Ajit Jain, our super-cat manager, whose underwriting skills are the finest. His value to us is simply enormous.
  • [[Data in Investing]] - doesn’t necessarily work when all your deals are rare outliers
• The second benefit of our capital strength is that we can write policies for amounts that no one else can even consider. For example, during 1994, a primary insurer wished to buy a short-term policy for $400 million of California earthquake coverage and we wrote the policy immediately. We know of no one else in the world who would take a $400 million risk, or anything close to it, for their own account.
  • [[Bifurcation of Investing]] - massive pools of capital will be a category unto itself
• All things considered, we believe our worst-case insurance loss from a super-cat is now about $600 mion after-tax, an amount that would slightly exceed Berkshire’s annual earnings from other sources. If you are not comfortable with this level of exposure, the time to sell your Berkshire stock is now, not after the inevitable mega catastrophe.
  • Set [[Expectations]]
• Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-ofdifficulty doesn’t count. If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring, the payoff is the same as if you had correctly analyzed an investment alternative characterized by many constantly shifting and complex variables.
• Before looking at new investments, we consider adding to old ones. If a business is attractive enough to buy once, it may well pay to repeat the process. We would love to increase our economic interest in See’s or Scott Fetzer, but we haven’t found a way to add to a 100% holding. In the stock market, however, an investor frequently gets the chance to increase his economic interest in businesses he knows and likes. Last year we went that direction by enlarging our holdings in Coca-Cola and American Express.
  • Why not just buy more [[Shopify]]?
• I find that a long-term familiarity with a compary and its products is often helpful in evaluating it. #[[Long Term Thinking]]
• Egregious as it is, the Cap Cities decision earns only a silver medal. Top honors go to a mistake I made five years ago that fully ripened in 1994: Our $358 million purchase of USAir preferred stock, on which the dividend was suspended in September. In the 1990 Annual Report I correctly described this deal as an “unforced error,” meaning that I was neither pushed into the investment nor misled by anyone when making it. Rather, this was a case of sloppy analysis, a lapse that may have been caused by the fact that we were buying a senior security or by ndons Whatever the reason, the mistake was large.
• Charlie Munger, Berkshire’s Vice Chairman and my partner, and I want to build a collection of companiesboth wholly- and partly-owned-that have excellent economic characteristics and that are run by outstanding managers. Our favorite acquisition is the negotiated transaction that allows us to purchase 100% of such a business at a fair price. But we are almost as happy when the stock market offers us the chance to buy a modest percentage of an outstanding business at a pro-rata price well below what it would take to buy 100%. This double-barrelled approach-purchases of entire businesses through negotiation or purchases of part-interests through the stock market-gives us an important advantage over capital-allocators who stick to a single course. Woody Allen once explained why eclecticism works: “The real advantage of being bisexual is that it doubles your chances for a date on Saturday night.”
  • Same basic end in mind; different means
• These results have not sprung from some master plan that we concocted in 1965. In a general way, we knew then what we hoped to accomplish but had no idea what specific opportunities might make it possible. Today we remain similarly unstructured: Over time, we expect to improve the figures in both columns but have no road map to tell us how that will come about.
  • You create a structure and thesis around some capital and then actively wait
• The giant disadvantage we face is size: In the early years, we needed only good ideas, but now we need good big ideas. Unfortunately, the difficulty of finding these grows in direct proportion to our financial success, a problem that increasingly erodes our strengths.
  • Tracy Britt Cole’s opportunity
• In any case, why potential buyers even look at projections prepared by sellers baffles me. Charlie and I never give them a glance, but instead keep in mind the story of the man with an ailing horse. Visiting the vet, he said: “Can you help me? Sometimes my horse walks just fine and sometimes he limps.” The vet’s reply was pointed: “No problem-when he’s walking fine, sell him.” In the world of mergers and acquisitions, that horse would be peddled as Secretariat. #Forecasting
• Even so, we do have a few advantages, perhaps the greatest being that we don’t have a strategic plan. Thus we feel no need to proceed in an ordained direction (a course leading almost invariably to silly purchase prices) but can instead simply decide what makes sense for our owners. In doing that, we always mentally compare any move we are contemplating with dozens of other opportunities open to us, including the purchase of small pieces of the best businesses in the world via the stock market. Our practice of making this comparison-acquisitions against passive investments-is a discipline that managers focused simply on expansion seldom use. Talking to Time Magazine a few years back, Peter Drucker got to the heart of things: “I will tell you a secret: Dealmaking beats working. Dealmaking is exciting and fun, and working is grubby. Running anything is primarily an enormous amount of grubby detail work … dealmaking is romantic, sexy. That’s why you have deals that make no sense.”
• A few years back, management consultants popularized a technique called “management by walking around” (MBWA). At Berkshire, we’ve instituted ABWA (acquisitions by walking around).
  • Actively waiting
• The two retailing businesses we purchased this year are blessed with terrific managers who love to compete and have done so successfully for decades. Like the CEOS of our other operating units, they will operate autonomously: We want them to feel that the businesses they run are theirs. This means no second-guessing by Charlie and me. We avoid the attitude of the alumnus whose message to the football coach is “I’m 100% with you-win or tie.” Our basic goal as an owner is to behave with our managers as we like our owners to behave with us.
  • Steve Jobs quote about hiring smart people and having them tell us what to do
• Any company’s level of profitability is determined by three items: (1) what its assets earn; (2) what its liabilities cost; and (3) its utilization of “leverage”-that is, the degree to which its assets are funded by liabilities rather than by equity. Over the years, we have done well on Point 1, having produced high returns on our assets. But we have also benefitted greatly-to a degree that is not generally well-understood-because our liabilities have cost us very little. An important reason for this low cost is that we have obtained float on very advantageous terms. The same cannot be said by many other property and casualty insurers, who may generate plenty of float, but at a cost that exceeds what the funds are worth to them. In those circumstances, leverage becomes a disadvantage.
• We will get hit from time to time with large losses. Charlie and I, however, are quite willing to accept relatively volatile results in exchange for better long-term earnings than we would otherwise have had. In other words, we prefer a lumpy 15% to a smooth 12%. Since most managers opt for smoothness, we are left with a competitive advantage that we try to maximize. We do, though, monitor our aggregate exposure in order to keep our “worst case” at a level that leaves us comfortable. #Volatility
• At Berkshire, we believe in Charlie’s dictum-”Just tell me the bad news; the good news will take care of itself”-and that is the behavior we expect of our managers when they are reporting to us. Consequently, I also owe you-Berkshire’s owners-a report on three operations that, though they continued to earn decent (or better) returms on invested capital, experienced a decline in earnings last year. Each encountered a different type of problem.
• Seriously, costs matter. For example, equity mutual funds incur corporate expenses-largely payments to the funds’ managers-that average about 100 basis points, a levy likely to cut the returns their investors earn by 10% or more over time. Charlie and I make no promises about Berkshire’s results. We do promise you, however, that virtually all of the gains Berkshire makes will end up with shareholders. We are here to make money with you, not off you. #[[Investment Returns]]
• Over time, the aggregate gains made by Berkshire shareholders must of necessity match the business gains of the company. When the stock temporarily overperforms or underperforms the business, a limited number of shareholders-either sellers or buyers-receive outsized benefits at the expense of those they trade with. Generally, the sophisticated have an edge over the innocents in this game.
  • You have to understand the underlying business performance better than you understand the stock performance
• The party took place on January 26. Though the music was loud-Why must bands play as if they will be paid by the decibel?-I just managed to hear Roy say he’d come from a directors meeting at Kansas Bankers Surety, a company I’d always admired. I shouted back that he should let me know if it ever became available for purchase. On February 12, I got the following letter from Roy: “Dear Warren: Enclosed is the annual financial information on Kansas Bankers Surety. This is the company that we talked about at Janie’s party. If I can be of any further help, please let me know.” On February 13, I told Roy we would pay $75 million for the company-and before long we had a deal. I’m now scheming to get invited to Jane’s next party. Our other acquisition in 1996-FlightSafety International, the world’s leader in the training of pilots-was far larger, at about $1.5 billion, but had an equally serendipitous origin. The heroes of this story are first, Richard Sercer, a Tucson aviation consultant, and second, his wife, Alma Murphy, an ophthalmology graduate of Harvard Medical School, who in 1990 wore down her husband’s reluctance and got him to buy Berkshire stock. Since then, the two have attended all our Annual Meetings, but I didn’t get to know them personally.
  • Deals come to Warren Buffett not just from the people he knows personally but from shareholders he doesn’t really know. Allow people to become invested in your journey and they’ll make it that much smoother.
• Selling fine businesses on “scary” news is usually a bad decision. (Robert Woodruff, the business genius who built Coca-Cola over many decades and who owned a huge position in the company, was once asked when it might be a good time to sell Coke stock. Woodruff had a simple answer: “I don’t know. I’ve never sold any.”) #[[Buy and Never Sell]]
• Under almost any conditions, GEICO would be an exceptionally valuable asset. With Tony at the helm, it is reaching levels of performance that the organization would only a few years ago have thought impossible.
  • Find people to work with who are multipliers on capital
• There’s nothing esoteric about GEICO’s success: The company’s competitive strength flows directly from its position as a low-cost operator. Low costs permit low prices, and low prices attract and retain good policyholders. The final segment of a virtuous circle is drawn when policyholders recommend us to their friends. GEICO gets more than one million referrals annually and these produce more than half of our new business, an advantage that gives us enormous savings in acquisition expenses-and that makes our costs still lower.
  • Not just sacrificing quality for the lowest cost but creating the culture and processes to run at low cost/high quality (e.g. [[Costco]] for simplicity, [[Amazon]] for scale)
• Today, the bonuses received by dozens of top executives, starting with Tony, are based upon only two key variables: (1) growth in voluntary auto policies and (2) underwriting profitability on “seasoned” auto business (meaning policies that have been on the books for more than one year). In addition, we use the same yardsticks to calculate the annual contribution to the company’s profit-sharing plan. Everyone at GEICO knows what counts.
• The GEICO plan exemplifies Berkshire’s incentive compensation principles: Goals should be (1) tailored to the economics of the specific operating business; (2) simple in character so that the degree to which they are being realized can be easily measured; and (3) directly related to the daily activities of plan participants. As a corollary, we shun “lottery ticket” arrangements, such as options on Berkshire shares, whose ultimate value-which could range from zero to huge-is totally out of the control of the person whose behavior we would like to affect. In our view, a system that produces quixotic payoffs will not only be wasteful for owners but may actually discourage the focused behavior we value in managers. Lou Simpson continues to manage GEICO’s money in an outstanding manner: Last year, the equities e portolio outdid the S&P 500 by 6.2 percentage points. In Lou’s part of GEICO’s operation, we again tie compese don to performance-but to investment performance over a four-vear period, not to underwriting results nor to de performance of GEICO as a whole, We think it foolish for an insurance company to pay bonuses that are dee 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. In Lou and Tony, however, we are lucky to have Hall-ofFamers in both key positions.
  • [[Compensation]]: Attached to short-term AND long-term metrics
• Charlie and I believe that large tax payments by Berkshire are entirely fitting. The contribution we thus make to society’s well-being is at most only proportional to its contribution to ours. Berkshire prospers in America as it would nowhere else. #Taxes
• Our portfolio shows little change: We continue to make more money when snoring than when active. #Patience
• 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. This investor would get a similar result if he followed a policy of purchasing an interest in, say, 20% of the future earnings of a number of outstanding college basketball stars. A handful of these would go on to achieve NBA stardom, and the investor’s take from them would soon dominate his royalty stream. To suggest that this 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. #Rebalancing
• I was recently studying the 1896 report of Coke (and you think that you are behind in your reading!). At that time Coke, though it was already the leading soft drink, had been around for only a decade. But its blueprint for the next 100 years was already drawn. Reporting sales of $148,000 that year, Asa Candler, the company’s president, said: “We have not lagged in our efforts to go into all the world teaching that Coca-Cola is the article, par excellence, for the health and good feeling of all people.” Though “health” may have been a reach, I love the fact that Coke still relies on Candler’s basic theme today-a century later. Candler went on to say, just as Roberto could now, “No article of like character has ever so firmly entrenched itself in public favor.” Sales of syrup that year, incidentally, were 116,492 gallons versus about 3.2 billion in 1996. I can’t resist one more Candler quote: “Beginning this year about March 1st… we employed ten traveling salesmen by means of which, with systematic correspondence from the office, we covered almost the territory of the Union.” That’s my kind of sales force.
  • Connect to Munger case study on Coca Cola
• Obviously many companies in high-tech businesses or embryonic industries will grow much faster in percentage terms than will The Inevitables. But I would rather be certain of a good result than hopeful of a great one. #[[Risk Management]]
• Loss of focus is what most worries Charlie and me when we contemplate inveșting 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. That’s not going to happen again at Coke and Gillette, however—not given their current and prospective managements.
  • The ability for someone to sit in a room and do nothing #[[Find the Quote]]
• Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word “selected”: 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. #Focus
• 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. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses-How to Value a Business, and How to Thìnk About Market Prices. #Fundamentals
• 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 five, ten and twenty 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. You must also resist the temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value. #[[Portfolio Strategy]]
• These costs, if left unchecked, portended disaster, however reassuring the airline’s past record might be. (If history supplied all of the answers, the Forbes 400 would consist of librarians.) #History
  • Sick burn
• In recent years, it has been written that Charlie and I are unhappy about all investment-banking fees. That’s dead wrong. We have paid a great many fees over the last 30 years-beginning with the check we wrote to Charlie Heider upon our purchase of National Indemnity in 1967-and we are delighted to make payments that are commensurate with performance. In the case of the 1996 transactions at Salomon Brothers, we more than got our money’s worth.
  • You don’t have to hate investment bakers or VCs in general. But you can hate them in their excess or impropriety
• Given our gain of 34.1%, it is tempting to declare victory and move on. But last year’s performance was no great triumph: Any investor can chalk up large returns when stocks soar, as they did in 1997. In a bull market, one must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in the world. A right-thinking duck would instead compare its position after the downpour to that of the other ducks on the pond.
  • Don’t get cocky
• Pundits who ignore what our 38,000 employees contribute to the company, and instead simply view Berkshire as a de facto investment company, should study the figures in the second column. We made our first business acquisition in 1967, and since then our pre-tax operating earnings have grown from $1 million to $888 million. Furthermore, as noted, in this exercise we have assigned all of Berkshire’s corporate expenses-overhead of $6.6 million, interest of $66.9 million and shareholder contributions of $15.4 million-to our business operations, even though a portion of these could just as well have been assigned to the investment side.
  • [[Family of Companies]] - this isn’t just buying and picking stocks, it’s about creating real value
• Our rate of progress in both investments and operations is certain to fall in the future. For anyone deploying capital, nothing recedes like success. My own history makes the point: Back in 1951, when I was attending Ben Graham’s class at Columbia, an idea giving me a $10,000 gain improved my investment performance for the year by a full 100 percentage points. Today, an idea producing a $500 million pre-tax profit for Berkshire adds one percentage point to our performance. It’s no wonder that my annual results in the 1950s were better by nearly thirty percenage points than my annual gains in any subsequent decade. Charlie’s experience was similar. We weren’t smarter en, just smaller. At our present size, any performance superiority we achieve will be minor.
  • The curse of size and scale; Tracy Britt Cole
• Under these circumstances, we try to exert a Ted Williams kind of discipline. In his book The Science of Hitting, Ted explains that he 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.
• In the 1995 report, I described the enormous debt that you and I owe to Lorimer Davidson. On a Saturday early in 1951, he patiently explained the ins and outs of both GEICO and its industry to me-a 20-year-old stranger who’d arrived at GEICO’s headquarters uninvited and unannounced. Davy later became the company’s CEO and has remained my friend and teacher for 47 years. The huge rewards that GEICO has heaped on Berkshire would not have materialized had it not been for his generosity and wisdom. Indeed, had I not met Davy, I might never have grown to understand the whole field of insurance, which over the years has played such a key part in Berkshire’s success.
  • [[History]] turns on a dime
• Here’s a story illustrating what Melvyn and Shirley are like: When they told their associates of the sale, they also announced that Star would make large, special payments to those who had helped them succeed-and then deTihed that group as everyone in the business. Under the terms of our deal, it was Melvyn and Shirley’s money, not ours, that funded this distribution. Charlie and I love it when we become partners with people who behave like that.
  • If the seller is fine to screw their employees then you should be concerned about the partner you’ve just gained - you should look for the opposite
• The four remaining preferred commitments included two, Gillette and First Empire State, that we had converted into common stock in which we had large unrealized gains, and two others, USAir and Salomon, that had been trouble-prone. At times, the last two had me mouthing a line from a country song: “How can I miss you if you won’t go away?”
  • [[Twitter]] Humor
• We received extra dividend payments during that period, but we were also capped in the price appreciation we could realize. Despite the cap, this holding has proved extraordinarily profitable thanks to a move by your Chairman that combined luck and skill-110% luck, the balance skill.
  • “Awe, shucks” persona
• But one thing is certain: Our future rates of gain will fall far short of those achieved in the past. Berkshire’s capital base is now simply too large to allow us to earn truly outsized returns. If you believe otherwise, you should consider a career in sales but avoid one in mathematics (bearing in mind that there are really only three kinds of people in the world: those who can count and those who can’t).
• To balance this gain of 9,500 in hands-on employees, we have enlarged the staff at world headquarters from 12 to 12.8. (The .8 doesn’t refer to me or Charlie: We have a new person in accounting, working four days a week.) Despite this alarming trend toward corporate bloat, our after-tax overhead last year was about $3.5 million, or well under one basis point (.01 of 1%) of the value of the assets we manage.
  • Scalability of the model
• Writing checks to the IRS that include strings of zeros does not bother Charlie or me. Berkshire as a corporation, and we as individuals, have prospered in America as we would have in no other country. Indeed, if we lived in some other part of the world and completely escaped taxes, I’m sure we would be worse off financially (and in many other ways as well). Overall, we feel extraordinarily lucky to have been dealt a hand in life that enables us to write large checks to the government rather than one requiring the government to regularly write checks to us -say, because we are disabled or unemployed. #Gratitude #Taxes
• Nevertheless, Berkshire’s ownership may make even the best of managers more effective. First, we eliminate all of the ritualistic and nonproductive activities that normally go with the job of CEO, Our managers are totally in charge of their personal schedules. Second, we give each a simple mission: Just run your business as if: 1) you own 100% of it; 2) it is the only asset in the world that you and your family have or will ever have; and 3) you can’t sell or merge it for at least a century. As a corollary, we tell them they should not let any of their decisions be affected even slightly by accounting considerations. We want our managers to think about what counts, not how it will be counted.
  • Creating a solid goal line
• Very few CEOS of public companies operate under a similar mandate, mainly because they have owners who focus on short-term prospects and reported earnings. Berkshire, however, has a shareholder base – which it will have for decades to come - that has the longest investment horizon to be found in the public-company universe. Indeed, a majority of our shares are held by investors who expect to die still holding them. We can therefore ask our CEOS to manage for maximum long-term value, rather than for next quarter’s earnings. We certainly don’t ignore the current results of our businesses in most cases, they are of great importance - but we never want them to be achieved at the expense of our building ever-greater competitive strengths. #[[Long Term Thinking]]
• For many decades, General Re’s name has stood for quality, integrity and professionalism in reinsurance-and under Ron Ferguson’s leadership, this reputation has been burnished still more. Berkshire can add absolutely nothing to the skills of General Re’s and Cologne Re’s managers. On the contrary, there is a lot that they can teach us. Nevertheless, we believe that Berkshire’s ownership will benefit General Re in important ways and that its earnings a decade from now will materially exceed those that would have been attainable absent the merger. We base this optimism on the fact that we can offer General Re’s management a freedom to operate in whatever manner will best allow the company to exploit its strengths.
• At Berkshire, the news is all good: Our average cost over the 32 years has been well under zero. In aggregate, we have posted a substantial underwriting profit, which means that we have been paid for holding a large and growing amount of money. This is the best of all worlds. Indeed, though our net float is recorded on our balance sheet as a liability, it has had more economic value to us than an equal amount of net worth would have had. As long as we can continue to achieve an underwriting profit, float will continue to outrank net worth in value.
• Today, Berkshire has an unusually large number of individuals, such as Ralph, who are truly legends in their industries. Many of these joined us when we purchased their companies, but in recent years we have also identified a number of strong managers internally. We further expanded our corps of all-stars in an important way when we acquired General Re and EJA. Charlie and I have the easy jobs at Berkshire: We do very little except allocate capital. And, even then, we are not all that energetic. We have one excuse, though: In allocating capital, activity does not correlate with achievement. Indeed, in the fields of investments and acquisitions, frenetic behavior is often counterproductive. Therefore, Charlie and I mainly just wait for the phone to ring. Our managers, however, work very hard -and it shows. Naturally, they want to be paid fairly for their efforts, but pay alone can’t explain their extraordinary accomplishments. Instead, each is primarily motivated by a vision of just how far his or her business can go and by a desire to be the one who gets it there. Charlie and I thank them on your behalf and ours. #[[Talent Networking]]
• Our never-comment-even-if-untrue policy in regard to investments may disappoint “piggybackers” but will benefit owners: Your Berkshire shares would be worth less if we discussed what we are doing. Incidentally, we should warn you that media speculation about our investment moves continues in most cases to be incorrect. People who rely on such commentary do so at their own peril.
  • [[Constellation Software]] deciding to stop publishing their annual letters and deal details
• Instead, the pro-forma adjustment came about because we are replacıng Generat Re’s fongstanding stock option plan with a cash plan that ties the incentive compensation of General Re managers to their operating achievements. Formerly what counted for these managers was General Re’s stock price; now their payoff will come from the business performance they deliver. #Compensation
• In effect, accounting principles offer management a choice: Pay employees in one form and count the cost, or pay them in another form and ignore the cost.
• A few years ago we asked three questions in these pages to which we have not yet received an answer: “If options aren’t a form of compensation, what are they? If compensation isn’t an expense, what is it? And, if expenses shouldn’t go into the calculation of earnings, where in the world should they go?” #Compensation
• If we are to disappoint you, we would rather it be with our earnings than with our accounting.
• A big piece of news, however, is that the SEC, led by its chairman, Arthur Levitt, seems determined to get corporate America to clean up its act. In a landmark speech last September, Levitt called for an end to “earnings management.” He correctly observed, “Too many corporate managers, auditors and analysts are participants in a game of nods and winks.” And then he laid on a real indictment: “Managing may be giving way to manipulating; integrity may be losing out to illusion.”
• The numbers on the facing page show just how poor our 1999 record was. We had the worst absolute performance of my tenure and, compared to the S&P, the worst relative performance as well. Relative results are what concern us: Over time, bad relative numbers will produce unsatisfactory absolute results. Even Inspector Clouseau could find last year’s guilty party: your Chairman. My performance reminds me of the quarterback whose report card showed four Fs and a D but who nonetheless had an understanding coach. “Son,” he drawled, “I think you’re spending too much time on that one subject.” My “one subject” is capital allocation, and my grade for 1999 most assuredly is a D. #[[Capital Allocation]]
• Berkshire’s collection of managers is unusual in several important ways. As one example, a very high percentage of these men and women are independently wealthy, having made fortunes in the businesses that they run. They work neither because they need the money nor because they are contractually obligated to-we have no contracts at Berkshire. Rather, they work long and hard because they love their businesses. And I use the word “their” advisedly, since these managers are truly in charge-there are no show-and-tell presentations in Omaha, no budgets to be approved by headquarters, no dictums issued about capital expenditures. We simply ask our managers to run their companies as if these are the sole asset of their families and will remain so for the next century.
  • [[Autonomy]] - is this how [[Tiny]] does it?
• In their relations with Berkshire, our managers often appear to be hewing to President Kennedy’s charge, “Ask not what your country can do for you; ask what you can do for your country.” Here’s a remarkable story from last year: It’s about R. C. Willey, Utah’s dominant home furnishing business, which Berkshire purchased from Bill Child and his family in 1995. Bill and most of his managers are Mormons, and for this reason R. C. Willey’s stores have never operated on Sunday. This is a difficult way to do business: Sunday is the favorite shopping day for many customers. Bill, nonetheless, stuck to his principles — and while doing so built his business from $250,000 of annual sales in 1954, when he took over, to $342 million in 1999. Bill felt that R. C. Willey could operate successfully in markets outside of Utah and in 1997 suggested that we open a store in Boise. I was highly skeptical about taking a no-Sunday policy into a new territory where we would be up against entrenched rivals open seven days a week. Nevertheless, this was Bill’s business to run. So, despite my reservations, I told him to follow both his business judgment and his religious convictions. Bill then insisted on a truly extraordinary proposition: He would personally buy the land and build the store about $9 million as it turned out -and would sell it to us at his cost if it proved to be successful. On the other hand, if sales fell short of his expectations, we could exit the business without paying Bill a cent. This outcome, of course, would leave him with a huge investment in an empty building. I told him that I appreciated his offer but felt that if Berkshire was going to get the upside it should also take the downside. Bill said nothing doing: If there was to be failure because of his religious beliefs, he wanted to take the blow personally. The store opened last August and immediately became a huge success. Bill thereupon turned the property over to us - including some extra land that had appreciated significantly-and we wrote him a check for his cost. And get this: Bill refused to take a dime of interest on the capital he had tied up over the two years.
  • Stick to your principles. What a guy! #[[Missionary Work]]
• In Ajit, we have an underwriter equipped with the intelligence to properly rate most risks; the realism to forget about those he can’t evaluate; the courage to write huge policies when the premium is appropriate; and the discipline to reject even the smallest risk when the premium is inadequate. It is rare to find a person possessing any one of these talents. For one person to have them all is remarkable.
  • Well-rounded skill set
• At both General Re and its Cologne subsidiary, incentive compensation plans are now directly tied to the variables of float growth and cost of float, the same variables that determine value for owners.
  • [[Incentives]] can’t be tied to the top of the funnel or else you’ll just sacrifice quality (e.g. get them in and we can sort them out later.)
• Currently two trends are affecting acquisition costs. The bad news is that it has become more expensive to develop inquiries. Media rates have risen, and we are also seeing diminishing returns-that is, as both we and our competitors step up advertising, inquiries per ad fall for all of us. These negatives are partly offset, however, by the fact that our closure ratio - the percentage of inquiries converted to sales-has steadily improved. Overall, we believe that our cost of new business, though definitely rising, is well below that of the industry. Of even greater importance, our operating costs for renewal business are the lowest among broad-based national auto insurers. Both of these major competitive advantages are sustainable. Others may copy our model, but they will be unable to replicate our economics. #[[CAC]] #[[Customer Acquisition]]
• The fractional-ownership industry is still in its infancy. EJA is now building critical mass in Europe, and over time we will expand around the world. Doing that will be expensive very expensive- but we will spend what it takes. Scale is vital to both us and our customers: The company with the most planes in the air worldwide will be able to offer its customers the best service. “Buy a fraction, get a fleet” has real meaning at EJA. #[[Fractional Ownership]]
• And now, brace yourself. Last year, EJA passed the ultimate test: Charlie signed up. No other endorsement could speak more eloquently to the value of the EJA service. Give us a call at 1-800-848-6436 and ask for our “white paper” on fractional ownership.
  • The [[Subscription Economy]] is older than I realized. #[[Fractional Ownership]]
• Our acquisitions usually develop in the same way. At other companies, executives may devote themselves to pursuing acquisition possibilities with investment bankers, utilizing an auction process that has become standardized. In this exercise the bankers prepare a “book” that makes me think of the Superman comics of my youth. In the Wall Street version, a formerly mild-mannered company emerges from the investment banker’s phone booth able to leap over competitors in a single bound and with earnings moving faster than a speeding bullet. Titillated by the book’s description of the acquiree’s powers, acquisition-hungry CEOS - Lois Lanes all, beneath their cool exteriors promptly swoon. What’s particularly entertaining in these books is the precision with which earnings are projected for many years ahead. If you ask the author-banker, however, what his own firm will earn next month, he will go into a protective crouch and tell you that business and markets are far too uncertain for him to venture a forecast. Here’s one story I can’t resist relating: In 1985, a major investment banking house undertook to sell Scott Fetzer, offering it widely- but with no success. Upon reading of this strikeout, I wrote Ralph Schey, then and now Scott Fetzer’s CEO, expressing an interest in buying the business. I had never met Ralph, but within a week we had a deal. Unfortunately, Scott Fetzer’s letter of engagement with the banking firm provided it a $2.5 million fee upon sale, even if it had nothing to do with finding the buyer. I guess the lead banker felt he should do something for his payment, so he graciously offered us a copy of the book on Scott Fetzer that his firm had prepared. With his customary tact, Charlie responded: “I’ll pay $2.5 million not to read it. #[[Sourcing]] #[[Forecasting]]
• We made few portfolio changes in 1999. As I mentioned earlier, several of the companies in which we have large investments had disappointing business results last year. Nevertheless, we believe these companies have important competitive advantages that will endure over time. This attribute, which makes for good long-term investment results, is one Charlie and I occasionally believe we can identify. More often, however, we can’t — not at least with a high degree of conviction. This explains, by the way, why we don’t own stocks of tech companies, even though we share the general view that our society will be transformed by their products and services. Our problem -which we can’t solve by studying up is that we have no insights into which participants in the tech field possess a truly durable competitive advantage. Our lack of tech insights, we should add, does not distress us. After all, there are a great many business areas in which Charlie and I 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 long-term 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 with what we understand. If we stray, we will have done so inadvertently, not because we got restless and substituted hope for rationality. Fortunately, it’s almost certain there will be opportunities from time to time for Berkshire to do well within the circle we’ve staked out. – we neither envy nor emulate them. Instead, we just stick Right now, the prices of the fine businesses we already own are just not that attractive. In other words, we feel much better about the businesses than their stocks. That’s why we haven’t added to our present holdings. Nevertheless, we haven’t yet scaled back our portfolio in a major way: If the choice is between a questionable business at a comfortable price or a comfortable business at a questionable price, we much prefer the latter. What really gets our attention, however, is a comfortable business at a comfortable price.
  • [[Circle of Competence]] -> there are lots of different ways to make money.
• That day is past, Now, repurchases are all the rage, but are all too often made for an unstated and, in our vjew ignoble reason: to pump or support the stock price. The shareholder who chooses to sell today, of course, is benefitted by any buyer, whatever his origin or motives. But the contimuing shareholder is penalized by repurchases above intrinsic value. Buying dollar bills for $1.10 is not good business for those who stick around. #[[Share Buybacks]]
• Our managers are a very special breed. At most large companies, the truly talented divisional managers seldom have the job they really want. Instead they yearn to become CEOS, either at their present employer or elsewhere. Indeed, if they stay put, they and their colleagues are likely to feel they have failed.
  • Find those hungry managers and give them resources to run with. #Management
• We find it meaningful when an owner cares about whom he sells to. We like to do business with someone who loves his company, not just the money that a sale will bring him (though we certainly understand why he likes that as well). When this emotional attachment exists, it signals that important qualities will likely be found within the business: honest accounting, pride of product, respect for customers, and a loyal group of associates having a strong sense of direction. The reverse is apt to be true, also. When an owner auctions off his business, exhibiting a total lack of interest in what follows, you will frequently find that it has been dressed up for sale, particularly when the seller is a “financial owner.” And if owners behave with little regard for their business and its people, their conduct will often contaminate attitudes and practices throughout the company.
  • Deserve the partner that you want (Munger quote). Connect to Barbarians at the Gate
• Agonizing over errors is a mistake. But acknowledging and analyzing them can be useful, though that practice is rare in corporate boardrooms. There, Charlie and I have almost never witnessed a candid post-mortem of a failed decision, particularly one involving an acquisition. A notable exception to this never-look-back approach is that of The Washington Post Company, which unfailingly and objectively reviews its acquisitions three years after they are made. Elsewhere, triumphs are trumpeted, but dumb decisions either get no follow-up or are rationalized. #[[Spirit of Humility]]
• First, in our advertising we have pushed “frequency” very hard, and we probably overstepped in certain media. We’ve always known that increasing the number of messages through any medium would eventually produce diminishing returns. The third ad in an hour on a given cable channel is simply not going to be as effective as the first.
  • If you watch [[Hulu]] you know they still haven’t learned their lesson
• tany, the competitive picture changed in at least one important respect: State Farm- by far the largest personal auto insurer, with about 19% of the market - has been very slow to raise prices. Its costs, however, are clearly increasing right along with those of the rest of the industry. Consequently, State Farm had an underwriting loss last year from auto insurance (including rebates to policyholders) of 18% of premiums, compared to 4% at GEICO. Our loss produced a float cost for us of 6.1%, an unsatisfactory result. (Indeed, at GEICO we expect float, over time, to be free.) But we estimate that State Farm’s float cost in 2000 was about 23%. The willingness of the largest player in the industry to tolerate such a cost makes the economics difficult for other participants.
  • [[Pricing]] is a [[Prisoner’s Dilemma]] in a commodity market
• That does not take away from the fact that State Farm is one of America’s greatest business stories. I’ve urged that the company be studied at business schools because it has achieved fabulous success while following a path that in many ways defies the dogma of those institutions. Studying counter-evidence is a highly useful activity, though not one always greeted with enthusiasm at citadels of learning. State Farm was launched in 1922, by a 45-year-old, semi-retired Illinois farmer, to compete with longhaughty institutions in New York, Philadelphia and Hartford that possessed overwhelming advantages in capital, reputation, and distribution. Because State Farm is a mutual company, its board members and managers could not be owners, and it had no access to capital markets during its years of fast growth. Similarly, the business never had the stock options or lavish salaries that many people think vital if an established insurers American enterprise is to attract able managers and thrive. In the end, however, State Farm eclipsed all its competitors. In fact, by 1999 the company had amassed a tangible net worth exceeding that of all but four American businesses. If you want to read how this happened, get a copy of The Farmer from Merna. #[[The Profile but for companies]]
• Leaving aside tax factors, the formula we use for evaluating stocks and businesses is identical. Indeed, the formula for valuing all assets that are purchased for financial gain has been unchanged since it was first laid out by a very smart man in about 600 B.C. (though he wasn’t smart enough to know it was 600 B.C.). The oracle was Aesop and his enduring, though somewhat incomplete, investment insight was “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 long-term U.S. bonds)? If you can answer these three 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. And, of course, don’t literally think birds. Think dollars. Aesop’s investment axiom, thus expanded and converted into dollars, is immutable. It applies to outlays for farms, oil royalties, bonds, stocks, lottery tickets, and manufacturing plants. And neither the advent of the steam engine, the harnessing of electricity nor the creation of the automobile changed the formula one iota-nor will the Internet. Just insert the correct numbers, and you can rank the attractiveness of all possible uses of capital throughout the universe. Common yardsticks such as diívidend 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. Indeed, 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. #[[Investing 101 2.0]]
• Alas, though Aesop’s proposition and the third variablethat is, interest rates-are simple, plugging in numbers for the other two variables is a difficult task. Using precise numbers is, in fact, foolish; working with a range of possibilities is the better approach. #Triangulation
• This surreal scene was accompanied by much loose talk about “value creation.” We readily acknowledge that there has been a huge amount of true value created in the past decade by new or young businesses, and that there is much more to come. But value is destroyed, not created, by any business that loses money over its lifetime, no matter how high its interim valuation may get. #[[Amazon]]
• I clearly made a mistake in paying what I did for Dexter in 1993. Furthermore, I compounded that mistake in a huge way by using Berkshire shares in payment. Last year, to recognize my error, we charged off all the remaining accounting goodwill that was attributable to the Dexter transaction. We may regain some economic goodwill at Dexter in the future, but we clearly have none at present. #[[Post Mortem]]
• When Charlie and I read reports, we have no interest in pictures of personnel, plants or products. References to EBITDA make us shudder – does management think the tooth fairy pays for capital expenditures? We’re very suspicious of accounting methodology that is vague or unclear, since too often that means management wishes to hide something. And we don’t want to read messages that a public relations department or consultant has turned out. Instead, we expect a company’s CEO to explain in his or her own words what’s happening.
  • What an annual report should be #[[Investing 101 2.0 Wiki]]
• One further thought while I’m on my soapbox: Charlie and I think it is both deceptive and dangerous for CEOS to predict growth rates for their companies. They are, of course, frequently egged on to do so by both analysts and their own investor relations departments. They should resist, however, because too often these predictions lead to trouble. It’s fine for a CEO to have his own internal goals and, in our view, it’s even appropriate for the CEO to publicly express some hopes about the future, if these expectations are accompanied by sensible caveats. But for a major corporation to predict that its per-share earnings will grow over the long term at, say, 15% annually is to court trouble. That’s true because a growth rate of that magnitude can only be maintained by a very small percentage of large businesses. Here’s a test: Examine the record of, say, the 200 highest earning companies from 1970 or 1980 and tabulate how many have increased per-share earnings by 15% annually since those dates. You will find that only a handful have. I would wager you a very significant sum that fewer than 10 of the 200 most profitable companies in 2000 will attain 15% annual growth in earnings-per-share over the next 20 years. The problem arising from lofty predictions is not just that they spread unwarranted optimism. Even more troublesome is the fact that they corrode CEO behavior. Over the years, Charlie and I have observed many instances in which CEOS engaged in uneconomic operating maneuvers so that they could meet earnings targets they had announced. Worse still, after exhausting all that operating acrobatics would do, they sometimes played a wide variety of accounting games to “make the numbers.” These accounting shenanigans have a way of snowballing: Once a company moves earnings from one period to another, operating shortfalls that occur thereafter require it to engage in further accounting maneuvers that must be even more “heroic.” These can turn fudging into fraud. (More money, it has been noted, has been stolen with the point of a pen than at the point of a gun.) Charlie and I tend to be leery of companies run by CEOS who woo investors with fancy predictions. A few of these manager will prove prophetic - but others will turn out to be congenital optimists, or even charlatans. Unfortunately it’s not easy for investors to know in advance what species they are dealing with.
  • #Forecasting - you get what you measure
• The Constitution’s First Amendment allows the media to print or say almost anything. Journalism’s First Principle should require that the media be scrupulous in deciding what that will be. #Journalism
• Two years ago, reporting on 1999, I said that we had experienced both the worst absolute and relative performance in our history. I added that “relative results are what concern us,” a viewpoint I’ve had since forming my first investment partnership on May 5, 1956. Meeting with my seven founding limited partners that evening, I gave them a short paper titled “The Ground Rules” that included this sentence: “Whether we do a good job or a poor job is to be measured agaínst the general experience in securities.” We initially used the Dow Jones Industrials as our benchmark, but shifted to the S&P 500 when that index became widely used. Our comparative record since 1965 is chronicled on the facing page; last year Berkshire’s advantage was 5.7 percentage points. Some people disagree with our focus on relative figures, arguing that “you can’t eat relative performance.” But if you expect as Charlie Munger, Berkshire’s Vice Chairman, and I do - that owning the S&P 500 will produce reasonably satisfactory results over time, it follows that, for long-term investors, gaining small advantages annually over that index must prove rewarding. Just as you can eat well throughout the year if you own a profitable, but highly seasonal, business such as See’s (which loses considerable money during the summer months) so, too, can you regularly feast on investment returns that beat the averages, however variable the absolute numbers may be. #[[Investment Returns]]
• Another of my 1956 Ground Rules remains applicable: “I cannot promise results to partners.” But Charlie and I can promise that your economic result from Berkshire will parallel ours during the period of your ownership: We will not take cash compensation, restricted stock or option grants that would make our results superior to yours.
  • Skin in the game
• Why, you might ask, didn’t I recognize the above facts before September 11? The answer, sadly, is that I did - but I didn’t convert thought into action. I violated the Noah rule: Predicting rain doesn’t count; building arks does. I consequently let Berkshire operate with a dangerous level of risk - at General Re in particular. I’m sorry to say that much risk for which we haven’t been compensated remains on our books, but it is running off by the day.
  • Connect to Spencer W. Kimball quote about “it is not enough to know, we must do.”
• Jack Welch’s terrific book, Jack, Straight from the Gut #books-to-read
• Bad terminology is the enemy of good thinking. When companies or investment professionals use terms such as “EBITDA” and “pro forma,” they want you to unthinkingly accept concepts that are dangerously flawed. (In golf, my score is frequently below par on a pro forma basis: I have firm plans to “restructure” my putting stroke and therefore only count the swings I take before reaching the green.)
• In neither the purchase of goods nor the hiring of personnel, do we ever consider the religious views, the gender, the race or the sexual orientation of the persons we are dealing with. It would not only be wrong to do so, it would be idiotic. We need all of the talent we can find, and we have learned that able and trustworthy managers, employees and suppliers come from a very wide spectrum of humanity.
• My managerial model is Eddie Bennett, who was a batboy. In 1919, at age 19, Eddie began his work with the Chicago White Sox, who that year went to the World Series. The next year, Eddie switched to the Brooklyn Dodgers, and they, too, won their league title. Our hero, however, smelled trouble. Changing boroughs, he joined the Yankees in 1921, and they promptly won their first pennant in history. Now Eddie settled in, shrewdly seeing what was coming. In the next seven years, the Yankees won five American League titles. What does this have to do with management? It’s simple - to be a winner, work with winners. In 1927, for example, Eddie received $700 for the 1/8th World Series share voted him by the legendary Yankee team of Ruth and Gehrig. This sum, which Eddie earned by working only four days (because New York swept the Series) was roughly equal to the full-year pay then earned by batboys who worked with ordinary associates. Eddie understood that how he lugged bats was unimportant; what counted instead was hooking up with the cream of those on the playing field. I’ve learned from Eddie. At Berkshire, I regularly hand bats to many of the heaviest hitters in American business.
  • Work with winners
• We cherish cost-consciousness at Berkshire. Our model is the widow who went to the local newspaper to place an obituary notice. Told there was a 25-cents-a-word charge, she requested “Pred Brown died.” She was then informed there was a seven-word minimum. “Okay the bereaved woman replied, “make it ‘Fred Brown died, golf clubs for sale.”
• Accountability and stewardship withered in the last decade, becoming qualities deemed of little importance by those caught up in the Great Bubble. As stock prices went up, the behavioral norms of managers went down. By the late ’90s, as a result, CEOS who traveled the high road did not encounter heavy traffic. Most CEOS, it should be noted, are men and women you would be happy to have as trustees for your children’s assets or as next-door neighbors. Too many of these people, however, have in recent years behaved badly at the office, fudging numbers and drawing obscene pay for mediocre business achievements. These otherwise decent people simply followed the career path of Mae West: “I was Snow White but I drifted.” #Leadership
• Why have intelligent and decent directors failed so miserably? The answer lies not in inadequate Laws-it’s always been clear that directors are obligated to represent the interests of shareholders – but tau in what I’d call boardroom atmosphere.” It’s almost impossible, for example, in a boardroom populated by well-mannered people, to raise the question of whether the CEO should be replaced. It’s equally awkward to question a proposed acquisition that has been endorsed by the CEO, particularly when his inside staff and outside advisors are present and unanimously support his decision. (They wouldn’t be in the room if they didn’t.) Finally, when the compensation committee armed, as always, with support from a high-paid consultant- reports on a oneofontions to the CEO, it would be like belching at the dinner table for a director to suggest that the committee reconsider, These “Social” difficulties argue for outside directors regularly meeting without the CEO - a reform het is being instituted and that I enthusiastically endorse. I doubt, however, that most of the other new ovemance nules and recommendations will provide benefits commensurate with the monetary and other costs they impose.
  • Being in a board. Connect to 1993 letter
• Over a span of 40 years, I have been on 19 public-company boards (excluding Berkshire’s) and have Interacted with perhaps 250 directors. Most of them were “independent” as defined by today’s rules t the merdclority of these directors lacked at least one of the three qualities I value. As a result, their Sontribution to shareholder well-being was minimal at best and, too often, negative. These people, decent and intelligent though they were, simply did not know enough about business and/or care enough about sharcholders to question foolish acquisitions or egregious compensation. My own behavior, I must ruefully add, frequently fell short as well: Too often I was silent when management made proposals that I judged to be counter to the interests of shareholders. In those cases, collegiality trumped independence.
• John Bogle’s Common Sense on Mutual Funds #books-to-read
• 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 (except, of course, in the offering books of investment bankers). Charlie and I not only don’t know today what our businesses will earn next year - we don’t even know what they will earn next quarter. We are suspicious of those CEOS who regularly claim they do know the future- and we become downright incredulous if they consistently reach their declared targets. Managers that always promise to “make the numbers” will at some point be tempted to make up the numbers. #Forecasting
• It’s per-share intrinsic value that counts, however, not book value. Here, the news is good: Between 1964 and 2003, Berkshire morphed from a struggling northern textile business whose intrinsic value was less than book into a widely diversified enterprise worth far more than book. Our 39-year gain in intrinsic value has therefore somewhat exceeded our 22.2% gain in book. (For a better understanding of intrinsic value and the economic principles that guide Charlie Munger, my partner and Berkshire’s vicechairman, and me in running Berkshire, please read our Owner’s Manual, beginning on page 69.)
  • Really understand the difference between intrinsic and book value
• If we fail, we will have no excuses. Charlie and I operate in an ideal environment. To begin with, we are supported by an incredible group of men and women who run our operating units. If there were a Corporate Cooperstown, its roster would surely include many of our CEOS. Any shortfall in Berkshire’s results will not be caused by our managers. Additionally, we enjoy a rare sort of managerial freedom. Most companies are saddled with institutional constraints. A company’s history, for example, may commit it to an industry that now offers limited opportunity. A more common problem is a shareholder constituency that pressures manager to dance to Wall Street’s tune. Many CEOS resist, but others give in and adopt operating and capital allocation policies far different from those they would choose if left to themselves. At Berkshire, neither history nor the demands of owners impede intelligent decision-making When Charlie and I make mistakes, they are-in tennis parlance- unforced errors. #Accountability
• In recent years, however, we’ve found it hard to find significantly undervalued stocks, a difficulty greatly accentuated by the mushrooming of the funds we must deploy. Today, the number of stocks that can be purchased in large enough quantities to move the performance needle at Berkshire is a small fraction of the number that existed a decade ago. (Investment managers often profit far more from piling up assets than from handling those assets well. So when one tells you that increased funds won’t hurt his investment performance, step back: His nose is about to grow.)
  • [[Bifurcation of Investing]] - funds moving up market
• This past February, the group opted for a book- which, luckily for me, was the recently-published autobiography of Jim Clayton, founder of Clayton Homes. I already knew the company to be the class act of the manufactured housing industry, knowledge I acquired after earlier making the mistake of buying some distressed junk debt of Oakwood Homes, one of the industry’s largest companies. At the time of that purchase, I did not understand how atrocious consumer-financing practices had become throughout most of the manufactured housing industry. But I learned: Oakwood rather promptly went bankrupt. Manufactured housing, it should be emphasized, can deliver very good value to home purchasers. Indeed, for decades, the industry has accounted for more than 15% of the homes built in the U.S. During those years, moreover, both the quality and variety of manufactured houses consistently improved. #[[Alternative Housing]]
• Today, the manufactured housing industry remains awash in problems. Delinquencies continue high, repossessed units still abound and the number of retailers has been halved. A different business model is required, one that eliminates the ability of the retailer and salesman to pocket substantial money front by making sales financed by loans that are destined to default. Such transactions cause hardship to up both buyer and lender and lead to a flood of repossessions that then undercut the sale of new units. Under a proper model - one requiring significant down payments and shorter-term loans- the industry will likely remain much smaller than it was in the 90s. But it will deliver to home buyers an asset in which they will have equity, rather than disappointment, upon resale. #[[Alternative Housing]]
• In early spring, Byron Trott, a Managing Director of Goldman Sachs, told me that Wal-Mart wished to sell its McLane subsidiary. McLane distributes groceries and nonfood items to convenience stores, drug stores, wholesale clubs, mass merchandisers, quick service restaurants, theaters and others. It’s a good business, but one not in the mainstream of Wal-Mart’s future. It’s made to order, however, for us. I should add that Byron has now been instrumental in three Berkshire acquisitions. He understands Berkshire far better than any investment banker with whom we have talked andit hurts me to say this - earns his fee. I’m looking forward to deal number four (as, I am sure, is he).
  • There are useful investment bankers #[[Investment Banking]]
• In last year’s report, I took a look at how “independent” directors - as defined by statute had performed in the mutual fund field. The Investment Company Act of 1940 mandated such directors, and that means we’ve had an extended test of what statutory standards produce. In our examination last year, we looked at the record of fund directors in respect to the two key tasks board members should perform whether at a mutual fund business or any other. These two all-important functions are, first, to obtain (or retain) an able and honest manager and then to compensate that manager fairly. #[[Board Directors]]
• The bottom line for our directors: You win, they win big: you lose, they lose big. Our approach might be called owner-capitalism. We know of no better way to engender true independence. #[[Board Directors]]
• The primary job of our directors is to select my successor, either upon my death or disability, or when I begin to lose my marbles. (David Ogilvy had it right when he said: “Develop your eccentricities when young. That way, when you get older, people won’t think you are going gaga.” Charlie’s family and mine feel that we overreacted to David’s advice.)
• No matter how financially sophisticated you are, you can’t possibly learn from reading the disclosure documents of a derivatives-intensive company what risks lurk in its positions. Indeed, the more you know about derivatives, the less you will feel you can learn from the disclosures normally proffered you. In Darwin’s words, “Ignorance more frequently begets confidence than does knowledge.”
• You wonder why we borrow money while sitting on a mountain of cash. It’s because of may our “every tub on its own bottom” philosophy. We believe that any subsidiary lending money should pay an appropriate rate for the funds needed to carry its receivables and should not be subsidized by its parent. Otherwise, having a rich daddy can lead to sloppy decisions. Meanwhile, the cash we accumulate at Berkshire is destined for business acquisitions or for the purchase of securities that offer opportunities for significant profit. Clayton’s loan portfolio will likely grow to at least $5 billion in not too many years and, with sensible credit standards in place, should deliver significant earnings.
  • Intelligently leveraging [[Debt]]
• Within the apparel group, Fruit of the Loom is our largest operation. Fruit has three major assets: a 148-year-old universally-recognized brand, a low-cost manufacturing operation, and John Holland, its CEO.
  • Invest in all kinds of assets
• “Victory,” President Kennedy told us after the Bay of Pigs disaster, “has a thousand fathers, but defeat is an orphan.” At NFM, we knew we had a winner a month after the boffo opening in Kansas City, when our new store attracted an unexpected paternity claim. A speaker there, referring to the Blumkin family, asserted, “They had enough confidence and the policies of the Administration were working such that they were able to provide work for 1,000 of our fellow citizens.” The proud papa at the podium? President George W. Bush.
• A 2003 book that investors can learn much from is Bull! by Maggie Mahar. Two other books I’d recommend are The Smartest Guys in the Room by Bethany McLean and Peter Elkind, and In an Uncertain World by Bob Rubin. All three are well-reported and well-written. Additionally, Jason Zweig last year did a first-class job in revising The Intelligent Investor, my favorite book on investing. #books-to-read
• However the yearly comparisons work out, Berkshire’s long-term performance versus the S&P remains all-important. Our shareholders can buy the S&P through an index fund at very low cost. Unless we achieve gains in per-share intrinsic value in the future that outdo the S&P, Charlie and I will be adding nothing to what you can accomplish on your own.
  • Recognize that your stakeholders have a variety of alternatives
• There have been three primary causes: first, high costs, usually because investors traded excessively or spent far too much on investment management; second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and third, a start-and-stop approach to the market marked by untimely entries (after an advance has been long underway) and exits (after periods of stagnation or decline). 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.
  • Understand the reasons behind your outcomes #[[Post Mortem]]
• Our failure here illustrates the importance of a guideline - stay with simple propositions- that we usually apply in investments as well as operations. If only one variable is key to a decision, and the variable has a 90% chance of going your way, the chance for a successful outcome is obviously 90%. But if ten independent variables need to break favorably for a successful result, and each has a 90% probability of success, the likelihood of having a winner is only 35%. In our zinc venture, we solved most of the problems. But one proved intractable, and that was one too many. Since a chain is no stronger than its weakest link, it makes sense to look for- if you’ll excuse an oxymoron- mono-linked chains.
• Naturally, a business that follows a no-layoff policy must be especially careful to avoid overstaffing when times are good. Thirty years ago Tom Murphy, then CEO of Cap Cities, drove this point Chome to me with a hypothetical tale about an employee who asked his boss for permission to hire an assistant. The employee assumed that adding $20,000 to the annual payroll would be inconsequential. But his boss told him the proposal should be evaluated as a $3 million decision, given that an additional person would probably cost at least that amount over his lifetime, factoring in raises, benefits and other expenses (more people, more toilet paper). And unless the company fell on very hard times, the employee added would be unlikely to be dismissed, however marginal his contribution to the business.
  • Quantifying fully-loaded decisions
• Shaw fielded a barrage of price increases in its main fiber materials during the year, a hit that added more than $300 million to its costs. (When you walk on carpet you are, in effect, stepping on processed oil.)
  • Do oil alternatives also address these types of process use cases? #Cosmas
• At Utah-based R. C. Willey, the gains from expansion have been even more dramatic, with 41.9% of 2004 sales coming from out-of-state stores that didn’t exist before 1999. The company also improved its profit margin in 2004, propelled by its two new stores in Las Vegas. I would like to tell you that these stores were my idea. In truth, I thought they were mistakes. R. C. Willey will soon open in Reno. Before making this commitment, Bill and Scott again asked for my advice. Initially, I was pretty puffed up about the fact that they were consulting me. But then it dawned on me that the opinion of someone who is always wrong has its own special utility to decisionmakers.
  • Give people their due for being right
• At FlightSafety, the world’s leader in pilot training, profits rose as corporate aviation rebounded and our business with regional airlines increased. We now operate 283 simulators with an original cost of $1.2 billion. Pilots are trained one at a time on this expensive equipment. This means that as much as $3.50 of capital investment is required to produce $1 of annual revenue. With this level of capital intensity, FlightSafety requires very high operating margins in order to obtain reasonable returns on capital, which means that utilization rates are all-important. Last year, FlightSafety’s return on tangible equity improved to 15.1% from 8.4% in 2003.
  • [[Capital Efficiency]] is about what levers you can pull and when
• Some people may look at this table and view it as a list of stocks to be bought and sold based upon chart patterns, brokers’ opinions, or estimates of near-term earnings. Charlie and I ignore such distractions and instead view our holdings as fractional ownerships in businesses. This is an important distinction. Indeed, this thinking has been the cornerstone of my investment behavior since I was 19. At that time I read Ben Graham’s The Intelligent Investor, and the scales fell from my eyes. (Previously, I had been entranced by the stock market, but didn’t have a clue about how to invest.) #[[Investing 101 2.0]]
• In 2004, Berkshire’s share of the group’s carnings amounted to $1.2 billion. These earnings might legitimately be considered “normal.” True, they were swelled because Gillette and Wells Fargo omitted option costs in their presentation of carnings; but on the other hand they were reduced because Coke had a non-recurring write-off. Our share of the carnings of these four companics has grown almost every year, and now amounts to about 31,3% of our cost. Their cash distributions to us have also grown consistently, totaling $434 million in 2004, or about 11.3% of cost. All in all, the Big Four have delivered us a satisfactory, though far from spectacular, business result.
  • LTV/CAC for stocks
• Nevertheless, I can properly be criticized for merely clucking about nose-bleed valuations during the Bubble rather than acting on my views. Though I said at the time that certain of the stocks we held were priced ahead of themselves, I underestimated just how severe the overvaluation was. I talked when I should have walked. #Conviction
• You may be surprised to learn that Lou does not necessarily inform me about what he is doing. When Charlie and I assign responsibility, we truly hand over the baton - and we give it to Lou just as we do to our operating managers. Therefore, I typically learn of Lou’s transactions about ten days after the end of each month. Sometimes, it should be added, I silently disagree with his decisions. But he’s usually right. #Delegation
• Proponents of the trade status quo are fond of quoting Adam Smith: “What is prudence in the conduct of every family can scarce be folly in that of a great kingdom. If a foreign country can supply S with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.”
  • Worth of your time vs. dropping cost of everything
• John Maynard Keynes said in his masterful The General Theory: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” (Or, to put it in less elegant terms, lemmings as a class may be derided but never does an individual lemming get criticized.)
• So far, however, the moves made by institutions have been less than awe-inspiring. Usually, they’ve focused on minutiae and ignored the 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? #Checklists
• That’s 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. I’ve made this kind of deal a few times myself – and, on balance, my actions have cost you money.
  • Stock-based acquisitions vs. “high value currency” - connect to Twilio and Segment thought pieces
• While our brand strength is not quantifiable, I believe it also grew significantly. When Berkshire acquired control of GEICO in 1996, its annual advertising expenditures were $31 million. Last year we were up to $502 million. And I can’t wait to spend more.
  • The [[Marketing]] strategy of something that scales very well
• Was this onslaught of more frequent and more intense storms merely an anomaly? Or was it caused by changes in climate, water temperature or other variables we don’t fully understand? And could these factors be developing in a manner that will soon produce disasters dwarfing Katrina? Joe, Ajit and I don’t know the answer to these all-important questions. What we do know is that our ignorance means we must follow the course prescribed by Pascal in his famous wager about the existence of God. As you may recall, he concluded that since he didn’t know the answer, his personal gain/loss ratio dictated an affirmative conclusion.
  • The people who believed in [[Climate Change]] and the people who ignored it have at least one thing in common. They profited from their belief
• So I failed in my attempt to exit painlessly, and in the meantime more trades were put on the books. Fault me for dithering. (Charlie calls it thumb-sucking.) When a problem exists, whether in personnel or in business operations, the time to act is now.
  • Knowing when to wait and when to act
• Every day, in countless ways, the competitive position of each of our businesses grows either weaker or stronger. If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength. But if we treat customers with indifference or tolerate bloat, our businesses will wither. On a daily basis, the effects of our actions are imperceptible; cumulatively, though, their consequences are enormous. When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as “widening the moat.” And doing that is essential if we are to have the kind of business we want a decade or two from now. We always, of course, hope to earn more money in the short-term. But when short-term and long-term conflict, widening the moat must take precedence. If a management makes bad decisions in order to hit short-term earnings targets, and consequently gets behind the eight-ball in terms of costs, customer satisfaction or brand strength, no amount of subsequent brilliance will overcome the damage that has been inflicted. Take a look at the dilemmas of managers in the auto and airline industries today as they struggle with the huge problems handed them by their predecessors. Charlie is fond of quoting Ben Franklin’s “An ounce of prevention is worth a pound of cure.” But sometimes no amount of cure will overcome the mistakes of the past.
  • Failure is rarely death by sudden implosion and more often a slow death by a thousand cuts over years
• In this manner, outlandish “goodies” are showered upon CEOS simply because of a corporate version of the argument we all used when children: “But, Mom, all the other kids have one.” When comp committees follow this “logic,” yesterday’s most egregious excess becomes today’s baseline. #Compensation
• The U.S., it should be emphasized, is extraordinarily rich and will get richer. As a result, the huge imbalances in its current account may continue for a long time without their having noticeable deleterious effects on the U.S. economy or on markets. I doubt, however, that the situation will forever remain benign. Either Americans address the problem soon in a way we select, or at some point the problem will likely address us in an unpleasant way of its own.
  • Success has become our downfall. Growth hides a myriad of issues
• And that’s where we are today: A record portion of the earnings that would go in their entirety to owners if they all just stayed in their rocking chairs - is now going to a swelling army of Helpers. Particularly expensive is the recent pandemic of profit arrangements under which Helpers receive large portions of the winnings when they are smart or lucky, and leave family members with all of the losses and large fixed fees to boot- when the Helpers are dumb or unlucky (or occasionally crooked). #[[Investment Returns]]
• Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
  • Inability of someone to sit in a room - find the quote
• u And that’s about it. We are not interested in incurring any significant debt at Berkshire for acquisitions or operating purposes. Conventional business wisdom, of course, would argue that we are being too conservative and that there are added profits that could be safely earned if we injected moderate leverage into our balance sheet. Maybe so. But many of Berkshire’s hundreds of thousands of investors have a large portion of their net worth in our stock (among them, it should be emphasized, a large number of our board and key managers) and a disaster for the company would be a disaster for them. Moreover, there are people who have been permanently injured to whom we owe insurance payments that stretch out for fifty years or more. To these and other constituencies we have promised total security, whatever comes: financial panics, stock-exchange closures (an extended one occurred in 1914) or even domestic nuclear, chemical or biological attacks. We are quite willing to accept huge risks. Indeed, more than any other insurer, we write high-limit policies that are tied to single catastrophic events. We also own a large investment portfolio whose market value could fall dramatically and quickly under certain conditions (as happened on October 19, 1987). Whatever occurs, though, Berkshire will have the net worth, the earnings streams and the liquidity to handle the problem with ease.
  • When it comes to leverage if you’re smart you don’t need it and if you’re dumb you shouldn’t touch it (find the quote)
• You also want to know what happens if I should die tonight. That second question is easy to answer. Most of our many businesses have strong market positions, significant momentum, and terrific managers. The special Berkshire culture is deeply ingrained throughout our subsidiaries, and these operations won’t miss a beat when I die.
  • Creating a [[Culture]] that outlasts you
• That remarkable gain has allowed GEICO to maintain its all-important position as a low-cost producer, even though it has dramatically increased advertising expenditures. Last year GEICO spent $631 million on ads, up from $238 million in 2003 (and up from $31 million in 1995, when Berkshire took control). Today, GEICO spends far more on ads than any of its competitors, even those much larger. We will continue to raise the bar.
  • Efficiency engine that can absorb spend
• Charlie Munger- my partner and Berkshire’s vice chairman- and I run what has turned cunt to h a big business, one with 217,000 employees and annual revenues approaching S100 billion. We certin didn’t plan it that way. Charlie began as a lawyer, and I thought of myself as a security analyst. Sining those seats, we both grew skeptical about the ability of big entities of any type to function well. Size se to make many organizations slow-thinking, resistant to change and smug. In Churchill’s words: “We share our buildings, and afterwards our buildings shape us.” Here’s a telling fact: Of the ten non-oil companis having the largest market capitalization in 1965 - titans such as General Motors, Sears, DuPont and Eastman Kodak - only one made the 2006 list.
• So I’ve taken the easy route, just sitting back and working through great managers who run their own shows. My only tasks are to cheer them on, sculpt and harden our corporate culture, and make major capital-allocation decisions. Our managers have returned this trust by working hard and effectively. #Delegation
• Last year we had a good increase in non-insurance eamings- 38%. Large gains from here on i though, will come only if we are able to make major, and sensible, acquisitions. That will not be easy. We do, however, have one advantage: More and more, Berkshire has become “the buyer of choice” for business owners and managers.
  • Marketing your attributes as a buyer becomes a competitive advantage - connect to Morgan Housel talking about Buffet and Marks
• Paul rejected the idea of a “strategic” buyer, knowing that in the pursuit of “synergies,” an owner of that type would be apt to dismantle what he had so carefully built, a move that would uproot hundreds of his associates (and perhaps wound TTI’s business in the process). He also ruled out a private equity firm, which would very likely load the company with debt and then flip it as soon as possible.
• We continue, however, to need “elephants” in order for us to use Berkshire’s flood of incoming cash. Charlie and I must therefore ignore the pursuit of mice and focus our acquisition efforts on much bigger game.
  • [[Bifurcation of Investing]] - connect to Tracy Britt Cole
• When we were due to close the purchase at Charlie’s office, Jack was late. Finally ariving, he explained that he had been driving around looking for a parking meter with some unexpired time. That was a magic moment for me. I knew then that Jack was going to be my kind of manager.
  • What personalities do you look for?
• At the end of 2006, our float had grown to $50.9 billion, and we have since written a huge retroactive reinsurance contract with Equitas- which I will describe in the next section- that boosts float by another $7 billion. Much of the gain we’ve made has come through our acquisition of other insurers, but we’ve also had outstanding internal growth, particularly at Ajit Jain’s amazing reinsurance operation. Naturally, I had no notion in 1967 that our float would develop as it has. There’s much to be said for just putting one foot in front of the other every day,
  • You don’t always know what your “float” will be
• Appropriate prices don’t guarantee profits in any given year, but inappropriate prices most certainly guarantee eventual losses. Rates have recently fallen because a flood of capital has entered the super-cat field. We have therefore sharply reduced our wind exposures. Our behavior here parallels that which we employ in financial markets: Be fearful when others are greedy, and be greedy when others are fearful. #[[Valuation]]
• Our tale begins around 1688, when Edward Lloyd opened a small coffee house in London. Though no Starbucks, his shop was destined to achieve worldwide fame because of the commercial activities of its clientele - shipowners, merchants and venturesome British capitalists. As these parties sipped Edward’s brew, they began to write contracts transferring the risk of a disaster at sea from the owners of ships and their cargo to the capitalists, who wagered that a given voyage would be completed without incident. These capitalists eventually became known as “underwriters at Lloyd’s.”
  • If you create a community around shared interests and activities you can create something almost spontaneously #[[Clark’s Coffeehouse]] #[[Lloyd’s]]
• Not all of our businesses are destined to increase profits. When an industry’s underlying economics are crumbling, talented management may slow the rate of decline. Eventually, though, eroding fundamentals will overwhelm managerial brilliance. (As a wise friend told me long ago, “If you want to get a reputation as a good businessman, be sure to get into a good business.”) And fundamentals are definitely eroding in the newspaper industry, a trend that has caused the profits of our Buffalo News to decline, The skid will almost certainly continue.
  • Management vs. industry
• Picking the right person(s) will not be an easy task. It’s not hard, of course, to find smart people, among them individuals who have impressive investment records. But there is far more to successful longterm investing than brains and performance that has recently been good. Over time, markets will do extraordinary, even bizarre, things. A single, big mistake could wipe out a long string of successes. We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered. Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions. Temperament is also important., Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success, I’ve seen a lot of very smart people who have lacked these virtues. Finally, we have a special problem to consider: our ability to keep the person we hire. Being able to list Berkshiìre on a resume would materially enhance the marketability of an investment manager, We will need, therefore, to be sure we can retain our choice, even though he or she could leave and make much more money elsewhere.
  • Warren Buffett 2.0 Criteria
• In selecting a new director, we were guided by our long-standing criteria, which are that board members be owner-oriented, business-savvy, interested and truly independent. #[[Board Directors]]
• How much time does this aspect of my job take? Virtually none. How many CEOS have voluntarily left us for other jobs in our 42-year history? Precisely none. Berkshire employs many different incentive arrangements, with their terms depending on such elements as the economic potential or capital intensity of a CEO’s business. Whatever the compensation arrangement, though, I try to keep it both simple and fair. When we use incentives - and these can be large - they are always tied to the operating results for which a given CEO has authority. We issue no lottery tickets that carry payoffs unrelated to business performance. If a CEO bats .300, he gets paid for being a .300 hitter, even if circumstances outside of his control cause Berkshire to perform poorly. And if he bats .150, he doesn’t get a payoff just because the successes of others have enabled Berkshire to prosper mightily. An example: We now own $61 billion of equities at Berkshire, whose value can easily rise or fall by 10% in a given year. Why in the world should the pay of our operating executives be affected by such $6 billion swings, however important the gain or loss may be for shareholders? #Incentives #Compensation
• In 2006, promises and fees hit new highs. A flood of money went from institutional investors to the 2-and-20 crowd. For those innocent of this arrangement, let me explain: It’s a lopsided system whereby 2% of your principal is paid each year to the manager even if he accomplishes nothing- or, for that matter, loses you a bundle - and, additionally, 20% of your profit is paid to him if he succeeds, even if his success is due simply to a rising tide. For example, a manager who achieves a gross return of 10% in a year will keep 3.6 percentage points - two points off the top plus 20% of the residual 8 points leaving only 6.4 percentage points for his investors. On a $3 billion fund, this 6.4% net “performance” will deliver the manager a cool $108 million. He will receive this bonanza even though an index fund might have returned 15% to investors in the same period and charged them only a token fee. #[[Investment Returns]]
• Walter managed a remarkably successful investment partnership, from which he took not a dime unless his investors made money.
• When Walter and Edwin were asked in 1989 by Outstanding Investors Digest, “How would you summarize your approach?” Edwin replied, “We try to buy stocks cheap.” So much for Modern Portfolio Theory, technical analysis, macroeconomic thoughts and complex algorithms.
• If the winds roar or the earth trembles, results could be far worse. So be prepared for lower insurance earnings during the next few years.
  • Manage expectations
• Over our entire history, however, we’ve been profitable, and I expect we will average breakeven results or better in the future. If we do that, our investments can be viewed as an unencumbered source of value for Berkshire shareholders.
  • Look for sources of unencumbered value
• Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensíble price tag. We like to buy the whole business or, if management is our partner, at least 80%. When control-type purchases of quality aren’t available, though, we are also happy to simply buy small portions of great businesses by way of stockmarket purchases. 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 returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore a formidable barrier such as a company’s being the lowcost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success. Business history is filled with “Roman Candles,” companies whose moats proved illusory and were soon crossed. Our criterion of “enduring” causes us to rule out companies in industries prone to rapid and continuous change. Though capitalism’s “creative destruction” is highly beneficial for society, it precludes investment certainty. A moat that must be continuously rebuilt will eventually be no moat at all. Additionally, this criterion eliminates the business whose success depends on having a great manager. Of course, a terrific CEO is a huge asset for any enterprise, and at Berkshire we have an abundance of these managers. Their abilities have created billions of dollars of value that would never have materialized if typical CEOS had been running their businesses. But if a business requires a superstar to produce great results, the business itself cannot be deemed great. A medical partnership led by your area’s premier brain surgeon may enjoy outsized and growing carnings, but that tells little about its future. The partnership’s moat will go when the surgeon goes. You Can count, though, on the moat of the Mayo Clinic to endure, even though you can’t name its CEO. Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere. There’s no rule that you have to invest money where you’ve earned it. Indeed, it’s often a mistake to do so: Truly great businesses, earning huge returns on tangible assets, can’t for any extended period reinvest a large portion of their earnings internally at high rates of return.
  • Always restate your criteria. Build consistency. What are examples of companies who have maintained a competitive advantage that weren’t growing very fast?
• After paying corporate taxes on the profits, we have used the rest to buy other attractive businesses. Just as Adam and Eve kick-started an activity that led to six billion humans, See’s has given birth to multiple new streams of cash for us. (The biblical command to “be fruitful and multiply” is one we take seriously at Berkshire.).
• Now let’s move to the gruesome. 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. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.
• To date, Dexter is the worst deal that I’ve made. But I’ll make more mistakes in the future - vou can bet on that. A line from Bobby Bare’s country song explains what too often happens with acquisitions: “I’ve never gone to bed with an ugly woman, but I’ve sure woke up with a few.” #[[Radical Candor]]
• Susan came to Borsheims 25 years ago as a $4-an-hour saleswoman. Though she lacked a managerial background, I did not hesitate to make her CEO in 1994. She’s smart, she loves the business, and she loves her associates. That beats having an MBA degree any tìme.
  • Acquisition through [[Apprenticeship]]
• (An aside: Charlie and I are not big fans of resumes. Instead, we focus on brains, passion and integrity. Another of our great managers is Cathy Baron Tamraz, who has significantly increased Business Wire’s earnings since we purchased it early in 2006. She is an owner’s dream. It is positively dangerous to stand between Cathy and a business prospect. Cathy, it should be noted, began her career as a cab driver.) #Resumes
• There’s been much talk recently of sovereign wealth funds and how they are buying large pieces of American businesses. This is our doing, not some nefarious plot by foreign governments. Our trade equation gurtees massive foreign investment in the US. When we force-feed $2 bilion daily to the rest of the world they must invest in something here. Why should we complain when they choose stocks over bonds? #LP
• At Berkshire, we will attempt to further increase our stream of direct and indirect foreign earnings. Even if we are successful, however, our assets and earnings will always be concentrated in the U.S. Despite our country’s many imperfections and unrelenting problems of one sort or another, America’s rule of law, market-responsive economic system, and belief in meritocracy are almost certain to produce evergrowing prosperity for its citizens.
  • Has this changed? Are you still long America?
• Former Senator Alan Simpson famously said: “Those who travel the high road in Washington need not fear heavy traffic.” If he had sought truly deserted streets, however, the Senator should have looked to Corporate America’s accounting.
• Naturally, everyone expects to be above average, And those helpers bless their hearts will certainly encourage their clients in this belief. But, as a class, the helper-aided group must be below average. The reason is simple: 1) Investors, overall, will necessarily earn an average return, minus costs they incur; 2) Passive and index investors, through their very inactivity, will earn that average minus costs that are very low; 3) With that group earning average returns, so must the remaining group the active investors. But this group will incur high transaction, management, and advisory costs. Therefore, the active investors will have their returns dimìnished by a far greater percentage than will their inactive brethren. That means that the passive group- the “know-nothings”-must win. #[[Investment Performance]]
• Amid this bad news, however, never forget that our country has faced far worse travails in the past. In the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or so panics and recessions; virulent inflation that led to a 21 2% prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15% and 25% for many years. America has had no shortage of challenges. Without fail, however, we’ve overcome them. In the face of those obstacles - and many others – the real standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow Jones Industrials rose from 66 to 11,497. Compare the record of this period with the dozens of centuries during which humans secured only tiny gains, if any, in how they lived. Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead.
  • Small picture pessimism; big picture optimism
• In good years and bad, Charlie and I simply focus on four goals: (1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of excess liquidity, near-term obligations that are modest, and dozens of sources of earnings and cash; (2) widening the “moats” around our operating businesses that give them durable competitive advantages; (3) acquiring and developing new and varied streams of earnings; (4) expanding and nurturing the cadre of outstanding operating managers who, over the years, have delivered Berkshire exceptional results. #Focus
• When investing, pessimism is your friend, euphoria the enemy.
• Long ago, Ben Graham taught me that “Price is what you pay; value is what you get.” Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.
• Our long-avowed goal is to be the “buyer of choice” for businesses - particularly those built and owned | by families. The way to achieve this goal is to deserve it. That means we must keep our promises; avoid leveraging up acquired businesses; grant unusual autonomy to our managers; and hold the purchased companies through thick and thin (though we prefer thick and thicker). Our record matches our rhetoric. Most buyers competing against us, however, follow a different path. For them, acquisitions are “merchandise.” Before the ink dries on their purchase contracts, these operators are contemplating “exit strategies.” We have a decided advantage, therefore, when we encounter sellers who truly care about the future of their businesses. Some years back our competitors were known as “leveraged-buyout operators.” But LBO became a bad name. So in Orwellian fashion, the buyout firms decided to change their moniker. What they did not change, though, were the essential ingredients of their previous operations, including their cherished fee structures and love of leverage. Their new label became “private equity,” a name that turns the facts upside-down: A purchase of a business by these firms almost invariably results in dramatic reductions in the equity portion of the acquiree’s capital structure compared to that previously existing. A number of these acquirees, purchased only two to three years ago, are now in mortal danger because of the debt piled on them by their private-equity buyers. Much of the bank debt is selling below 70¢ on the dollar, and the public debt has taken a far greater beating. The privateequity firms, it should be noted, are not rushing in to inject the equity their wards now desperately need, Instead, they’re keeping their remaining funds very private. #[[Private Equity]]
• Overall, these companies improved their competitive positions last year, partly because our financial strength let us make advantageous tuck-in acquisitions. In contrast, many competitors were treading water (or sinking).
  • Improving your competitive moats even when you don’t perform as well financially
• Putting people into homes, though a desirable goal, shouldn’t be our country’s primary objective. Keeping them in their homes should be the ambition.
  • Measure what matters
• The type of fallacy involved in projecting loss experience from a universe of non-insured bonds onto a deceptively-similar universe in which many bonds are insured pops up in other areas of finance. “Back-tested” models of many kinds are susceptible to this sort of eror. Nevertheless, they are frequently touted in financial markets as guides to future action. (If merely looking up past financial data would tell you what the future holds, the Forbes 400 would consist of librarians.) #Forecasting
• Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of geeks bearing formulas. #Forecasting
• However, I have pledged – to you, the rating agencies and myself – to always run Berkshire with more than ample cash. We never want to count on the kindness of strangers in order to meet tomorrow’s obligations. When forced to choose, I will not trade even a night’s sleep for the chance of extra profits. #Consistency
• Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier. Beware the investment activity that produces applause; the great moves are usually greeted by yawns. #[[Investing 101 2.0]]
• It’s important to Charlie Munger, my long-time partner, and me that all of our owners understand Berkshire’s operations, goals, limitations and culture. In each annual report, consequently, we restate the economic principles that guide us.
  • What is your operating manual?
• Charlie and I avoid businesses whose futures we can’t evaluate, no matter how exciting their products may be. In the past, it required no brilliance for people to foresee the fabulous grOwih that awaited such industries as autos (in 1910), aircraft (in 1930) and television sets (in 1950). But the future then also included competitive dynamics that would decimate almost all of the companies entering those industries. Even the survivors tended to come away bleeding. Just because Charlie and I can clearly see dramatic growth ahead for an industry does not mean we can judge what its profit margins and returns on capital will be as a host of competitors battle for supremacy. At Berkshire we will stick with businesses whose profit picture for decades to come seems reasonably predictable. Even then, we will make plenty of mistakes. #[[Circle of Competence]]
• Instead, we plan to operate as a collection of separately-managed medium sized and large businesses, most of whose decision-making occurs at the operating level. Charlie and I will limit ourselves to allocating capital, controlling enterprise risk, choosing managers and setting their compensation. #Delegation
• Three years ago, he took over huge liabilities from Lloyds, allowing it to clean up its relationship with 27,972 participants (“names”) who had written problem-ridden policies that at one point threatened the survival of this 322-year-old institution. #[[Clark’s Coffeehouse]]
• For many years I had struggled to think of side products that we could offer our millions of loyal GEICO customers. Unfortunately, I finally succeeded, coming up with a brilliant insight that we should market our own credit card. I reasoned that GEICO policyholders were likely to be good credit risks and, assuming we offered an attractive card, would likely favor us with their business. We got business all right- but of the wrong type.
  • How is this different now with all the cards [[Marqeta]] is helping to create?
• These businesses continue to bump along the bottom, though their competitive positions remain undented.
  • Competitive positioning and financial performance are not the same. They’re both relative to different comp sets.
• The industry is in shambles for two reasons, the first of which must be lived with if the U.S. economy is to recover. This reason concerns U.S. housing starts (including apartment units). In 2009, starts were 554,000, by far the lowest number in the 50 years for which we have data. Paradoxically, this is good news. People thought it was good news a few years back when housing starts - the supply side of the picture - were running about two million annually. But household formations - the demand side - only amounted to about 1.2 million. After a few years of such imbalances, the country unsurprisingly ended up with far too many houses.
  • Too many houses? Connect to Utah project to give houses to homeless people
• The second reason that manufactured housing is troubled is specific to the industry: the punitive differential in mortgage rates between factory-built homes and site-built homes. Before you read further, let me underscore the obvious: Berkshire has a dog in this fight, and you should therefore assess the commentary that follows with special care. That warning made, however, let me explain why the rate differential causes problems for both large numbers of lower-income Americans and Clayton.
  • Caveat your own claims with your illustrated bias
• Last year I told you why our buyers - generally people with low incomes - performed so well as credit risks. Their attitude was all-important: They signed up to live in the home, not resell or refinance it. Consequently, our buyers usually took out loans with payments geared to their verified incomes (we weren’t making “liar’s loans”) and looked forward to the day they could burn their mortgage. If they lost their jobs, had health problems or got divorced, we could of course expect defaults. But they seldom walked away simply because house values had fallen. Even today, though job-loss troubles have grown, Clayton’s delinquencies and defaults remain reasonable and will not cause us significant problems.
  • Understand peoples motivation for doing something
• We told you last year that very unusual conditions then existed in the corporate and municipal bond markets and that these securities were ridiculously cheap relative to U.S. Treasuries. We backed this view with ome purchases, but I should have done far more. Big opportunities come infrequently. When it’s raining gold, reach for a bucket, not a thimble. #Conviction
• We entered 2008 with $44.3 billion of cash-equivalents, and we have since retained operating earnings of $17 billion. Nevertheless, at yearend 2009, our cash was down to $30.6 billion (with $8 billion earmarked for the BNSF acquisition). We’ve put a lot of money to work during the chaos of the last two years. It’s been an ideal period for investors: A climate of fear is their best friend. Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance. In the end, what counts in investing is what you pay for a business - through the purchase of a small piece of it in the stock market - and what that business earns in the succeeding decade or two.
  • Greedy when others are fearful
• The CEOS and directors of the failed companies, however, have largely gone unscathed. Their fortunes may have been diminished by the disasters they oversaw, but they still live in grand style. It is the behavior of these CEOS and directors that needs to be changed: If their institutions and the country are harmed by their recklessness, they should pay a heavy price- one not reimbursable by the companies they’ve damaged nor by insurance. CEOS and, in many cases, directors have long benefitted from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well.
• When stock is the currency being contemplated in an acquisition and when directors are hearing from an advisor, it appears to me that there is only one way to get a rational and balanced discussion. Directors should hire a second advisor to make the case against the proposed acquisition, with its fee contingent on the deal not going through. Absent this drastic remedy, our recommendation in respect to the use of advisors remains: “Don’t ask the barber whether you need a haircut.”
  • Become your own devils advocate. Connect to Charles Darwin quote
• Don’t let that reality spook you. Throughout my lifetime, politicians and pundits have constantly moaned about terrifying problems facing AAmerica. Yet our citizens now live an astonishing six times better than when I was born. The prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War - remains alive and effective. #Patriotism
• We are not natively smarter than we were when our country was founded nor do we work harder. But look around you and see a world beyond the dreams of any colonial citizen. Now, as in 1776, 1861, 1932 and 1941, America’s best days lie ahead.
  • Connect to Gordon B Hinckley quote from his dad
• Charlie and I believe that those entrusted with handling the funds of others should establish performance goals at the onset of their stewardship. Lacking such standards, managements are tempted to shoot the arrow of performance and then paint the bull’s-eye around wherever it lands. #[[Investment Performance]]
• At Berkshire, managers can focus on running their businesses: They are not subjected to meetings at headquarters nor financing worries nor Wall Street harassment. They simply get a letter from me every two years (it’s reproduced on pages 104-105) and call me when they wish. And their wishes do differ: There are managers to whom I have not talked in the last year, while there is one with whom I talk almost daily. Our trust is in people rather than process. A “hire well, manage little” code suits both them and me. #[[Delegation]]
• There is even a supplement to this world-is-our-oyster advantage: In addition to evaluating the attractions of one business against a host of others, we also measure businesses against opportunities available in marketable securities, a comparison most managements don’t make. Often, businesses are priced ridiculously high against what can likely be earned from investments in stocks or bonds. At such moments, we buy securities and bide our time. Our flexibility in respect to capital allocation has accounted for much of our progress to date. We have been able to take money we earn from, say, See’s Candies or Business Wire (two of our best-run businesses, but also two offering limited reinvestment opportunities) and use it as part of the stake we needed to buy BNSF.
  • Competitive advantage 1: flexibility
• Our final advantage is the hard-to-duplicate culture that permeates Berkshire. And in businesses, culture counts. To start with, the directors who represent you think and act like owners. They receive token compensation: no options, no restricted stock and, for that matter, virtually no cash. We do not provide them directors and officers liability insurance, a given at almost every other large public company. If they mess up with your money, they will lose their money as well. Leaving my holdings aside, directors and their families own Berkshire shares worth more than $3 billion. Our directors, therefore, monitor Berkshire’s actions and results with keen interest and an owner’s eye. You and I are lucky to have them as stewards. This same owner-orientation prevails among our managers. In many cases, these are people who have sought out Berkshire as an acquirer for a business that they and their families have long owned. They came to us with an owner’s mindset, and we provide an environment that encourages them to retain it. Having managers who love their businesses is no small advantage. Cultures self-propagate. Winston Churchill once said, “You shape your houses and then they shape you.” That wisdom applies to businesses as well. Bureaucratic procedures beget more bureaucracy, and imperial corporate palaces induce imperious behavior. (As one wag put it, “You know you’re no longer CEO when you get in the back seat of your car and it doesn’t move.”) At Berkshire’s “World Headquarters” our annual rent is $270.212. Moreover, the home-office investment in furniture, art, Coke dispenser, lunch room, high-tech equipment - you name it - totals $301,363. As long as Charlie and I treat your money as if it were our own, Berkshire’s managers are likely to be careful with it as well. Our compensation programs, our annual meeting and even our annual reports are all designed with an eve to reinforcing the Berkshire culture, and making it one that will repel and expel managers of a different bent. This culture grows stronger every year, and it will remain intact long after Charlie and I have left the scene.
  • Competitive advantage 2: [[Culture]]
• One day at the library, I checked out Ben’s entry in Who’s Who in America and found he was chairman of Government Employees Insurance Co. (now called GEICO). I knew nothing of insurance and had never heard of the company. The librarian, however, steered me to a large compendium of insurers and, after reading the page on GEICO, I decided to visit the company. The following Saturday, I boarded an early train for Washington. Alas, when I arrived at the company’s headquarters, the building was closed. I then rather frantically started pounding on a door, until finally a janitor appeared. I asked him if there was anyone in the office I could talk to, and he steered me to the only person around, Lorimer Davidson. That was my lucky moment. During the next four hours, “Davy” gave me an education about both insurance and GEICO. It was the beginning of a wonderful friendship. Soon thereafter, I graduated from Columbia and became a stock salesman in Omaha. GEICO, of course, was my prime recommendation, which got me off to a great start with dozens of customers. GEICO also jump-started my net worth because, soon after meeting Davy, I made the stock 75% of my $9,800 investment portfolio. (Even so, I felt over-diversified.)
  • Competitive advangtage 3: let opportunities thrive
• Home ownership makes sense for most Americans, particularly at today’s lower prices and bargain interest rates. All things considered, the third best investment I ever made was the purchase of my home, though I would have made far more money had I instead rented and used the purchase money to buy stocks. (The two best investments were wedding rings.) For the $31,500 I paid for our house, my family and I gained 52 years of terrific memories with more to come. #[[Real Estate]]
• It’s easy to identify many investment managers with great recent records. But past results, though important, do not suffice when prospective performance is being judged. How the record has been achieved is crucial, as is the manager’s understanding of - and sensitivity to- risk (which in no way should be measured by beta, the choice of too many academics). In respect to the risk criterion, we were looking for someone with a hard-to-evaluate skill: the ability to anticipate the effects of economic scenarios not previously observed. Finally, we wanted someone who would regard working for Berkshire as far more than a job.
  • Job description
• As long as I am CEO, I will continue to manage the great majority of Berkshire’s holdings, both bonds and equities. Todd initially will manage funds in the range of one to three billion dollars, an amount he can reset annually. His focus will be equities but he is not restricted to that form of investment. (Fund consultants like to require style boxes such as “long-short,” “macro,” “international equities.” At Berkshire our only style box is “smart.”)
  • Flexibility: connect to 3 Berkshire competitive advantages
• If we really thought net income important, we could regularly feed realized gains into it simply because we have a huge amount of unrealized gains upon which to draw. Rest assured, though, that Charlie and I have never sold a security because of the effect a sale would have on the net income we were soon to report. We both have a deep disgust for “game playing” with numbers, a practice that was rampant throughout corporate America in the 1990s and still persists, though it occurs less frequently and less blatantly than it used to.
  • Decide what you’re going to measure based on what goes into the things you’re considering measuring
• Part of the appeal of Black-Scholes to auditors and regulators is that it produces a precise number. Charlie and I can’t supply one of those. We believe the true liability of our contracts to be far lower than that calculated by Black-Scholes, but we can’t come up with an exact figure- anymore than we can come up with a precise value for GEICO, BNSF, or for Berkshire Hathaway itself. Our inability to pinpoint a number doesn’t bother us: We would rather be approximately right than precisely wrong. #Forecasting
• Unquestionably, some people have become very rich through the use of borrowed money. However, that’s also been a way to get very poor. When leverage works, it magnifies your gains. Your spouse thinks you’re clever, and your neighbors get envious, But leverage is addictive, Once having profited from its wonders, very few people retreat to more conservative practices. And as we all learned in third grade - and some relearned in 2008-any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all to0o often produces zeroes, even when it is employed by very smart people. #Debt
• You might feel that this should be invested and bring you an income. Forget it — the mental satisfaotion of having $1000.00 laid away where you can put your hands on it, is worth more than what interest it might bring, especially if you have the investment in something that you could not realize on quiokly.For your information, I might mention that there has never been a Buffett who ever left a very large estate, but there has never been one that did not leave some thing. They never spent all they made, but always saved part of what they made, and it has all worked out pretty well.
• We agree with investment writer Ray DeVoe’s observation, “More money has been lost reaching for yield than at the point of a gun.” At Berkshire, we don’t rely on bank lines, and we don’t enter into contracts that could require postings of collateral except for amounts that are tiny in relation to our liquid assets.
• Our goal, which we pursue both through these annual letters and by our meeting discussions, is to give you a better understanding of the business that you own.
• The priority is that all of us continue to zealously guard Berkshire’s reputation. We can’t be perfect but we can try to be. As I’ve said in these memos for more than 25 years: “We can afford to lose - even a shred of reputation.” We money even a lot of money. But we can’t afford to lose reputation must continue to measure every act against not only what is legal but also what we would be happy to have written about on the front page of a national newspaper in an article written by an unfriendly but intelligent reporter.
• As a corollary, let me know promptly if there’s any significant bad news. I can handle bad news but I don’t like to deal with it after it has festered for awhile, A reluctance to face up immediately to bad news is what turned a problem at Salomon from one that could have easily been disposed of into one that almost caused the demise of a firm with 8,000 employees.
• Your attitude on such matters, expressed by behavior as well as words, will be the most important factor in how the culture of your business develops. Culture, more than rule books, determines how an organization behaves.
• The first law of capital allocation - whether the money is slated for acquisitions or share repurchases is that what is smart at one price is dumb at another. (One CEO who always stresses the price/value factor in repurchase decisions is Jamie Dimon at J.P. Morgan; I recommend that you read his annual letter.) #[[Capital Allocation]]
• The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply. #[[Day Trading]]
• wwAt bottom, a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively evaluate the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that will deliver a profit, on average, after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained. ab ma Many insurers pass the first three tests and flunk the fourth. They simply can’t turn their back on business that their competitors are eagerly writing. That old line, “The other guy is doing it so we must as well,” spells trouble in any business, but in none more so than insurance. Indeed, a good underwriter needs an independent mindset akin to that of the senior citizen who received a call from his wife while driving home. “Albert, be careful,” she warned, “I just heard on the radio that there’s a car going the wrong way down the Interstate.” “Mabel, they don’t know the half of it,” replied Albert, “It’s not just one car, there are hundreds of them.
  • [[Insurance]] 101
• Berkshire’s newer shareholders may be puzzled over our decision to hold on to my mistakes. After all, their earnings can never be consequential to Berkshire’s valuation, and problem companies require more managerial time than winners. Any management consultant or Wall Street advisor would look at our laggards and say “dump them.” That won’t happen. For 29 years, we have regularly laid out Berkshire’s economic principles in these reports (pages 93-98) and Number 11 describes our general reluctance to sell poor performers (which, in most cases, lag because of industry factors rather than managerial shortcomings). Our approach is far from Darwinian, and many of you may disapprove of it. I can understand your position. However, we have made - and continue to make – a commitment to the sellers of businesses we buy that we will retain those businesses through thick and thin. So far, the dollar cost of that commitment has not been substantial and may well be offset by the goodwill it builds among prospective sellers looking for the right permanent home for their treasured business and loyal associates. These owners know that what they get with us can’t be delivered by others and that our commitments will be good for many decades to come.
  • Your character as an investor is almost better evaluated in instances where things go wrong
• Overall, the intrinsic value of the businesses in this Berkshire sector significantly exceeds their book value. For many of the smaller companies, however, this is not true. I have made more than my share of mistakes buying small companies. Charlie long ago told me, “If something’s not worth doing at all, it’s not worh doing well,” and I should have listened harder. In any event, our large purchases have generally worked well extraordinarily well in a few cases- and overall this sector is a winner for us.
  • Connect to Spencer calvert quote
• As was the case with Coca-Cola in 1988 and the railroads in 2006, I was late to the IBM party. I have been reading the company’s annual report for more than 50 years, but it wasn’t until a Saturday in March last year that my thinking crystallized. As Thoreau said, “It’s not what you look at that matters, it’s what you see.”
  • Think of it as building a relationship with a company #[[The Profile but for companies]]
• Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power- after taxes have been paid on nominal gains - in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date. #[[Investing 101 2.0]]
• Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the “proof” delivered by the market, and the pool of buyers- for a time- expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.” #[[Herd Mentality]]
• We heard “cash is king” in late 2008, just when cash should have been deployed rather than held. Similarly, we heard “cash is trash” in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort. #Conviction
• Be sure to visit the Bookworm. It will carry more than 35 books and DVDS, including a couple of new ones. I recommend(MiTek) an informative history of one of our very successful subsidiaries. You’ll learn how my interest in the company was originally piqued by my receiving in the mail a hunk of ugly metal whose purpose I couldn’t fathom. Since we bought MiTek in 2001, it has made 33 “tuck-in” acquisitions, almost all successful. I think you’ll also like a short book that (Peter Bevelin has put together explaining Berkshire’s investment and operating principles. #books-to-read
• The four companies possess marvelous businesses and are run by managers who are both talented and shareholder-oriented. At Berkshire we much prefer owning a non-controlling but substantial portion of a wonderful business to owning 100% of a so-so business. Our flexibility in capital allocation gives us a significant advantage over companies that limit themselves only to acquisitions they can operate. #Flexibility
• A thought for my fellow CEOS: Of course, the immediate future is uncertain; America has faced the unknown since 1776. It’s just that sometimes people focus on the myriad of uncertainties that always exist while at other times they ignore them (usually because the recent past has been uneventful). #[[Recency Bias]]
• Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.
• Newspapers continue to reign supreme, however, in the delivery of local news. If you want to know what’s going on in your town – whether the news is about the mayor or taxes or high school football - there is no substitute for a local newspaper that is doing its job. A reader’s eyes may glaze over after they take in a couple of paragraphs about Canadian tariffs or political developments in Pakistan; a story about the reader himself or his neighbors will be read to the end. Wherever there is a pervasive sense of community, a paper that serves the special informational needs of that community will remain indispensable to a significant portion of its residents. #Journalism
• Charlie and I believe that papers delivering comprehensive and reliable information to tightly-bound communities and having a sensible Internet strategy will remain viable for a long time. We do not believe that success will come from cutting either the news content or frequency of publication. Indeed, skimpy news.coverage will almost certainly lead to skimpy readership. And the less-than-daily publication that is now being tried in some large towns or cities - while it may improve profits in the short term - seems certain to diminish the papers’ relevance over time. Our goal is to keep our papers loaded with content of interest to our readers and to be paid appropriately by those who find us useful, whether the product they view is in their hands or on the Internet.
• Above all, dividend policy should always be clear, consistent and rational. A capricious policy will confuse owners and drive away would-be investors. Phil Fisher put it wonderfully 54 years ago in Chapter 7 of his Common Stocks and Uncommon Profits, a book that ranks behind only The Intelligent Investor and the 1940 edition of Security Analysis in the all-time-best list for the serious investor. Phil explained that you can successfully run a restaurant that serves hamburgers or, alternatively, one that features Chinese food. But you can’t switch capriciously between the two and retain the fans of either. #Dividends #books-to-read
• Carol Loomis, who has been invaluable to me in editing this letter since 1977, has recently authored Tap Dancing to Work: Warren Buffett on Practically Everything. She and I have cosigned 500 copies, available exclusively at the meeting. The Outsiders, by William Thorndike, Jr., is an outstanding book about CEOS who excelled at capital allocation. It has an insightful chapter on our director, Tom Murphy, overall the best business manager I’ve ever met. I also recommend The Clash of the Cultures by Jack Bogle and Laura Rittenhouse’s Investing Between the Lines. Should you need to ship your book purchases, a shipping service will be available nearby. #books-to-read