Letters from Warren Buffet to stockholders 1979.docx
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Letters from Warren Buffet to stockholders 1979.docx
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LettersfromWarrenBuffettostockholders1979
BERKSHIREHATHAWAYINC.
TotheShareholdersofBerkshireHathawayInc.:
Again,wemustleadoffwithafewwordsaboutaccounting.
Sinceourlastannualreport,theaccountingprofessionhas
decidedthatequitysecuritiesownedbyinsurancecompaniesmust
becarriedonthebalancesheetatmarketvalue.Wepreviously
havecarriedsuchequitysecuritiesatthelowerofaggregate
costoraggregatemarketvalue.Becausewehavelargeunrealized
gainsinourinsuranceequityholdings,theresultofthisnew
policyistoincreasesubstantiallyboththe1978and1979
yearendnetworth,evenaftertheappropriateliabilityis
establishedfortaxesoncapitalgainsthatwouldbepayable
shouldequitiesbesoldatsuchmarketvaluations.
Asyouknow,BlueChipStamps,our60%ownedsubsidiary,is
fullyconsolidatedinBerkshireHathaway�sfinancialstatements.
However,BlueChipstillisrequiredtocarryitsequity
investmentsatthelowerofaggregatecostoraggregatemarket
value,justasBerkshireHathaway�sinsurancesubsidiariesdid
priortothisyear.Shouldthesameequitiesbepurchasedatan
identicalpricebyaninsurancesubsidiaryofBerkshireHathaway
andbyBlueChipStamps,presentaccountingprinciplesoften
wouldrequirethattheyendupcarriedonourconsolidated
balancesheetattwodifferentvalues.(Thatshouldkeepyouon
yourtoes.)MarketvaluesofBlueChipStamps�equityholdings
aregiveninfootnote3onpage18.
1979OperatingResults
Wecontinuetofeelthattheratioofoperatingearnings
(beforesecuritiesgainsorlosses)toshareholders�equitywith
allsecuritiesvaluedatcostisthemostappropriatewayto
measureanysingleyear�soperatingperformance.
Measuringsuchresultsagainstshareholders�equitywith
securitiesvaluedatmarketcouldsignificantlydistortthe
operatingperformancepercentagebecauseofwideyear-to-year
marketvaluechangesinthenetworthfigurethatservesasthe
denominator.Forexample,alargedeclineinsecuritiesvalues
couldresultinaverylow�marketvalue�networththat,in
turn,couldcausemediocreoperatingearningstolook
unrealisticallygood.Alternatively,themoresuccessfulthat
equityinvestmentshavebeen,thelargerthenetworthbase
becomesandthepoorertheoperatingperformancefigureappears.
Therefore,wewillcontinuetoreportoperatingperformance
measuredagainstbeginningnetworth,withsecuritiesvaluedat
cost.
Onthisbasis,wehadareasonablygoodoperating
performancein1979-butnotquiteasgoodasthatof1978-
withoperatingearningsamountingto18.6%ofbeginningnet
worth.Earningspershare,ofcourse,increasedsomewhat(about
20%)butweregardthisasanimproperfigureuponwhichto
focus.Wehadsubstantiallymorecapitaltoworkwithin1979
thanin1978,andourperformanceinutilizingthatcapitalfell
shortoftheearlieryear,eventhoughper-shareearningsrose.
�Earningspershare�willriseconstantlyonadormantsavings
accountoronaU.S.SavingsBondbearingafixedrateofreturn
simplybecause�earnings�(thestatedinterestrate)are
continuouslyplowedbackandaddedtothecapitalbase.Thus,
evena�stoppedclock�canlooklikeagrowthstockifthe
dividendpayoutratioislow.
Theprimarytestofmanagerialeconomicperformanceisthe
achievementofahighearningsrateonequitycapitalemployed
(withoutundueleverage,accountinggimmickry,etc.)andnotthe
achievementofconsistentgainsinearningspershare.Inour
view,manybusinesseswouldbebetterunderstoodbytheir
shareholderowners,aswellasthegeneralpublic,ifmanagements
andfinancialanalystsmodifiedtheprimaryemphasistheyplace
uponearningspershare,anduponyearlychangesinthatfigure.
LongTermResults
Inmeasuringlongtermeconomicperformance-incontrastto
yearlyperformance-webelieveitisappropriatetorecognize
fullyanyrealizedcapitalgainsorlossesaswellas
extraordinaryitems,andalsotoutilizefinancialstatements
presentingequitysecuritiesatmarketvalue.Suchcapitalgains
orlosses,eitherrealizedorunrealized,arefullyasimportant
toshareholdersoveraperiodofyearsasearningsrealizedina
moreroutinemannerthroughoperations;itisjustthattheir
impactisoftenextremelycapriciousintheshortrun,a
characteristicthatmakestheminappropriateasanindicatorof
singleyearmanagerialperformance.
ThebookvaluepershareofBerkshireHathawayonSeptember
30,1964(thefiscalyearendpriortothetimethatyourpresent
managementassumedresponsibility)was$19.46pershare.At
yearend1979,bookvaluewithequityholdingscarriedatmarket
valuewas$335.85pershare.Thegaininbookvaluecomesto
20.5%compoundedannually.Thisfigure,ofcourse,isfarhigher
thananyaverageofouryearlyoperatingearningscalculations,
andreflectstheimportanceofcapitalappreciationofinsurance
equityinvestmentsindeterminingtheoverallresultsforour
shareholders.Itprobablyalsoisfairtosaythatthequoted
bookvaluein1964somewhatoverstatedtheintrinsicvalueofthe
enterprise,sincetheassetsownedatthattimeoneitheragoing
concernbasisoraliquidatingvaluebasiswerenotworth100
centsonthedollar.(Theliabilitiesweresolid,however.)
Wehaveachievedthisresultwhileutilizingalowamountof
leverage(bothfinancialleveragemeasuredbydebttoequity,and
operatingleveragemeasuredbypremiumvolumetocapitalfundsof
ourinsurancebusiness),andalsowithoutsignificantissuanceor
repurchaseofshares.Basically,wehaveworkedwiththecapital
withwhichwestarted.Fromourtextilebasewe,orourBlue
ChipandWescosubsidiaries,haveacquiredtotalownershipof
thirteenbusinessesthroughnegotiatedpurchasesfromprivate
ownersforcash,andhavestartedsixothers.(It�swortha
mentionthatthosewhohavesoldtoushave,almostwithout
exception,treateduswithexceptionalhonorandfairness,both
atthetimeofsaleandsubsequently.)
Butbeforewedrowninaseaofself-congratulation,a
further-andcrucial-observationmustbemade.Afewyears
ago,abusinesswhoseper-sharenetworthcompoundedat20%
annuallywouldhaveguaranteeditsownersahighlysuccessful
realinvestmentreturn.Nowsuchanoutcomeseemslesscertain.
Fortheinflationrate,coupledwithindividualtaxrates,will
betheultimatedeterminantastowhetherourinternaloperating
performanceproducessuccessfulinvestmentresults-i.e.,a
reasonablegaininpurchasingpowerfromfundscommitted-for
youasshareholders.
Justastheoriginal3%savingsbond,a5%passbooksavings
accountoran8%U.S.TreasuryNotehave,inturn,been
transformedbyinflationintofinancialinstrumentsthatchewup,
ratherthanenhance,purchasingpowerovertheirinvestment
lives,abusinessearning20%oncapitalcanproduceanegative
realreturnforitsownersunderinflationaryconditionsnotmuch
moreseverethanpresentlyprevail.
Ifweshouldcontinuetoachievea20%compoundedgain-not
aneasyorcertainresultbyanymeans-andthisgainis
translatedintoacorrespondingincreaseinthemarketvalueof
BerkshireHathawaystockasithasbeenoverthelastfifteen
years,yourafter-taxpurchasingpowergainislikelytobevery
closetozeroata14%inflationrate.Mostoftheremainingsix
percentagepointswillgoforincometaxanytimeyouwishto
convertyourtwentypercentagepointsofnominalannualgaininto
cash.
Thatcombination-theinflationrateplusthepercentageof
capitalthatmustbepaidbytheownertotransferintohisown
pockettheannualearningsachievedbythebusiness(i.e.,
ordinaryincometaxondividendsandcapitalgainstaxon
retainedearnings)-canbethoughtofasan�investor�smisery
index�.Whenthisindexexceedstherateofreturnearnedon
equitybythebusiness,theinvestor�spurchasingpower(real
capital)shrinkseventhoughheconsumesnothingatall.Wehave
nocorporatesolutiontothisproblem;highinflationrateswill
nothelpusearnhigherratesofreturnonequity.
Onefriendlybutsharp-eyedcommentatoronBerkshirehas
pointedoutthatourbookvalueattheendof1964wouldhave
boughtaboutone-halfounceofgoldand,fifteenyearslater,
afterwehaveplowedbackallearningsalongwithmuchblood,
sweatandtears,thebookvalueproducedwillbuyaboutthesame
halfounce.AsimilarcomparisoncouldbedrawnwithMiddle
Easternoil.Therubhasbeenthatgovernmenthasbeen
exceptionallyableinprintingmoneyandcreatingpromises,but
isunabletoprintgoldorcreateoil.
Weintendtocontinuetodoaswellaswecaninmanaging
theinternalaffairsofthebusiness.Butyoushouldunderstand
thatexternalconditionsaffectingthestabilityofcurrencymay
verywellbethemostimportantfactorindeterminingwhether
thereareanyrealrewardsfromyourinvestmentinBerkshire
Hathaway.
SourcesofEarnings
WeagainpresentatableshowingthesourcesofBerkshire�s
earnings.Asexplainedlastyear,Berkshireownsabout60%of
BlueChipStampswhich,inturn,owns80%ofWescoFinancial
Corporation.Thetableshowsbothaggregateearningsofthe
variousbusinessentities,aswellasBerkshire�sshare.Allof
thesignificantcapitalgainsorlossesattributabletoanyof
thebusinessentitiesareaggregatedintherealizedsecurities
gainfigureatthebottomofthetable,andarenotincludedin
operatingearnings.
NetEarnings
EarningsBeforeIncomeTaxesAfterTax
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