Golden Ideas from 1978 Berkshire Hathaway Inc. Letter to shareholders (part 1/3)

• Reporting of capital gains in a company financial statement

„While we believe its improper to include capital gains or losses in evaluationg the performance of a single year, they are an important component of the longer term record. Because of such gains, Berkshire’s long-term growth in equity per share has been greater than would be indicated by compounding the returns from operating earnings that we have reporthed annually.“

• Forecasts of the short term stock market behavior

„We make no attempt to predict how security markets will behave; successfully forecasting short term stock price movements is something we think neither we nor anyone else can do. In the long run, however, we feel that many of our major equity holdings are going to be worth considerably more than we paid, and that investment gains will add significantly to the operating returns of the insurance group.“

• Purchasing a mediocre business in undiffrentiated industry for bargain prices

Buffett talking about BRK’s textile business points out that „…despite this „bargain cost“ of fixed assets, capital turnover is relatively low reflecting required high investment levels in receivables and inventory compared to sales. Slow capital turnover, coupled with low profit margins on sales, invevitably produces inadequate return on capital. Obvious approaches to improved profit margins involve differentiation of product, lowered manufacturing costs through more efficient equipment or better utilization of people, redirection toward fabrics enjoying stronger market trends, etc. Our management is diligent in pursuing such objectives. The problem, of course, is that our competitors are just as diligently doing the same thing.“ He also contiues on that producers in such industry „…must earn inadequate returns except under conditions of tight supply or real shortage. As long as excess productive capacity exists, prices tend to reflect direct operating costs rather than capital employed.“ Here Buffett concludes that „We hope we don’t get into many more businesses with such though economic characteristics.“

Source: http://berkshirehathaway.com/letters/1978.html

Golden Ideas from 1977 Berkshire Hathaway Inc. Letter to shareholders (part 3/3)

• About stock market prices and securities purchases

„…pro-rata portions of truly outstanding business sometimes sell in the securities markets at very large discounts from the price they would command in negotiated transactions involving entire companies. Consequently, bargains in business ownershipm which simply are not available directly through corporate acquisition, can be obtained indirectly through stock ownership. When prices are appropriate, we are willing to také very large positons in selected companies, not with any intention of taking control and not foreseeing sell out merger, but with the expectation that excellent business results by corporations will translate over the long term into correspondingly excellent market value and dividend results for owners, minority as well as majority.“

• Direct and indirect purchase of a business and management of its operations

An example is given of BRK purchasing Capital Cities Communications wheen „To purchase, directly, properties such as Capital Cities owns would cost in the area of twice our cost of purchase via the stock market, and direct onwnership would offer no important advantages to us. While control would give us the opportunity – and the responsibility – to manage operations and corporate 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.“

Source: http://berkshirehathaway.com/letters/1977.html

Golden Ideas from 1977 Berkshire Hathaway Inc. Letter to shareholders (part 2/3)

• Complexities and importance of personel in a „commodity“ business

Again talking about BRK’s insurance business however can be applied to any business operating with a commodity-like products: „Insurance companies offer standardiszed policies which can be copied by anyone. The only products are promises. It is not difficult to be licensed, and rates are 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.“ and „…there is no question that the nature of the insurance business magnifies the effect which individual managers have on company performance.“

• Capital gains and judging the sucess of the stockholdings

The unrealized capital gain „…like any other figure of a single date should not be taken too seriously. Most of our large stock positions are going to be held for many years and the scorecards 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.“

• Finding the potential stockmarket winners

„We select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety. We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at very attractive price. We ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term. In fact, if their business experience continues to satisfy us, we welcome lower market prices of stock we own as an opportunity to acquire even more of a good thing at better price.“

Source: http://berkshirehathaway.com/letters/1977.html