Today, we’ll take a look at the 1959 partnership letter written by Warren Buffett. The letter is dated February 20, 1960.
THE GENERAL STOCK MARKET IN 1959
In this letter, Buffett first notes that the Dow-Jones Industrial Average achieved an overall gain of 19.9% in 1959. However, he then notes that:
“Despite this indication of a robust market, more stocks declined than advanced on the New York Stock Exchange during the year by a margin of 710 to 628. Both the Dow-Jones Railroad Average and Utility Average registered declines.”
Buffett then tells his readers that, in 1959, “most investment trusts had a difficult time in comparison with the Industrial Average.” He cites two examples: 1) “Tri-Continental Corp., the nation’s largest closed-end investment company (total assets of $400 million) had an overall gain of about 5.7% for the year,” and 2) “Massachusetts Investors Trust, the country’s largest mutual fund with assets of $1.5 billion showed an overall gain of about 9% for the year.”
In my mind, the above information lets Buffett’s limited partners know that the Dow-Jones Industrial Average (DJIA) is no pushover in terms of performance. The “nation’s largest closed-end investment company” trailed the DJIA by about 14 percentage points, and the “country’s largest mutual fund” trailed the DJIA by almost 11 percentage points.
Buffett then states the following:
“Most of you know I have been very apprehensive about general stock market levels for several years. To date, this caution has been unnecessary. By previous standards, the present level of ‘blue chip’ security prices contains a substantial speculative component with a corresponding risk of loss. Perhaps other standards of valuation are evolving which will permanently replace the old standards. I don’t think so. I may very well be wrong; however, I would rather sustain the penalties resulting from over-conservatism than face the consequences of error, perhaps with permanent capital loss, resulting from the adoption of a ‘New Era’ philosophy where trees really do grow to the sky.”Here are a few thoughts about the above passage:
- Even though Buffett had been concerned about “general stock market levels for several years,” he continued to make new investments when he came across attractive situations.
- Buffett notes that the “present level of ‘blue chip’ security prices contains a substantial speculative component with a corresponding risk of loss.” This passage makes it sound like Buffett looked at security prices as the sum of two different components: an investment component and a speculative component. The investment component would obviously be a value that was conservative and justifiable based on relevant information and sound logic. Any price over the investment component would be part of the speculative component. Apparently, at the time this letter was written, blue chip security prices contained a “substantial” speculative component.
- Buffett was unwilling to play a game that he did not understand. He would rather be overly conservative (and possibly miss out on a speculative jump in the market) than commit errors that could result in permanent capital loss.
RESULTS IN 1959
In this section, Buffett writes:
“We were fortunate to achieve reasonably good results in 1959. The six partnerships that operated throughout the year achieved overall net gains ranging from 22.3% to 30.0%, and averaging about 25.9%. Portfolios of these partnerships are now about 80% comparable, but there is some difference due to securities and cash becoming available at varying times, payments made to partners, etc. Over the past few years, there hasn’t been any partnership which has consistently been at the top or bottom of performance from year to year, and the variance is narrowing as the portfolios tend to become comparable.”If you remember, the DJIA posted an overall gain of 19.9% in 1959. The six Buffett partnerships that operated throughout the year, on the other hand, achieved net gains ranging from 22.3% to 30.0%, and averaged about 25.9%. So, the worst performing partnership beat the DJIA by 2.4 percentage points, the best performing partnership beat the DJIA by 10.1 percentage points, and average result of the partnerships beat the DJIA by 6 percentage points. Buffett mentions that they were “fortunate to achieve these reasonably good results in 1959.”
In the above quote, Buffett also addresses partnership portfolio comparability and performance. His comments add some color to the 1959 partnership results.
Later in this section of the 1959 letter, Buffett addresses how overall net gain is determined.
“The overall net gain is determined on the basis of market values at the beginning and end of the year adjusted for payments made to partners or contributions received from them. It is not based on actual realized profits during the year, but it is intended to measure the change in liquidating value for the year. It is before interest allowed to partners (where that is specified in the partnership agreement) and before any division of profit to the general partner, but after operating expenses."I think it was a good idea for Buffett to lay out his definition of overall net gain for his limited partners – to ensure that everyone was on the same page.
One other item to note is that overall net gain was calculated “after operating expenses.” At this point in time, Buffett was running the partnerships out of his bedroom, and he was the only full-time employee. Knowing these bits of information, it isn’t hard to imagine that Buffett kept all of the partnership’s operating expenses to a minimum.
THE PRESENT PORTFOLIO
Warren Buffett begins this section by describing a large holding of the partnership:
“Last year I mentioned a new commitment which involved about 25% of the assets of the various partnerships. Presently, this investment is about 35% of assets. This is an unusually large percentage, but has been made for strong reasons. In effect, this Company is partially an investment trust owning some thirty or forty other securities of high quality. Our investment was made and is carried at a substantial discount from asset value based on market value of their securities and a conservative appraisal of the operating business.”The large partnership investment described above represented “35% of assets” as of February 20, 1960. Buffett calls this “an unusually large percentage,” but he notes that the investment was made for “strong reasons.” These reasons are: 1) “this Company is partially an investment trust owning some thirty or forty other securities of high quality,” and 2) the “investment was made and is carried at a substantial discount from asset value based on market value of their securities and a conservative appraisal of the operating business.”
“We are the Company’s largest stockholder by a considerable margin, and the two other large holders agree with our ideas. The probability is extremely high that the performance of this investment will be superior to that of the general market until its disposition, and I am hopeful that this will take place this year.”
Stated differently, Buffett made this large financial commitment because
- Ownership of this Company translated into ownership of a good number other securities of high quality, and
- The investment in this Company was made at a “substantial discount” to market value of these securities plus a conservative value for the operating business (i.e., Investment cost<< market value of securities + conservative value of operating business).
It also sounds like Buffett thought he had a control situation on his hands, as the partnership was the “Company’s largest stockholder by a considerable margin, and the two other large holders agree with our ideas.” Thus, Warren Buffett probably felt that he and the other large holders of the Company could influence management to take steps to realize full value of the assets in a relatively short amount of time. Perhaps for this reason, Buffett writes: “The probability is extremely high that the performance of this investment will be superior to that of the general market until its disposition, and I am hopeful that this will take place this year.”
To end this section of the letter, Buffett talks about the rest of the partnership’s portfolio:
“The remaining 65% of the portfolio is in securities which I consider undervalued and work-out operations. To the extent possible, I continue to attempt to invest in situations at least partially insulated from the behavior of the general market.”Buffett notes that the remaining 65% of the portfolio is in “undervalued and work-out operations,” and that he was attempting to invest in situations that were somewhat market neutral. I believe the reason for this goes back to a previous statement he made in the 1959 letter: “Most of you know I have been very apprehensive about general stock market levels for several years.”
“This policy should lead to superior results in bear markets and average performance in bull markets....”
Buffett felt that this investment positioning should allow the partnership to achieve “superior results in bear markets and average performance in bull markets.”
Well, that’s it for the 1959 partnership letter. Thanks for reading my thoughts.
Next time, we’ll look at the 1960 partnership letter.
Links to other articles in the Buffett Partnership Series:
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Introduction: Buffett Partnership Letter Series