Now we continue to scan through the shareholder letter of Warren Buffett to Berkshire Hathaway (BRK.A)(BRK.B) shareholders, one of the greatest sources to learn about value investing.
Accounting
In consolidation, US GAAP requires the acquirer to report full consolidation of assets and debts. So the final figures in the consolidated financial statements are the lump sum from many different industries with different economic characteristics. Buffett has commented:
“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 of no value of us in any management activities”
When talking about that, Buffett mentioned merger between Berkshire Hathaway and Diversified Retailing Company. Right after the merger, the ownership in Blue Chips Stamp increased to 58%. Although the ownership is only 58%, Berkshire had to include every single items of Blue Chip Stamps in its consolidate statements, leaving the ownership of others as the minority interest, the liability of balance sheet.
Judging performance and behavior to stock market
“While we believe it is improper to include capital gains or losses in evaluating the performance of the single year, they are in important component of longer term record.”
The short term is always speculating, while investment is only for the long term. As Ben Graham often said: “In the short run, the market is a voting machine but in the long run, it is a weighing machine”
Buffett wrote again about his attitude to the stock market: “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”
Performance Measurement
Textile was the origin industry that Berkshire Hathaway operated. In this year, textile PPE was small in the book, and the old equipment still function similar to the new equipment. But even the fixed assets were the great bargain; the capital turnover was relatively low, reflecting required high investment levels in receivables and inventories as the percentage of sales. “Slow capital turnover, coupled with low profit margins on sales, inevitably produces inadequate return on capital."
Insurance operation
Buffett has commented on reinsurance activity:
“It is very easy to fool yourself regarding underwriting results in reinsurance (particularly in casualty lines involving long delays in settlement), and we believe this situation prevails with many of our competitors. Unfortunately, self-delusion in company reserving almost always lead to inadequate industry rate levels. If major factors in the market don’t know their true costs, the competitive “fall-out” hits all – even those with adequate cost knowledge.”
In some years, when insurance activity is the busiest, the rate was normally unacceptable. Conversely, when it got hit by any event which caused massive losses to some big insurance players, the rate would be adjusted down to the acceptable level, or even decline more. Buffett had stressed that Berkshire will write the policy, as long as he got the appropriate rate.
Insurance investments
He again mentioned the four famous criteria to commit the large percentage of insurance company net worth to equities. He has to find: (1) a business that he can understand, (2) with favorable long term prospects, (3) operated by honest and competent people and (4) with attractive price. Buffett often found a few investments meeting criteria (1), (2) and (3), but the last criterion “often prevents actions.”
As we might all recall, the booming of the stock market was in 1971. The market was at record high, and then it got hit pretty badly in the beginning of 1973 and 1974. Buffett made the following observations: “An irresistible footnote: In 1971, pension fund managers invested a record 122% of net funds available in equities – at full prices they couldn’t buy enough of them. In 1974, after the bottom had fallen out, they committed a then record low of 21% to stocks.” Clearly, pension fund managers had come into equity investment when the market was very high; then when the market seemed to be cheapest, they held cash.
“We continue to find for our insurance portfolios small portions of really outstanding businesses that are available, through the auction pricing mechanisms of security markets, at prices dramatically cheaper than the valuations inferior businesses command on negotiated sales.”
A lot of new value investors, including me when I first got into the field, are often confused in terms of choosing the style to be the most beneficial: to play the asset game and be much diversified, or look for some great opportunities and hold very concentrated holdings. In 1978, Buffett had preferred to hold very concentrated holdings:
“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.”
In this year, Berkshire Hathaway has purchased shares of SAFECO, one of the best large property and casualty insurance company in the US. He described the investment and the company thus: “Their underwriting abilities are simply superb, their loss reserving is conservative, and their investments policies make great sense… our purchase of SAFECO was made at substantially under book value... And there is no way to start a new operation – with necessarily uncertain prospects – at less than 100 cents on the dollar.”
Retained earnings and dividends
“We are at all unhappy when our wholly-owned businesses retain all of their earnings if they can utilize internally those funds at attractive rates… in industries with low capital requirements, or if management has a record of plowing capital into projects of low profitability, then earnings should be paid out or used to repurchase shares – often by far the most attractive option for capital utilization.”
Management and costs
“Our experience has been that the manager of an already high-cost operation frequently is uncommonly resourceful in finding new ways to add to overhead, while the manager of a tightly-run operation usually continues to find additional methods to curtail costs, even when his costs are already well below those of his competitors.”
It is always great and helpful to read Buffett’s letter to shareholders over and over, as it is simple, thoughtful and a lot of learning for any value investor. Also check out:
Accounting
In consolidation, US GAAP requires the acquirer to report full consolidation of assets and debts. So the final figures in the consolidated financial statements are the lump sum from many different industries with different economic characteristics. Buffett has commented:
“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 of no value of us in any management activities”
When talking about that, Buffett mentioned merger between Berkshire Hathaway and Diversified Retailing Company. Right after the merger, the ownership in Blue Chips Stamp increased to 58%. Although the ownership is only 58%, Berkshire had to include every single items of Blue Chip Stamps in its consolidate statements, leaving the ownership of others as the minority interest, the liability of balance sheet.
Judging performance and behavior to stock market
“While we believe it is improper to include capital gains or losses in evaluating the performance of the single year, they are in important component of longer term record.”
The short term is always speculating, while investment is only for the long term. As Ben Graham often said: “In the short run, the market is a voting machine but in the long run, it is a weighing machine”
Buffett wrote again about his attitude to the stock market: “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”
Performance Measurement
Textile was the origin industry that Berkshire Hathaway operated. In this year, textile PPE was small in the book, and the old equipment still function similar to the new equipment. But even the fixed assets were the great bargain; the capital turnover was relatively low, reflecting required high investment levels in receivables and inventories as the percentage of sales. “Slow capital turnover, coupled with low profit margins on sales, inevitably produces inadequate return on capital."
Insurance operation
Buffett has commented on reinsurance activity:
“It is very easy to fool yourself regarding underwriting results in reinsurance (particularly in casualty lines involving long delays in settlement), and we believe this situation prevails with many of our competitors. Unfortunately, self-delusion in company reserving almost always lead to inadequate industry rate levels. If major factors in the market don’t know their true costs, the competitive “fall-out” hits all – even those with adequate cost knowledge.”
In some years, when insurance activity is the busiest, the rate was normally unacceptable. Conversely, when it got hit by any event which caused massive losses to some big insurance players, the rate would be adjusted down to the acceptable level, or even decline more. Buffett had stressed that Berkshire will write the policy, as long as he got the appropriate rate.
Insurance investments
He again mentioned the four famous criteria to commit the large percentage of insurance company net worth to equities. He has to find: (1) a business that he can understand, (2) with favorable long term prospects, (3) operated by honest and competent people and (4) with attractive price. Buffett often found a few investments meeting criteria (1), (2) and (3), but the last criterion “often prevents actions.”
As we might all recall, the booming of the stock market was in 1971. The market was at record high, and then it got hit pretty badly in the beginning of 1973 and 1974. Buffett made the following observations: “An irresistible footnote: In 1971, pension fund managers invested a record 122% of net funds available in equities – at full prices they couldn’t buy enough of them. In 1974, after the bottom had fallen out, they committed a then record low of 21% to stocks.” Clearly, pension fund managers had come into equity investment when the market was very high; then when the market seemed to be cheapest, they held cash.
“We continue to find for our insurance portfolios small portions of really outstanding businesses that are available, through the auction pricing mechanisms of security markets, at prices dramatically cheaper than the valuations inferior businesses command on negotiated sales.”
A lot of new value investors, including me when I first got into the field, are often confused in terms of choosing the style to be the most beneficial: to play the asset game and be much diversified, or look for some great opportunities and hold very concentrated holdings. In 1978, Buffett had preferred to hold very concentrated holdings:
“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.”
In this year, Berkshire Hathaway has purchased shares of SAFECO, one of the best large property and casualty insurance company in the US. He described the investment and the company thus: “Their underwriting abilities are simply superb, their loss reserving is conservative, and their investments policies make great sense… our purchase of SAFECO was made at substantially under book value... And there is no way to start a new operation – with necessarily uncertain prospects – at less than 100 cents on the dollar.”
Retained earnings and dividends
“We are at all unhappy when our wholly-owned businesses retain all of their earnings if they can utilize internally those funds at attractive rates… in industries with low capital requirements, or if management has a record of plowing capital into projects of low profitability, then earnings should be paid out or used to repurchase shares – often by far the most attractive option for capital utilization.”
Management and costs
“Our experience has been that the manager of an already high-cost operation frequently is uncommonly resourceful in finding new ways to add to overhead, while the manager of a tightly-run operation usually continues to find additional methods to curtail costs, even when his costs are already well below those of his competitors.”
It is always great and helpful to read Buffett’s letter to shareholders over and over, as it is simple, thoughtful and a lot of learning for any value investor. Also check out:
