A letter a day!

A letter a day!

Letter #25 1971

The previous letters before 1969 were all relating to Buffett’s communication as a public fund manager. The letters to follow from 1970 is more focused on Berkshire Hathaway and how it progressed later on.

Since the letters contains details of all divisions together, I have divided the learnings in various parts:

1. General:

1.The letters starting from this year become more descriptive. Two metrics used by Buffet to measure performance ROE and ROCE. One of the key point to note , he clearly communicates to the investors not to have unrealistic expectations as it may not be sustainable( He did the same in 1965).

“It is a pleasure to report that operating earnings in 1971, excluding capital gains, amounted to more than 14% of beginning shareholders’ equity. This result—considerably above the average of American industry—was achieved in the face of inadequate earnings in our textile operation, making clear the benefits of redeployment of capital inaugurated five years ago. It will continue to be the objective of management to improve return on total capitalization (long term debt plus equity), as well as the return on equity capital. However, it should be realized that merely maintaining the present relatively high rate of return may well prove more difficult than was improvement from the very low levels of return which prevailed throughout most of the 1960’s.

2. Insurance operations

Buffett explains the insurance operations in great detail in this letter. He explains the various insurance divisions that Berkshire is running, its development over the years, new divisions, acquisitions and as usual praises his managers, the newly acquired company
(Home & Automobile Insurance Company) and its founder, Victor Raab. Insurance as a sector has still not gained that much attention. People are still becoming aware regarding its importance even today. Buffett wrote the same in his letter to not expect returns in short term and have a long term view.

“We set no volume goals in our insurance business generally — and certainly not in reinsurance — as virtually any volume can be achieved if profitability standards are ignored.”

3. Banking operations
   In discussing the performance of the Illinois National Bank, Buffett also gives us the metrics on which a bank can be evaluated. So if you are looking to invest in a bank, you now know what parameters to check.
   “In 1971, Illinois National earned well over 2% after tax on average deposits while (1) not using borrowed funds except for very occasional reserve balancing transactions; (2) maintaining a liquidity position far above average; (3) recording loan losses far below average; and (4) utilizing a mix of over 50% time deposits with all consumer savings accounts receiving maximum permitted interest rates throughout the year.
   This reflects a superb management job by Gene Abegg and Bob Kline.”

4. Financial operations:
   Buffett is clearly known for his capital allocation skills which is depicted in this letter. He re-casted Berkshire Hathaway’s loan which helped him to acquire Home & Auto. There is also a display of discipline which he shows in building financial strength.

“Because of the volume gains being experienced by our insurance subsidiaries early in 1971, we re-cast Berkshire Hathaway’s bank loan so as to provide those companies with additional capital funds. This financing turned out to be particularly propitious when the opportunity to purchase Home & Auto occurred later in the year.

Our insurance and banking subsidiaries possess a fiduciary relationship with the public. We retain a fundamental belief in operating from a very strongly finances position so as to be in a position to unquestionably fulfill our responsibilities. Thus, we will continue to map our financial future for maximum financial strength in our subsidiaries as well as at the parent level.”