A letter a day!

A letter a day!

Letter # 30 1976

Key learnings:

1. Textile division
   The business continues to face problems. Apart from the overall industrial factors, Buffett has also stated some misses on their part which resulted in poor performance. He writes:

“Our textile division was a significant disappointment during 1976. Earnings, measured either by return on sales or by return on capital employed, were inadequate. In part, this was due to industry conditions that did not measure up to expectations of a year ago. But equally important were our own shortcomings. Marketing efforts and mill capabilities were not properly matched in our new Waumbec operation. Unfavorable manufacturing cost variances were produced by improper evaluation of machinery and personnel capabilities.”

Further, he also clarifies that one may not expect a good return on investment from textile operations. However, it is a good business from an employment generation point of view.

“It should be recognized that the textile business does not offer the expectation of high returns on investment. Nevertheless, we maintain a commitment to this division—a very important source of employment in New Bedford and Manchester—and believe reasonable returns on average are possible.”

2. Insurance underwriting

The combined ratio is one of the yardsticks to measure the performance of the insurance business. A combined ratio of 100 is breakeven. Anything above that will indicate losses and anything below that is profitable.

As the insurance industry was facing headwinds due to inflation and competition, some relief is observed this year as competitors have finally reacted to the inadequacy of the past rates. As per Buffett, this is a temporary phase. He writes

“Thus present rates, which are adequate for today, will not be adequate tomorrow.
Our opinion is that before long, perhaps in 1978, the industry will fall behind on rates as
temporary prosperity produces unwise competition. If this happens, we must be prepared to meet the next wave of inadequate pricing by a significant reduction in volume”

3. He has concluded the expected performance of the business. This is very beautiful communication and a must-read if you are a fund manager who needs to communicate expected fund performance to the investors. Rather than stating an expected number of the fund performance, it is always to give an idea about the expected performance of the businesses you are holding, since that will ultimately translate to the fund performance.

“However, we consider the yearly business progress of the companies in which we own stocks to be very important. And here, we have been delighted by the 1976 business performance
achieved by most of our portfolio companies. If the business results continue excellent over a
period of years, we are certain eventually to achieve good financial results from our stock
holdings, regardless of wide year‐to‐year fluctuations in market values.”