A letter a day!
Letter #34 1980
Key learnings:
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In the beginning of the letter Buffett has explained many micro accounting concepts. A good read if you want some clarity on accounting .
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Buffet on reporting the retained earnings of the minority holdings in the portfolio:
I found the explanation beautiful and so i am sharing an excerpt here:
“The value to Berkshire Hathaway of retained earnings is not determined by whether we own
100%, 50%, 20% or 1% of the businesses in which they reside. Rather, the value of those
retained earnings is determined by the use to which they are put and the subsequent level of
earnings produced by that usage. This is true whether we determine the usage, or whether
managers we did not hire ‐ but did elect to join ‐ determine that usage. (It’s the act that counts,
not the actors.) And the value is in no way affected by the inclusion or non‐inclusion of those
retained earnings in our own reported operating earnings. If a tree grows in a forest partially
owned by us, but we don’t record the growth in our financial statements, we still own part of
the tree. “ -
According to Buffett, the best use of the retained earnings by any company can be repurchase of its own share .
He writes
“One usage of retained earnings we
often greet with special enthusiasm when practiced by companies in which we have an
investment interest is repurchase of their own shares. The reasoning is simple: if a fine
business is selling in the market place for far less than intrinsic value, what more certain or
more profitable utilization of capital can there be than significant enlargement of the interests
of all owners at that bargain price? The competitive nature of corporate acquisition activity
almost guarantees the payment of a full ‐ frequently more than full price when a company buys
the entire ownership of another enterprise. But the auction nature of security markets often
allows finely‐run companies the opportunity to purchase portions of their own businesses at a
price under 50% of that needed to acquire the same earning power through the negotiated
acquisition of another enterprise.” -
Buffet on shifting to bonds against investing in direct equity
“Our insurance companies will continue to make large investments in well‐run, favorably situated, non‐controlled companies that very often will pay out in dividends only small
proportions of their earnings. Following this policy, we would expect our long‐term returns to
continue to exceed the returns derived annually from reported operating earnings. Our
confidence in this belief can easily be quantified: if we were to sell the equities that we hold
and replace them with long‐term tax‐free bonds, our reported operating earnings would rise
immediately by over $30 million annually. Such a shift tempts us not at all.”
- A high inflation rate can make even the positive returns for the owners turn negative. In this letter Buffett has give a good comparison of taxation and inflation.
“Explicit income taxes alone, unaccompanied by any implicit inflation tax, never can turn a
positive corporate return into a negative owner return. (Even if there were 90% personal
income tax rates on both dividends and capital gains, some real income would be left for the
owner at a zero inflation rate.) But the inflation tax is not limited by reported income. Inflation
rates not far from those recently experienced can turn the level of positive returns achieved by a majority of corporations into negative returns for all owners, including those not required to pay explicit taxes. (For example, if inflation reached 16%, owners of the 60% plus of corporate America earning less than this rate of return would be realizing a negative real return ‐ even if income taxes on dividends and capital gains were eliminated.)”
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The largest non controlled holding in the Berkshire Hathaway through its insurance companies was GEICO. A much talked about stock of the past where many famous investors like Peter Lynch too made money. In this letter he has stated the entire story of GEICO for those who are interested to read.
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The reinsurance business continues to remain flat. Buffett has stated reasons for the same:
“The reinsurance business continues to reflect the excesses and problems of the primary
writers. Worse yet, it has the potential for magnifying such excesses. Reinsurance is
characterized by extreme ease of entry, large premium payments in advance, and much delayed loss reports and loss payments. Initially, the morning mail brings lots of cash and few
claims. This state of affairs can produce a blissful, almost euphoric, feeling akin to that
experienced by an innocent upon receipt of his first credit card.” -
Textile operations: Buffett has reduced the textile operations . He has separated manufacturing and sales division so that each can do business independently of each other.
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It is also said that you should never invest with the borrowed money. This year Buffett has borrowed additional money and given a reason for the same
“Unlike most businesses, Berkshire did not finance because of any specific immediate needs.
Rather, we borrowed because we think that, over a period far shorter than the life of the loan,
we will have many opportunities to put the money to good use. The most attractive
opportunities may present themselves at a time when credit is extremely expensive ‐ or even
unavailable. At such a time we want to have plenty of financial firepower.”
- A para I found worth quoting from this letter:
“You learn a great deal about a person when you purchase a business from him and he then
stays on to run it as an employee rather than as an owner. Before the purchase the seller
knows the business intimately, whereas you start from scratch. The seller has dozens of
opportunities to mislead the buyer ‐ through omissions, ambiguities, and misdirection. After
the check has changed hands, subtle (and not so subtle) changes of attitude can occur and
implicit understandings can evaporate. As in the courtship‐marriage sequence,
disappointments are not infrequent.”
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