A letter a day!

A letter a day!

Letter #35 1981

Theme: Acquisitions

Key learnings:

1. In the last letter, Buffet has explained the retained earnings of the non controlled entities in detail. In this letter he shares that

“In aggregate, our non-controlled business interests have more favorable underlying economic characteristics than our controlled businesses. That’s understandable; the area of choice has been far wider. Small portions of exceptionally good businesses are usually available in the securities markets at reasonable prices. But such businesses are available for purchase in their entirety only rarely, and then almost always at high prices.”

2. Buffett has mentioned in this letter that if you are buying a company for 2x or 3x its turnover, there should be some potential in the
   same. Otherwise, its better to buy a small quantity.

” In other words, investors can always buy toads at the going price for toads If investors instead bankroll princesses who wish to pay double for the right to kiss the toad, those kisses had better pack some real dynamite. We’ve observed many kisses but very few miracles. Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses – even after their corporate backyards are knee-deep in unresponsive toads.”

3. Buffet states 2 categories of companies which can turn out to be standout acquisitions:

1.The first involves companies that, through design or accident, have purchased only businesses that are particularly well adapted to an inflationary environment. Such favored business must have two characteristics: (1) an ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital. Managers of ordinary ability, focusing solely on acquisition possibilities meeting these tests, have achieved excellent results in recent decades. However, very few enterprises possess both characteristics, and competition to buy those that do has now become fierce to the point of being self-defeating.

2. The second category involves the managerial superstars – men who can recognize that rare prince who is disguised as a toad, and who have managerial abilities that enable them to peel away the disguise.

4. It is easier to correct mistakes in the non controlled business than in the controlled business.

5)5) Insurance underwritting business continue to suffer because of inflation and the underwritting policies abd Buffett projects 1982 as one of the
worst years as far as Insurance underwritting is concerned.

“As Pogo would say, “The future isn’t what it used to be.” Current pricing practices promise devastating results, particularly if the respite from major natural disasters that the industry has enjoyed in recent years should end. For underwriting experience has been getting worse in spite of good luck, not because of bad luck. In recent years hurricanes have stayed at sea and motorists have reduced their driving. They won’t always be so obliging.”