A letter a day!
Letter #36 1982
Theme: Theme: Non controlled ownerships and merger & acquisitions.
Key learnings:
- Buffett has previously stated importance of having appropriate yardsticks in order to measure the performance. In the times of underperformance, fund managers often forget the yardsticks.
“Yardsticks seldom are discarded while yielding favorable readings. But when results deteriorate, most managers favor disposition of the yardstick rather than disposition of the manager.“
- Prefer economic earnings over accounting earnings.
“We prefer a concept of “economic” earnings that includes all undistributed earnings, regardless of ownership percentage. In our view, the value to all owners of the retained earnings of a business enterprise is determined by the effectiveness with which those earnings are used ‐ and not by the size of one’s ownership percentage”
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Accounting numbers are the beginning and not the end of valuation.
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Purchasing a full company is a far more difficult job than purchasing few shares at a reasonable price.
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In insurance, as elsewhere, the reaction of weak managements to
weak operations is often weak accounting.
6)Businesses in industries with both substantial over‐capacity and a “commodity” product (undifferentiated in any customer‐important way by factors such as performance, appearance, service support, etc.) are prime candidates for profit troubles. These may be escaped, true, if prices or costs are administered in some manner and thereby insulated at least partially from normal market forces. This administration can be carried out (a) legally through government intervention (until recently, this category included pricing for
truckers and deposit costs for financial institutions), (b) illegally through collusion, or (c) “extralegally” through OPEC‐style foreign cartelization (with tag‐along benefits for domestic non cartel operators).
7)If, costs and prices are determined by full‐bore competition, there is more than ample capacity, and the buyer cares little about whose product or distribution services he uses, industry economics are almost certain to be unexciting. They may well be disastrous.
Hence the constant struggle of every vendor to establish and emphasize special qualities of product or service. This works with candy bars (customers buy by brand name, not by asking
for a “two‐ounce candy bar”) but doesn’t work with sugar (how often do you hear, “I’ll have a cup of coffee with cream and C & H sugar, please”).
8)8) In the insurance industry, there can be no surge in demand for insurance policies , rather the supply of the available insurance coverage must be controlled.
- This year Berkshire has announce merger with Blue chip. (Holding company of see candy). Buffett prefers not issuing any shares to the existing shareholders unless they derive intrinsic value.
“Our share issuances follow a simple basic rule: we will not issue shares unless we receive as much intrinsic business value as we give. Such a policy might seem axiomatic. Why, you might ask, would anyone issue dollar bills in exchange for fifty‐cent pieces? Unfortunately, many corporate managers have been willing to do just that.”
A detailed write up given on the mergers part. It is very interesting to read.
- In acquiring the companies, Buffett considers the below points:
(1) large purchases (at least $5 million of after-tax earnings),
(2) demonstrated consistent earning power (future projections are of little interest to us, nor are “turn-around” situations),
(3) businesses earning good returns on equity while employing little or no debt,
(4) management in place (we can’t supply it),
(5) simple businesses (if there’s lots of technology, we won’t understand it),
(6) an offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily,about a transaction when price is unknown).
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