A letter a day!

A letter a day!

Letter #41 1987

Key learnings:

1.Growth in the enterprise value is more important than growth in the book value.

“What counts, of course, is the rate of gain in per-share business value, not book value. In many cases, a corporation’s book value and business value are almost totally unrelated. For example, just before they went bankrupt, LTV and Baldwin-United published yearend audits showing their book values to be $652 million and $397 million, respectively. Conversely, Belridge Oil was sold to Shell in 1979 for $3.6 billion although its book value was only $177 million. “

2. Three important characteristics of superior businesses:

1)The current business value of these seven units is far above their historical book value.
2)A little capital is required to run these businesses, they can grow while concurrently making almost all of their earnings available for deployment in new opportunities.
3)These businesses are run by truly extraordinary managers.

3. Severe change in the business and exceptional returns usually dont mix.

“Experience, however, indicates that the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago. That is no argument for managerial complacency. Businesses always have opportunities to improve service, product lines, manufacturing techniques, and the like, and obviously these opportunities should be seized. But a business that constantly encounters major change also encounters many chances for major error. Furthermore, economic terrain that is forever shifting violently is ground on which it is difficult to build a fortress-like business franchise. Such a franchise is usually the key to sustained high returns.”

4. How to differentiate a good insurance business from others in the industry?

1. Financial Strength.
2. Maintenance of volume.

5. The investment success will not be produced by arcane formulae, computer programs or
   signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior
   from the super-contagious.

6.Buffett on borrowing money to invest in stocks:

“Good business or investment decisions will eventually produce quite satisfactory economic results, with no aid from leverage. Therefore, it seems to us to be both foolish and improper to risk what is important (including, necessarily, the welfare of innocent bystanders such as policyholders and employees) for some extra returns that are relatively unimportant. This view is not the product of either our advancing age or prosperity: Our opinions about debt have remained constant.

However, we are not phobic about borrowing. (We’re far from believing that there is no fate worse than debt.) We are willing to borrow an amount that we believe – on a worst-case basis will pose no threat to Berkshire’s well-being.”