A letter a day!

A letter a day!

Letter #47 1993

Key learnings:

1. In the long run, it is the earnings growth that will matter and not the market price.

Two years ago, Coca-Cola and Gillette, both large holdings of ours, enjoyed market price increases that dramatically outpaced their earnings gains. In the 1991 Annual Report, I said that the stocks of these companies could not continuously overperform their businesses.

From 1991 to 1993, Coke and Gillette increased their annual operating earnings per share by 38% and 37% respectively, but their market prices moved up only 11% and 6%. In other words the companies overperformed their stocks, a result that no doubt partly reflects Wall Street’s new apprehension about brand names. Whatever the reason, what will count over time is the earnings performance of these companies. If they prosper, Berkshire will also prosper, though not in a lock-step manner.

(Buffett still holding Coca Cola – Quantity of 400,000,000, stake 9.2%, CMP $63.46 and vale $25,384,000,000, Stake in the company 7.4%).

2. Acquisition of Dexter shoes:

Berkshire Hathaway entered the shoe business with the purchase of H H brown in the year 1991. Next, it acquired Lowell Shoes at the end of the year 1992 which primarily focused on manufacturing of women’s and nurse’s shoes. This year it went on to acquire Dexter shoes, which is into the manufacturing of popular price men’s and women’s shoes.

“Five years ago we had no thought of getting into shoes. Now we have 7,200 employees in that industry, and I sing “There’s No Business Like Shoe Business” as I drive to work. So much for strategic plans.
At Berkshire, we have no view of the future that dictates what businesses or industries we will enter. Indeed, we think it’s usually poison for a corporate giant’s shareholders if it embarks upon new ventures pursuant to some grand vision.”

3. As an investor, whenever we come across a story of a multi-bagger stock, we often think now it’s too late to buy it. Buffet writes on the same with the example of Coca-Cola.

“Yes, the competition there was in 1938 and in 1993 as well. But it’s worth noting that in 1938 .The Coca-Cola Co. sold 207 million cases of soft drinks (if its gallonage then is converted into the 192-ounce cases used for measurement today) and in 1993 it sold about 10.7 billion cases, a 50-fold increase in physical volume from a company that in 1938 was already dominant in its very major industry. Nor was the party over in 1938 for an investor: Though the $40 invested in 1919 in one share had (with dividends reinvested) turned into $3,277 by the end of 1938, a fresh $40 then invested in Coca-Cola stock would have grown to $25,000 by yearend 1993.”

4. The following factors can be used to judge the risk of the company apart from the beta:

1. The certainty with which the long-term economic characteristics of the business can be evaluated;
2. The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows;
3. The certainty with which management can be counted on to channel the rewards from the business to the shareholders rather than to itself;
4. The purchase price of the business;
5. The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor’s purchasing-power return is reduced from his gross return.

“These factors will probably strike many analysts as unbearably fuzzy, since they cannot be extracted from a data base of any kind. But the difficulty of precisely quantifying these matters does not negate their importance nor is it insuperable. Just as Justice Stewart found it impossible to formulate a test for obscenity but nevertheless asserted, “I know it when I see it,” so also can investors – in an inexact but useful way – “see” the risks inherent in certain investments without reference to complex equations or price histories.”

5. If you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you. It is apt simply to hurt your results and increase your risk. Rather than putting money into the new company, adding the same money to the top choices will be less risky.

6. In this letter, Buffett writes in detail about corporate governance. He has stated three types of corporate governance and what should shareholders/directors do in each case.

1. No controlling owner.
2. Controlling owner involved in the management.
3. Controlling owner not invovled in the management.

It is advisable to read this in detail from this letter.

7. Buffett on what will happen if for any reason is unable to continue to be an owner or/manager at Berkshire:

“After my death, all of my stock will go to my wife, Susie, should she survive me, or to a foundation if she dies before I do. In neither case will taxes and bequests require the sale of consequential amounts of stock.

When my stock is transferred to either my wife or the foundation, Berkshire will enter the third governance mode, going forward with a vitally interested, but non-management, owner and with a management that must perform for that owner. In preparation for that time, Susie was elected to the board a few years ago, and in 1993 our son, Howard, joined the board. These family members will not be managers of the company in the future, but they will represent the controlling interest should anything happen to me. Most of our other directors are also significant owners of Berkshire stock, and each has a strong owner-orientation”

P.S Third governance mode is controlling owner not involved in the mangement.