A letter a day!

A letter a day!

Letter #48 1994

Key learnings:

1. Even though you might have surplus capital, always wait for the right opportunity to park your funds.

“Nevertheless, we will stick with the approach that got us here and try not to relax our standards. Ted Williams, in The Story of My Life, explains why: “My argument is, to be a good hitter, you’ve got to get a good ball to hit. It’s the first rule in the book. If I have to bite at stuff that is out of my happy zone, I’m not a .344 hitter. I might only be a .250 hitter.” Charlie and I agree and will try to wait for opportunities that are well within our own “happy zone.”

2. Fear is the foe of the faddist, but the friend of the fundamentalist.

” A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results.

What we promise you – along with more modest gains – is that during your ownership of Berkshire, you will fare just as Charlie and I do. If you suffer, we will suffer; if we prosper, so will you. And we will not break this bond by introducing compensation arrangements that give us greater participation in the upside than the downside.”

3. Book value VS intrinsic value
   The intrinsic value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.

He has explained the relationship between the book value and the intrinsic value through the case study of Scott Fetzer which they acquired in 1986. At the time of the acquisition, the book value of Scott was $172 million and Berkshire purchased it for $315 million which is almost close to double its book value.

Buffett paid a higher price because of his view that its current value is more than its book value. An entire case study is explained with the numbers in the letter, a must-read.

4. The intrinsic value is as important for managers as it is for investors. When managers are making capital allocation decisions – including decisions to repurchase shares – it’s vital that they act in ways that increase per-share intrinsic value and avoid moves that decrease it. This principle may seem obvious but we constantly see it violated. And, when misallocations occur, shareholders are hurt.

5. Due to its strong financial strength, Berkshire had 2 advantages in the insurance business

1). It had the ability to protect the insured against big catastrophe events without being default.

2). It had the capability to write an insurance policy for an amount that no one in its peers can write.

“Given the risks we accept, Ajit and I constantly focus on our worst case,” knowing, of course, that it is difficult to judge what this is, since you could conceivably have a Long Island hurricane, a California earthquake, and Super Cat X all in the same year. Additionally, insurance losses could be accompanied by non-insurance troubles. For example, were we to have super-cat losses from a large Southern California earthquake, they might well be accompanied by a major drop in the value of our holdings in See’s, Wells Fargo and Freddie Mac.

All things considered, we believe our worst-case insurance loss from a super-cat is now about $600 million after-tax, an amount that would slightly exceed Berkshire’s annual earnings from other sources. If you are not comfortable with this level of exposure, the time to sell your Berkshire stock is now, not after the inevitable mega-catastrophe.”

6. If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring, the payoff is the same as if you had correctly analyzed
   an investment alternative characterized by many constantly shifting and complex variables.

7. Try to price, rather than time, purchases.

8. Before looking at the new investments, consider adding to old ones. ( This was said in the last letter also)